ITEM 1. BUSINESS
Our Business, Products and Services
We are a leading online service provider of live and on-demand Internet video, corporate audio and web communications and content management applications. We had approximately 93 full time employees as of September 30, 2012, with operations organized in two main operating groups:
· Digital Media Services Group
· Audio and Web Conferencing Services Group
Products and services provided by each of the groups are:
Digital Media Services Group
Our Digital Media Services Group consists of our Webcasting division, our DMSP (“Digital Media Services Platform”) division, our UGC (“User Generated Content”) division and our Smart Encoding division. This group represented approximately 42.7% and 45.9% of our revenues for the years ended September 30, 2012 and 2011, respectively. These revenues are comprised primarily of fees for hosting/storage, search/retrieval and distribution/streaming of digital assets as well as encoding and production fees.
Our Webcasting division, which operates primarily from Pompano Beach, Florida, provides an array of corporate-oriented, web-based media services to the corporate market including live audio and video webcasting and on-demand audio and video streaming for any business, government or educational entity. This includes online webcasting services, a cost effective means for corporations to broadcast conference calls live, making them available to the investing public, the media and to anyone worldwide with Internet access. The Webcasting division also has a sales and production support office in New York City as well as additional production and back-up webcasting facilities in our San Francisco office. We market the webcasting services through a direct sales force and through channel partners, also known as resellers. Each webcast can be heard and/or viewed live, and then archived for replay, with an option for accessing the archived material through a company's own web site. These webcasts primarily communicate corporate earnings and other financial information; product launches and other marketing information; training, emergency or other information directed to employees; and corporate or other special events.
Our DMSP division, which operates primarily from Colorado Springs, Colorado provides an online, subscription based service that includes access to enabling technologies and features for our clients to acquire, store, index, secure, manage, distribute and transform these digital assets into saleable commodities. In December 2004 we completed our acquisition of an entity formerly named Onstream Media Corporation that we now identify as Acquired Onstream. Acquired Onstream was a development stage company founded in 2001 with the business objective of developing a feature rich digital asset management service and offering the service on a subscription basis over the Internet. This service was the initial version of what became the DMSP, which is comprised of four separate products - encoding, storage, search/retrieval and distribution. Although a limited version of the DMSP was released in November 2005, the first complete version of the DMSP, known as “Store and Stream”, was offered for sale to the general public since October 2006. In February 2009, we launched “Streaming Publisher”, a second version of the DMSP with additional functionality. Streaming Publisher is a stand-alone product based on a different architecture than Store and Stream and is a primary building block of the recently launched MarketPlace365 platform, which will enable the creation of on-line virtual marketplaces and trade shows utilizing many of our other technologies such as DMSP, webcasting, UGC and conferencing.
Our UGC division, which also operates as Auction Video, provides a video ingestion and flash encoder that can be used by our clients on a stand-alone basis or in conjunction with the DMSP. In March 2007 we completed the acquisition of Auction Video. The primary assets acquired included the video ingestion and flash transcoder as well as related technology and patents pending.
Our Smart Encoding division, which operates primarily from San Francisco, California, provides both automated and manual encoding and editorial services for processing digital media, using a set of coordinated technologies and processes that allow the quick and efficient online search, retrieval and streaming of this media, which can include photos, videos, audio, engineering specs, architectural plans, web pages, and many other pieces of business collateral.
Audio and Web Conferencing Services Group
Our Audio and Web Conferencing Services Group consists of our Infinite Conferencing (“Infinite”) division, which operates primarily from the New York City area and provides “reservationless” and operator-assisted audio and web conferencing services and our EDNet division, which operates primarily from San Francisco, California and provides connectivity within the entertainment and advertising industries through its managed network, which encompasses production and post-production companies, advertisers, producers, directors, and talent.
This group represented approximately 57.3% and 54.1% of our revenues for the years ended September 30, 2012 and 2011, respectively. These revenues are comprised primarily of network access and usage fees as well as the sale and rental of communication equipment.
Sales and Marketing
We use a variety of marketing methods, including our internal sales force and channel partners, also known as resellers, to market our products and services. One key element of our marketing strategy has been to enter into distribution agreements with recognized leaders in each of the markets for our products and services. By offering our products and services in conjunction with the distributors’ products, we believe these distribution agreements enable us to take advantage of the particular distributors' existing marketing programs, sales forces and business relationships. Contracts with these distributors generally range from one to two years and may be terminable earlier based on certain contractual provisions.
We have expanded our marketing efforts during the past year to include: targeted e-mail campaigns, trade show participation, advanced search engine optimization, pay-per-click, a public relations byline program and selected trade magazine advertising. We intend to continue these actions during the coming year.
No single customer has represented more than 10% of our consolidated revenues during the years ended September 30, 2012 or 2011.
Competition
We operate in highly competitive and rapidly changing business segments. We expect our competition to intensify. We compete with:
· other web sites, Internet portals and Internet broadcasters to acquire and provide content to attract users;
· video and audio conferencing companies and Internet business service broadcasters;
· online services, other web site operators and advertising networks;
· traditional media, such as television, radio and print; and
· end-user software products.
Our webcasting products and services fall into two competitive areas: live or archived financial and fair-disclosure related conferences, and all other live or archived webcast productions for the corporate, financial, educational and government segments. In the financial conferences area, we compete with Accordent Technologies (Polycom), BT Conferencing, Intercall, MediaPlatform, Netbriefings, ON24, Premiere Global Services (PGi), PTEK Holdings, Shareholder.com, Sonic Foundry, Talkpoint, Thomson Financial Group, ViaVid, Viewcast, Wall Street Transcripts, WILink and others that offer live webcasts of quarterly earnings conference calls. This list includes entities that are currently active resellers of our services and not in significant competition with us, but could compete with us under certain circumstances. For other webcast production, we compete with other smaller geographically local entities. Our production services, however, have been in demand by some of our competitors, and from time to time we have provided services to these companies. The nature of the streaming media sector of the Internet market is highly interdependent while being competitive.
While there is competition for the provision of digital media services by our Digital Media Services Group, this is a relatively new product and environment with few established professional services providers. We believe that our approach of partnering with complimentary technology providers such as SAIC, Autonomy/Virage Application Services, Adobe Systems and Microsoft reduces the number of full-scale competitors in our markets. We also believe that our strategic offering of integrated webcasting, multi-screen encoding, intelligent syndication with broad spectrum video indexing services, all as part of a unified and scalable digital media platform (the DMSP) provides significant differentiation from our competitors. However, companies that compete in some portion of the digital media services market targeted by us include Akamai, Ascent Media, BrightCove, Edgecast, Kit Digital, Limelight, Maven Networks (Yahoo), Neulion, PermissionTV, Sonic Foundry, Telestream, thePlatform (Comcast), Twistage and VitalStream (Internap). There are video publishing platforms that compete with our DMSP, including those offered by ExtendMedia, Move Networks, Ooyala and others.
Competition for audio and web conferencing is primarily segregated between the low-cost, low-service offerings such as FreeConference.Com and other more high-end providers such as BT Conferencing, GoToMeeting, Intercall Conferencing, Premiere Global Services (PGi) and WebEx. Our Infinite division services a niche market for audio and web conferencing services primarily for SMB (small to medium size) companies looking for superior customer service at an affordable rate. This division's niche also includes a growing demand for lead generation “webinars” (seminars presented via the Internet), which it addresses by offering a dedicated account manager to coordinate a customized solution for each event.
Competition for the audio and video networking services provided by our EDNet division is based upon the ability to provide equipment, connectivity and technical support for disparate audio and video communications systems and to provide interoperable compatibility for proprietary and off-the-shelf codecs. Due to the difficulty and expense of developing and maintaining private digital networks, bridging services, engineering availability and service quality, we believe that the number of audio networking competitors is small and will remain so. Our primary video networking competitors are video and audio appliance dealers that source encoding, decoding and transport hardware. This division's advantage is the provision of a total solution including system design, isochronous (a data flow type used for streaming audio and video) connection and broadband connection sourcing, and custom software connectivity applications that include a comprehensive digital path for radio and television commercial transport. However, companies that compete in some portion of the audio and video networking services market targeted by us include Ascent Media, Digital Generation (DG) Systems, Pathfire, Savvis, SohoNet, Source Elements and Telestream.
Government Regulation
Although existing laws governing issues such as property ownership, export or import restrictions, content, taxation, defamation and privacy may apply to Internet based activities, the majority of such laws was adopted before the widespread use and commercialization of the Internet and, as a result, may not contemplate or address the unique issues of the Internet and related technologies. Laws and regulations directly applicable to providers of Internet and related technologies cover issues such as broadcast license fees, copyrights, privacy, pricing, sales and other taxes and characteristics and quality of Internet services, but are in many instances unclear or unsettled. Furthermore, it is likely that new laws and regulations will be adopted in the United States and elsewhere that may be applicable to us in the above areas as well as the areas of content, network security, encryption and the use of key escrow, data and privacy protection, electronic authentication or "digital" signatures, illegal and harmful content, access charges and retransmission activities. Any new legislation or regulation or increased governmental enforcement of existing regulations may limit the growth of the Internet, increase our cost of doing business or increase our legal exposure, which could have a material adverse effect on our business, financial condition and results of operations.
A number of U.S. federal laws, including those referenced below, impact our business. The Digital Millennium Copyright Act (“DMCA”) is intended, in part, to limit the liability of eligible online service providers for listing or linking to third-party websites that include materials that infringe copyrights or other rights of others. Portions of the Communications Decency Act (“CDA”) are intended to provide statutory protections to online service providers who distribute third-party content. We rely on the protections provided by both the DMCA and the CDA in conducting our business. If these laws or judicial interpretations are changed to narrow their protections, we will be subject to greater risk of liability, our costs of compliance with these regulations or to defend litigation may increase, or our ability to operate certain lines of business may be limited.
Federal, state and international laws and regulations (including “Red Flag” regulations issued by the U.S. Federal Trade Commission in 2007 to curb identity theft) govern the collection, use, retention, sharing and security of data that we receive from and about our customers (and in some cases, their customers). Any failure, or perceived failure, by us to comply with these laws and regulations could result in proceedings or actions against us by governmental entities or others, which could potentially have an adverse effect on our business. Further, failure or perceived failure by us to comply with these laws and regulations could result in a loss of customer confidence in us which could adversely affect our business. In addition, various federal, state and foreign legislative or regulatory bodies may enact new or additional laws and regulations concerning privacy, data-retention and data-protection issues which could adversely impact our business.
By distributing content over the Internet, we face potential liability for claims based on the nature and content of the materials that we distribute, including claims for defamation, negligence or copyright, patent or trademark infringement, which claims have been brought, and sometimes successfully litigated, against Internet companies.
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.
To protect our company from certain claims that may relate to the above matters, we maintain general liability (including umbrella coverage), professional liability and employment practices liability insurance. These insurances may not cover all potential claims of this type or may not be adequate to indemnify us for any liability to which we may be exposed. Any liability not covered by insurance or in excess of insurance coverage could have a material adverse effect on our business, results of operations and financial condition.
Intellectual Property
Our success depends in part on our ability to protect our intellectual property. To protect our proprietary rights, we rely generally on copyright, trademark and trade secret laws, confidentiality agreements with employees and third parties, and agreements with consultants, vendors and customers, although we have not signed such agreements in every case.
As part of our March 2007 acquisition of Auction Video, a pending United States patent was assigned to us covering certain aspects of uploading live webcam images. A parallel filing was done to protect these patent rights on an international basis, via the filing of a “Patent Cooperation Treaty Request”. We are currently pursuing the final approval of this patent application and in March 2008 retained the law firm of Hunton & Williams to assist in expediting the patent approval process and to help protect rights related to 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 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. Our response to the June 2012 rejection is due on or before April 7, 2013, which will require payment of extension fees (because our filing will be after November 7, 2012). 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.
Despite such protections, a third party could, without authorization, copy or otherwise obtain and use our content. We can give no assurance that our agreements with employees, consultants and others who participate in development activities will not be breached, or that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known or independently developed by competitors.
We may pursue the registration of certain of our trademarks and service marks in the United States, although we have not secured registration of all our marks. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective copyright, trademark and trade secret protection may not be available in such jurisdictions. In general, there can be no assurance that our efforts to protect our intellectual property rights through copyright, trademark and trade secret laws will be effective to prevent misappropriation of our content. Our failure or inability to protect our proprietary rights could materially adversely affect our business, financial condition and results of operations.
Employees
At January 11, 2013 we had approximately 102 full time employees, of whom 60 were design, production and technical personnel, 16 were sales and marketing personnel and 26 were general, administrative and executive management personnel. None of the employees are covered by a collective bargaining agreement and our management considers relations with our employees to be good.
General
We were formed under the laws of the State of Florida in May 1993. Our executive offices are located at 1291 SW 29th Avenue, Pompano Beach, Florida 33069. Our telephone number at that location is (954) 917-6655.
ITEM 2.
ITEM 2. PROPERTIES
We lease:
· an approximately 16,500 square foot facility at 1291 SW 29th Street in Pompano Beach, Florida, which serves as our corporate headquarters and houses the majority of our webcasting activities. Our lease expires on September 15, 2013 and provides one two-year renewal option, with a three percent (3%) rent increase in year one. The current monthly base rental is 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), with annual increases of two percent (2%).
· an approximately 4,700 square foot facility at 901 Battery Street, Suite 200 in San Francisco, which serves as administrative headquarters for the Smart Encoding division of the Digital Media Services Group, as well as the EDNet division of the Audio and Web Conferencing Services Group, and houses the centralized network hub for electronically bridging affiliate studios. In addition, the facility operates as a backup to Florida for webcasting operations and houses the majority of the development and operating staff for MP365. Our lease expires on July 31, 2015 and provides for one five-year renewal option at 95% of fair market value and also provides for early cancellation at any time after August 1, 2011 at our option, with six month notice and a payment of no more than approximately $14,000. The monthly base rental is approximately $9,700 (including month-to-month parking) with annual increases up to 5.1%.
· an approximately 9,300 square foot facility at 100 Morris Avenue in Springfield, New Jersey, which houses the Infinite Conferencing audio and web conferencing operations. Our lease expires on October 31, 2013 and provides one two-year renewal option, with no rent increase. The monthly base rental is approximately $15,700 with annual five percent (5%) increases.
· business offices located at 545 Fifth Avenue, New York City, New York. These offices total approximately 1,200 square feet and serve primarily for webcasting sales activities and backup to Florida-based webcasting operations. Our lease expires January 24, 2018 and provides one two-year renewal option at the greater of the fifth year rental or fair market value. The lease 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 monthly base rental is approximately $7,900 with annual increases up to 2.8%.
· a small office facility in San Diego, California, under a short-term entered into in connection with the November 2012 Intella2 acquisition.
· small limited purpose office space in Colorado Springs, Colorado, as well as equipment space at co-location or other equipment housing facilities in South Florida; Atlanta, Georgia; Jersey City, New Jersey; and Colorado Springs, Colorado.
ITEM 3.
ITEM 3. LEGAL 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 future financial position or results of operations.
ITEM 4.
ITEM 4. REMOVED AND RESERVED
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed for trading on OTC Markets' OTCQB marketplace ("OTCQB"), under the symbol "ONSM." 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 OTCQB.
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 need to be at least $1.00 per share for a minimum of ten consecutive business days prior to that date.
The following table sets forth the high and low closing sale prices for our common stock as reported on NASDAQ or OTCQB, as applicable, for the period from October 1, 2010 through January 11, 2013. These prices do not include retail mark-ups, markdowns or commissions, and may not necessarily represent actual transactions.
High
Low
FISCAL YEAR 2011
First Quarter
$1.19
$0.75
Second Quarter
$1.68
$0.75
Third Quarter
$1.95
$0.96
Fourth Quarter
$1.29
$0.72
FISCAL YEAR 2012
First Quarter
$0.82
$0.47
Second Quarter
$0.78
$0.55
Third Quarter
$0.70
$0.49
Fourth Quarter
$0.80
$0.47
FISCAL YEAR 2013
First Quarter
$0.48
$0.27
Second Quarter (to Jan 11, 2013)
$0.33
$0.29
On January 11, 2013, the last reported sale price of the common stock on OTCQB was $0.29 per share. As of January 11, 2013 there were approximately 541 shareholders of record of the common stock.
Dividend Policy
We have never declared or paid any cash dividends on our common stock. We currently expect to retain future earnings, if any, to finance the growth and development of our business. As of January 11, 2013, there are no preferred shares outstanding, including the Series A-13 Convertible Preferred and the Series A-14 Convertible Preferred. As of January 11, 2013, all dividends have been paid with respect to those and all other preferred securities.
Recent Sales of Unregistered Securities
During the period from August 11, 2012 through September 30, 2012, we recorded the issuance of 150,000 unregistered shares of common stock for financial consulting and advisory and legal services. The services are being provided over periods of two months to one year, and will result in a professional fees expense of approximately $90,000 over the service periods. None of these shares were issued to our directors or officers.
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. On October 24, 2012, 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 $5,400.
On November 15, 2012 we received $100,000 for an unsecured subordinated note. The total interest of $20,000 is payable in applicable monthly installments starting December 15, 2012, and the principal balance is due on May 15, 2013. On November 21, 2012, an origination fee was paid to the lender by the issuance of 35,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $13,300.
On April 30, 2012 we received $100,000 for a note bearing interest at 15% per annum, with principal payable in equal monthly installments of $8,333 starting November 30, 2012 and the balance of $58,333 payable on April 30, 2013. Finders and origination fees were paid by the issuance of an aggregate of 20,000 restricted common shares. On December 31, 2012 we issued an additional 35,000 common shares to the holder of the 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.
On December 31, 2012 we issued 8,750 common shares to CCJ Trust (“CCJ”), representing Series A-13 dividends for the twelve months ended December 31, 2012. The amount of such dividends is $17,500 - as allowed for in the Series A-13 Designation, we elected to pay such dividends with our common shares using a $2.00 per share conversion rate. CCJ is a trust for the adult children of Mr. Charles Johnston, one of our directors, and he disclaims any beneficial ownership interest in CCJ.
During the three months ended December 31, 2012, Lincoln Park Capital Fund, LLC (“LPC”) converted 160,000 shares of Series A-14 to 160,000 common shares. Although the shares of common stock issuable upon conversion of Series A-14 were sold and issued to LPC pursuant to prospectus supplements filed by us on September 24, 2010 and on July 1, 2011 with the Securities and Exchange Commission in connection with a takedown of an aggregate of 4.1 million shares from our Shelf Registration, as a result of the October 22, 2012 transfer of the listing of our common shares from NASDAQ to OTCQB, as discussed above, and the resulting loss of our S-3 eligibility, this registration statement was no longer effective at the time of those conversions.
During the three months ended December 31, 2012, we recorded the issuance of 90,000 unregistered shares of common stock for financial consulting and advisory and legal services. The services are being provided over periods between six months and one year, and will result in a professional fees expense of approximately $40,000 over the service periods. None of these shares were issued to our directors or officers.
On January 2, 2013 we received $25,000 pursuant to an unsecured promissory note issued to CCJ (the “New CCJ Note”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. New CCJ 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 this financing, on January 7, 2013 we issued 30,000 restricted common shares (the “CCJ Common Stock”) to CCJ, of which we have agreed to buy back up to 5,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the CCJ 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 2,500 shares of the originally issued CCJ Common Stock from CCJ at $0.80 per share. If the fair market value of the CCJ 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 5,000 shares of the originally issued CCJ Common Stock, less the amount of any shares already bought back at the one year point, from CCJ at $0.80 per share. The above only applies to the extent the CCJ Common Stock is still held CCJ at the applicable dates.
All of the above securities were offered and sold without such offers and sales being registered under the Securities Act of 1933, as amended (together with the rules and regulations of the Securities and Exchange Commission (the "SEC") promulgated thereunder, the "Securities Act"), in reliance on exemptions therefrom as provided by Section 4(2) of the Securities Act of 1933, for securities issued in private transactions. The recipients were accredited investors and the certificates evidencing the shares that were issued contained a legend restricting their transferability absent registration under the Securities Act of 1933 or the availability of an applicable exemption therefrom. The purchasers had access to business and financial information concerning our company. Each purchaser represented that he or she was acquiring the shares for investment purposes only, and not with a view towards distribution or resale except in compliance with applicable securities laws.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth securities authorized for issuance under our 2007 Equity Incentive Plan, individual compensation arrangements and any other compensation plans as of September 30, 2012.
1) 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.
2) On December 15, 2004, a majority of our shareholders voted to issue 270,047 Non-Plan options to certain executives, directors and other management in connection with the Onstream Merger, of which (i) 84,375 were cancelled on August 11, 2009 in exchange for the issuance of an equivalent number of 2007 Plan Options, (ii) 124,884 were cancelled on December 17, 2009 in exchange for the issuance of an equivalent number of 2007 Plan Options and (iii) 48,446 had expired as of September 30, 2012.
3) During the fiscal years ended September 30, 2009 through 2011, we issued Non-Plan options to consultants in exchange for financial consulting and advisory services, 433,333 of which were still outstanding and fully vested as of September 30, 2012. These outstanding options are summarized below:
Issuance period
Number
of shares
Exercise price
per share
Expiration
Date
Year ended September 30, 2011
300,000
$1.50
March 2015
Year ended September 30, 2010
125,000
$3.00 - $6.00
Oct 2013 - July 2014
Year ended September 30, 2009
8,333
$3.00
Sept 2013
Total common shares underlying
Non-Plan consultant options
as of September 30, 2012
433,333
5) 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, vest over two years and are exercisable at $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. The Compensation Committee is in the process of finalizing this grant, which grant when finalized would reduce the shares shown as available above.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read together with the information contained in the Consolidated Financial Statements and related Notes included in the annual report.
Overview
We are a leading online service provider of live and on-demand 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 102 full time employees as of January 11, 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 its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and its Current Reports on Form 8-K.
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 total preliminary purchase price was approximately $1.1 million of which we paid approximately $760,000 in cash as of November 30, 2012. The remaining balance is payable in the event of, and to the extent that, eligible revenues for the twelve months ending November 30, 2013 exceed the purchase price payments already made (which were based on 65% of eligible revenues for the twelve months ending August 31, 2012), but subject to the minimum purchase price discussed below. An additional earn out of up to approximately $300,000 would be paid based on 50% of the excess of eligible revenues for the twelve months ending November 30, 2013 over eligible revenues for the twelve months ending August 31, 2012.
