UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

                     (Mark One)

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

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2012

OR

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

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to _________

Commission file number 000-22849

(Exact name of registrant as specified in its charter)

(IRS Employer Identification No.)

(State or other jurisdiction of incorporation or organization)

(Address of principal executive offices)

(Registrant's telephone number)

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

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  As of February 15, 2013 the registrant had issued and outstanding 15,033,103 shares of common stock.

TABLE OF CONTENTS

CERTAIN CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

 Certain statements in this quarterly report on Form 10-Q contain or may contain forward-looking statements that are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause our actual results to differ materially from those in the forward-looking statements. These risks, uncertainties and other factors include, but are not limited to, our ability to implement our strategic initiatives (including our ability to successfully complete, produce, market and/or sell the DMSP and/or MP365 and/or our ability to eliminate cash flow deficits by increasing our sales), economic, political and market conditions and fluctuations, government and industry regulation, interest rate risk, U.S. and global competition, and other factors affecting our operations and the fluctuation of our common stock price, and other factors discussed elsewhere in this report and in other documents filed by us with the Securities and Exchange Commission from time to time. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of December 31, 2012, unless otherwise stated. You should carefully review this Form 10-Q in its entirety, including but not limited to our financial statements and the notes thereto, as well as our most recently filed 10-K. Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. Actual results could differ materially from the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will, in fact, occur. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

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

PART I – FINANCIAL INFORMATION

Item 1 - Financial Statements

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

THREE MONTHS ENDED DECEMBER 31, 2012

(unaudited)

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Continued)

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(continued)

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 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 note 2.

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 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 $132.3 million as of December 31, 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. For the three months ended December 31, 2012, we had a net loss of approximately $715,000, although cash used by operating activities for that period was approximately $77,000. Although we had cash of approximately $196,000 at December 31, 2012, our working capital was a deficit of approximately $3.8 million at that date.  This working capital deficit includes an approximately $500,000 accrued liability for compensation and other amounts due to our senior executives, which we have agreed to satisfy by the issuance of 1.7 million common shares and which issuance is expected to occur in the near future - see note 5.

On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”) – see note 2. 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 and other liabilities during the three months ended December 31, 2012 that was associated specifically or generally with this acquisition – see notes 2 and 4.

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Liquidity (continued)

During the three months ended June 30, 2012 (our most favorable recent quarter), our revenues were sufficient to fund our operating cash expenditures plus all capital expenditures and debt service expenditures (monthly principal and interest payments on the Rockridge Note and interest payable in cash on the Line and other debts). This was not the case for the three months ended September 30, 2012, primarily due to a seasonal decline in our revenues for that quarter, as compared to revenues for the three months ended June 30, 2012. However our revenues for the three months ended December 31, 2012 exceeded 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. 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 through December 31, 2013. 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.

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

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

Basis of Consolidation

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Cash and cash equivalents

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

Concentration of Credit Risk

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

Bad Debt Reserves

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

Inventories

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

Fair Value Measurements

We have determined that the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, amounts due to directors and officers and deferred revenue approximate fair value due to the short maturity of the instruments. We have also determined that the carrying amounts of certain notes and other debt approximate fair value due to the short maturity of the instruments, as well as the market value interest rates they carry – these include the Line of Credit, Secured Short Term Note and Equipment Notes and Leases. The accrued liability for the contingent portion of the Intella2 purchase price, a portion of which is classified as non-current as of December 31, 2012, was determined based on its fair value as of the November 30, 2012 Intella2 acquisition – see note 2 - and the fair value of that liability will be re-evaluated at the end of each subsequent accounting period and adjusted accordingly. The accrued liability for our USF contribution obligation, although a portion was classified as non-current as of December 31, 2012, was immediately due and payable until a letter agreement promissory note was approved by USAC on February 15, 2013- see note 9 – and was therefore determined to approximate fair value until that approval date. The fair value of the USAC Note will be evaluated as part of the Instruments discussed below, effective March 31, 2013.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Fair Value Measurements (continued)

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

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

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

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

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

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

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Fair Value Measurements (continued)

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.

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.

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.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Software

Included in property and equipment is computer software developed for internal use, including the Digital Media Services Platform (“DMSP”), 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.

