UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C.
20549
FORM 10-QSB
|X| QUARTERLY REPORT UNDER SECTION 13 OR
15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 31,
2008
|_| TRANSITION REPORT UNDER SECTION 13
OR 15(d) OF THE EXCHANGE ACT
For the transition period from ________
to________
Commission file number
333-108632
NARROWSTEP INC.
(Exact name of small business issuer as
specified in its charter)
DELAWARE
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33-1010941
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(State or other jurisdiction
of
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(I.R.S.
Employer
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incorporation or
organization)
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Identification
No.)
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116 Village Blvd, Suite
200
Princeton, New Jersey
08540
United States
(Address of principal executive
offices)
(609) 951-2221
(Issuer’s telephone
number)
Check whether the issuer (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Exchange Act
during the past 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
|X| Yes |_| No
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).
|_| Yes |X| No
State the number of shares outstanding
of each of the issuer’s classes of common equity, as of the latest practicable
date: 138,422,477 shares of common stock, $0.000001 par
value.
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Item
1 - Financial Statements
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NARROWSTEP
INC. AND SUBSIDIARIES
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CONDENSED CONSOLIDATED BALANCE
SHEETS
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May 31,
2008
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February 29,
2008
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(Unaudited)
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$
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$
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Assets
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Current
assets:
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Cash and cash
equivalents
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1,908,135
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4,170,850
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Short-term
investments
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281,790
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Accounts receivable, net of
allowance for doubtful accounts
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776,782
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923,850
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of $681,864 and $767,470 at May
31, 2008 (unaudited) and
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February 29, 2008,
respectively
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Prepaid expenses and other current
assets
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263,638
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411,110
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Total current
assets
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3,230,345
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5,505,810
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Property and equipment,
net
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1,739,459
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1,995,504
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Software development costs,
net
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796,689
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682,060
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Other
assets
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-
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281,790
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Total
Assets
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5,766,493
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8,465,164
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Liabilities and Stockholders'
Equity
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Liabilities
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Current
liabilities:
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Unearned
revenue
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158,600
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31,536
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Accounts
payable
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481,867
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735,776
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Net obligations under capital
leases, current
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148,939
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153,322
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Accrued expenses and other current
liabilities
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491,951
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814,214
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Total current
liabilities
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1,281,357
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1,734,848
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Net obligations under capital
leases, long-term
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108,528
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143,408
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Total
Liabilities
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1,389,885
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1,878,256
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Commitments and
Contingencies
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Stockholders'
Equity
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Common stock, $0.000001 par value
450,000,000 shares authorized,
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138
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137
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138,422,477 issued and
outstanding at May 31, 2008 (unaudited) and
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137,561,227 issued and outstanding
at February 29, 2008
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Additional paid-in
capital
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41,060,938
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40,745,085
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Accumulated
deficit
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( 36,712,856
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)
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( 34,196,475
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)
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Accumulated other comprehensive
income
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28,388
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38,161
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Total Stockholders'
Equity
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4,376,608
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6,586,908
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Total Liabilities and
Stockholders' Equity
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5,766,493
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8,465,164
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See Notes to Condensed
Consolidated Financial Statements.
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CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
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AND
COMPREHENSIVE LOSS (Unaudited)
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Three
Months Ended
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May
31, 2008
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May
31, 2007
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$
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$
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Revenue
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Narrowcasting
and other
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961,081
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1,415,160
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Production
services
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-
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175,633
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Total
revenue
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961,081
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1,590,793
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Costs
and Expenses
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Operating
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938,547
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1,225,791
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Selling,
general and administrative
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2,306,674
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2,645,624
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Research
& development
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245,429
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798,750
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Total
operating expenses
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3,490,650
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4,670,165
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Operating
Loss
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(2,529,569
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)
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(3,079,372
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)
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Interest
income
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20,852
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48,249
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Interest
expense
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(8,008
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)
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(227,892
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)
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Currency
exchange income (loss)
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344
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(1,903
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)
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Net
Loss
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(2,516,381
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)
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(3,260,918
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)
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Foreign currency translation
adjustment
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(9,773
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)
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17,472
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Comprehensive
Loss
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(2,526,154
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)
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(3,243,446
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)
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Net Loss per Common Share - Basic
and Diluted
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(0.02
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)
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(0.07
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)
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Weighted-Average Number of Common
Shares Outstanding,
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Basic and
Diluted
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138,216,105
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45,348,974
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See Notes to Condensed
Consolidated Financial Statements.