We are expecting positive operating cash flow from these acquired operations for the ten months from December 1, 2012 through September 30, 2013, although we also incurred new debt of approximately $900,000 subsequent to September 30, 2012, mostly associated specifically or generally with this acquisition. In addition to this new financing, we negotiated modifications of certain debts outstanding as of September 30, 2012, which resulted in balance sheet reclassification of approximately $1.1 million of debt (gross, before unamortized discount) from short-term (i.e., current) to long-term (i.e., non-current). These financing transactions resulted in our issuance of 780,000 common shares for financing related fees during the three months ended December 31, 2012,, as well as our agreement to issue 225,000 additional common shares as an origination fee upon notice from the noteholder. We also agreed to issue 583,333 common shares during fiscal 2013 to repay $175,000 of Equipment Notes and agreed to reimburse any shortfall from the noteholders’ resale of those shares. We also issued an aggregate of 597,500 common shares during the three months ended December 31, 2012 related to the conversion of all remaining outstanding Series A-13 and Series A-14 preferred shares. See Liquidity and Capital Resources.
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, one of our directors, 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.
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 division generally charges for audio conferencing and web conferencing services on a per-minute usage rate, although webconferencing services are also available for a monthly subscription fee allowing a certain level of usage. Audio conferencing and web conferencing revenue is recognized based on the timing of the customer’s use of those services. The EDNet division primarily generates revenue from customer usage of digital telephone connections controlled by them. EDNet purchases digital phone lines from telephone companies and sells access to the lines, as well as separate per-minute usage charges. Network usage and bridging revenue is recognized based on the timing of the customer’s usage of those services.
We include the DMSP and UGC divisions’ revenues, along with the Smart Encoding division’s revenues from hosting, storage and streaming, in the DMSP and Hosting revenue caption. We include the EDNet division’s revenues from equipment sales and rentals and the Smart Encoding division’s revenues from encoding and editorial services in the Other Revenue caption.
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 year ended September 30, 2012 was approximately $2.6 million ($0.22 loss per share) as compared to a loss of approximately $5.2 million ($0.52 loss per share) for the prior fiscal year, a decrease in our loss of approximately $2.6 million (49.3%). The decreased net loss was primarily due to:
(i) A $1,150,000, or 67.6%, reduction in impairment loss on goodwill and other intangible assets for the year ended September 30, 2012, as compared to the prior fiscal year,
(ii) An approximately $776,000, or 9.0%, reduction in compensation expense for the year ended September 30, 2012, as compared to the prior fiscal year,
(iii) An approximately $495,000, or 39.0%, reduction in interest expense for the year ended September 30, 2012, as compared to the prior fiscal year, and
(iv) An approximately $281,000, or 2.4%, increase in gross margin for the year ended September 30, 2012, as compared to the prior fiscal year, which increase corresponded to an approximately 2.6% increase in our revenues for that same period.
See further discussion of the first two items above in " Operating Expenses" section below.
The following table shows, for the periods indicated, the percentage of revenue represented by items on our consolidated statements of operations.
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 thereto.
Revenues and Gross Margin
Consolidated operating revenue was approximately $18.2 million for the year ended September 30, 2012, an increase of approximately $459,000 (2.6%) from the prior fiscal year, due to increased revenues of the Audio and Web Conferencing Services Group.
Audio and Web Conferencing Services Group revenues were approximately $10.4 million for the year ended September 30, 2012, an increase of approximately $835,000 (8.7%) from the prior fiscal year. This increase was primarily a result of increased audio conferencing revenues in the Infinite division.
Infinite division revenues increased by approximately $767,000 (10.1%) for the year ended September 30, 2012 as compared to the prior fiscal year. This was due to a 16.9% increase in the number of minutes billed by the Infinite division, which was approximately 123.0 million for the year ended September 30, 2012, as compared to approximately 105.2 million minutes billed for the prior fiscal year. The revenue impact of this increase in billed minutes was partially offset by a decrease in the average revenue per minute, which was approximately 7.0 cents for the year ended September 30, 2012, as compared to approximately 7.3 cents for the prior fiscal year. The average revenue per minute statistic includes auxiliary services and fees that are not billed to the customer on a per minute basis. 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.
We believe that Infinite’s alliance with BT Conferencing to provide a jointly developed conferencing platform to Infinite’s reservationless client base, along with Infinite’s other sales initiatives, is a significant contributor to the current growth in Infinite division revenues.
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 as part of the Audio and Web Conferencing Services Group. 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 agreed to pay 70% of the future free conferencing business revenues, net of applicable expenses, to Intella2 through November 30, 2017, after which we have agreed to pay Intella2 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.
We are expecting positive operating cash flow from these acquired operations for the ten months from December 1, 2012 through September 30, 2013, although we also incurred debt subsequent to September 30, 2012 that was associated specifically or generally with this acquisition - see Liquidity and Capital Resources below.
Based on the above, we expect the fiscal 2013 revenues of the Audio and Web Conferencing Services Group, as well as of its Infinite division, to exceed the respective fiscal 2012 amounts for the year as a whole, although this cannot be assured.
Digital Media Services Group revenues were approximately $7.7 million for the year ended September 30, 2012, a decrease of approximately $377,000 (4.6%) from the prior fiscal year, primarily due to a decrease in DMSP and hosting division revenues.
DMSP and hosting division revenues decreased by approximately $276,000 (14.0%) for the year ended September 30, 2012 as compared to the prior fiscal year. This decline was primarily related to the 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 $151,000 (2.5%) for the year ended September 30, 2012 as compared to the prior fiscal year. This is because the approximately 5,000 webcasts we produced during the year ended September 30, 2012, represented a decrease of approximately 2,300 webcasts as compared to the prior fiscal year. However since this decline was almost entirely related to lower priced audio-only events instead of higher priced video events, the average revenue per webcast event of approximately $1,205 for the year ended September 30, 2012 represented an increase of approximately $350, or 42.8%, from 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 in fiscal 2013 by a comprehensive update to our webcasting platform (V4), which we are releasing in January 2013. The updated webcasting platform will include the following features that are not in the current 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 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.
Consolidated gross margin was approximately $12.1 million for the year ended September 30, 2012, an increase of approximately $281,000 (2.4%) from the prior fiscal year. This increase was due to approximately $757,000 additional gross margin from the Infinite division of the Audio and Web Conferencing Services Group, corresponding to an approximately $767,000 increase in Infinite division revenues.
Our consolidated gross margin percentage was 66.4% for the year ended September 30, 2012, versus 66.5% for the prior fiscal year. During the third quarter of fiscal 2012, we renegotiated certain supplier contracts which we expect will reduce our cost of sales by approximately $186,000 in fiscal 2013, as compared to fiscal 2012.
Consistent with our expectations that our consolidated fiscal 2013 revenues will exceed the respective corresponding fiscal 2012 amounts for the year as a whole, as discussed above, 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 $14.1 million for the year ended September 30, 2012, a decrease of approximately $2.0 million (12.1%) from the prior fiscal year, due to
(i) A $1,150,000, or 67.6%, reduction in impairment loss on goodwill and other intangible assets for the year ended September 30, 2012, as compared to the prior fiscal year, and
(ii) An approximately $776,000, or 9.0%, reduction in compensation expense for the year ended September 30, 2012, as compared to the prior fiscal year.
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. In accordance with that review performed as of September 30, 2011, the Acquired Onstream goodwill was determined to be impaired as of that date and a $1.7 million adjustment was made to reduce the carrying value of that goodwill to approximately $821,000. In accordance with that review performed as of September 30, 2012, the Acquired Onstream goodwill was determined to be further impaired as of that date and a $550,000 adjustment was made to reduce the carrying value of that goodwill to approximately $271,000. These adjustments were reflected in our results of operations for the years ended September 30, 2012 and 2011, respectively, as a charge for impairment of goodwill and other intangible assets.
The decrease in compensation expense is primarily because the Black-Scholes value of certain stock options granted to the Executives in September 2007 with a four-year vesting period was fully expensed during the period from October 2007 through September 2011. The non-cash compensation expense related to these options was approximately $470,000 for the year ended September 30, 2011 and zero for the year ended September 30, 2012. In addition, during March and April 2011, we took actions which reduced our compensation expenses by approximately $113,000 for fiscal 2012 as compared to fiscal 2011, although subsequent increases in certain other compensation expenses have partially offset some of these savings. Furthermore, during October and November 2011, we took actions which reduced our compensation expenses by approximately $240,000 for fiscal 2012 as compared to fiscal 2011, although subsequent increases in certain other compensation expenses have partially offset some of these savings.
During the second quarter of fiscal 2012, we terminated a consulting contract, which termination we expect will reduce our professional fee expense by approximately $300,000 in fiscal 2013, as compared to fiscal 2012.
Excluding the impact, if any, arising from any fiscal 2013 goodwill impairment charges as compared to those costs in fiscal 2013, 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 $615,000 for the year ended September 30, 2012 represented an approximately $325,000 (49.3%) decrease as compared to the prior fiscal year.
This decrease was due to an approximately $494,000, or 39.0%, reduction in interest expense for the year ended September 30, 2012, as compared to the prior fiscal year. This in turn was primarily attributable to (i) approximately $201,000 recognized as non-cash interest expense during the year ended September 30, 2011, which represented the excess of the market value of common shares issued over the carrying value of related Equipment Notes being retired with those shares, with no corresponding transaction occurring during the year ended September 30, 2012, and (ii) approximately $160,000 greater interest expense during the year ended September 30, 2011 related to the Equipment Notes, resulting from the amortization of discount on those notes ending on the original June 2011 maturity date, the outstanding balance of $1.0 million during the majority of the year ended September 30, 2011 as compared to $350,000 (interest-bearing portion) during the year ended September 30, 2012 and the excess of the fair market value of common shares, issued in lieu of cash interest payments, over the calculated cash interest amount.
Due to the price-based anti-dilution protection provisions (also known as “down round” provisions) included in a warrant issued by us in September 2010 in connection with the LPC Purchase Agreement ( “LPC Warrant 1”) and in accordance with ASC Topic 815, “Contracts in Entity’s Own Equity”, we are required to recognize LPC Warrant 1 as a liability at its fair value on each reporting date. Changes in the fair value of this liability are recognized in our consolidated statement of operations as other income or expense. Accordingly, we recognized other income of approximately $107,000 during the year ended September 30, 2012. However, effective October 24, 2012, LPC Warrant 1 and another warrant issued to LPC were cancelled and replaced with new warrants with terms that only allow the number of underlying shares and the option exercise price to be adjusted in accordance with standard anti-dilution provisions - the price-based anti-dilution provisions discussed above are not contained within the new warrants. As a result of this transaction, the non-current liability of approximately $81,374 on our September 30, 2012 balance sheet (related to LPC Warrant 1) will be relieved during the three months ended December 31, 2012 and recognized as non-operating income. This will be partially offset by non-operating expense of approximately $68,000, representing the aggregate Black-Scholes value of the new warrants. Therefore, the net impact on our statement of operations for the three months ended December 31, 2012 will be net non-operating income of approximately $13,000.
Liquidity and Capital Resources
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. Although we had cash of approximately $360,000 at September 30, 2012, our working capital was a deficit of approximately $2.7 million at that date.
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 $878,000 at September 30, 2012. 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 Rockridge Note is repayable in equal monthly principal and interest installments of $41,409 extending through November 14, 2012 (the “Maturity Date”) and 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, will be 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”). 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 NASDAQ Capital Market (or such other exchange or market on which ONSM common shares are trading) prior to such Rockridge notice, but such conversion price will not be less than $2.40 per share.
The Note and Stock Purchase Agreement, as amended by the December 12, 2012 second Allonge to the Note, provides that Rockridge may receive 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 September 30, 2012, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if the closing ONSM share price of $0.29 per share on January 11, 2013 was used as a basis of calculation, the required payment would be approximately $75,000.
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 $1.6 million as of January 11, 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 were in compliance with this Covenant for the March 31, June 30 and September 30, 2012 quarters.
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.
We are obligated under convertible Equipment Notes with an outstanding principal balance of $350,000. These Equipment Notes are collateralized by specifically designated software and equipment owned by us, as well as a subordinated lien on certain other of our assets to the extent that the designated software and equipment, or other software and equipment added to the collateral at a later date, is not considered sufficient security for the loan. On December 31, 2012 we issued an aggregate of 140,000 restricted common shares to the Noteholders in exchange for a modification of the scheduled principal payment date 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”). As part of the December 2012 modification, we also agreed to issue the Noteholders an aggregate of 583,335 restricted common shares (split into two tranches on January 15 and June 30, 2013), which will 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) resulting in a Credited Value of $175,000 and a remaining outstanding Equipment Notes balance of $175,000. Upon issuance of these shares, the remaining outstanding Equipment Notes balance will no longer be convertible into any additional common shares.
On the Maturity Dates, 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 shares issued per the above plus (ii) the value of the shares issued per the above 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 the outstanding Equipment Notes balance shall be reduced, but to no less than zero, by 50% (fifty percent) of such excess. If the Credited Value exceeds the Recognized Value, then the outstanding Equipment Notes balance shall be increased by such excess.
We would have been obligated to pay $100,000 on December 31, 2012 under an unsecured subordinated note payable note (the “CCJ Note”) issued to CCJ Trust (“CCJ”), 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. The combined obligation of $145,779 was the principal amount of a replacement subordinated note issued to CCJ dated January 1, 2013 and payable in 24 monthly principal and interest installments of $6,862.32 starting January 31, 2013 and which payment amount includes interest at 12% per annum. Prior to the issuance of the January 1, 2013 replacement note, the CCJ Note was convertible by CCJ into our common shares - however, the January 1, 2013 replacement note has no conversion rights.
On March 9, 2012 we received $100,000 for a 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. Interest payments were made on this note through November 30, 2012, at which time we issued an Intella2 Investor Note (as discussed below) for $100,000 in exchange for the satisfaction of this note.
On April 30, 2012 we received $100,000 for a 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. 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. Interest for the first six months was paid on October 31, 2012. The next interest payment (for the preceding three months) is due on January 31, 2013 and every three months thereafter through October 31, 2014.
On June 1, 2012 we received $100,000 in exchange for our issuance of an unsecured subordinated promissory note, which bears interest at 12% per annum. The principal is payable in equal monthly installments of $8,333 starting January 1, 2013, with the balance of $58,333 payable on June 1, 2013. Interest for the first six months is payable on December 1, 2012 and is payable thereafter on a monthly basis. Finders and origination fees were paid by the issuance of an aggregate of 40,000 restricted ONSM common shares.
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. An origination fee was paid to the lender by the issuance of 15,000 restricted ONSM common shares.
On November 15, 2012 we received $100,000 for an unsecured subordinated note. The total interest of $20,000 is payable in applicable monthly installments starting December 15, 2012, and the principal balance is due on May 15, 2013. An origination fee was paid to the lender by the issuance of 35,000 restricted ONSM common shares.
On November 30, 2012 we received $350,000 pursuant to unsecured promissory notes issued to five investors (the “Intella2 Investor Notes”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. 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. 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 financing as well as to potential additional financing which may be raised under these terms.
On November 30, 2012, we issued an additional Intella2 Investor Note for $100,000 to one of the five investors in exchange for the satisfaction of a note previously issued by us on March 9, 2012, as discussed above. This investor also purchased and funded $100,000 of the original $350,000 of Intella2 Investor Notes issuance. After this transaction, the total outstanding principal balance of the Intella2 Investor Notes was $450,000 and the amount held by this investor was $200,000.
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.
On or about November 30, 2012 we received $175,000 pursuant to unsecured promissory notes issued to four investors (the “Investor Notes”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. 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. We paid a third-party agent financing fees of $14,000 plus 35,000 unrestricted common shares related to this financing.
In connection with the above financing, we issued to the holders of the Investor Notes an aggregate of 210,000 restricted common shares (the “Common Stock”), of which we have agreed to buy back up to 35,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the 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 17,500 shares of the originally issued Common Stock from the investor at $0.80 per share. If the fair market value of the 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 35,000 shares of the originally issued 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 Common Stock is still held by the investor(s) at the applicable dates.
On November 30, 2012 we received $200,000 pursuant to a promissory note issued to a single investor and bearing interest at 12% per annum. This note is secured by our assets (but subordinated to our secured debts to Thermo Credit and Rockridge Capital, as well as to other property and equipment liens). The principal, along with accrued interest and an origination fee of $8,000, is repayable in a single balloon payment on March 1, 2013.
On January 2, 2013 we received $25,000 pursuant to an unsecured promissory note issued to CCJ (the “New CCJ Note”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. New CCJ 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 this financing, we issued 30,000 restricted common shares (the “CCJ Common Stock”) to CCJ, of which we have agreed to buy back up to 5,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the CCJ 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 2,500 shares of the originally issued CCJ Common Stock from CCJ at $0.80 per share. If the fair market value of the CCJ 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 5,000 shares of the originally issued CCJ Common Stock, less the amount of any shares already bought back at the one year point, from CCJ at $0.80 per share. The above only applies to the extent the CCJ Common Stock is still held by CCJ at the applicable dates.
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 total preliminary purchase price was approximately $1.1 million of which we paid approximately $760,000 in cash as of November 30, 2012. The remaining balance is payable in the event of, and to the extent that, eligible revenues for the twelve months ending November 30, 2013 exceed the purchase price payments already made (which were based on 65% of eligible revenues for the twelve months ending August 31, 2012), but subject to the minimum purchase price discussed below. An additional earn out of up to approximately $300,000 would be paid based on 50% of the excess of eligible revenues for the twelve months ending November 30, 2013 over eligible revenues for the twelve months ending August 31, 2012. Eligible revenues exclude free conferencing business revenues and non-recurring revenues and are further defined in the Asset Purchase Agreement dated November 30, 2012. Any additional purchase price payments discussed above will be made in quarterly installments commencing August 31, 2013 and ending May 31, 2014. The minimum total purchase price is $950,000 and the maximum total purchase price is $1,450,000, including broker fees.
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 agreed to pay 70% of the future free conferencing business revenues, net of applicable expenses, to Intella2 through November 30, 2017, after which we have agreed to pay Intella2 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.
We are expecting positive operating cash flow from these acquired operations for the ten months from December 1, 2012 through September 30, 2013.
Projected capital expenditures for the twelve months ending September 30, 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.
During the second quarter of fiscal 2012, we terminated a consulting contract, which termination we expect will reduce our professional fee expense by approximately $300,000 in fiscal 2013, as compared to 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 $186,000 in fiscal 2013, as compared to fiscal 2012.
During the three months ended June 30, 2012, 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 the three months ended December 31, 2012 exceed the revenues for the three months ended September 30, 2012 and we expect that this quarter to quarter increase will continue through the three months ending June 30, 2013, excluding the impact of the Intella2 acquisition noted above. However, in the event we are unable to achieve the expected recovery of revenues from the seasonal decrease, 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 for the next twelve months. We will closely monitor our revenue and other business activity to determine if and when further cost reductions, the raising of additional capital, or other activity is considered necessary.
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.
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 market price of our common stock has been less than $0.75 per share for a large majority of the trading days since that date and the closing market price was $0.29 per share on January 11, 2013. 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 (which is after giving effect to the terms of an April 28, 2011 amendment) but may be terminated by us at any time after the first year at our discretion without any cost to us and may be terminated by us at any time in the event LPC does not purchase shares as directed by us in accordance with the terms of the Purchase Agreement. LPC may terminate the Purchase Agreement upon certain events of default set forth therein, including but not limited to the occurrence of a material adverse effect, delisting of our common stock and the lack of immediate relisting on one of the specified alternate markets and the lapse of the effectiveness of the applicable registration statement for more than the specified number of days. 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.
The shares of common stock sold and issued under the Purchase Agreement, and the shares of common stock issuable upon conversion of Series A-14, were sold and issued pursuant to prospectus supplements filed by us on September 24, 2010 and on July 1, 2011 with the Securities and Exchange Commission in connection with a takedown of an aggregate of 4.1 million shares from our Shelf Registration. In connection with the Purchase Agreement, we also entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with LPC, dated September 17, 2010, under which we agreed, among other things, to use our best efforts to keep the registration statement effective until the maturity date as defined in the Purchase Agreement and to indemnify LPC for certain liabilities in connection with the sale of the securities. As a result of the October 22, 2012 transfer of the listing of our common shares from NASDAQ to OTCQB, as discussed above, and the resulting loss of our S-3 eligibility, this registration statement is no longer effective.
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. This transaction was unrelated to 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, one of our directors, 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.
We have incurred losses since our inception, and have an accumulated deficit of approximately $131.6 million as of September 30, 2012. Our operations have been financed primarily through the issuance of equity and debt. Cash required to fund our continued operations will be affected by numerous known and unknown risks and uncertainties including, but not limited to, our ability to successfully market and sell the DMSP, iEncode and MarketPlace365 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.
Notwithstanding the cash flow results for the three months ended June 30, 2012 as discussed above, 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, the LPC Purchase Agreement, Shelf Registration or Funding Letter, as discussed above), we do not presently have any additional sources of working capital other than cash on hand and cash, if any, generated from operations. As a result of the uncertainty as to our available working capital over the upcoming months, we may be required to delay or cancel certain of the projected capital expenditures, some of the planned marketing expenditures, or other planned expenses. In addition, it is 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.
Our continued existence is dependent upon our ability to raise capital and to market and sell our services successfully. However, there are no assurances whatsoever that we will be able to sell additional common shares or other forms of equity under the LPC Purchase Agreement, the Shelf Registration or otherwise and/or that we will be able to borrow further funds under the Line, the Funding Letter or otherwise and/or that we will increase our revenues and/or control our expenses to a level sufficient to provide positive cash flow.
Cash provided by operating activities was approximately $1.1 million for the year ended September 30, 2012, as compared to approximately $35,000 provided by operations for the prior fiscal year. The $1.1 million reflects our net loss of approximately $2.6 million, reduced by approximately $2.1 million of non-cash expenses included in that loss and by approximately $387,000 arising from a net decrease in non-cash working capital items during the period and increased by approximately $113,000 of non-cash income included in that loss. The net decrease in non-cash working capital items for the year ended September 30, 2012 is primarily due to an approximately $281,000 increase in accounts payable, accrued liabilities and amounts due to directors and officers. This compares to a net increase in non-cash working capital items of approximately $236,000 for the prior fiscal year. The primary non-cash expenses included in our loss for the year ended September 30, 2012 were approximately $1.4 million of depreciation and amortization, approximately $607,000 of professional fee expenses paid with equity (and including amortization of deferred expenses for prior period issuances), approximately $587,000 of employee compensation expenses paid with options and other equity and $550,000 impairment loss on goodwill and other intangible assets. The primary sources of cash inflows from operations are from receivables collected from sales to customers.
Cash used in investing activities was approximately $948,000 for the year ended September 30, 2012 as compared to approximately $1.0 million for the prior fiscal year. Current and prior period investing activities related primarily to the acquisition of property and equipment, including capitalized software development costs.
Cash used in financing activities was approximately $48,000 for the year ended September 30, 2012 as compared to approximately $452,000 provided in 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 and sale of common shares, fully or partially offset by repayments of notes and leases payable and convertible debentures.
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.