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 December 31 and September 30, 2012 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.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Revenue Recognition (continued)

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

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

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

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

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

We add to our customer billings for certain services an amount to recover Universal Service Fund (“USF”) contributions which we have determined that we will be obligated to pay to the Federal Communications Commission (“FCC”), related to those particular services. This additional billing to our customers is not reflected as revenue by us, but rather is recorded as a liability on our books at the time of such billing, which liability is relieved upon our remittance of USF contributions as they are billed to us by USAC, an administrative and collection agency of the FCC. See notes 5 and 9.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 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 $84.5 million in Federal net operating loss carryforwards as of December 31, 2012, which expire in fiscal years 2018 through 2033. Our utilization of approximately $20 million of the net operating loss carryforwards, acquired from the 2001 acquisition of EDNet and the 2002 acquisition of MOD and included in this $84.5 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 $31.8 million and $31.6 million as of December 31 and September 30, 2012, respectively, primarily resulting from net operating loss carryforwards. A full valuation allowance has been recorded related to the deferred tax asset due to the uncertainty of realizing the benefits of certain net operating loss carryforwards before they expire. Our management will continue to assess the likelihood that the deferred tax asset will be realizable and the valuation allowance will be adjusted accordingly.

Accordingly, no income tax benefit was recorded in our consolidated statement of operations as a result of the net tax losses for the three months ended December 31, 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 December 31 and September 30, 2012 we have not taken, nor recognized the financial statement impact of, any material tax positions, as defined above. Our policy is to recognize, as non-operating expense, interest or penalties related to income tax matters at the time such payments become probable, although we had not recognized any such material items in our statement of operations for the three months ended December 31, 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

DECEMBER 31, 2012

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

Valuation of Derivatives

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

Net Loss per Share

For the three months ended December 31, 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 2,743,141 and 3,368,687 at December 31, 2012 and 2011, respectively.

In addition, the potential dilutive effects of the following convertible securities outstanding at December 31, 2012 have been excluded from the calculation of weighted average shares outstanding: (i) the $779,267 outstanding balance of the Rockridge Note, which could have potentially converted into up to 324,695 shares of our common stock (ii) the right of Rockridge to receive 591,667 restricted shares of our common stock for an origination fee in connection with the Rockridge Note, issuable upon not less than sixty-one (61) days written notice to us and (iii) $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).

In addition, the potential dilutive effects of the following convertible securities outstanding at December 31, 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 $1,157,223 outstanding balance of the Rockridge Note, which could have potentially converted into up to 482,176 shares of our common stock (iv) the right of Rockridge to receive 366,667 restricted shares of our common stock for an origination fee in connection with the Rockridge Note, issuable upon not less than sixty-one (61) days written notice to us, (v) $350,000 of convertible notes which in aggregate could have potentially converted into up to 500,000 shares of our common stock, excluding interest, (vi) $35,000 of convertible notes which in aggregate could have potentially converted into up to 7,292 shares of our common stock and (vii) the $100,000 CCJ Note, which could have potentially converted into up to 50,000 shares of our common stock.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 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 $1,062,000 and $966,000 as of December 31 and September 30, 2012, respectively, related to salaries, commissions, taxes, vacation and other benefits earned but not paid as of those dates.

Equity Compensation to Employees and Consultants

We have a stock based compensation plan (the “Plan”) for our employees, directors and consultants. In accordance with the Compensation – Stock Compensation topic of the ASC, we measure compensation cost for all share-based payments, including employee stock options, at fair value, using the modified-prospective-transition method. Under this method, compensation cost recognized for the three months ended December 31, 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. There were no Plan options granted during the three months ended December 31, 2012. For Plan options that were granted (or extended) and thus valued under the Black-Scholes model during the three months ended December 31, 2011, the expected volatility rate was 105%, the risk-free interest rate was 1.0% and the expected term was 5 years.

We have granted Non-Plan Options to consultants and other third parties. These options have been accounted for under the Equity topic (Equity-Based Payments to Non-Employees subtopic) of the ASC, under which the fair value of the options at the time of their issuance, calculated using the Black-Scholes model, is reflected as a prepaid expense in our consolidated balance sheet at that time and expensed as professional fees during the time the services contemplated by the options are provided to us. There were no Non-Plan options granted during the three months ended December 31, 2012 or December 31, 2011.

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

Advertising and marketing

Advertising and marketing costs, which are charged to operations as incurred and classified in our financial statements under Professional Fees or under Other General and Administrative Operating Expenses, were approximately $163,000 and $176,000 for the three months ended December 31, 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.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

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.

Interim Financial Data

In the opinion of our management, the accompanying unaudited interim financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission. These interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with our annual financial statements as of September 30, 2012. These interim financial statements have not been audited. However, our management believes the accompanying unaudited interim financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary to present fairly our consolidated financial position as of December 31, 2012 and the results of our operations and cash flows for the three months ended December 31, 2012 and 2011. The results of operations and cash flows for the interim period are not necessarily indicative of the results of operations or cash flows that can be expected for the year ending September 30, 2013.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

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 had 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 was effective for our fiscal year ending September 30, 2013 and is to be applied retrospectively.  We do not believe adoption of this guidance had a material impact on our consolidated financial statements.