Our prior acquisitions of several businesses, including the Onstream Merger and the Infinite Merger, have resulted in significant increases in goodwill and other intangible assets. Goodwill and other unamortized intangible assets, which include acquired customer lists, were approximately $10.4 million at September 30, 2012, representing approximately 63% of our total assets and approximately 109% of the book value of shareholder equity. In addition, property and equipment as of September 30, 2012 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.
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.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements are contained in pages through, which appear at the end of this annual report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A
ITEM 9A (T). CONTROLS AND PROCEDURES
Management’s report on disclosure controls and procedures:
As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the end of the period covered by the annual report, being September 30, 2012, we have carried out an evaluation of the effectiveness of the design and operation of our company's disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our company's management, including our company's President along with our company's Chief Financial Officer. Based upon that evaluation, our company's President along with our company's Chief Financial Officer concluded that our company's disclosure controls and procedures are effective.
Disclosure controls and procedures and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time period specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is accumulated and communicated to management including our President and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.
Management’s report on internal control over financial reporting:
We are responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of external financial statements in accordance with generally accepted accounting principles. However, all internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As required by Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as of the end of the period covered by the annual report, being September 30, 2012, we have carried out an evaluation of the effectiveness of the design and operation of our company's internal control over financial reporting. This evaluation was carried out under the supervision and with the participation of our company's management, including our company's President along with our company's Chief Financial Officer and was based on the criteria set forth in “Internal Control - Integrated Framework”, issued by the Committee of Sponsoring Organizations of the Treadway Commission (‘COSO”). This evaluation included review of the documentation of controls, evaluation of the design effectiveness of controls and testing of the operating effectiveness of controls. Based upon that evaluation, our company's President along with our company's Chief Financial Officer concluded that our company's internal control over financial reporting is effective. Based upon that evaluation, no change in our company's internal controls over financial reporting has occurred during the quarter then ended, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Executive Officers and Directors
Our executive officers and directors, and their ages are as follows:
Name
Age
Position
Randy S. Selman
Chairman of the Board, President and Chief Executive Officer
Alan M. Saperstein
Director and Chief Operating Officer
Robert E. Tomlinson
Senior Vice President and Chief Financial Officer
Clifford Friedland
Director and Senior Vice President Business Development
David Glassman
Senior Vice President and Chief Marketing Officer
Charles C. Johnston (1) (2) (3)
Director
Carl L. Silva (1) (2) (3) (4)
Director
Leon Nowalsky (2) (3)
Director
Robert D. (“RD”) Whitney (1)
Director
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
(3) Member of the Governance and Nominating Committee.
(4) Member of the Finance Committee.
Randy S. Selman. Mr. Selman has served as our Chairman of the Board, President and Chief Executive Officer since our inception in May 1993 and, from September 1996 through June 1999 and from August 1, 2004 through December 15, 2004, has also been our Chief Financial Officer. From March 1985 through May 1993, Mr. Selman was Chairman of the Board, President and Chief Executive Officer of SK Technologies Corporation (NASDAQ:SKTC), a software development company. SKTC developed and marketed software for point-of-sale with complete back office functions such as inventory, sales analysis and communications. Mr. Selman founded SKTC in 1985 and was involved in their initial public offering in 1989. Mr. Selman's responsibilities included management of SKTC, public and investor relations, finance, high level sales and general overall administration.
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Selman should currently serve as a director, in light of our business and structure, are as follows: executive management, sales and software development industry experience with SKTC and executive management and public and investor relations experience with Onstream.
Alan M. Saperstein. Mr. Saperstein has served as our Executive Vice President and a director since our inception in May 1993, and has also been our Chief Operating Officer since December 2004. From March 1989 until May 1993, Mr. Saperstein was a free-lance producer of video film projects. Mr. Saperstein has provided consulting services for corporations that have set up their own sales and training video departments. From 1983 through 1989, Mr. Saperstein was the Executive Director/Entertainment Division of NFL Films where he was responsible for supervision of all projects, budgets, screenings and staffing.
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Saperstein should currently serve as a director, in light of our business and structure, are as follows: video and film industry experience with NFL Films and executive management and webcasting and digital media operations experience with Onstream.
Robert E. Tomlinson. On December 15, 2004 Mr. Tomlinson was appointed as our Chief Financial Officer. Mr. Tomlinson joined us as Vice President-Finance in September 2004. Mr. Tomlinson started his financial and accounting career in 1977 with the international accounting firm of Price Waterhouse. In 1982 he left that firm to join Embraer, an international aircraft manufacturing and support firm, at their U.S. subsidiary in Fort Lauderdale, Florida, where he managed all financial functions and eventually was named Senior Vice President-Finance and a member of the U.S. firm’s Board of Directors. Mr. Tomlinson left Embraer in 1994 and joined staffing and human resource firm OutSource International, serving as its Chief Financial Officer and helping to take the company public in 1997. Mr. Tomlinson's areas of responsibility at OutSource International included corporate accounting, treasury and risk management. From when he left OutSource International in February 2000 until 2002 he worked as an independent certified public accountant, focusing on accounting and tax services to corporations. From 2002 until joining us, Mr. Tomlinson served as CFO for Total Travel and Tickets, a Fort Lauderdale based ticket broker. Mr. Tomlinson has held an active Certified Public Accountant license since 1978.
Clifford Friedland. Mr. Friedland was re-appointed as a member of our Board of Directors in April 2011. His initial appointment was in December 2004 and he continued as a board member until his resignation from the board in June 2010, although he continued as Senior Vice President, Business Development. Mr. Friedland’s voluntary resignation was to restore our board to the required majority of independent members, following the death of another board member. He served as Chairman, CEO and co-founder of Acquired Onstream from June 2001 until joining our company. Mr. Friedland was Vice President of Business Development and co-founder of TelePlace, Inc., a developer and owner of Internet data centers and central offices from December 1999 to May 2001. Mr. Friedland was co-founder, Chairman and co-CEO of Long Distance International, Inc., one of the first competitive European telephone operators from May 1993 to December 1999. Mr. Friedland was President of Clifford Friedland Inc., a technology consulting firm, from January 1991 to April 1993. Mr. Friedland was a Director and co-founder of Action Pay-Per-View, a pay per view cable channel from January 1988 to December 1990. Mr. Friedland was President and co-founder of Long Distance America, one of the first competitive long distance operators after the breakup of AT&T from June 1984 to December 1987. Mr. Friedland was Vice President and co-founder of United States Satellite Systems, Inc., an FCC licensed builder and operator of geosynchronous communications satellites from April 1981 until December 1983. Mr. Friedland was Director and co-founder of United Satellite Communications, Inc., the world’s first direct-to-home satellite network from April 1981 until May 1984.
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Friedland should currently serve as a director, in light of our business and structure, are as follows: Internet and digital media industry experience (Acquired Onstream, TelePlace, Inc., and Action Pay-Per-View), telecommunications industry experience (Long Distance International, Inc., Long Distance America, United States Satellite Systems, Inc. and United Satellite Communications, Inc.) and executive management experience with Onstream.
David Glassman. Mr. Glassman has served as our Chief Marketing Officer since December 2004. He served as Vice Chairman, President and co-founder of Acquired Onstream from June 2001 until joining our company. Mr. Glassman was Vice President of Marketing and co-founder of TelePlace, Inc., a developer and owner of internet data centers and central offices from December 1999 to May 2001. Mr. Glassman was co-founder, Vice Chairman and Co-CEO of Long Distance International, Inc., one of the first competitive European telephone operators from May 1993 to December 1999. Mr. Glassman was an independent technology consultant from January 1988 to April 1993, with a client list that included Action Pay Per View. Mr. Glassman was President and co-founder of Long Distance America, one of the first competitive long distance operators after the breakup of AT&T from January 1984 to December 1987. Mr. Glassman was a communications consultant from January 1981 to January 1984 providing services to United States Satellite Systems Inc. and United Satellite Communications Inc. Mr. Glassman was co-founder and director of All American Hero, Inc., a fast food franchisor, from January 1981 until December 1986.
Charles C. Johnston. Mr. Johnston has been a member of our Board of Directors since April 2003 and serves on our Audit (as Chairman), Compensation and Governance and Nominating Committees. Mr. Johnston has been the Chairman of Ventex Technology, Inc., a privately-held neon light transformer company, since July 1993. Mr. Johnston has also served as Chairman of Inshore Technologies, a private company, since 1994 and J&C Resources, a private company, since 1987. Mr. Johnston has been a member of the board of directors of AuthentiDate Holding Company (Nasdaq National Market: ADAT), Internet Commerce Corporation (Nasdaq National Market: ICCA), McData Corporation (Nasdaq National Market: MCDT), Grumman Corporation and Teleglobe Corporation. Mr. Johnston serves as a Trustee of Worcester Polytechnic Institute, where he earned his Bachelor of Science degree.
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Johnston should currently serve as a director, in light of our business and structure, are as follows: management and board experience at public technology-oriented companies (ADAT, ICCA, MCDT, Grumman, Teleglobe) and management experience in other technology-oriented firms (Ventex, Inshore).
Carl Silva. Mr. Silva, who has been a member of our Board of Directors since July 2006, serves on our Audit, Compensation (as Chairman), Governance and Nominating and Finance Committees. Mr. Silva has over 25 years of experience in the telecommunications and high tech industry, and he has held a variety of positions in business development, sales, marketing, software engineering, and systems engineering during this time. During 2012, Mr. Silva joined ANXeBusiness Corp. as their Chief Scientist, responsible for developing a new nationwide credit card protection system. In 2011, Mr. Silva cofounded Smalltell, which focuses on social commerce solutions, such as mobile payment technologies, user-generated content, wireless broadband devices, and nationwide data plans. Also in 2011, Mr. Silva was Chief Scientist and VP of Technology for Nexaira Wireless, Inc. (NXWI.OB), a 3G/4G Router company, starting there in 2008. Prior to this Mr. Silva was CEO of Cognigen Business Systems, Inc. (NASDAQ: CNGW), a managed service provider for small to mid-size businesses for VoIP and high speed Internet. In May 2003, Mr. Silva started Anza Borrego Partners as a management consulting firm designed to support entrepreneurs in the growth of their businesses. Mr. Silva was Senior Vice-President for SAIC’s Converged Network Professional services organization from July 1998 to May 2003. From September 1994 to June 1998, he was with Telcordia Technologies (formerly Bell Communications Research, or Bellcore), where he implemented the first VoIP softswitch in the cable industry.
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Silva should currently serve as a director, in light of our business and structure, are as follows: over 25 years of experience in the telecommunications and high tech industry, most notably at ANX, Nexaira, Cognigen and SAIC.
Leon Nowalsky. Mr. Nowalsky was appointed a member of our Board of Directors in December 2007 and serves on our Compensation and Governance and Nominating (as Chairman) Committees. Mr. Nowalsky, a partner in the New Orleans-based law firm of Nowalsky, Bronston & Gothard APLLC (NBG), possesses over twenty years of experience in the field of telecommunications law and regulation. Mr. Nowalsky presently is a founder and board member of Thermo Credit, LLC, a specialty finance company for the telecommunications industry and J.C. Dupont, Inc., a Louisiana based oil and gas concern. Mr. Nowalsky has been general counsel for Telemarketing Communications of America, Inc., (“TMC”), as well as lead counsel in TMC’s mergers and acquisitions program, and following TMC’s acquisition by a wholly owned subsidiary of Advanced Telecommunications Corporation, Mr. Nowalsky served as ATC’s chief regulatory counsel as well as interim general counsel. In 1990, Mr. Nowalsky left ATC to set up a private law practice specializing in telecommunications regulatory matters, mergers and acquisitions and corporate law, which later expanded to become NBG. Mr. Nowalsky has previously served as a director of the following companies: Network Long Distance, Inc., a long distance company which was acquired by IXC Communications; RFC Capital Corp., a specialty finance company dedicated exclusively to the telecommunications industry which was purchased in 1999 by TFC Financial Corp., a division of Textron (NYSE:TXT); and New South Communications, a facilities-based competitive local exchange carrier which merged to form NUVOX, which was subsequently acquired by Windstream; W2Com, LLC, a video conferencing and distance learning provider which was acquired by Arel Communications & Software, Ltd. (NASDAQ: ARLC).
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Nowalsky should currently serve as a director, in light of our business and structure, are as follows: over twenty years of experience in the field of telecommunications law and regulation, most notably at TMC and ATC, as well his currently active private law practice specializing in telecommunications regulatory matters, mergers and acquisitions and corporate law.
Robert D. (“RD”) Whitney. Mr. Whitney was appointed a member of our Board of Directors in April 2011 and serves on our Audit Committee. Mr. Whitney has been a partner since January 2011 with Greenhaven Partners (“Greenhaven”), a private-equity firm focusing on investments in specialty information and digital media oriented businesses, and in connection with that role is Chief Executive Officer of two Greenhaven owned entities - Management Networks, LLC (including the Institute of Finance and Management) and Exchange Networks, LLC (a MarketPlace365 promoter) and Chief Operating Officer of a third - Chief Executive Group, LLC. From 2008 through 2010, Mr. Whitney was CEO of the online media division of the Tarsus Group, PLC, a London-based B2B conference and event producer (TRS.L) and in this position he was also associated with Onstream in various roles during the development and commercial introduction phases of MarketPlace365. From 1997 through 2005, and again in 2006 through 2008, he served in various roles (including Vice President of Operations and General Manager) with Kennedy Information, a firm specializing in delivering market intelligence through multiple media. During this time, Mr. Whitney was instrumental in the sale of Kennedy Information to its current parent company, BNA, which was the largest independent publisher of information and analysis products for professionals in business and government. He also has held positions at Kluwer Law International (a division of Wolters Kluwer), the Thompson Publishing Group, Yankee Publishing, Vicon Publishing and Connell Communications (a division of IDG). Mr. Whitney holds an MBA from Fitchburg State College and a BS from Bentley University.
The primary experience, qualifications, attributes and skills that led us to conclude that Mr. Whitney should currently serve as a director, in light of our business and structure, are as follows: over 20 years management-level experience in marketing and publishing (including Tarsus Group and Kennedy Information) as well as extensive experience in creating strategy for both B2B and B2C marketplaces and in management of major conferences, executive forums, and events (Tarsus Group), all of which we believe will provide valuable insight with respect to the proper focus of our development and sales efforts with respect to MarketPlace365 and our other products.
There is no family relationship between any of the executive officers and directors. Each director is elected at our annual meeting of shareholders and holds office until the next annual meeting of shareholders, or until his successor is elected and qualified. The bylaws permit the board of directors to fill any vacancy and such director may serve until the next annual meeting of shareholders or until his successor is elected and qualified. The board of directors elects officers annually and their terms of office are at the discretion of the Board. Our officers devote full time to our business.
Expansion of our Board of Directors
Our bylaws provide that the number of directors shall be no less than two and no more than nine. Our Board of Directors currently consists of seven directors.
Director Compensation Table
The following table presents director compensation (excluding directors who are Named Executive Officers) for the year ended September 30, 2012:
CHANGE IN
PENSION VALUE
FEES EARNED
NON-EQUITY
AND NONQUALIFIED
OR PAID IN
STOCK
OPTION
INCENTIVE PLAN
DEFERRED
ALL OTHER
TOTAL
CASH
AWARDS
AWARDS
COMPENSATION
COMPENSATION
COMPENSATION
COMPENSATION
NAME
($) (1)
($) (2)
($) (2)
($)
EARNINGS ($)
($)(1)
($)
Charles C. Johnston (4)
$51,000
$12,000
$63,000
Carl L. Silva
$15,000
$15,000
Leon Nowalsky
$15,000
$15,000
Robert D. Whitney
$15,000
$15,000
1) Directors who are not our employees received $3,750 per quarter ($15,000 per year) as compensation for serving on the Board of Directors during fiscal 2012, as well as reimbursement of reasonable out-of-pocket expenses incurred in connection with their attendance at Board of Directors meetings. In addition, Charles Johnston received (i) $36,000 during fiscal 2012 for serving as chairman of the Audit Committee of the Board of Directors (ii) $12,000 during fiscal 2012 as a non-accountable travel and expense allowance. Although the travel and expense allowance is non-accountable, the amount was established based on the costs expected to be incurred by Mr. Johnston in connection with his duties as director as well as chairman of the Audit Committee.
2) No shares or options were issued to the directors who were not also Named Executive Officers during the year ended September 30, 2012. Options granted in previous years were still held as of September 30, 2012 by members of our Board of Directors (excluding those who are Named Executive Officers), as follows:
Messrs. Johnston, Silva and Nowalsky each hold four-year Plan options to purchase 25,000 shares of our common stock with an exercise price of $1.23 per share ( fair market value on the date of issuance), issued to them on January 14, 2011 as part of a company-wide grant. These options vest over two years and are exercisable at $1.23 per share, fair market value on the date of the grant. Options to purchase another 25,000 common shares were approved for issuance to each of these individuals by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
Mr. Whitney holds immediately exercisable four-year Plan options to purchase 25,000 shares of our common stock with an exercise price of $1.00 per share (above fair market value on the date of issuance), issued to him on June 13, 2011 upon his initial appointment to our Board of Directors.
Mr. Johnston holds immediately exercisable five-year Plan options to purchase 16,667 shares of our common stock with an exercise price of $9.42 per share (above fair market value on the date of issuance), issued to him in August and December 2009.
3) In addition to the allocation of a percentage of the Company Sale Price to the Executives, as discussed below in Item I - Executive Compensation, on August 11, 2009 our Compensation Committee determined that an additional two percent (2.0%) of the Company Sale Price would be allocated, on the same terms, to the then four outside members of our Board of Directors (0.5% each), as a supplement to provide appropriate compensation for ongoing services as a director and as a termination fee. On June 5, 2010, one of the four outside Directors passed away and on April 18, 2011, Mr. Whitney was appointed to fill that outside director seat. The status of this item, both with respect to the deceased outside director and/or the new outside director, has not been further addressed by the Compensation Committee to date.
4) The above table excludes compensation to Mr. Johnston and/or certain entities affiliated with Mr. Johnston related to financing activities - see Item L below - Transactions With Related Persons.
Board of Directors Meetings and Committees
The Board of Directors meets regularly (in-person and/or by telephone conference) during the year to review matters affecting us and to act on matters requiring Board approval and it also holds special meetings whenever circumstances require. In addition, it may act by written consent. During the fiscal year ended September 30, 2012, there were six meetings of the Board, and the Board took action nine times by written consent. The Board of Directors has four standing committees as discussed below and may, from time to time, establish additional committees.
Board leadership structure and role in risk oversight
The Board’s leadership structure combines the positions of chairman and CEO, which we have determined to be appropriate, given our specific characteristics and circumstances. In particular, our chairman and CEO is able to utilize the in-depth focus and perspective as a company co-founder and his practical experience gained during several years of running the company since its founding to effectively and efficiently guide the Board. The Board has not designated a lead independent director, since it has determined that our chairman closely interacts with the other members of the Board, particularly the independent directors, in fulfilling his responsibilities as chairman and CEO. Although it is management’s responsibility to assess and manage the various risks we face, it is the Board’s responsibility to oversee management in this effort. The Board administers its risk oversight function by appropriate discussions with the CEO, CFO and other members of management during meetings of the Board and at other times.
Audit Committee
The Audit Committee of the Board of Directors is responsible for the engagement of our independent public accountants, approves services rendered by our accountants, reviews the activities and recommendations of our internal audit department, and reviews and evaluates our accounting systems, financial controls and financial personnel. The Board has previously adopted a charter for the Audit Committee. Pursuant to the requirements of the Securities and Exchange Commission which requires that we provide our shareholders with a copy of the Audit Committee Charter at least once every three years, we have included a copy of the Audit Committee Charter as Appendix C to our proxy statement for our 2010 Annual Meeting filed with the SEC on February 19, 2010.
The Audit Committee is presently composed of Messrs. Johnston (chairman), Silva and Whitney. The Audit Committee met (in-person and/or by telephone conference) four times in fiscal 2012.
Compensation Committee
The Compensation Committee establishes and administers our executive and director compensation practices and policies, including the review of the individual elements of total compensation for executive officers and directors and recommendation of adjustments to the Board of Directors. In addition, the Compensation Committee administers our 1996 Stock Option Plan and our 2007 Equity Incentive Plan and determines the number of performance shares and other equity incentives awarded to executives and directors (as well as all other employees) and the terms and conditions of which they are granted and recommends plans and plan amendments to the Board. The Compensation Committee is presently composed of Messrs. Silva (chairman), Johnston and Nowalsky. The Compensation Committee met in fiscal 2012 in conjunction with meetings of the full Board of Directors.
The Compensation Committee has the responsibility to review, recommend, and approve all executive officer compensation arrangements. The Compensation Committee has the specific responsibility and authority to (i) review and approve corporate goals and objectives relevant to the compensation of our Chief Executive Officer (“CEO”), (ii) evaluate the performance of our CEO in light of those goals and objectives, and (iii) determine and approve the compensation level of our CEO based upon that evaluation. The Compensation Committee also has the responsibility to annually review the compensation of our other executive officers and to determine whether such compensation is reasonable under existing facts and circumstances. In making such determinations, the Compensation Committee seeks to ensure that the compensation of our executive officers aligns the executives’ interests with the interests of our shareholders. The Compensation Committee must also review and approve all forms of incentive compensation, including stock option grants, stock grants, and other forms of incentive compensation granted to our executive officers. The Compensation Committee takes into account the recommendations of our CEO in reviewing and approving the overall compensation of the other executive officers.
We believe that the quality, skills, and dedication of our executive officers are critical factors affecting our long-term value and success. Thus, one of our primary executive compensation goals is to attract, motivate, and retain qualified executive officers. We seek to accomplish this goal by rewarding past performance, providing an incentive for future performance, and aligning our executive officers’ long-term interests with those of our shareholders. Our compensation program is specifically designed to reward our executive officers for individual performance, years of experience, contributions to our financial success, and creation of shareholder value. Our compensation philosophy is to provide overall compensation levels that (i) attract and retain talented executives and motivate those executives to achieve superior results, (ii) align executives’ interests with our corporate strategies, our business objectives, and the long-term interests of our shareholders, and (iii) enhance executives’ incentives to increase our stock price and maximize shareholder value. In addition, we strive to ensure that our compensation, particularly salary compensation, is consistent with our constant focus on controlling costs. Our primary strategy for building senior management depth is to develop personnel from within our company to ensure that our executive team as a whole remains dedicated to our customs, practices, and culture, recognizing, however, that we may gain talent and new perspectives from external sources.
Our compensation program for executive officers generally consists of the following five elements: (i) base salary, (ii) performance-based annual bonus (currently equity based) determined primarily by reference to objective financial and operating criteria, (iii) long-term equity incentives in the form of stock options and other stock-based awards or grants, (iv) specified perquisites and (v) benefits that are generally available to all of our employees.
The Compensation Committee has the responsibility to make and approve changes in the total compensation of our executive officers, including the mix of compensation elements. In making decisions regarding an executive’s total compensation, the Compensation Committee considers whether the total compensation is (i) fair and reasonable, (ii) internally appropriate based upon our culture and the compensation of our other employees, and (iii) within a reasonable range of the compensation afforded by other opportunities. The Compensation Committee also bases its decisions regarding compensation upon its assessment of the executive’s leadership, individual performance, years of experience, skill set, level of commitment and responsibility required in the position, contributions to our financial success, the creation of shareholder value, and current and past compensation. In determining the mix of compensation elements, the Compensation Committee considers the effect of each element in relation to total compensation. Consistent with our desired culture of industry leading performance and cost control, the Compensation Committee has attempted to keep base salaries at moderate levels for companies within our market and total capitalization and weight overall compensation toward incentive cash and equity-based compensation. The Compensation Committee specifically considers whether each particular element provides an appropriate incentive and reward for performance that sustains and enhances long-term shareholder value. In determining whether to increase or decrease an element of compensation, we rely upon the Compensation Committee’s judgment concerning the contributions of each executive and, with respect to executives other than the CEO, we consider the recommendations of the CEO. We generally do not rely on rigid formulas (other than performance measures under our annual cash bonus program) or short-term changes in business performance when setting compensation.
Pursuant to the requirements of the Securities and Exchange Commission which requires that we provide our shareholders with a copy of the Compensation Committee Charter at least once every three years, we have included a copy of the Committee Charter as Appendix D to our proxy statement for our 2010 Annual Meeting filed with the SEC on February 19, 2010.
Finance Committee
The Finance Committee reviews and makes recommendations concerning:
· proposed dividend actions, stock splits and repurchases,
· current and projected capital requirements,
· issuance of debt or equity securities,
· strategic plans and transactions, including mergers, acquisitions, divestitures, joint ventures and other equity investments,
· customer financing activities, business and related customer finance business and funding plans of Onstream and its subsidiaries,
· overall company risk management program and major insurance programs, and
· investment policies, administration and performance of the trust investments of our employee benefit plans.
Mr. Silva is currently the sole member of the Finance Committee. The Finance Committee met in fiscal 2012 in conjunction with meetings of the full Board of Directors.
Governance and Nominating Committee
While we have not adopted a formal charter for the Governance and Nominating Committee, in June 2003 our Board of Directors adopted Corporate Governance and Nominating Committee Principles. An updated copy of our Corporate Governance and Nominating Committee Principles was included as Appendix A to the proxy statement for our 2008 and 2009 Annual Meeting of Stockholders filed with the SEC on January 28, 2009.
The Governance and Nominating Committee reviews and makes recommendations to the Board of Directors with respect to:
· the responsibilities and functions of the Board and Board committees and with respect to Board compensation,
· the composition and governance of the Board, including recommending candidates to fill vacancies on, or to be elected or re-elected to, the Board,
· candidates for election as Chief Executive Officer and other corporate officers, and
· monitoring the performance of the Chief Executive Officer and our plans for senior management succession.
The Governance and Nominating Committee has not yet had the occasion to, but will, consider properly submitted proposed nominations by stockholders who are not one of our directors, officers, or employees. These nominations will be evaluated on the same basis as candidates proposed by any other person. A stockholder may nominate a person for election as a director at an annual meeting of the stockholders only if such stockholder gives written notice to our Corporate Secretary as described in the applicable proxy statement for the previous year’s annual meeting of stockholders. Each written notice must set forth, as to each person whom the stockholder proposes to nominate for election as a director, (i) all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or that is otherwise required, in each case pursuant to and in accordance with Regulation 14A under the Securities Exchange Act of 1934, as amended, and (ii) such person’s written consent to being named in the proxy statement as a nominee and to serve as a director if elected. Each written notice must also set forth, as to the stockholder making such nomination, (i) the name and address of such stockholder, as they appear on our books, (ii) the class and number of shares of our stock which are owned by such stockholder, (iii) a representation that the stockholder is a holder of record of our stock entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to propose such nomination, and (iv) a representation whether the stockholder intends or is a part of a group which intends (y) to deliver a proxy statement and/or form of proxy to holders of at least the percentage of our outstanding capital stock required to elect the nominee and/or (z) otherwise to solicit proxies from stockholders in support of such nomination. We will evaluate the suitability of potential candidates nominated by stockholders in the same manner as other candidates identified to the Governance and Nominating Committee, including the specific minimum qualifications described below.
The procedures for identifying candidates include a review of Onstream's current directors, soliciting input from existing directors and executive officers, and a review of submissions from stockholders, if any. Onstream’s management believes that the Board should be composed of:
· directors chosen with a view to bringing to the Board a variety of experiences and backgrounds,
· directors who have high level managerial experience or are accustomed to dealing with complex problems,
· directors who will represent the balanced, best interests of the stockholders as a whole rather than special interest groups or constituencies, while also taking into consideration the overall composition and needs of the Board, and
· a majority of the Board's directors must be independent directors under the criteria for independence required by the Securities and Exchange Commission and the NASDAQ Stock Market.
In considering possible candidates for election as an outside director, the Governance and Nominating Committee and other directors should be guided by the foregoing general guidelines and by the following criteria:
· Each director should be an individual of the highest character and integrity, have experience at (or demonstrated understanding of) strategy/policy-setting and a reputation for working constructively with others.
· Each director should have sufficient time available to devote to our affairs in order to carry out the responsibilities of a director.
· Each director should be free of any conflict of interest, which would interfere with the proper performance of the responsibilities of a director.
· The Chief Executive Officer is expected to be a director. Other members of senior management may be considered, but Board membership is not necessary or a prerequisite to a higher management position.
The Governance and Nominating Committee is presently composed of Messrs. Nowalsky (chairman), Johnston and Silva, who are each "independent" as independence for nominating committee members is defined within the NASDAQ Listing Rules. The Governance and Nominating Committee met in fiscal 2012 in conjunction with meetings of the full Board of Directors.
Code of Business Conduct and Ethics
Effective December 18, 2003, our Board of Directors adopted a Code of Business Conduct and Ethics that applies to, among other persons, our President (being our principal executive officer) and our Chief Financial Officer (being our principal financial and accounting officer), as well as persons performing similar functions. As adopted, our Code of Business Conduct and Ethics sets forth written standards that are designed to deter wrongdoing and to promote:
· honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships,
· full, fair, accurate, timely, and understandable disclosure in reports and documents that we file with, or submit to, the Securities and Exchange Commission and in other public communications made by us,
· compliance with applicable governmental laws, rules and regulations,
· the prompt internal reporting of violations of the Code of Business Conduct and Ethics to an appropriate person or persons identified in the Code of Business Conduct and Ethics, and
· accountability for adherence to the Code of Business Conduct and Ethics.
Our Code of Business Conduct and Ethics requires, among other things, that all of our personnel shall be accorded full access to our President and to our Chief Financial Officer, with respect to any matter that may arise relating to the Code of Business Conduct and Ethics. Further, all of our personnel are to be accorded full access to our Board of Directors if any such matter involves an alleged breach of the Code of Business Conduct and Ethics by our President or by our Chief Financial Officer.
In addition, our Code of Business Conduct and Ethics emphasizes that all employees, and particularly managers and/or supervisors, have a responsibility for maintaining financial integrity within our company, consistent with generally accepted accounting principles, and federal, provincial and state securities laws. Any employee who becomes aware of any incidents involving financial or accounting manipulation or other irregularities, whether by witnessing the incident or being told of it, must report it to his or her immediate supervisor or to our President or our Chief Financial Officer. If the incident involves an alleged breach of the Code of Business Conduct and Ethics by our President or by our Chief Financial Officer, the incident must be reported to any member of our Board of Directors. Any failure to report such inappropriate or irregular conduct of others is to be treated as a severe disciplinary matter. It is against our policy to retaliate against any individual who reports in good faith the violation or potential violation of our Code of Business Conduct and Ethics by another.
Our Code of Business Conduct and Ethics was included as an exhibit to our fiscal 2003 annual report filed on Form 10-K. We will provide a copy of our Code of Business Conduct and Ethics to any person without charge, upon request. Requests can be sent to: Onstream Media Corporation, 1291 SW 29 Avenue, Pompano Beach, Florida 33069.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to us under Rule 16a-3(d) of the Securities Exchange Act of 1934, as amended, during the fiscal year ended September 30, 2012 and Forms 5 and amendments thereto furnished to us with respect to the fiscal year ended September 30, 2012, as well as any written representation from a reporting person that no Form 5 is required, we are not aware of any person that failed to file on a timely basis, as disclosed in the aforementioned Forms, reports required by Section 16(a) of the Securities Exchange Act of 1934 during the fiscal year ended September 30, 2012.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table sets forth certain information relating to the compensation of (i) our Chief Executive Officer; and (ii) each of our executive officers who earned more than $100,000 in total compensation during the most recent fiscal year (collectively, the “Named Executive Officers”):
Total compensation as presented in the following table includes cash and non-cash elements. The most significant non-cash element is the value assigned to options based on the Black-Scholes model, and those options as discussed in footnotes 11 and 12 below had strike prices that significantly exceeded the market value of our shares as of September 30, 2012 and 2011, respectively and thus at those dates were what is commonly described as “under water”. The options discussed in footnote 12 below were also unvested and thus not available to be exercised at that date. The shares discussed in footnote 12 below are prohibited to be traded until all restrictions are removed by the Board. See footnote 14 below for a table that presents the cash and non-cash elements of compensation for the years ended September 30, 2012 and 2011:
(1) Includes $12,557 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $21,411 for retirement savings and 401(k) match.
(2) Includes $14,392 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $21,397 for retirement savings and 401(k) match.
(3) Includes $18,293 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $18,000 for retirement savings.
(4) Includes $18,892 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $18,000 for retirement savings.
(5) Includes $14,299 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $20,895 for retirement savings and 401(k) match.
(6) Includes $18,892 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $20,883 for retirement savings and 401(k) match.
(7) Includes $16,572 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $21,694 for retirement savings and 401(k) match.
(8) Includes $18,892 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $21,476 for retirement savings and 401(k) match.
(9) Includes $12,557 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $21,476 for retirement savings and 401(k) match.
(10) Includes $14,009 for medical and other insurance; $12,000 for automobile allowance; $5,000 for dues allowance and $21,689 for retirement savings and 401(k) match.
(11) On January 14, 2011 our Compensation Committee, as part of a company-wide grant, awarded 90,000 four-year Plan options to each of our Named Executive Officers, which options vest over two years and are exercisable at $1.23 per share, fair market value on the date of the grant. However, the quoted market value of an ONSM share was $0.73 per share as of September 30, 2011. As a result of this issuance, we recognized aggregate non-cash compensation expense of approximately $367,560 ($73,512 each) as fiscal 2011 compensation in the above table, which represents the full valuation of the related options using the Black-Scholes model. For book purposes, the expense will be recognized over a two year period commencing on the grant date.
(12) Effective October 1, 2009, a significant portion of our workforce, including the Named Executive Officers, took a 10% payroll reduction, which we expect will be maintained until increased revenue levels result in positive cash flow (sufficient to cover capital expenditures and debt service). However, even though this 10% was deducted from the amounts paid to the Named Executive Officers and the contractually scheduled September 28, 2010 and 2011 raises were not given effect, no adjustment was made to the terms of their related employment agreements, as set forth below, to reflect these matters. Based on approval by our Compensation Committee effective September 29, 2011, an aggregate of 41,073 restricted common Plan shares and four-year Plan options to purchase an aggregate of 266,074 common shares for $0.97 per share (in excess of fair market value on the date of the grant) were issued to the Named Executive Officers as partial consideration for this withheld compensation and are reflected as non-cash compensation for fiscal 2011 in the above table, in the aggregate amount of $165,074. The common shares are prohibited from trading unless all restrictions are removed by the Board and the options are as of now unvested. A portion of the accrued liability under the caption “Amounts due to executives and officers” on our September 30, 2012 balance sheet pertains to the unresolved contractual obligations through that date, to the extent not addressed by the issuance of restricted shares and options discussed above. However, this will not be reflected as compensation in the above table until and unless additional payments are made to the Named Executive Officers in settlement of those amounts.
(13) The Named Executive Officers did not receive non-equity incentive plan compensation or compensation from changes in pension value and nonqualified deferred compensation earnings during the periods covered by the above table.
(14) Below is a table that presents the cash and non-cash elements of compensation for the years ended September 30, 2012 and 2011:
For the year ended September 30, 2012:
Cash
Non-Cash
Compensation
Compensation
Randy S. Selman
$
323,851
$
-
Alan Saperstein
$
301,369
$
-
Robert Tomlinson
$
286,359
$
-
Clifford Friedland
$
275,495
$
-
David Glassman
$
271,482
$
-
For the year ended September 30, 2011:
Cash
Non-Cash
Compensation
Compensation
Randy S. Selman
$
324,540
$
111,255
Alan Saperstein
$
300,939
$
107,824
Robert Tomlinson
$
287,442
$
105,549
Clifford Friedland
$
277,122
$
104,003
David Glassman
$
272,234
$
104,003
Employment Agreements
On September 27, 2007, our Compensation Committee and Board of Directors approved three-year employment agreements with Messrs. Randy Selman (President and CEO), Alan Saperstein (COO and Treasurer), Robert Tomlinson (Chief Financial Officer), Clifford Friedland (Senior Vice President Business Development) and David Glassman (Senior Vice President Marketing), collectively referred to as “the Executives”. On May 15, 2008 and August 11, 2009 our Compensation Committee and Board approved certain corrections and modifications to those agreements, which are reflected in the discussion of the terms of those agreements below. The agreements provide that the initial term shall automatically be extended for successive one (1) year terms thereafter unless (a) the parties mutually agree in writing to alter the terms of the agreement; or (b) one or both of the parties exercises their right, pursuant to various provisions of the agreement, to terminate the employment relationship.
The agreements provide initial annual base salaries of $253,000 for Mr. Selman, $230,000 for Mr. Saperstein, $207,230 for Mr. Tomlinson and $197,230 for Messrs. Friedland and Glassman, plus 10% annual increases through December 27, 2008 and 5% per year thereafter. In addition, each of the Executives receives an auto allowance payment of $1,000 per month, a “retirement savings” payment of $1,500 per month and an annual reimbursement of dues or charitable donations up to $5,000. We also pay insurance premiums for the Executives, including medical, life and disability coverage. These agreements contain certain non-disclosure and non-competition provisions and we have agreed to indemnify the Executives in certain circumstances.
Under the terms of the above employment agreements, upon a termination subsequent to a change of control, termination without cause or constructive termination, each as defined in the agreements, we would be obligated to pay each of the Executives an amount equal to three times the Executive’s base salary plus full benefits for a period of the lesser of (i) three years from the date of termination or (ii) the date of termination until a date one year after the end of the initial employment contract term. We may defer the payment of all or part of this obligation for up to six months, to the extent required by Internal Revenue Code Section 409A. In addition, if the five day average closing price of the common stock is greater than or equal to $6.00 per share on the date of any termination or change in control, all options previously granted the Executive(s) will be cancelled, with all underlying shares (vested or unvested) issued to the executive, and we will pay all related taxes for the Executive(s). If the five-day average closing price of the common stock is less than $6.00 per share on the date of any termination or change in control, the options will remain exercisable under the original terms.
Under the terms of the above employment agreements, we may terminate an Executive’s employment upon his death or disability or with or without cause. To the extent that an Executive is terminated for cause, no severance benefits are due him. If an employment agreement is terminated as a result of the Executive’s death, his estate will receive one year base salary plus any bonus or other compensation amount or benefit then payable or that would have been otherwise considered vested or earned under the agreement during the one-year period subsequent to the time of his death. If an employment agreement is terminated as a result of the Executive’s disability, as defined in the agreement, he is entitled to compensation in accordance with our disability compensation for senior executives to include compensation for at least 180 days, plus any bonus or other compensation amount or benefit then payable or that would have been otherwise considered vested or earned under the agreement during the one-year period subsequent to the time of his disability.
The above employment agreements also provide that in the event we are sold for a Company Sale Price that represents at least $6.00 per share (adjusted for recapitalization including but not limited to splits and reverse splits), the Executives will receive, as a group, cash compensation of twelve percent (12.0%) of the Company Sale Price, payable in immediately available funds at the time of closing such transaction. The Company Sale Price is defined as the number of Equivalent Common Shares outstanding at the time we are sold multiplied by the price per share paid in such Company Sale transaction. The Equivalent Common Shares are defined as the sum of (i) the number of common shares issued and outstanding, (ii) the common stock equivalent shares related to paid for but not converted preferred shares or other convertible securities and and (iii) the number of common shares underlying “in-the-money” warrants and options, such sum multiplied by the market price per share and then reduced by the proceeds payable upon exercise of the “in-the-money” warrants and options, all determined as of the date of the above employment agreements but the market price per share used for this purpose to be no less than $6.00. The 12.0% is allocated in the employment agreements as two and one-half percent (2.5%) each to Messrs. Selman, Saperstein, Friedland and Glassman and two percent (2.0%) to Mr. Tomlinson.
On January 14, 2011 our Compensation Committee agreed that it would approve amendments to the executive employment agreements, as well as amending the same terms as applicable to the Board members (see below), allowing for all or part of such compensation to be paid in shares at the recipient’s option, at any time if our stock is trading above $6.00 per share, without requiring that we be sold. The issuance of such shares would be to the extent permitted by applicable law and subject to shareholder and/or any other required regulatory approvals.
The above description is qualified in its entirety by the terms and conditions of the employment agreements.
Outstanding Equity Awards at Fiscal Year-End Table
The following table sets forth certain information regarding stock options held as of September 30, 2012 by the Named Executive Officers. There were no outstanding stock awards held by them as of that date:
(1) These options are discussed in footnote 11 to the Summary Compensation table presented above. The options presented exclude additional Plan options to purchase 90,000 common shares approved for issuance to each of the Named Executive Officers by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
(2) These options are discussed in footnote 12 to the Summary Compensation table presented above.
(3) The executive’s employment agreement provides that under certain circumstances, all options previously granted to the executive will be cancelled, with all underlying shares (vested or unvested) issued to the executive, and we will pay all taxes for the executive. These conditions are discussed in detail below, under Item J - “Employment Agreements”.
2007 Equity Incentive Plan
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. The options and stock grants authorized for issuance under the Plan were in addition to those already issued under the 1996 Plan, although as discussed above we may no longer issue additional options or stock grants under the 1996 Plan. On March 25, 2010, our Board of Directors and a majority of our shareholders approved a 1,000,000 increase in the number of shares authorized for issuance under the 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. At September 30, 2012, there were unexercised options to purchase 1,978,999 shares of our common stock outstanding under the Plan. Such options were issued to our directors, employees and consultants at exercise prices ranging from $0.65 to $15.00 per share.
The stated purpose of the Plan is to increase our employees', advisors', consultants' and non-employee directors' proprietary interest in our company, and to align more closely their interests with the interests of our shareholders, as well as to enable us to attract and retain the services of experienced and highly qualified employees and non-employee directors. The Plan is administered by the Compensation Committee of our Board of Directors (“the Committee"). The Committee determines, from time to time, those of our officers, directors, employees and consultants to whom Stock Grants and Plan Options will be granted, the terms and provisions of the respective Grants and Plan Options, the dates such Plan Options will become exercisable, the number of shares subject to each Plan Option, the purchase price of such shares and the form of payment of such purchase price. Stock Grants may be issued by the Committee at up to a 10% discount to market at the time of grant. All other questions relating to the administration of the Plan, and the interpretation of the provisions thereof, are to be resolved at the sole discretion of our Board of Directors or the Committee.
Plan Options granted under the Plan may either be options qualifying as incentive stock options ("Incentive Options") under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or options that do not so qualify ("Non-Qualified Options"). The exercise price of any Incentive Option granted to an eligible employee owning more than 10% of our common stock must be at least 110% of such fair market value as determined on the date of the grant.
The term of each Plan Option and the manner in which it may be exercised is determined by our Board of Directors or the Committee, provided that no Plan Option may be exercisable more than 10 years after the date of its grant and, in the case of an Incentive Option granted to an eligible employee owning more than 10% of our common stock, no more than five years after the date of the grant. In any case, the exercise price of any stock option granted under the Plan will not be less than 85% of the fair market value of the common stock on the date of grant. The exercise price of Non-Qualified Options is determined by the Committee.
The per share purchase price of shares subject to Plan Options granted under the Plan may be adjusted in the event of certain changes in our capitalization, but any such adjustment shall not change the total purchase price payable upon the exercise in full of Plan Options granted under the Plan. Officers, directors and employees of and consultants to us and our subsidiaries are eligible to receive Non-Qualified Options under the Plan. Only such individuals who are employed by us or by any of our subsidiaries thereof are eligible to receive Incentive Options.
All Plan Options are nonassignable and nontransferable, except by will or by the laws of descent and distribution and, during the lifetime of the optionee, may be exercised only by such optionee. If an optionee's employment is terminated for any reason, other than his death or disability or termination for cause, or if an optionee is not our employee but is a member of our Board of Directors and his service as a Director is terminated for any reason, other than death or disability, the Plan Option granted may be exercised on the earlier of the expiration date or 90 days following the date of termination. If the optionee dies during the term of his employment, the Plan Option granted to him shall lapse to the extent unexercised on the earlier of the expiration date of the Plan Option or the date one year following the date of the optionee's death. If the optionee is permanently and totally disabled within the meaning of Section 22(c)(3) of the Code, the Plan Option granted to him lapses to the extent unexercised on the earlier of the expiration date of the option or one year following the date of such disability.
The Board of Directors may amend, suspend or terminate the Plan at any time, except that no amendment shall be made which (i) increases the total number of shares subject to the Plan or changes the minimum purchase price therefore (except in either case in the event of adjustments due to changes in our capitalization) without the consent of our shareholders, (ii) affects outstanding Plan Options or any exercise right thereunder, (iii) extends the term of any Plan Option beyond ten years, or (iv) extends the termination dates of the Plan.
Unless the Plan has been earlier suspended or terminated by the Board of Directors, the Plan shall terminate 10 years from the date of the Plan’s adoption. Any such termination of the Plan shall not affect the validity of any Plan Options previously granted thereunder.
The potential benefit to be received from a Plan Option is dependent on increases in the market price of the common stock. The ultimate dollar value of the Plan Options that have been or may be granted under the Plan are therefore not ascertainable. On January 11, 2013, the closing price of our common stock as reported on OTCQB was $0.29 per share.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table contains information regarding beneficial ownership of our common stock as of January 11, 2013 held by:
· persons who own beneficially more than 5% of our outstanding common stock,
· our directors,
· named executive officers, and
· all of our directors and officers as a group.