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 first 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 this guidance for our fiscal year ended September 30, 2012, which we do not believe had a material impact on our consolidated financial statements.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 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:

Intella2 – November 30, 2012

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

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Intella2 – November 30, 2012 (continued)

The total preliminary purchase price of the Intella2 assets and operations has been determined to be approximately $1.4 million, of which we have paid approximately $713,000 in cash to Intella2 through December 31, 2012. The remaining portion of the total preliminary purchase price, approximately $646,000, is the present value of management’s estimate of total additional payments considered probable with respect to the following remaining obligations incurred in connection with the Intella2 purchase:

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

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

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

Eligible revenues for purposes of items (i) and (ii) above exclude free conferencing business revenues and non-recurring revenues and are further defined in the Asset Purchase Agreement dated November 30, 2012. The additional purchase price payments per items (i) and (ii) above are due in quarterly installments commencing August 31, 2013 and ending May 31, 2014. The additional purchase price payments per item (iii) above are due in quarterly installments commencing February 28, 2013, subject to certain holdbacks and reserves. The unpaid portion of the total preliminary purchase price is reflected on our December 31, 2012 balance sheet as a liability for $646,461, with a current portion of $311,666 and a non-current portion of $334,795.

The total purchase price and the liability for the unpaid portion of that purchase price recorded by us as of December 31, 2012 depends significantly on projections and estimates. Authoritative accounting guidance allows one year from the acquisition date for us to make adjustments to these amounts, in the event that such adjustments are based on facts and circumstances that existed as of the acquisition date that, if known, would have resulted in such adjusted assets and liabilities as of that date. Regardless of this, a contingent consideration liability shall be remeasured to fair value at each reporting date until the contingency is resolved. Changes resulting from facts and circumstances arising after the acquisition date, such as meeting a revenue target, shall be recognized in our results of operations. Changes resulting from a change in the discount rates applied to estimates of future cash flows shall also be recognized in our results of operations.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Intella2 – November 30, 2012 (continued)

The fair value of certain intangible assets (customer lists, tradenames, URLs (internet domain names) and employment and non-compete agreements) acquired as part of the Intella2 acquisition was determined to be approximately $650,000 by our management at the time of the acquisition. This fair value was primarily based on the discounted projected cash flows related to these assets for the three to six years immediately following the acquisition on a stand-alone basis without regard to the Intella2 acquisition, as projected by our management and Intella2’s former management. The discount rate utilized considered equity risk factors (including small stock risk) as well as risks associated with profitability and working capital, competition, and intellectual property. The projections were adjusted for charges related to fixed assets, working capital and workforce retraining. The fair value of certain tangible assets (primarily equipment) acquired as part of the Intella2 acquisition was determined to be approximately $246,000 by our management at the time of the acquisition. This fair value was primarily based on management’s inspection of and evaluation of the condition and utility of the equipment, as well as comparable market values of similar used equipment when available. We are depreciating and amortizing these assets over useful lives ranging from 3 to 10 years. The approximately $1.4 million purchase price exceeded the fair values we assigned to Intella2’s tangible and intangible assets (net of liabilities at fair value) by approximately $464,000, which we recorded as goodwill as of the purchase date.

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.

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.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Infinite Conferencing – April 27, 2007 (continued)

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.

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”).

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Auction Video – March 27, 2007 (continued)

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.

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.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

Acquired Onstream – December 23, 2004 (continued)

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

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

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

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.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

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

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

·         Onstream’s credit rating and access to capital

·         A decline in market-dependent multiples in absolute terms

·         Telecommunications industry growth projections

·         Internet industry growth projections

·         Entertainment industry growth projections (re EDNet customer base)

·         Onstream’s current sales compared to last year

·         Onstream’s technological accomplishments compared to its peer group

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

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

An annual impairment review of our goodwill and other acquisition-related intangible assets will be performed as part of preparing our September 30, 2013 financial statements. Until that time, we will review certain factors to determine whether a triggering event has occurred that would require an interim impairment review Those factors include, but are not limited to, our management’s estimates of future sales and operating income, which in turn take into account specific company, product and customer factors, as well as general economic conditions and the market price of our common stock. Based on that review, including an increase in the closing price of our common shares from $0.48 per share at September 30, 2012 to $0.55 per share as of February 15, 2013, we have concluded that no triggering event has occurred through February 15, 2013.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

NOTE 3:  PROPERTY AND EQUIPMENT