Unless otherwise indicated, the address of each of the listed beneficial owners identified is c/o Onstream Media Corporation, 1291 SW 29th Avenue, Pompano Beach, Florida 33069. Unless otherwise noted, we believe that all persons named in the table have sole voting and investment power with respect to all shares of our common stock beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such a person within 60 days from January 11, 2013 upon exercise of options, warrants, convertible securities or other rights to receive our common shares. Each beneficial owner's percentage of ownership is determined by assuming that options, warrants, convertible securities or other rights to receive our common shares that are held by such a person (but not those held by any other person) and are exercisable within 60 days from the date hereof (unless otherwise indicated below) have been exercised. All information is based upon a record list of stockholders received from our transfer agent as of January 11, 2013. At that date, approximately 76% of our outstanding shares were held by CEDE & Co., which is accounted for as a single shareholder of record for multiple beneficial owners. CEDE & Co. is a nominee of the Depository Trust Company (DTC), with respect to securities deposited by participants with DTC, e.g., mutual funds, brokerage firms, banks, and other financial organizations. Shares held by CEDE & Co. are not reflected in the following table.
(1) Includes 1,660 shares of our common stock presently outstanding, vested options to acquire 90,000 common shares at $1.23 per share, vested options to acquire 75,000 common shares at $9.42 per share, vested options to acquire 52,291 common shares at $10.38 per share and vested options to acquire 66,667 common shares at $15.00 per share. Excludes unvested options to acquire 75,486 common shares at $0.97 per share and options to purchase 90,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
(2) Includes 1,973 shares of our common stock presently outstanding, vested options to acquire 90,000 common shares at $1.23 per share, vested options to acquire 75,000 common shares at $9.42 per share, vested options to acquire 52,291 common shares at $10.38 per share and vested options to acquire 66,667 common shares at $15.00 per share. Excludes unvested options to acquire 68,624 common shares at $0.97 per share and options to purchase 90,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
(3) Includes 74,538 shares of our common stock presently outstanding, 24,684 shares of our common stock held by Titan Trust, 24,684 shares of our common stock held by Dorado Trust, vested options to acquire 90,000 common shares at $1.23 per share and vested options to acquire 52,291 common shares at $10.38 per share. Excludes unvested options to acquire 60,982 common shares at $0.97 per share and options to purchase 90,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued. Mr. Friedland is the control person and beneficial owner of both Titan Trust and Dorado Trust and exercises sole voting and dispositive powers over these shares.
(4) Includes 74,510 shares of our common stock presently outstanding, 24,684 shares of our common stock held by JMI Trust, 24,684 shares of our common stock held by Europa Trust, vested options to acquire 90,000 common shares at $1.23 per share and vested options to acquire 52,291 common shares at $10.38 per share. Excludes unvested options to acquire 60,982 common shares at $0.97 per share and options to purchase 90,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued. Mr. Glassman is the control person and beneficial owner of both JMI Trust and Europa Trust and exercises sole voting and dispositive powers over these shares.
(5) Includes vested options to acquire 90,000 common shares at $1.23 per share, vested options to acquire 25,000 common shares at $7.26 per share and vested options to acquire 52,291 common shares at $10.38 per share. Excludes 41,073 restricted common shares that may not be transacted by Mr. Tomlinson for any reason whatsoever prior to Board approval, which has not been granted and options to purchase 90,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
(6) Includes 34,686 shares of our common stock presently outstanding, 155,203 shares of our common stock held by J&C Resources, LLC, 103 shares of our common stock held by Asset Factoring, Ltd., vested options to acquire 25,000 common shares at $1.23 per share and vested options to acquire 16,667 Onstream common shares at $9.42 per share. Excludes options to purchase 25,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued. Mr. Johnston is the control person of J&C Resources, LLC and Asset Factoring, Ltd. and exercises sole voting and dispositive powers over these shares. Mr. Johnston's holdings exclude our securities owned by CCJ Trust. CCJ Trust is a trust for Mr. Johnston's adult children and he disclaims any beneficial ownership interest in CCJ Trust.
(7) Includes vested options to acquire 25,000 common shares at $1.23 per share. Excludes options to purchase 25,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
(8) Includes vested options to acquire 25,000 common shares at $1.23 per share. Excludes options to purchase 25,000 common shares approved for issuance by the Compensation Committee in January 2011 pending a sufficient increase in the Plan shares, for which shareholder approval was requested and received in June 2011 but the options have not yet been formally granted or issued.
(9) Includes vested options to acquire 25,000 common shares at $1.00 per share.
(10) See footnotes (1) through (9) above.
(11) Includes 944,758 shares of our common stock presently outstanding. These shares of common stock are as reported on a Form 13G/A filed by Lewis Asset Management on January 5, 2009 and attributing beneficial ownership of 777,508 shares to Lewis Opportunity Fund and beneficial ownership of 167,250 shares to LAM Opportunity Fund, Ltd. These numbers are after adjustment of the reported shares to reflect the 1-for-6 reverse split of our common stock that was effective on April 5, 2010. As of January 11, 2013 Lewis Asset Management has not filed any update to this information and we have not undertaken to request an update from them. Mr. Lewis is the control person and beneficial owner of these entities and exercises sole voting and dispositive powers over these shares.
Mr. Fred Deluca has beneficial ownership of 324,695 shares as of January 11, 2013, issuable upon conversion of a note (the “Rockridge Note”) held by Rockridge Capital Holdings, LLC (“Rockridge”). Mr. Deluca is the control person and beneficial owner of Rockridge and exercises sole voting and dispositive powers over these shares. These 324,695 shares represent approximately 2.2% beneficial ownership, which is less than the 5% threshold for inclusion of Mr. Deluca in the beneficial ownership table above. However, in connection with the transaction giving rise to the Rockridge Note, Rockridge may also receive an origination fee upon not less than sixty-one (61) days written notice to us, payable by our issuance of 591,667 restricted Onstream common shares. Based on the 60 day threshold discussed above, these shares are not considered to be beneficially owned by Rockridge or Mr. Deluca as of January 11, 2013. However, if these 591,667 shares were added to the 324,695 which are considered beneficially owned by Mr. Deluca as of that date, the combined total of 916,362 shares would represent 6.0% beneficial ownership.
Upon notice from Rockridge at any time and from time to time prior to the Maturity Date, the outstanding balance of the Rockridge Note may be converted into a number of restricted shares of Onstream common stock. The conversion will use a conversion price of eighty percent (80%) of the fair market value of the average closing bid price for Onstream common stock for the twenty (20) days of trading on the OTCQB (or such other exchange or market on which Onstream common shares are trading) prior to such Rockridge notice, but such conversion price will not be less than $2.40 per share. We will not effect any conversion of the Rockridge Note, to the extent Rockridge and Frederick DeLuca, after giving effect to such conversion, would beneficially own in excess of 9.9% of our outstanding common stock (the “Beneficial Ownership Limitation”). The Beneficial Ownership Limitation may be waived by Rockridge upon not less than sixty-one (61) days prior written notice to us unless such waiver would result in a violation of the NASDAQ shareholder approval rules. The minimum conversion price of $2.40 per share would result in the issuance of 324,695 common shares upon the conversion of the remaining outstanding balance of the Rockridge Note as of January 11, 2013, which was $779,267.
Securities Authorized for Issuance Under Equity Compensation Plans - See Item 5 - Market For Registrant’s Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity Securities.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Certain relationships and related transactions
In December 2007, we entered into a line of credit arrangement (the “Line”) with a financial institution (the “Lender”) under which we could borrow up to an aggregate of $1.0 million for working capital, collateralized by our accounts receivable and certain other related assets. In August 2008 the maximum allowable borrowing amount under the Line was increased to $1.6 million and in December 2009 this amount was again increased to $2.0 million. The outstanding balance bears interest at 12.0% per annum, adjustable based on changes in prime after December 27, 2011 (was prime plus 8% per annum through December 2, 2008, prime plus 11% per annum from that date through December 28, 2009 and 13.5% per annum from that date to December 27, 2011), payable monthly in arrears. Effective December 28, 2009, we also incur a weekly monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit, payable monthly in arrears. We paid the Lender initial origination and commitment fees in December 2007 aggregating $20,015, an additional commitment fee in August 2008 of $6,000 related to the increase in the lending limit for the remainder of the year, a commitment fee of $16,000 in December 2008 related to the continuation of the increased Line for an additional year, a commitment fee of $20,000 in December 2009 related to the continuation of the Line for an additional year as well as an increase in the lending limit, a commitment fee of $20,000 in December 2010 related to the continuation of the Line for an additional year, a commitment fee of $20,000 in March 2012 related to the continuation of the Line for the year ended December 2012, and a commitment fee of $20,000 in December 2012 related to the continuation of the Line for the year ended December 2013. The expiration of the Line is December 27, 2013. We also pay the Lender fees and expenses totaling approximately two to three thousand dollars per quarter related to their reviews of our receivable and other records related to the loan. Mr. Leon Nowalsky, a member of our Board of Directors, is also a founder and board member of the Lender.
In April 2009 we borrowed $750,000 from Rockridge Capital Holdings, LLC (“Rockridge”), an entity controlled by Mr. Fred Deluca, one of our largest shareholders, in accordance with the terms of a Note and Stock Purchase Agreement (the “Rockridge Agreement”) between Rockridge and us. In June 2009, we borrowed an additional $250,000 from Rockridge in accordance with the Rockridge Agreement. On September 14, 2009, we entered into Amendment Number 1 to the Agreement (the “Amendment”), as well as an Allonge to the Note (the “Allonge”), which allowed us to borrow up to an additional $1.0 million from Rockridge. We borrowed $500,000 on September 18, 2009 and the remaining $500,000 on October 20, 2009, resulting in cumulative borrowings under the Rockridge Agreement, as amended, of $2.0 million. This transaction is secured by a first priority lien on all of our assets, such lien subordinated only to the extent higher priority liens on assets, primarily accounts receivable and certain designated software and equipment, are held by certain of our other lenders and is repayable in equal monthly installments through September 14, 2014. The outstanding principal amount, or portions thereof, are convertible into our common stock (using a minimum conversion price of $2.40 per share) and the Note and Stock Purchase Agreement also provides that Rockridge may receive an origination fee of 591,667 restricted Onstream common shares (the “Shares”) upon not less than sixty-one (61) days written notice to us, which notice has not yet been given. The Rockridge Agreement, as amended, provides that on the Maturity Date we shall pay Rockridge up to a maximum of $75,000, based on the sum of (i) the cash difference between the per share value of $1.20 (the “Minimum Per Share Value”) and the average sale price for all previously sold Shares (whether such number is positive or negative) multiplied by the number of sold Shares and (ii) for the Shares which were not previously sold by Rockridge, the cash difference between the Minimum Per Share Value and the market value of the Shares at the Maturity Date (whether such number is positive or negative) multiplied by the number of unsold Shares, up to a maximum shortfall amount of $75,000 in the aggregate for items (i) and (ii). We have recorded no accrual for this matter on our financial statements as of September 30, 2012, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if the closing ONSM share price of $0.29 per share on January 11, 2013 was used as a basis of calculation, the required payment would be approximately $75,000.
On December 29, 2009, we entered into an agreement with CCJ Trust (“CCJ”) whereby accrued interest on a previous $200,000 cash advance through that date of $5,808 was paid by us in cash and the $200,000 advance was converted to an unsecured subordinated note payable (the “CCJ Note”) at a rate of 8% interest per annum in equal monthly installments of principal and interest for 48 months plus a $100,000 principal balloon at maturity, although none of those payments were subsequently made by us. CCJ is a trust for the adult children of Mr. Charles Johnston, one of our directors, and he disclaims any beneficial ownership interest in CCJ. To resolve the payment default, the CCJ Note was amended in January 2011 to prospectively increase the interest rate to 10% per annum, payable quarterly, and to require two principal payments of $100,000 each on December 31, 2011 and December 31, 2012, respectively. This amendment also called for our cash payment of the previously accrued interest in the amount of $16,263 on or before January 31, 2011. On July 22, 2011, in order to reduce our near-term cash requirements, we agreed to convert $90,000 of the $100,000 December 31, 2011 principal payment to 100,000 common shares, leaving a remaining balance outstanding under the CCJ Note of $110,000, of which $10,000 was paid in January 2012. Three quarterly interest payments on the remaining outstanding $100,000 balance were subsequently made in cash 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. The combined obligation of $145,779 was the principal amount of a replacement subordinated note issued to CCJ dated January 1, 2013 and payable in 24 monthly principal and interest installments of $6,862.32 starting January 31, 2013 and which payment amount includes interest at 12% per annum. Prior to the issuance of the January 1, 2013 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 (which was $3.00 per share prior to the January 2011 renegotiation). The January 1, 2013 replacement note has no conversion rights.
In conjunction with and in consideration of the December 2009 note transaction, the 35,000 shares of Series A-12 (with a stated value of $10.00 per share and convertible into common at $6.00 per share) held by CCJ at that date were exchanged for 35,000 shares of Series A-13 (with a stated value of $10.00 per share and convertible into common at $3.00 per share) plus four-year warrants for the purchase of 29,167 Onstream common shares at $3.00 per share. In conjunction with and in consideration of January 2011 note transaction entered into by us with CCJ, it was agreed that certain terms of the 35,000 shares of Series A-13 held by CCJ at that date would be modified as follows - the conversion rate to common shares, as well as the minimum conversion rate for payment of dividends in common shares, will be $2.00 per share, the maturity date will be December 31, 2012 and dividends will be paid quarterly, in cash or, at our option, in unregistered shares. In addition it was agreed that $28,000 in A-13 dividends for calendar 2010 would be immediately paid by issuance of 14,000 unregistered common shares, using the minimum conversion rate of $2.00 per share.
During December 2009, we received funding commitment letters executed by three (3) entities agreeing to provide us, within twenty (20) days after our notice given on or before December 31, 2010, aggregate cash funding of $750,000. The funding under the commitment letters would be in exchange for our equity under mutually agreeable terms to be negotiated at the time of funding, or in the event such terms could not be reached, in the form of repayable debt. Terms of the repayable debt would also be subject to negotiation at the time of funding, provided that, among other things, the debt would be unsecured and subordinated and the rate of return on such debt, including cash and equity consideration given, would not be greater than (i) a cash coupon rate of fifteen percent (15%) per annum and a (ii) total effective interest rate of thirty percent (30%) per annum. As consideration for these commitment letters, the issuing entities received an aggregate of 12,500 unregistered shares. One of these funding commitment letters, for $250,000, was executed by Mr. Charles Johnston, one of our directors, who received 4,167 of the 12,500 shares.
On January 4, 2011, we received a funding commitment letter (the “2011 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, 2011, aggregate cash funding of up to $500,000, which could be requested in multiple tranches. Mr. Charles Johnston, one of our directors, is the president of J&C. The 2011 Funding Letter was obtained by us solely to demonstrate our ability to obtain short-term funds in the event other funding sources were not available, but did not represent any obligation on our part to accept such funding on those terms, was not expected by us to be exercised and was not exercised. The cash provided under the 2011 Funding Letter would be in exchange for our issuance of (a) a note or notes with interest payable monthly at 15% per annum and principal payable on the earlier of a date twelve months from funding or July 1, 2012 and (b) our issuance of 1 million unregistered common shares, which shares would be prorated in the case of partial funding. The note or notes would be unsecured and subordinated to all of our other debts, except to the extent such the terms of such debts would allow pari passu status. Furthermore, the note or notes would not be subject to any provisions, other than with respect to priority of payments or collateral, of our other debts. Upon receipt by us of an equivalent amount in dollars of investment from any other source after the date of the 2011 Funding Letter, other than funding received in connection with the LPC Facility, this Funding Letter would be terminated.
On January 10, 2012, we received a funding commitment letter (the “January 2012 Funding Letter”) from J&C, agreeing to provide us, within twenty (20) days after our notice given on or before December 31, 2012, aggregate cash funding of up to $550,000, which may be requested in multiple tranches. This January 2012 Funding Letter was obtained by us solely to demonstrate our ability to obtain short-term funds in the event other funding sources are not available, but does not represent any obligation on our part to accept such funding on these terms and is not expected by us to be exercised. The cash provided under the January 2012 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, 2013 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 January 2012 Funding Letter, other than funding received in connection with the LPC Facility, this January 2012 Funding Letter will be terminated.
In January 2012, as part of the transaction under which J&C issued the January 2012 Funding 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 shares CCJ received 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 $2.00 per common share to $1.72 per common share. 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 Lincoln Park Capital arising from certain anti-dilution provisions, the total economic cost of this funding commitment letter was approximately $130,000.
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, one of our directors, 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, 2013 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.
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, 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. 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.
During 2008 we received an aggregate of $1.0 million from seven accredited individuals and other entities (the “Investors”), under a software and equipment financing arrangement. This included $50,000 received on July 8, 2008 from CCJ Trust (“CCJ”). We issued notes to those Investors (the “Equipment Notes”), which had an original maturity date of June 3, 2011 and were collateralized by specifically designated software and equipment owned by us with a cost basis of approximately $1.5 million, as well as a subordinated lien on certain other of our assets to the extent that the designated software and equipment, or other software and equipment added to the collateral at a later date, is not considered sufficient security for the loan. The Equipment Notes were originally convertible to restricted ONSM common shares at any time prior to their maturity date, at the Investors’ option, based on a conversion price equal to seventy-five percent (75%) of the average ONSM closing price for the thirty (30) trading days prior to the date of conversion, but in no event may the conversion price be less than $4.80 per share. On April 4, 2011 we offered to amend the Equipment Notes, which offer was accepted by certain of those Investors including CCJ, to allow the conversion of 25% of the outstanding principal using a conversion price of $1.20 per share. On April 28, 2011 we offered to amend the Equipment Notes, which offer was accepted by certain of those Investors including CCJ, to allow the conversion of 25% of the outstanding principal using a conversion price of $1.00 per share. Effective October 1, 2011 certain of these Equipment Notes, including $25,000 due to CCJ, 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. In October 2011, CCJ’s note was assigned to a third party unrelated to CCJ, Mr. Johnston or Onstream Media Corporation.
On January 2, 2013 we received $25,000 pursuant to an unsecured promissory note issued to CCJ (the “New CCJ Note”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. New CCJ 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 this financing, we issued 30,000 restricted common shares (the “CCJ Common Stock”) to CCJ, of which we have agreed to buy back up to 5,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the CCJ 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 2,500 shares of the originally issued CCJ Common Stock from CCJ at $0.80 per share. If the fair market value of the CCJ 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 5,000 shares of the originally issued CCJ Common Stock, less the amount of any shares already bought back at the one year point, from CCJ at $0.80 per share. The above only applies to the extent the CCJ Common Stock is still held by CCJ at the applicable dates.
Review, approval or ratification of transactions with related persons
Prior to us entering into any related person transaction, our Board of Directors reviews the terms of the proposed transaction to ensure that they are fair and reasonable, on market terms and on an arms-length basis. Legal or other counsel is consulted as appropriate.
If a related party transaction involves compensation or is otherwise related to an employment relationship with us, the related party transaction will be reviewed by the Compensation Committee. Related party transactions are reported to the Audit Committee for their review and approval of the related disclosure.
With respect to transactions in which a director or executive officer or immediate family member may have a direct or indirect material interest, only disinterested members of the Board of Directors, the Compensation Committee and/or the Audit Committee may vote on whether to approve the transaction.
Director independence
Our independent directors are Messrs. Johnston, Silva, Nowalsky and Whitney.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit Fees
The audit fees billed to us by Mayer Hoffman McCann P.C. (“MHM”) for professional services rendered during the fiscal year ended September 30, 2012 were $220,000 for the audit of our annual financial statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2011 as well as the review of our quarterly financial statements included in our quarterly reports on Form 10-Q for the quarters ended December 31, 2011, and March 31 and June 30, 2012.
The audit fees billed to us by MHM for professional services rendered during the fiscal year ended September 30, 2011 were $217,000 for the audit of our annual financial statements included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010 as well as the review of our quarterly financial statements included in our quarterly reports on Form 10-Q for the quarters ended December 31, 2010, and March 31 and June 30, 2011.
Audit Related Fees
The aggregate fees billed to us by MHM for assurance and related services relating to the performance of the audit of our financial statements which are not reported under the caption "Audit Fees" above were none and $5,750 for the fiscal years ended September 30, 2012 and 2011, respectively.
Tax Fees
There were no tax fees billed by MHM for the fiscal years ended September 30, 2012 and 2011, respectively.
All Other Fees
Other than fees relating to the services described above under “Audit Fees,” “Audit-Related Fees” and “Tax Fees,” there were no additional fees billed to us by MHM for services rendered for the fiscal years ended September 30, 2012 or 2011.
Audit Committee Policies
Effective May 6, 2003, the Securities and Exchange Commission adopted rules that require that before our independent auditor is engaged by us to render any auditing or permitted non-audit related service, the engagement be:
· approved by our audit committee; or
· entered into pursuant to pre-approval policies and procedures established by the audit committee, provided the policies and procedures are detailed as to the particular service, the audit committee is informed of each service, and such policies and procedures do not include delegation of the audit committee's responsibilities to management.
The audit committee pre-approves all services provided by our independent auditors, including those set forth above. The audit committee has considered the nature and amount of fees billed by Goldstein Lewin and MHM and believes that the provision of services for activities unrelated to the audit is compatible with maintaining Goldstein Lewin’s and MHM’s independence.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as a part of this report or are incorporated by reference to previous filings, if so indicated:
Number Description
2.1 Agreement and Plan of Merger dated as of October 22, 2003 by and between Visual Data Corporation, OSM, Inc., a subsidiary of Visual Data Corporation, and Onstream Media Corporation (11)
2.2 Amendment #1 to Agreement and Plan of Merger dated as of October 15, 2004 by and between Visual Data Corporation, OSM, Inc., a subsidiary of Visual Data Corporation, and Onstream Media Corporation (13)
2.3 Agreement and Plan of Merger dated June 4, 2001 among Entertainment Digital Network, Inc., Visual Data Corporation and Visual Data San Francisco, Inc. (6)
2.4 Agreement and Plan of Reorganization between Visual Data Corporation, Media on Demand, Inc. and Charles Saracino (7)
2.5 Infinite Conferencing Merger Agreement dated March 26, 2007 (22)
3.1.1 Articles of Incorporation (1)
3.1.2 Articles of Amendment dated July 26, 1993 (1)
3.1.3 Articles of Amendment dated January 17, 1994 (1)
3.1.4 Articles of Amendment dated October 11, 1994 (1)
3.1.5 Articles of Amendment dated March 25, 1995 (1)
3.1.6 Articles of Amendment dated October 31, 1995 (1)
3.1.7 Articles of Amendment dated May 23, 1996 (1)
3.1.8 Articles of Amendment dated May 5, 1998 (5)
3.1.9 Articles of Amendment dated August 11, 1998 (2)
3.1.10 Articles of Amendment dated June 13, 2000 (4)
3.1.11 Articles of Amendment dated April 11, 2002 (8)
3.1.12 Articles of Amendment dated June 24, 2003, with regard to Series A-9 Convertible Preferred Stock (9)
3.1.13 Articles of Amendment dated June 20, 2003, with regard to reverse stock split (10)
3.1.14 Articles of Amendment dated December 23, 2004, with regard to the designations for Series A-10 Convertible Preferred Stock (15)
3.1.15 Articles of Amendment dated December 30, 2004, with regard to corporate name change (14)
3.1.16 Articles of Amendment dated February 7, 2005 with regard to the designations for Series A-10 Convertible Preferred Stock (16)
3.1.17 Articles of Amendment dated January 7, 2009 with regard to the designations for Series A-12 Redeemable Convertible Preferred Stock (21)
3.1.18 Articles of Amendment dated December 23, 2009 with regard to the designations for Series A-13 Convertible Preferred Stock (28)
3.1.19 Articles of Amendment dated April 5, 2010 with regard to reverse stock split (29)
3.1.20 Articles of Amendment dated June 17, 2010 with regard to the number of authorized shares (30)
3.1.21 Articles of Amendment dated September 22, 2010 with regard to the designations for Series A-14 Convertible Preferred Stock (31)
3.1.22 Articles of Amendment dated March 2, 2011 with regard to the designations for Series A-13 Convertible Preferred Stock (25)
3.1.23 Articles of Amendment dated January 20, 2012 with regard to the designations for Series A-13 Convertible Preferred Stock (33)
3.1.24 Articles of Amendment dated December 21, 2012 with regard to the designations for Series A-13 Convertible Preferred Stock (34)
3.2 By-laws (1)
4.1 Specimen Common Stock Certificate (1)
4.2 Form of $1.50 Warrant for Subordinated Secured Convertible Notes (21)
4.3 Form of 12% Convertible Secured Note (23)
4.4 12% Convertible Secured Note - Rockridge (17)
4.5 Allonge to 12% Convertible Secured Note - Rockridge (27)
4.6 Amended and Restated Promissory Note dated December 27, 2011 - Thermo Credit (35)
10.1 Form of 2007 Equity Incentive Plan (36)
10.2 Employment Agreement (Amended) dated August 11, 2009 between Onstream Media Corporation and Randy S. Selman (28)
10.3 Employment Agreement (Amended) dated August 11, 2009 between Onstream Media Corporation and Alan Saperstein (28)
10.4 Employment Agreement (Amended) dated August 11, 2009 between Onstream Media Corporation and Clifford Friedland (28)
10.5 Employment Agreement (Amended) dated August 11, 2009 between Onstream Media Corporation and David Glassman (28)
10.6 Employment Agreement (Amended) dated August 11, 2009 between Onstream Media Corporation and Robert Tomlinson (28)
10.7 Form of Subscription Agreement used for sale of $11.0 million common shares - March 2007 (19)
10.8 Form of Subscription Agreement for 12% Convertible Secured Notes (23)
10.9 Form of Security Agreement for 12% Convertible Secured Notes (23)
10.10 Note and Stock Purchase Agreement for 12% Convertible Secured Note - Rockridge (17)
10.11 Security Agreement for 12% Convertible Secured Note - Rockridge (17)
10.12 First Amendment to Note and Stock Purchase Agreement for 12% Convertible Secured Note - Rockridge (27)
10.13 Amended and Restated Loan Agreement dated December 27, 2011 - Thermo Credit (35)
10.14 Amended and Restated Security Agreement dated December 27, 2011 - Thermo Credit (35)
10.15 Purchase Agreement, dated as of September 17, 2010, by and between the Company and Lincoln Park Capital Fund, LLC (31)
10.16 Registration Rights Agreement, dated as of September 17, 2010, by and between the Company and Lincoln Park Capital Fund, LLC (31)
10.17 Form of Warrant to be issued to Lincoln Park Capital Fund, LLC (31)
10.18 Amendment dated April 28, 2011 to September 17, 2010 Purchase Agreement by and between the Company and Lincoln Park Capital Fund, LLC (32)
14.1 Code of Business Conduct and Ethics (12)
14.2 Corporate Governance and Nominating Committee Principles (26)
14.3 Audit Committee Charter (20)
14.4 Compensation Committee Charter (20)
21.1 Subsidiaries of the registrant
23.1 Consent of Independent Registered Public Accounting Firm
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1 Section 906 Certification of Chief Executive Officer
32.2 Section 906 Certification of Chief Financial Officer
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.
(1) Incorporated by reference to the exhibit of the same number filed with the registrant's registration statement on Form SB-2, registration number 333-18819, as amended and declared effective by the SEC on July 30, 1997.
(2) Incorporated by reference to the registrant's current report on Form 8-K dated August 21, 1998.
(3) Not used.
(4) Incorporated by reference to the registrant's Quarterly Report on Form 10-QSB for the period ended June 30, 2000.
(5) Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended September 30, 2000.
(6) Incorporated by reference to the registrant’s current report on Form 8-K filed on June 12, 2001.
(7) Incorporated by reference to the registrant’s current report on Form 8-K filed on February 5, 2002.
(8) Incorporated by reference to exhibit 3.1 to the registrant's registration statement on Form S-3, file number 333-89042, declared effective on June 7, 2002.
(9) Incorporated by reference to the registrant's current report on Form 8-K filed July 2, 2003.
(10) Incorporated by reference to the registrant's Quarterly Report on Form 10-QSB for the period ended June 30, 2003.
(11) Incorporated by reference to the registrant's current report on Form 8-K filed October 28, 2003.
(12) Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended September 30, 2003.
(13) Incorporated by reference to the registrant’s Annual Report on Form 10-KSB for the year ended September 30, 2004.
(14) Incorporated by reference to the registrant’s current report on Form 8-K filed on January 4, 2005.
(15) Incorporated by reference to the registrant’s current report on Form 8-K/A filed on January 4, 2005.
(16) Incorporated by reference to the registrant's current report on Form 8-K filed February 11, 2005.
(17) Incorporated by reference to the registrant's current report on Form 8-K filed April 20, 2009.
(18) Incorporated by reference to the registrant's current report on Form 8-K/A filed April 3, 2006.
(19) Incorporated by reference to the registrant's current report on Form 8-K filed March 28, 2007.
(20) Incorporated by reference to the registrant’s proxy statement for the 2010 Annual Meeting filed with the SEC on February 19, 2010.
(21) Incorporated by reference to the registrant's current report on Form 8-K filed January 7, 2009.
(22) Incorporated by reference to the registrant's current report on Form 8-K filed June 2, 2008.
(23) Incorporated by reference to the registrant's current report on Form 8-K filed June 6, 2008.
(24) Incorporated by reference to the registrant's current report on Form 8-K filed August 15, 2008.
(25) Incorporated by reference to the registrant's current report on Form 8-K filed March 4, 2011.
(26) Incorporated by reference to the registrant's Proxy Statement for the 2008 and 2009 Annual Shareholders Meeting filed on January 28, 2009.
(27) Incorporated by reference to the registrant's current report on Form 8-K filed September 18, 2009.
(28) Not used.
(29) Incorporated by reference to the registrant's current report on Form 8-K filed April 6, 2010.
(30) Incorporated by reference to the registrant's current report on Form 8-K filed June 18, 2010.
(31) Incorporated by reference to the registrant's current report on Form 8-K filed September 23, 2010.
(32) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q for the period ended March 31, 2011 and filed on May 16, 2011.
(33) Incorporated by reference to the registrant's current report on Form 8-K filed January 24, 2012.
(34) Incorporated by reference to the registrant's current report on Form 8-K filed December 26, 2012.
(35) Incorporated by reference to the registrant's Quarterly Report on Form 10-Q for the period ended December 31, 2011 and filed on February 21, 2012.
(36) Incorporated by reference to the registrant's Annual Report on Form 10-K for the period ended September 30, 2011 and filed on January 13, 2012.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Onstream Media Corporation (Registrant)
By: /s/ Randy S. Selman
Randy S. Selman
President, Chief Executive Officer
Date: January 15, 2013
By: /s/ Robert E. Tomlinson
Robert E. Tomlinson
Chief Financial Officer and
Principal Accounting Officer
Date: January 15, 2013
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
By: /s/ Randy S. Selman
Director, President,
January 15, 2013
Randy S. Selman
Chief Executive Officer
By: /s/ Robert E. Tomlinson
Chief Financial Officer and
January 15, 2013
Robert E. Tomlinson
Principal Accounting Officer
By: /s/ Alan Saperstein
Director and Chief
January 15, 2013
Alan Saperstein
Operating Officer
By: /s/ Clifford Friedland
Director and Senior Vice
January 15, 2013
Clifford Friedland
President Business Development
By: /s/ Charles C. Johnston
Director
January 15, 2013
Charles C. Johnston
By: /s/ Carl Silva
Director
January 15, 2013
Carl Silva
By: /s/ Leon Nowalsky
Director
January 15, 2013
Leon Nowalsky
By: /s/ Robert D. (“RD”) Whitney
Director
January 15, 2013
Robert D. (“RD”) Whitney
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Onstream Media Corporation
Pompano Beach, Florida
We have audited the accompanying consolidated balance sheets of Onstream Media Corporation and subsidiaries as of September 30, 2012 and 2011 and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Onstream Media Corporation and subsidiaries as of September 30, 2012 and 2011 and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
/s/ Mayer Hoffman McCann P.C.
MAYER HOFFMAN MCCANN P.C.
Certified Public Accountants
Boca Raton, Florida
January 15, 2013
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
The accompanying notes are an integral part of these consolidated financial statements.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated financial statements.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED SEPTEMBER 30, 2011 AND 2012
(Continued)
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED SEPTEMBER 30, 2011 AND 2012
(Continued)
The accompanying notes are an integral part of these consolidated financial statements.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
The accompanying notes are an integral part of these consolidated financial statements.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
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 notes 2 and 9.
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
SEPTEMBER 30, 2012
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 $131.6 million as of September 30, 2012. Our operations have been financed primarily through the issuance of equity and debt. 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. Although we had cash of approximately $360,000 at September 30, 2012, our working capital was a deficit of approximately $2.7 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 $300,000 in fiscal 2013, as compared to 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 $186,000 in fiscal 2013, as compared to fiscal 2012.
On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”) - see note 9. We are expecting positive operating cash flow from these acquired operations for the ten months from December 1, 2012 through September 30, 2013, although we also incurred debt subsequent to September 30, 2012 that was associated specifically or generally with this acquisition - see note 9.
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, one of our directors, 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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Liquidity (continued)
During the three months ended June 30, 2012, 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 the three months ended December 31, 2012 exceed the revenues for the three months ended September 30, 2012 and we expect that this quarter to quarter increase will continue through the three months ending June 30, 2013, excluding the impact of the Intella2 acquisition noted above. However, in the event we are unable to achieve the expected recovery of revenues from the seasonal decrease, 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 for the next twelve months. We will closely monitor our revenue and other business activity to determine if and when further cost reductions, the raising of additional capital, or other activity is considered necessary.
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., 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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Bad Debt Reserves
Where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations, we record a specific allowance against amounts due from it, and thereby 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.
Fair Value Measurements
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and amounts due to directors and officers approximate fair value due to the short maturity of the instruments. The carrying amounts of the current portion of notes, debentures and leases payable approximate fair value due to the short maturity of the instruments, as well as the market value interest rates they carry.
We have determined that the Rockridge Note, the CCJ Note, the Equipment Notes and the Subordinated Notes, 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 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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Value Measurements (continued)
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.
We have determined that there are no Level 1 inputs for determining the fair value of the Rockridge Note, the CCJ Note, the Equipment Notes or the Subordinated Notes. However, we have determined that the fair value of the Rockridge Note, the CCJ Note, the Equipment Notes and the Subordinated Notes may be determined using Level 2 inputs, as follows: the fair market value interest rate paid by us under our line of credit arrangement (the “Line”) as discussed in note 4 and the value of conversion rights contained in those arrangements, based on the relevant aspects of the same Black Scholes valuation model used by us to value our options and warrants. We have also determined that the fair value of the Rockridge Note, the CCJ Note, the Equipment Notes and the Subordinated Notes may be determined using Level 3 inputs, as follows: third party studies arriving at recommended discount factors for valuing payments made in unregistered restricted stock instead of cash.
Based on the use of the inputs described above, we have determined that there was no material difference between the carrying value and the fair value of the Rockridge Note, the CCJ Note, the Equipment Notes and the Subordinated Notes as of September 30, 2012, September 30, 2011 or September 30, 2010 and therefore no adjustment with respect to fair value was made to our consolidated financial statements as of those dates or for the years ended September 30, 2012 and 2011.
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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Property and Equipment
Property and equipment are recorded at cost, less accumulated depreciation. Property and equipment under capital leases are stated at the lower of the present value of the minimum lease payments at the beginning of the lease term or the fair value at the inception of the lease. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization expense on assets acquired under capital leases is included in depreciation expense. The costs of leasehold improvements are amortized over the lesser of the lease term or the life of the improvement.
Software
Included in property and equipment is computer software developed for internal use, including the Digital Media Services Platform (“DMSP”), the iEncode webcasting software and the MarketPlace365 (“MP365”) platform - see notes 2 and 3. Such amounts have been accounted for in accordance with the Intangibles - Goodwill and Other topic of the ASC and are amortized on a straight-line basis over three to five years, commencing when the related asset (or major upgrade release thereof) has been substantially placed in service.
Goodwill and other intangible assets
In accordance with the Intangibles - Goodwill and Other topic of the ASC, goodwill is reviewed annually (or more frequently if impairment indicators arise) for impairment. 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
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition
Revenues from sales of goods and services are recognized when (i) persuasive evidence of an arrangement between us and the customer exists, (ii) the 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 September 30, 2012 and as of September 30, 2011 was immaterial in relation to our recorded liabilities at those dates.
We include the DMSP and UGC divisions’ revenues, along with the Smart Encoding division’s revenues from hosting, storage and streaming, in the DMSP and hosting revenue caption. We include the EDNet division’s revenues from equipment sales and rentals and the Smart Encoding division’s revenues from encoding and editorial services in the Other Revenue caption.
The DMSP, UGC and Smart Encoding divisions of the Digital Media Services Group recognize revenues from the acquisition, editing, transcoding, indexing, storage and distribution of their customers’ digital media. Charges to customers by these divisions generally include a monthly subscription or hosting fee. Additional charges based on the activity or volumes of media processed, streamed or stored by us, expressed in megabytes or similar terms, are recognized at the time the service is performed. Fees charged for customized applications or set-up are recognized as revenue at the time the application or set-up is completed.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition (continued)
The Infinite division of the Audio and Web Conferencing Services Group generates revenues from audio conferencing and web conferencing services, plus recording and other ancillary services. Infinite owns telephone switches used for audio conference calls by its customers, which are generally charged for those calls based on a per-minute usage rate. Infinite provides online webconferencing services to its customers, charging either a per-minute rate or a monthly subscription fee allowing a certain level of usage. Audio conferencing and web conferencing revenue is recognized based on the timing of the customer’s use of those services.
The EDNet division of the Audio and Web Conferencing Services Group generates revenues from customer usage of digital telephone connections controlled by EDNet, as well as bridging services and the sale and rental of equipment. EDNet purchases digital phone lines from telephone companies (and resellers) and sells access to the lines, as well as separate per-minute usage charges. Network usage and bridging revenue is recognized based on the timing of the customer’s use of those services.
EDNet sells various audio codecs and video transport systems, equipment which enables its customers to collaborate with other companies or with other locations. As such, revenue is recognized for the sale of equipment when the equipment is installed or upon signing of a contract after the equipment is installed and successfully operating. All sales are final and there are no refund rights or rights of return. EDNet leases some equipment to customers under terms that are accounted for as operating leases. Rental revenue from leases is recognized ratably over the life of the lease and the related equipment is depreciated over its estimated useful life. All leases of the related equipment contain fixed terms.
Deferred revenue represents amounts billed to customers for webcasting, EDNet, smart encoding or DMSP services to be provided in future accounting periods. As projects or events are completed and/or the services provided, the revenue is recognized.
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.
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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we establish a valuation allowance. To the extent we establish a valuation allowance or change this allowance in a period, we include an expense or a benefit within the tax provision in our statement of operations.
We have approximately $84 million in Federal net operating loss carryforwards as of September 30, 2012, which expire in fiscal years 2018 through 2032. 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 $84 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 $31.6 million and $34.6 million as of September 30, 2012 and 2011, 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 years ended September 30, 2012 and 2011. The primary differences between the net loss for book and the net loss for tax purposes are the following items expensed for book purposes but not deductible for tax purposes - amortization of certain loan discounts, amortization and/or impairment adjustments of certain acquired intangible assets, and expenses for stock options and shares issued in payment for consultant and employee services but not exercised by the recipients, or in the case of shares, not registered for or eligible for resale.
The Income Taxes topic of the ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. However, as of September 30, 2012 and as of September 30, 2011 we have not taken, nor recognized the financial statement impact of, any material tax positions, as defined above. Our policy is to recognize, as non-operating expense, interest or penalties related to income tax matters at the time such payments become probable, although we had not recognized any such material items in our statement of operations for the years ended September 30, 2012 and 2011. The tax years ending September 30, 2009 and thereafter remain subject to examination by Federal and various state tax jurisdictions.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Net Loss per Share
For the years ended September 30, 2012 and 2011, net loss per share is based on the net loss divided by the weighted average number of shares of common stock outstanding. Since the effect of common stock equivalents was anti-dilutive, all such equivalents were excluded from the calculation of weighted average shares outstanding. The total outstanding options and warrants, which have been excluded from the calculation of weighted average shares outstanding, were 3,181,748 and 3,402,812 at September 30, 2012 and 2011, respectively.
In addition, the potential dilutive effects of the following convertible securities outstanding at September 30, 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) 160,000 shares of Series A-14 Convertible Preferred Stock (“Series A-14”) which were converted into 160,000 shares of ONSM common stock during the three months ended December 31, 2012, (iii) the $878,115 outstanding balance of the Rockridge Note, which could have potentially converted into up to 365,882 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 (and which fee was increased to 591,667 shares in connection with a December 2012 modification - see note 4), (v) $350,000 of Equipment Notes which in aggregate could have potentially converted into up to 583,333 shares of our common stock (and which was renegotiated in December 2012 under terms whereby 583,333 shares would be issued to preliminarily satisfy $175,000 of the outstanding balance and with no conversion rights for the remaining balance - 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 (and which note was renegotiated in December 2012 under terms that did not contain conversion rights - see note 4).
In addition, the potential dilutive effects of the following convertible securities outstanding at September 30, 2011 have been excluded from the calculation of weighted average shares outstanding: (i) 35,000 shares of Series A-13 Convertible Preferred Stock (“Series A-13”) which could have potentially converted into 175,000 shares of ONSM common stock (and of which 17,500 shares were converted into 101,744 shares based on a reduction in the conversion price agreed to by us in January 2012 and 17,500 shares 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 three months ended December 31, 2012, (iii) the $1,245,069 outstanding balance of the Rockridge Note, which could have potentially converted into up to 518,779 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) $385,000 of convertible notes which in aggregate could have potentially converted into up to 396,181 shares of our common stock (and of which $350,000 was subsequently given the right to convert into up to 500,000 common shares - see note 4), excluding interest and (vi) the $110,000 CCJ Note, which could have potentially converted into up to 55,000 shares of our common stock.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Compensation and related expenses
Compensation costs for employees considered to be direct labor are included as part of webcasting and smart encoding costs of revenue. Certain compensation costs for employees involved in development of software for internal use, as discussed under Software above, are capitalized. Accrued liabilities and amounts due to directors and officers includes, in aggregate, approximately $966,000 and $794,000 as of September 30, 2012 and September 30, 2011, 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. The Compensation - Stock Compensation topic of the ASC requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value, which we adopted as of October 1, 2006 (the required date) and first applied during the year ended September 30, 2007, using the modified-prospective-transition method. Under this method, compensation cost recognized for the years ended September 30, 2012 and 2011 includes compensation cost for all share-based payments granted subsequent to September 30, 2006, calculated using the Black-Scholes model, based on the estimated grant-date fair value and allocated over the applicable vesting and/or service period. As of October 1, 2006, there were no outstanding share-based payments granted prior to that date, but not yet vested. For Plan options that were granted and thus valued under the Black-Scholes model during the year ended September 30, 2012, the expected volatility rates were approximately 94% to 97%, the risk-free interest rates were approximately 0.4% to 1.1% and the expected terms were 3 to 5 years. For Plan options that were granted and thus valued under the Black-Scholes model during the year ended September 30, 2011, the expected volatility rate was approximately 94%, the risk-free interest rate was approximately 1.5% and the expected term was approximately 4 years.
We have granted Non-Plan Options to consultants and other third parties. These options have been accounted for under the Equity topic (Equity-Based Payments to Non-Employees subtopic) of the ASC, under which the fair value of the options at the time of their issuance, calculated using the Black-Scholes model, is reflected as a prepaid expense in our consolidated balance sheet at that time and expensed as professional fees during the time the services contemplated by the options are provided to us. There were no Non-Plan options granted during the year ended September 30, 2012. For Non-Plan options that were granted and thus valued under the Black-Scholes model during the year ended September 30, 2011, the expected volatility rate was approximately 94%, the risk-free interest rate was approximately 1.5% and the expected term was 4 years.
In all valuations above, expected dividends were $0 and the expected term was the full term of the related options (or in the case of extended options, the incremental increase in the option term as compared to the remaining term at the time of the extension). See Note 8 for additional information related to all stock option issuances.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 $710,000 and $712,000 for the years ended September 30, 2012 and 2011, 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, revenue reserves, inventory reserves, depreciation and amortization lives and methods, income taxes and related reserves, contingencies and goodwill and other impairment allowances. Such estimates are reviewed on an on-going basis and actual results could be materially affected by those estimates.
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 is effective for our fiscal year ending September 30, 2013, is to be adopted prospectively and early adoption is not permitted. We do not believe the adoption of this guidance will have a 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 is effective for our fiscal year ending September 30, 2013, is to be applied retrospectively and early adoption is permitted. We do not believe adoption of this guidance will have a material impact on our consolidated financial statements.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Effects of Recent Accounting Pronouncements (continued)
In September 2011, the FASB issued ASC update number 2011-08 - Software (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 apply this guidance to our fiscal year ended September 30, 2011 and the related annual impairment tests - see note 2. We do not believe the adoption of this guidance had a material impact on our consolidated financial statements.
In July 2012, the FASB issued ASU 2012-02, “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 for our fiscal year ended September 30, 2012. We do not believe the adoption of this guidance had a material impact on our consolidated financial statements.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
Information regarding the Company’s goodwill and other acquisition-related intangible assets is as follows:
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
SEPTEMBER 30, 2012
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
SEPTEMBER 30, 2012
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 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. Our response to the June 2012 rejection is due on or before April 7, 2013, which will require payment of extension fees (because our filing will be after November 7, 2012). 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
SEPTEMBER 30, 2012
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. Furthermore, as discussed in “Testing for Impairment” below (i) the Acquired Onstream goodwill was determined to be further impaired as of September 30, 2011 and a $1.7 million adjustment was made to reduce the carrying value of that goodwill to approximately $821,000 as of that date and (ii) the Acquired Onstream goodwill was determined to be further impaired as of September 30, 2012 and a $550,000 adjustment was made to reduce the carrying value of that goodwill to approximately $271,000 as of that date. These adjustments were reflected in our results of operations for the years ended September 30, 2012 and 2011, respectively, as a charge for impairment of goodwill and other intangible assets.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
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 goodwill of $2,799,000 associated with the acquisition of EDNet. 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 associated with EDNet was written down to approximately $2,071,000 as of that date. 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 associated with EDNet was written down to approximately $1,601,000 as of that date. 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 associated with EDNet was written down to approximately $1,271,000 as of that date. 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.
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
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued)
Testing for Impairment (continued)
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.
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.
NOTE 3: PROPERTY AND EQUIPMENT
Property and equipment, including equipment acquired under capital leases, consists of:
Depreciation and amortization expense for property and equipment was approximately $881,000 and $973,000 for the years ended September 30, 2012 and 2011, 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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 3: PROPERTY AND EQUIPMENT (Continued)
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.
In connection with development of “Streaming Publisher”, a second version of the DMSP with additional functionality, we have capitalized as part of the DMSP approximately $1.0 million of employee compensation, payments to contract programmers and related costs as of September 30, 2012. As of September 30, 2012, approximately $781,000 of these Streaming Publisher costs had been placed in service and are being depreciated over five years. 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 September 30, 2012 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. $297,000 of these costs, for phase one of MP365, were placed in service on August 1, 2010 and another $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 phase of MP365 under development. MP365 development costs exclude costs for development of Streaming Publisher, discussed separately above; and
(ii) approximately $1.1 million of employee compensation and other costs for the development of webcasting applications, including iEncode software, which runs on a self-administered, webcasting appliance used to produce a live video webcast. As of September 30, 2012, $820,000 of these costs had been placed in service and are being depreciated over five years. The remainder of the costs have not been placed in service and relate primarily to a new release of the webcasting platform that is under development.
The capitalized software development costs discussed above are summarized as follows:
Period
DMSP
MP365
Webcasting
Totals
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 September 30, 2012
$ 1,004,000
$ 1,361,000
$ 1,137,000
$ 3,502,000
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT
Debt includes convertible debentures and notes payable (including capitalized lease obligations).
Convertible Debentures
Convertible debentures consist of the following:
September 30,
September 30,
Rockridge Note
$ 878,115
$ 1,245,069
Equipment Notes
350,000
385,000
CCJ Note
100,000
110,000
Total convertible debentures
1,328,115
1,740,069
Less: discount on convertible debentures
(118,887)
(300,409)
Convertible debentures, net of discount
1,209,228
1,439,660
Less: current portion, net of discount
( 407,384)
( 407,790)
Convertible debentures, net of current portion
$ 801,844
$ 1,031,870
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, will be 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. 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 terms of payment. As consideration for the second Allonge to the Note, the loan origination fee was increased as discussed in more detail below.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Convertible Debentures (continued)
Rockridge Note (continued)
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.
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 September 30, 2012, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if the closing ONSM share price of $0.29 per share on January 11, 2013 was used as a basis of calculation, the required payment would be approximately $75,000.
F- 29
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Convertible Debentures (continued)
Rockridge Note (continued)
366,667 of the origination fee Shares discussed above are considered earned by Rockridge as of September 30, 2012 and had a fair market value of approximately $626,000 at the date of the Rockridge Agreement or the Amendment, as applicable. The value of these Shares, plus legal fees of $55,337 paid by us in connection with the Rockridge Agreement, were reflected as a $681,337 discount against the Rockridge Note (as well as a corresponding increase in additional paid-in capital for the value of the Shares), which is being amortized as interest expense over the term of the Rockridge Note. The unamortized portion of this discount was $78,771 and $251,059 as of September 30, 2012 and September 30, 2011, respectively. The value of the remaining origination fee Shares arising from the December 2012 Allonge discussed above will be reflected as a discount against the Rockridge Note (as well as a corresponding increase in additional paid-in capital for the value of the Shares on the date of the second Allonge to the Note) and amortized as interest expense over the remaining term of the Rockridge Note, as modified.
The effective interest rate of the Rockridge Note was approximately 44.3% per annum, until the September 2009 amendment, when it was reduced to approximately 28.0% per annum. The December 2012 amendment will increase the effective interest rate 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.
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. This included $50,000 received from CCJ Trust (“CCJ”). CCJ is a trust for the adult children of Mr. Charles Johnston, one of our directors, and he disclaims any beneficial ownership interest in CCJ. We issued notes to those Investors (the “Equipment Notes”), which had an original maturity date of June 3, 2011.
The Equipment Notes are 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, is not considered sufficient security for the loan. The outstanding principal is due on demand in the event a payment default is uncured ten (10) business days after written notice. Investors holding in excess of 50% of the outstanding principal amount of the Equipment Notes may declare a default and may take steps to amend or otherwise modify the terms of the Equipment Notes and related security agreement.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Convertible Debentures (continued)
Equipment Notes (continued)
In various transactions from April 4, 2011 through July 20, 2011 certain of the Equipment Notes, including the note held by CCJ, were amended to allow the conversion of an aggregate $550,000 of the original note amount into common shares, using conversion prices from $0.90 to $1.20 per share. As a result, we issued an aggregate of 513,889 unregistered common shares. The aggregate market value of these 513,889 shares at the times of their respective issuances exceeded the carrying value of the related Equipment Notes by $218,361, which excess was recognized as non-cash interest expense for the year ended September 30, 2011. $50,000 of the remaining principal outstanding under the Equipment Notes was repaid by us with cash in July 2011 and another $15,000 was repaid with cash in September 2011.
After the principal repayments in cash and conversions of principal to common shares, as discussed above, the outstanding principal balance under the Equipment Notes was $385,000 as of September 30, 2011. $350,000 (including $25,000 remaining due under the note held by CCJ) of this $385,000 was amended in July 2011 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 in the aggregate amount of $350,000 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. The remaining $35,000 of the $385,000 outstanding under the Equipment Notes as of September 30, 2011 was satisfied by our repayment of approximately $27,000 in February 2012 and approximately $8,000 in December 2012.
Effective May 14, 2012 the terms of 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 the May 14, 2012 modification was not materially different from the present value of the cash flows before the modification, under the provisions of ASC 470-50-40, "Derecognition" if the conversion rate modification results in a change in the fair value of the conversion option 10% or greater than the carrying value of the Equipment Notes immediately before such 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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Convertible Debentures (continued)
Equipment Notes (continued)
We have determined that the fair value of the conversion option of the Equipment Notes as modified to $0.60 per share is zero, which represents no change in the value of the conversion option before such modification, and as a result this transaction is not being treated as a debt extinguishment. 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 our 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 Board approval was obtained, the June 12, 2012 Board approval date of this transaction, 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 exchange for a modification of the scheduled principal payment date 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 is classified as non-current on our September 30, 2012 balance sheet based on the modified terms of payment. As part of the December 2012 modification, we also agreed to issue the Noteholders an aggregate of 583,335 restricted common shares (split into two tranches on January 15 and June 30, 2013), which will 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) resulting in a Credited Value of $175,000 and a remaining outstanding Equipment Notes balance of $175,000. Upon issuance of these shares, the remaining outstanding Equipment Notes balance will no longer be convertible into any additional common shares.
On the Maturity Dates, 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 shares issued per the above plus (ii) the value of the shares issued per the above 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 the outstanding Equipment Notes balance shall be reduced, but to no less than zero, by 50% (fifty percent) of such excess. If the Credited Value exceeds the Recognized Value, then the outstanding Equipment Notes balance shall be increased by such excess.
In lieu of cash payments for interest previously due on these Equipment Notes, we elected to issue the following unregistered common shares to the Investors, which in aggregate represent all interest from November 1, 2010 through September 30, 2011 on the Equipment Notes and were recorded based on the fair value of those shares on the issuance date.
Share issuance date
Number of unregistered common shares
Interest period
Interest if paid in cash
Fair value of shares at issuance
April 28, 2011
28,810
Nov 2010 - March 2011
$24,986
$50,129
July 21, 2011
5,233
Nov 2010 - June 2011
$ 6,279
$ 5,076
October 11, 2011
51,531
Nov 2010 - Sept 2011
$48,883
$38,648
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Convertible Debentures (continued)
Equipment Notes (continued)
In accordance with the October 2011, May 2012 and December 2012 amendments to the Equipment Notes, interest at 12% per annum is payable in semi-annual installments on April 15, 2012, October 15, 2012 and April 15, 2013, plus a final interest payment on the Maturity Dates. Interest is payable in cash or, at our option, in restricted ONSM common shares, based on a conversion price equal to seventy-five percent (75%) of the average ONSM closing price for the thirty (30) trading days prior to the date the applicable payment is due. The interest payments due on April 15, 2012 and October 15, 2012 were paid in cash.
From October 1, 2011 to May 12, 2012, the effective interest rate of the Equipment Notes was 12% per annum, excluding the effect of any premium or discount arising from our payment of principal or interest in common shares instead of cash, based on the market prices of our common shares at the time of issuance. The $49,000 fair value of the shares issued as part of the May 12, 2012 modification was recorded as a discount and is being amortized as interest expense over the remaining term of the Equipment Notes, resulting in a current effective interest rate of approximately 26% per annum. The unamortized portion of this discount was $30,625 as of September 30, 2012. The value of the 140,000 shares issued in December 2012, as discussed above, will be reflected as a discount against the Equipment Notes (as well as a corresponding increase in additional paid-in capital for the value of the shares on the date of issuance) and amortized as interest expense over the remaining term of the Equipment Notes, as modified, which will result in an effective interest rate at that point of approximately 46% per annum.
CCJ Note
On December 29, 2009, we entered into an agreement with CCJ converting a previously received $200,000 advance to an unsecured subordinated note (the “CCJ Note”) bearing 8% interest per annum and payable in equal monthly installments of principal and interest for 48 months plus a $100,000 principal balloon at maturity, although none of those payments were subsequently made by us. To resolve this payment default, the CCJ Note was amended in January 2011 to prospectively increase the interest rate to 10% per annum, payable quarterly, and to require two principal payments of $100,000 each on December 31, 2011 and 2012, respectively. In connection with this amendment, we paid $16,263 in cash for the previously accrued interest. On July 22, 2011, in order to reduce our near-term cash requirements, we agreed to convert $90,000 of the $100,000 December 31, 2011 principal payment to 100,000 restricted common shares. Although the market value of these shares at the time of the agreement exceeded the related principal amount by $38,000, we did not make the shares physically available to CCJ until two weeks later, by which time the market price had reduced to a level equal to the related principal amount. Accordingly, we determined that there was not an effective conversion premium over market and therefore there was no recognition of additional non-cash interest expense other than the write-off of debt discount as discussed below. The remaining $10,000 principal, plus the interest due on the $90,000 from April 1, 2011 and the interest due on the $10,000 from July 22, 2011, was paid with cash in January 2012.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Convertible Debentures (continued)
CCJ Note (continued)
Three quarterly interest payments on the remaining outstanding $100,000 balance were subsequently made in cash 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 January 1, 2013 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 is 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 January 1, 2013 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 (which was $3.00 per share prior to the January 2011 renegotiation). The January 1, 2013 replacement note has no conversion rights.
In conjunction with and in consideration of the December 29, 2009 note transaction, the 35,000 shares of Series A-12 held by CCJ at that date were exchanged for 35,000 shares of Series A-13 plus four-year warrants for the purchase of 29,167 ONSM common shares at $3.00 per share - 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 the January 2011 note amendment, 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 will be 12% per annum.
The unamortized portion of the debt discount was $9,491 and $49,350 at September 30, 2012 and September 30, 2011, respectively. Through December 31, 2010, the discount was being amortized as interest expense over the original four-year term of the CCJ Note. Effective January 1, 2011, the remaining unamortized discount, plus additional discount arising from the modified terms, is being amortized as interest expense over the modified two-year term of the CCJ Note. Approximately $29,000 of the discount was written off to interest expense in July 2011 in connection with the conversion of $90,000 debt principal to common shares, as discussed above.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Notes and Leases Payable
Notes and leases payable consist of the following:
September 30,
September 30,
Line of Credit Arrangement
$ 1,526,648
$ 1,531,318
Subordinated Notes
300,000
-
Equipment notes and leases
65,590
20,103
Total notes and leases payable
1,892,238
1,551,421
Less: discount on notes payable
(51,396)
(5,493)
Notes and leases payable, net of discount
1,840,842
1,545,928
Less: current portion, net of discount
( 1,650,985)
( 1,533,966)
Long term notes and leases payable, net of current portion
$ 189,857
$ 11,962
Line of Credit Arrangement
In December 2007, we entered into a line of credit arrangement (the “Line”) with a financial institution (the “Lender”) under which we may presently borrow up to an aggregate of $2.0 million for working capital, collateralized by our accounts receivable and certain other related assets. Mr. Leon Nowalsky, a member of our Board of Directors, is also a founder and board member of the Lender.
The outstanding balance bears interest at 12.0% per annum (13.5% prior to December 27, 2011), adjustable based on changes in prime after December 28, 2009, payable monthly in arrears. We also incur a weekly monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit, payable monthly in arrears.
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”), effective with the September 30, 2010 quarter. The Covenant, as defined in the applicable loan documents for quarterly periods through December 31, 2011, requires that our net income or loss, adjusted to remove all non-cash expenses as well as cash interest expense, be equal to or greater than that same cash interest expense. We were in compliance with this Covenant for the September 30, 2010 quarter. The Lender waived the Covenant requirement for the December 31, 2010 quarter, but charged us additional interest of 3% per annum from the March 16, 2011 waiver date through May 16, 2011, when we demonstrated that we were in compliance with the Covenant for the March 31, 2011 quarter. We were also in compliance with this Covenant for the June 30, September 30 and December 31, 2011 quarters.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Notes and Leases Payable (continued)
Line of Credit Arrangement (continued)
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 were in compliance with this Covenant for the March 31, June 30 and September 30, 2012 quarters.
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.
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. These amounts paid were $44,802 and $25,897 for the year ended September 30, 2012 and 2011, respectively. The unamortized portion of the debt discount was $23,446 and $5,493 as of September 30, 2012 and 2011, 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 $1.0 million Equipment Notes we issued in June and July 2008 and the Rockridge Note we issued for $1.0 million in April 2009 and amended to $2.0 million in September 2009. 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 allowable under one of the exceptions noted above.
Subordinated Notes
During the period from March 9, 2012 through June 1, 2012, we received an aggregate of $300,000 from three unrelated lenders in exchange for our issuance of three unsecured subordinated promissory notes (“Subordinated Notes”), which are fully subordinated to the Credit Line and the Rockridge Note or any assignees or successors thereto. Details of each note are as follows:
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 4: DEBT (Continued)
Notes and Leases Payable (continued)
Subordinated Notes (continued)
On March 9, 2012 we received $100,000 for a 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 will be amortized as interest expense over the one year term. Including this discount, the effective interest rate of this note is approximately 30% per annum. Interest payments were made on this note through November 30, 2012, at which time we issued an Intella2 Investor Note (see note 9) for $100,000 in exchange for the satisfaction of this note. The outstanding principal balance on the previously issued note was due in full by March 9, 2013 and was bearing interest at 15% per annum. The balance due under this note is classified as non-current on our September 30, 2012 balance sheet based on the terms of payment of the Intella2 Investor Note that replaced it. This investor also purchased and funded $100,000 for a second Intella2 Investor Note. After this transaction, the total outstanding principal balance of the Intella2 Investor Notes was $450,000 and the amount held by this investor was $200,000.
On April 30, 2012 we received $100,000 for a 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 is being amortized as interest expense over the one year term. Including this discount, the effective interest rate of this note is 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. The next interest payment (for the preceding three months) is due on January 31, 2013 and every three months thereafter through October 31, 2014. The value of the additional shares issued in December 2012 will be 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 amortized as interest expense over the remaining term of the note, as modified, which will result in an effective interest rate at that point of approximately 21% per annum.
On June 1, 2012 we received $100,000 for a note bearing interest at 12% per annum. The principal is payable in equal monthly installments of $8,333 starting January 1, 2013, with the balance of $58,333 payable on June 1, 2013. Interest for the first six months is payable on December 1, 2012 and is payable thereafter on a monthly basis. 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.
The aggregate unamortized portion of the debt discount recorded against the Subordinated Notes was $27,950 as of September 30, 2012.
The minimum cash payments required for the convertible debentures, notes payable and capitalized lease obligations listed above, including the impact of any renegotiated terms, are as follows:
Year Ending September 30:
$
2,137,893
892,951
189,509
-
-
Total minimum debt payments
$
3,220,353
The Line is shown as a fiscal 2013 payment, based on its balance sheet classification, even though the Line does not expire until December 2014. The entire outstanding balance of the Equipment Notes is shown as a fiscal 2014 payment, even though a certain portion of that balance is scheduled to be reduced by the issuance of common shares in fiscal 2013, since we have agreed to reimburse any shortfall upon the resale of those shares, with such reimbursement due in fiscal 2014. The amounts shown above are before deducting any unamortized discount.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
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”. On May 15, 2008 and August 11, 2009 our Compensation Committee and Board approved certain corrections and modifications to those agreements, which are reflected in the discussion of the terms of those agreements below. The agreements provide that the initial term shall automatically be extended for successive one (1) year terms thereafter unless (a) the parties mutually agree in writing to alter the terms of the agreement; or (b) one or both of the parties exercises their right, pursuant to various provisions of the agreement, to terminate the employment relationship.
The agreements provide initial annual base salaries of $253,000 for Mr. Selman, $230,000 for Mr. Saperstein, $207,230 for Mr. Tomlinson and $197,230 for Messrs. Friedland and Glassman, plus 10% annual increases through December 27, 2008 and 5% per year thereafter. In addition, each of the Executives receives an auto allowance payment of $1,000 per month, a “retirement savings” payment of $1,500 per month and an annual reimbursement of dues or charitable donations up to $5,000. We also pay insurance premiums for the Executives, including medical, life and disability coverage. These agreements contain certain non-disclosure and non-competition provisions and we have agreed to indemnify the Executives in certain circumstances.
Effective October 1, 2009, a significant portion of our workforce, including the Executives, took a 10% payroll reduction, which we expect will be maintained until increased revenue levels result in positive cash flow (sufficient to cover capital expenditures and debt service). However, even though this 10% was deducted from the amounts paid to the Executives and the contractually scheduled September 28, 2010 and September 28, 2011 raises were not given effect, no adjustment was made to the terms of their related employment agreements, as set forth above, to reflect these matters. 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 withheld compensation. The common shares are restricted from trading unless Board approval is given and the options are as of now unvested. A portion of the accrued liability under the caption “Amounts due to executives and officers” on our September 30, 2012 balance sheet pertains to the unresolved contractual obligations, to the extent not addressed by the issuance of restricted shares and options discussed above. We do not expect that the ultimate resolution of this matter will have a materially adverse effect on our financial position or results of operations.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)
Employment contracts and severance (continued)
Under the terms of the above employment agreements, upon a termination subsequent to a change of control, termination without cause or constructive termination, each as defined in the agreements, we would be obligated to pay each of the Executives an amount equal to three times the Executive’s base salary plus full benefits for a period of the lesser of (i) three years from the date of termination or (ii) the date of termination until a date one year after the end of the initial employment contract term. We may defer the payment of all or part of this obligation for up to six months, to the extent required by Internal Revenue Code Section 409A. In addition, if the five day average closing price of the common stock is greater than or equal to $6.00 per share on the date of any termination or change in control, all options previously granted the Executive(s) will be cancelled, with all underlying shares (vested or unvested) issued to the executive, and we will pay all related taxes for the Executive(s). If the five-day average closing price of the common stock is less than $6.00 per share on the date of any termination or change in control, the options will remain exercisable under the original terms.
Under the terms of the above employment agreements, we may terminate an Executive’s employment upon his death or disability or with or without cause. To the extent that an Executive is terminated for cause, no severance benefits are due him. If an employment agreement is terminated as a result of the Executive’s death, his estate will receive one year base salary plus any bonus or other compensation amount or benefit then payable or that would have been otherwise considered vested or earned under the agreement during the one-year period subsequent to the time of his death. If an employment agreement is terminated as a result of the Executive’s disability, as defined in the agreement, he is entitled to compensation in accordance with our disability compensation for senior executives to include compensation for at least 180 days, plus any bonus or other compensation amount or benefit then payable or that would have been otherwise considered vested or earned under the agreement during the one-year period subsequent to the time of his disability.
The above employment agreements also provide that in the event we are sold for a Company Sale Price that represents at least $6.00 per share (adjusted for recapitalization including but not limited to splits and reverse splits), the Executives will receive, as a group, cash compensation of twelve percent (12.0%) of the Company Sale Price, payable in immediately available funds at the time of closing such transaction. The Company Sale Price is defined as the number of Equivalent Common Shares outstanding at the time we are sold multiplied by the price per share paid in such Company Sale transaction. The Equivalent Common Shares are defined as the sum of (i) the number of common shares issued and outstanding, (ii) the common stock equivalent shares related to paid for but not converted preferred shares or other convertible securities and (iii) the number of common shares underlying “in-the-money” warrants and options, such sum multiplied by the market price per share and then reduced by the proceeds payable upon exercise of the “in-the-money” warrants and options, all determined as of the date of the above employment agreements but the market price per share used for this purpose to be no less than $6.00. The 12.0% is allocated in the employment agreements as two and one-half percent (2.5%) each to Messrs. Selman, Saperstein, Friedland and Glassman and two percent (2.0%) to Mr. Tomlinson.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)
Employment contracts and severance (continued)
On January 14, 2011 our Compensation Committee agreed that it would approve amendments to the executive employment agreements, as well as amending the same terms as applicable to the Board members (see below), allowing for all or part of such compensation to be paid in shares at the recipient’s option, at any time if our stock is trading above $6.00 per share, without requiring that we be sold. The issuance of such shares would be to the extent permitted by applicable law and subject to shareholder and/or any other required regulatory approvals.
Other compensation
In addition to the 12% allocation of the Company Sale Price to the Executives, as discussed above, on August 11, 2009 our Compensation Committee determined that an additional three percent (3.0%) of the Company Sale Price would be allocated, on the same terms, with two percent (2.0%) allocated to the then four outside Directors (0.5% each), as a supplement to provide appropriate compensation for ongoing services as a director and as a termination fee, one-half percent (0.5%) allocated to one additional executive-level employee and the remaining one-half percent (0.5%) to be allocated by the Board and our management at a later date, which will be primarily to compensate other executives not having employment contracts, but may also include additional allocation to some or all of these five senior Executives. On June 5, 2010, one of the four outside Directors passed away and on April 18, 2011 Mr. Robert D. ("RD") Whitney was appointed to fill that outside director seat. The status of this item, both with respect to the deceased outside director and/or the new outside director, has not been further addressed by the Compensation Committee to date.
Lease commitments
As of September 30, 2012, 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 are obligated for rent under a New York City office lease expiring on January 31, 2013 as well as for rent under a New York City office lease signed by us at another location which will replace the expiring location and is discussed in more detail below - although both leases are included in the total minimum rental obligation set forth below, this is only counted as one New York City location in the above office count. 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 9 - 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 provides for two percent (2%) annual increases, as well as one two-year renewal option, with a three percent (3%) rent increase in year one.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)
Lease commitments (continued)
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.
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 provides includes a one one-year renewal option, with no rent increase.
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 leases, plus the capital leases included in Notes Payable (see note 4), are as follows:
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; Jersey City, New Jersey and Colorado Springs, Colorado. 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 $802,000 and $842,000 for the years ended September 30, 2012 and 2011, respectively.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
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 $1.0 million, 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.
NOTE 6: CAPITAL STOCK
Common Stock
During the year ended September 30, 2011, we repaid certain debt by the issuance of common stock, as follows: (i) the $344,000 principal balance due under the Wilmington Notes by a cash payment of $238,756 plus the issuance of 137,901 common shares valued at approximately $110,000, which cash and shares also included the settlement of all cash and non-cash interest and fees otherwise due, (ii) the $172,000 principal balance due under the Lehmann Note by the issuance of 209,700 common shares, which shares also included the settlement of all accrued interest and fees otherwise due and were valued at approximately $178,000, (iii) $550,000 of the principal balance due under the Equipment Notes by the issuance of 513,889 common shares which were valued at approximately $769,000 and (iv) $90,000 of the principal balance due under the CCJ Note by the issuance of 100,000 common shares which were valued at approximately $90,000. Also, during the year ended September 30, 2011, we issued 110,812 unregistered common shares valued at approximately $127,000 for interest on the Equipment Notes. See note 4 for further details.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 6: CAPITAL STOCK (Continued)
Common Stock (continued)
During the year ended September 30, 2011 we issued 730,576 common shares for financial consulting and advisory services, comprised of (i) 532,686 unregistered common shares valued at approximately $531,000 and (ii) 197,890 unregistered common Plan shares valued at approximately $208,000. We also issued options to purchase our common shares, valued at approximately $190,000, for financial consulting and advisory services. These shares and options will be recognized as professional fees expense and as other general and administrative expense over various service periods of up to 12 months. None of these shares or options were issued to our directors or officers, except 30,519 shares issued to director Charles Johnston for his services as audit committee chairman for fiscal 2011.
During the year ended September 30, 2011 we issued 21,000 unregistered common shares for Series A-13 dividends for 2010 and the first and second calendar quarters of 2011, as discussed in more detail below.
During the year ended September 30, 2011 we issued 41,073 restricted common shares as partial satisfaction of withheld compensation - see note 4. This was the only issuance of shares included in the approximately $1.2 million recorded as an increase to shareholder’s equity for the issuance of shares and options for employee services during the year ended September 30, 2011.
During the year ended September 30, 2012 we issued 352,421 common shares for financial consulting and advisory services, comprised of (i) 30,000 unregistered common shares valued at approximately $29,000 (ii) 255,113 unregistered common Plan shares valued at approximately $149,000 and (iii) 67,308 unregistered common Plan shares valued at approximately $44,000. The first two tranches are being recognized as professional fees expense and as other general and administrative expense over various service periods of up to twelve months. The third tranche was issued in satisfaction of a previously accrued liability for consulting services performed over the thirty month period ended March 31, 2012. None of these shares were issued to our directors or officers.
Professional fee expenses arising from these and prior issuances of shares and options for financial consulting and advisory services were approximately $607,000 and $582,000 for the years ended September 30, 2012 and 2011, respectively. As a result of previously issued shares and options for financial consulting and advisory services, we have recorded approximately $69,000 in deferred equity compensation expense at September 30, 2012, 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.
During the year ended September 30, 2012, we issued 201,531 common shares for interest and fees, comprised of (i) 51,531 unregistered common shares valued at approximately $39,000 for interest on the Equipment Notes, (ii) 80,000 unregistered common shares valued at approximately $48,000 for origination and finders fees for the Subordinated Notes and (iii) 70,000 unregistered common shares valued at approximately $49,000 for the renegotiation and extension of the Equipment Notes. See note 4.
During the year ended September 30, 2012 we issued 7,000 unregistered common shares for Series A-13 dividends for the third and fourth calendar quarters of 2011, as discussed in more detail below. During March 2012 we issued 101,744 common shares as a result of the conversion of Series A-13, as discussed in more detail below. During September 2012 we issued 260,000 common shares as a result of the conversion of Series A-14, as discussed in more detail below.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
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 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). See notes 6 and 8 for further details with respect to the Series A-14 and the warrant.
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 market price of our common stock has been less than $0.75 per share for a large majority of the trading days since that date and the closing market price was $0.29 per share on January 11, 2013. 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 (which is after giving effect to the terms of an April 28, 2011 amendment) but may be terminated by us at any time after the first year at our discretion without any cost to us and may be terminated by us at any time in the event LPC does not purchase shares as directed by us in accordance with the terms of the Purchase Agreement. LPC may terminate the Purchase Agreement upon certain events of default set forth therein, including but not limited to the occurrence of a material adverse effect, delisting of our common stock and the lack of immediate relisting on one of the specified alternate markets and the lapse of the effectiveness of the applicable registration statement for more than the specified number of days. As a result of the October 22, 2012 transfer of the listing of our common shares from NASDAQ to OTCQB, as discussed in note 9, 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
SEPTEMBER 30, 2012
NOTE 6: CAPITAL STOCK (Continued)
Common Stock (continued)
The shares of common stock sold and issued under the Purchase Agreement, and the shares of common stock issuable upon conversion of Series A-14, were sold and issued pursuant to prospectus supplements filed by us on September 24, 2010 and on July 1, 2011 with the Securities and Exchange Commission in connection with a takedown of an aggregate of 4,100,000 million shares from our Shelf Registration. In connection with the Purchase Agreement, we also entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with LPC, dated September 17, 2010, under which we agreed, among other things, to use our best efforts to keep the registration statement effective until the maturity date as defined in the Purchase Agreement and to indemnify LPC for certain liabilities in connection with the sale of the securities. As a result of the October 22, 2012 transfer of the listing of our common shares from NASDAQ to OTCQB, as discussed in note 9, and the resulting loss of our S-3 eligibility, this registration statement is no longer effective. However, since there are no specified damages payable by us in the event of a default under the Registration Rights Agreement, we have determined that this is not a registration payment arrangement, as that term is defined in the Derivatives and Hedging topic (Contracts in Entity’s own Equity subtopic) of the ASC.
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. This transaction was unrelated to the Purchase Agreement.
Preferred Stock
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. On March 2, 2011, we filed an A-13 Designation with the Florida Secretary of State, reflecting certain changes arising from a January 2011 agreement with CCJ, as discussed below. On January 20, 2012, we filed an A-13 Designation with the Florida Secretary of State, reflecting certain changes arising from a January 2012 agreement with J&C Resources, as discussed below. On December 21, 2012, we filed an A-13 Designation with the Florida Secretary of State, reflecting certain changes arising from a December 2012 agreement with J&C Resources, as discussed below. The Series A-13 has a coupon of 8% per annum, an assigned value of $10.00 per preferred share and a conversion rate of $0.40 per common share (after the December 21, 2012 modification). Series A-13 dividends are cumulative and must be fully paid by us prior to the payment of any dividend on our common shares. Series A-13 dividends are payable in cash or at our option in the form of our common shares, using the greater of (i) $2.00 per share or (ii) the average closing bid price of a common share for the five trading days immediately preceding the conversion.
In conjunction with and in consideration of a January 2011 note transaction entered into by us with CCJ (see note 4), it was agreed that certain terms of the Series A-13 (of which 35,000 shares were held by CCJ at that date) would be modified so that the conversion rate to common shares, as well as the minimum conversion rate for payment of dividends in common shares, was adjusted from $3.00 to $2.00 per share; the maturity date was adjusted from December 31, 2011 to December 31, 2012 and dividends would be paid quarterly instead of just upon conversion.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 6: CAPITAL STOCK (Continued)
Preferred Stock (continued)
Series A-13 Convertible Preferred Stock (continued)
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 paid over a one year period 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 all Series A-13 shares (of which CCJ owned an additional 17,500 shares) 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 are amortizing to interest expense as a cost of the funding commitment letter over its one-year term commencing in January 2012. Through September 30, 2012 we had paid $42,000 against the shortfall liability and the remaining balance of $43,279 was included in a January 1, 2013 note issued to CCJ - 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 Lincoln Park Capital arising from certain 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.
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
SEPTEMBER 30, 2012
NOTE 6: CAPITAL STOCK (Continued)
Preferred Stock (continued)
Series A-13 Convertible Preferred Stock (continued)
In lieu of cash payments for dividends due on Series A-13, 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
As of September 30, 2012, accrued but unpaid Series A-13 dividends of $14,000 for the first three calendar quarters of 2012 were reflected as a current liability on our balance sheet. On December 31, 2012 we issued 8,750 common shares to CCJ, using the $2.00 per share minimum conversion rate, in lieu of $17,500 Series A-13 dividends for the twelve months then ended.
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. Series A-14 has a stated value of $1.25 per preferred share and a fixed conversion rate of $1.25 per common share. Series A-14 had a onetime 5% dividend payable in cash on the first anniversary of the original issue date, which was satisfied by our $26,250 cash payment on September 20, 2011. Series A-14 is senior to our common stock but subordinate to Series A-13 and the holders of Series A-14 shall not be entitled to vote on any matters as to which holders of our common shares are entitled to vote. Series A-14 is redeemable at our option for $1.56 per share plus accrued but unpaid dividends, provided that the holder has the right to convert to common during a ten day notice period prior to such redemption. The holders of Series A-14 may convert, at the option of the holder and subject to certain limitations, each share of Series A-14 into one fully-paid, non-assessable share of our common stock. Any shares of Series A-14 that are still outstanding as of second annual anniversary of the original issue date shall automatically be converted into our common shares, using the same ratio.
As discussed above, on September 17, 2010, we entered into a Purchase Agreement whereby LPC agreed to an initial purchase of common stock plus shares of Series A-14. We issued 420,000 shares of Series A-14 to LPC on September 24, 2010. The shares issuable upon conversion of Series A-14 were registered for resale subject to the LPC Registration Rights Agreement.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 6: CAPITAL STOCK (Continued)
Preferred Stock (continued)
Series A-14 Convertible Preferred Stock (continued)
Although based on the above, the 420,000 shares of Series A-14 owned by LPC would automatically convert to common shares on September 24, 2012, the Series A-14 Designation also provides that the number of shares of ONSM common stock that can be issued upon the conversion of Series A-14 is limited to the extent necessary to ensure that following the conversion the total number of shares of ONSM common stock beneficially owned by the holder does not exceed 4.999% of our issued and outstanding common stock, although this percentage may be changed at the holder’s option upon not less than 61 days advance notice to us and provided the changed limitation does not exceed 9.99%. 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 three months ended December 31, 2012.
The fair value of the warrant issued in connection with the Purchase Agreement was calculated to be approximately $386,000 using the Black-Scholes model (with the assumptions including expected volatility of 105% and a risk free interest rate of 1.08%). The common shares issued as a one-time commitment fee in connection with the Purchase Agreement were valued at approximately $55,000, based on the quoted market value on the date of issuance. The aggregate of these two items, plus the cash out-of-pocket costs incurred by us in connection with the Purchase Agreement, was allocated on a pro-rata basis between the number of common shares sold and the common shares underlying the Series A-14. The amount allocated to the Series A-14, $298,639, was recorded on our balance sheet as a discount and was amortized as a dividend over the term of the Series A-14. The unamortized portion of the discount was zero and $146,418 at September 30, 2012 and 2011, respectively. See Note 8 with respect to the recording of the warrant as a liability on our September 30, 2012 and 2011 balance sheets.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
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. All material sales, as well as property and equipment, are within the United States. Detailed below are the results of operations by segment for the years ended September 30, 2012 and 2011 and total assets by segment as of September 30, 2012 and 2011.
September 30,
September 30,
Assets:
Digital Media Services Group
$
3,931,714
$
4,490,057
Audio and Web Conferencing Services Group
12,018,033
12,486,260
Corporate and unallocated
619,184
789,047
Total assets
$
16,568,831
$
17,765,364
Depreciation and amortization, as well as corporate and unallocated shared expenses impairment loss on goodwill and other intangible assets 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
SEPTEMBER 30, 2012
NOTE 8: STOCK OPTIONS AND WARRANTS
As of September 30, 2012, we had issued options and warrants still outstanding to purchase up to 3,181,748 ONSM common shares, including 1,887,332 shares under Plan Options; 12,342 shares under Non-Plan Options to employees and directors; 525,000 shares under Plan and Non-Plan Options to financial and other consultants; and 757,074 shares under warrants issued in connection with various financings and other transactions.
On February 9, 1997, our Board of Directors and a majority of our shareholders adopted the 1996 Stock Option Plan (the "1996 Plan"), which, including the effect of subsequent amendments to the 1996 Plan, authorized up to 750,000 shares available for issuance as options and up to another 333,333 shares available for stock grants. We may no longer issue additional options or stock grants under the 1996 Plan, which expired on February 9, 2007. 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.
Detail of Plan Option activity under the 1996 Plan and the 2007 Plan for the years ended September 30, 2012 and 2011 is as follows:
We recognized non-cash compensation expense of approximately $587,000 and approximately $1.2 million for the years ended September 30, 2012 and 2011, respectively, primarily related to Plan Options granted to employees and consultants and vesting during those periods.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)
The outstanding Plan Options for the purchase of 1,887,332 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 2.0 years and are further described below.
Total number of underlying
Vested portion of
Exercise price per
Expiration
Grant date
Description
common shares
underlying common shares
share
date
Dec 2004
Senior management
25,000
25,000
$7.26
Aug 2014
Sept 2013 -
Sept 2007
Senior management
261,458
261,458
$10.38
Sept 2016
May 2008
Consultant
16,667
16,667
$6.00
May 2013
Jun 2014 -
May 2009
Consultant
33,333
33,333
$3.00
Jun 2018
Aug 2009
Directors and senior management
133,334
133,334
$15.00
Aug 2014
Aug 2009
Directors and senior management
76,773
76,773
$9.42
Aug 2014
Dec 2009
Directors and senior management
114,893
114,893
$9.42
Dec 2014
Jan 2011
Directors and senior management
525,000
262,500
$1.23
Jan 2015
Jan 2011
Employees excluding senior management
359,800
179,900
$1.23
Jan 2015
Jan 2011
Consultant
25,000
25,000
$1.23
Jan 2015
Jun 2011
RD Whitney - new director
25,000
25,000
$1.00
Jun 2015
Sept 2011
Senior management
266,074
-
$0.97
Sept 2015
July 2012
Employees excluding senior management
25,000
-
$1.00
July 2016
Total common shares underlying Plan Options as of September 30, 2012
1,887,332
1,153,858
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, vest over two years and are exercisable at $1.23 per share, fair market value on the date of the grant. The Black-Scholes valuation of this grant is approximately $803,000, which is being recognized as non-cash compensation expense over the two year service period starting in January 2011. 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. The Compensation Committee is in the process of finalizing this grant.
As of September 30, 2012, there were outstanding Non-Plan Options issued to employees and directors 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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)
As of September 30, 2012, 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
Sep 2013
Year ended September 30, 2009
25,000
Total common shares underlying consultant options
as of September 30, 2012
525,000
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)
As of September 30, 2012, there were outstanding vested warrants, issued in connection with various financings, to purchase an aggregate of 757,074 shares of common stock, as follows:
Description of transaction
Number of common
shares
Exercise price per share
Expiration Date
LPC stock purchase - February 2012 - see note 6 (“LPC Warrant 2”)
100,000
$1.00
February 2017
LPC Purchase Agreement - September 2010 - see note 6 (“LPC Warrant 1”)
627,907
$1.72
September 2015
CCJ Note - December 2009 - see note 4
29,167
$3.00
December 2013
Total common shares underlying warrantsas of September 30, 2012
757,074
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 are 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 provide that the exercise price may not be adjusted below $1.72 per share, those provisions do 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 $81,374, $188,211 and $386,404 on our consolidated balance sheets as of September 30, 2012, 2011 and 2010, respectively. The $106,837 decrease in the fair value of this liability from September 30, 2011 to September 30, 2012 was reflected as other income in our consolidated statement of operations for the year ended September 30, 2012. The $198,193 decrease in the fair value of this liability from September 30, 2010 to September 30, 2011 was reflected as other income in our consolidated statement of operations for the year ended September 30, 2011.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)
Effective October 24, 2012, LPC Warrant 1 and LPC Warrant 2 were cancelled and replaced with New LPC Warrant 1 and New LPC Warrant 2. New LPC Warrant 1 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. The expiration date of New LPC Warrant 1 is the same September 24, 2015 expiration date as LPC Warrant 1, which will extend to March 24, 2016 if/when the applicable registration statement is not effective for six months - see note 6.
New LPC Warrant 2 was issued with 50,000 underlying common shares exercisable at $0.38 per share, with such amounts only adjustable under standard anti-dilution provisions. The expiration date of New LPC Warrant 2 is the same February 15, 2017 expiration date as LPC Warrant 2.
The exercise prices of New LPC Warrant 1 and New LPC Warrant 2 are 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.
As a result of this transaction, the non-current liability of approximately $81,374 on our September 30, 2012 balance sheet (related to LPC Warrant 1) will be relieved during the three months ended December 31, 2012 and recognized as non-operating income. This will be partially offset by non-operating expense of approximately $68,000, representing the aggregate Black-Scholes value of New LPC Warrant 1 and New LPC Warrant 2. Therefore, the net impact on our statement of operations for the three months ended December 31, 2012 will be net non-operating income of approximately $13,000.
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%.
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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 9: SUBSEQUENT EVENTS
Notes 1 (Liquidity - receipt of Funding Letter in December 2012, revenues for three months ended December 31, 2012), 4 (Renegotiation of the Rockridge Note, the Equipment Notes, the CCJ Note and certain of the Subordinated Notes in December 2012; December 2012 payment of commitment fee to renew the Line), 5 (November 2012 lease commitment for San Diego office), 6 (October 2012 loss of registration statement effectiveness and related agreement with LPC with respect to the Purchase Agreement, Series A-13 modifications and share conversions in December 2012, Series A-14 conversions in November and December 2012) and 8 (October 2012 Renegotiation of LPC Warrants) contain disclosure with respect to transactions occurring after September 30, 2012.
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 need 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.
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. 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 $5,400. This amount will be reflected as a discount and amortized as interest expense over the six month term.
On November 15, 2012 we received $100,000 for an unsecured subordinated note. The total interest of $20,000 is payable in applicable monthly installments starting December 15, 2012, and the principal balance is due on May 15, 2013. An origination fee was paid to the lender by the issuance of 35,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $13,300. This amount will be reflected as a discount and amortized as interest expense over the six month term.
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.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 9: SUBSEQUENT EVENTS (Continued)
The total preliminary purchase price was approximately $1.1 million of which we paid approximately $760,000 in cash as of November 30, 2012. The remaining balance is payable in the event of, and to the extent that, eligible revenues for the twelve months ending November 30, 2013 exceed the purchase price payments already made (which were based on 65% of eligible revenues for the twelve months ending August 31, 2012), but subject to the minimum purchase price discussed below. An additional earn out of up to approximately $300,000 would be paid based on 50% of the excess of eligible revenues for the twelve months ending November 30, 2013 over eligible revenues for the twelve months ending August 31, 2012. Eligible revenues exclude free conferencing business revenues and non-recurring revenues and are further defined in the Asset Purchase Agreement dated November 30, 2012. Any additional purchase price payments discussed above will be made in quarterly installments commencing August 31, 2013 and ending May 31, 2014. The minimum total purchase price is $950,000 and the maximum total purchase price is $1,450,000, including broker fees.
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 agreed to pay 70% of the future free conferencing business revenues, net of applicable expenses, to Intella2 through November 30, 2017, after which we have agreed to pay Intella2 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.
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.
On November 30, 2012 we received $350,000 pursuant to unsecured promissory notes issued to five investors (the “Intella2 Investor Notes”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. 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. 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 financing as well as to potential additional financing which may be raised under these terms.
On November 30, 2012, we issued an additional Intella2 Investor Note for $100,000 to one of the five investors in exchange for the satisfaction of a note previously issued by us on March 9, 2012 - see note 4. This investor also purchased and funded $100,000 of the original $350,000 of Intella2 Investor Notes issuance. After this transaction, the total outstanding principal balance of the Intella2 Investor Notes was $450,000 and the amount held by this investor was $200,000.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 9: SUBSEQUENT EVENTS (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.
On or about November 30, 2012 we received $175,000 pursuant to unsecured promissory notes issued to four investors (the “Investor Notes”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. 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. We paid a third-party agent financing fees of $14,000 plus 35,000 unrestricted common shares related to this financing.
In connection with the above financing, we issued to the holders of the Investor Notes an aggregate of 210,000 restricted common shares (the “Common Stock”), of which we have agreed to buy back up to 35,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the 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 17,500 shares of the originally issued Common Stock from the investor at $0.80 per share. If the fair market value of the 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 35,000 shares of the originally issued 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 Common Stock is still held by the investor(s) at the applicable dates.
On November 30, 2012 we received $200,000 pursuant to a promissory note issued to a single investor and bearing interest at 12% per annum. This note is secured by our assets (but subordinated to our secured debts to Thermo Credit and Rockridge Capital, as well as to other property and equipment liens). The principal, along with accrued interest and an origination fee of $8,000, is repayable in a single balloon payment on March 1, 2013.
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2012
NOTE 9: SUBSEQUENT EVENTS (Continued)
On January 2, 2013 we received $25,000 pursuant to an unsecured promissory note issued to CCJ (the “New CCJ Note”), bearing interest at 12% per annum and subordinated to our secured debts to Thermo Credit and Rockridge Capital. New CCJ 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 this financing, we issued 30,000 restricted common shares (the “CCJ Common Stock”) to CCJ, of which we have agreed to buy back up to 5,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the CCJ 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 2,500 shares of the originally issued CCJ Common Stock from CCJ at $0.80 per share. If the fair market value of the CCJ 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 5,000 shares of the originally issued CCJ Common Stock, less the amount of any shares already bought back at the one year point, from CCJ at $0.80 per share. The above only applies to the extent the CCJ Common Stock is still held by CCJ at the applicable dates.