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NARROWSTEP
INC. AND SUBSIDIARIES
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CONDENSED CONSOLIDATED STATEMENTS
OF CASH FLOWS
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(Unaudited)
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Three Months
Ended
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May 31,
2008
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May 31,
2007
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$
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$
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Cash
Flows from Operating Activities
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Net
loss
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(2,516,381
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)
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(
3,260,918
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)
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Adjustments
to reconcile net loss to net cash used in operating
activities:
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Allowance
for doubtful accounts
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(85,606
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)
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581,605
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Depreciation
and amortization
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232,635
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205,848
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Loss
on disposal of property and equipment
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64,578
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-
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Stock-based
compensation expense
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315,854
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81,779
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Interest
on short-term investment
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3,605
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-
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Fair
value of options and warrants granted to third party
suppliers
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-
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19,625
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Changes
in net cash attributable to changes in operating assets and
liabilities:
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Accounts
receivable
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232,673
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(
593,775
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)
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Prepaid
expenses and other current assets
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147,472
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33,250
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Unearned
revenue
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127,064
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76,895
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Accounts
payable, accrued expenses and other current liabilities
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(576,172
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)
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304,489
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Net
Cash Used in Operating Activities
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(2,054,278
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)
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(
2,551,202
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)
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Cash
Flows from Investing Activities
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Purchases
of property and equipment
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(48,832
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)
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( 528,637
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)
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Payments
for software development costs
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(152,347
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)
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-
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Repayment
of Security Deposit
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281,790
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-
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Purchase
of short-term investments
|
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(281,790
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)
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-
|
|
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|
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|
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Net
Cash (Used in) Investing Activities
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(201,179
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)
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(
528,637
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)
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Cash
Flows from Financing Activities
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|
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Net
proceeds from issuance of convertible notes payable
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|
-
|
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6,950,130
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Payments
on capital leases
|
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(39,263
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)
|
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|
(
19,882
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)
|
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Net
Cash Provided by (Used in) Financing Activities
|
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|
(39,263
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)
|
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|
6,930,248
|
|
|
|
|
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|
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Net
Increase (Decrease) in Cash and Cash Equivalents
|
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|
(2,294,720
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)
|
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|
3,850,409
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Effect
of exchange rates on change in cash
|
|
|
32,005
|
|
|
|
10,933
|
|
Cash
and cash equivalents at the beginning of period
|
|
|
4,170,850
|
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|
466,870
|
|
|
|
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|
|
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Cash
and Cash Equivalents at the End of the Period
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|
1,908,135
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4,328,212
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|
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See Notes to Condensed
Consolidated Financial Statements.
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NARROWSTEP INC. AND
SUBSIDIARIES
NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. PREPARATION OF
INTERIM FINANCIAL STATEMENTS
Basis of
Presentation.
Throughout this document, Narrowstep
Inc. and its subsidiaries are referred to as “Narrowstep,” “we” or the
“Company.” The interim condensed consolidated financial statements
have been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (“SEC”) that permit reduced disclosure for interim
periods. We believe that these interim condensed consolidated
financial statements include all adjustments necessary to present fairly the
results for the interim periods shown. The results for the interim
periods are not necessarily indicative of the results of any other interim
period or for the full year. The reader is referred to the audited
consolidated financial statements and notes thereto for the year ended February
29, 2008 filed as part of Narrowstep Inc. and Subsidiaries (collectively, the
“Company”) Form 10-KSB for such year.
Principles of
Consolidation.
The interim condensed consolidated
financial statements include the accounts of the Company and its wholly-owned
subsidiaries. Our subsidiaries operate in the TV over the Internet
services industry both domestically and internationally providing various
services. All intercompany transactions have been eliminated in
consolidation.
Use of
Estimates.
The
preparation of the interim condensed consolidated financial statements requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the condensed consolidated financial statements and the reported
amounts of revenue and expenses during the reporting periods. Actual
results could differ from those estimates.
NOTE 2. GOING
CONCERN
The Company has incurred net losses and
negative cash flow from operations since inception.
We had an
accumulated deficit of approximately $36.7 million as of May 31,
2008. The Company historically has financed its operations primarily
through private equity and convertible debt financing. The Company
currently does not have the liquidity or financing available to fund its
operations for the next 12 months without additional capital being raised or
financing being acquired. On May 29, 2008, we entered into a
definitive merger agreement pursuant to which the Company will be acquired by
Onstream Media Corporation (See Note 3 for more details). We are
currently operating our business in accordance with the Restructuring Plan, as
outlined in the Merger Agreement with Onstream, which is intended to reduce
costs and operating losses. However, we cannot be certain when we
will operate profitably, if ever, and in the event the Merger Agreement is
terminated, we may not be able to continue as a going concern.
NOTE
3. RECENT EVENT
Merger
Agreement
On May
29, 2008, the Company entered into an Agreement and Plan of Merger (the “Merger
Agreement”) with Onstream Media Corporation, a Florida corporation (“Onstream”),
Onstream Merger Corp., a newly formed Delaware corporation and a wholly owned
subsidiary of Onstream (“Merger Sub”) and W. Austin Lewis IV, as stockholder
representative for the Company’s stockholders. Pursuant to the terms
and subject to the conditions set forth in the Merger Agreement, Onstream will
acquire the Company by means of a merger of Merger Sub with and into the Company
(the “Merger”), with the Company continuing as the surviving corporation and a
wholly-owned subsidiary of Onstream after the Merger (the “Surviving
Corporation”).
Pursuant
to the Merger Agreement, at the effectiveness of the Merger (the “Effective
Time”), each outstanding share of the Company’s common stock, par value
$0.000001 per share, other than shares held by stockholders who have perfected
their appraisal rights under Delaware law, shares held by Onstream and shares
held by any subsidiary of the Company (collectively, the “Shares to be
Converted”), will be converted into (i) shares of Onstream common stock, par
value $0.0001 per share (“Onstream Common Stock”), based on an exchange ratio
determined as described below and (ii) one contingent value right (a “Contingent
Value Right”) having terms and conditions described below. Onstream
Common Stock and Contingent Value Rights issued in respect of the Company’s
common stock subject to certain restricted stock awards will be subject to any
vesting conditions contained in such awards.
The
aggregate number of shares of Onstream Common Stock issuable in the Merger in
exchange for the Shares to be Converted will be the greater of (i) the sum of
(A) two (2) times Annualized Company Revenue (as defined in the Merger
Agreement) and (B) the greater of (1) the amount of the Company’s cash and cash
equivalents immediately prior to the Effective Time and (2) 1,500,000 and (ii)
10,500,000. The exchange ratio will be the amount determined as
described in the prior sentence divided by the Shares to be Converted (the
“Exchange Ratio”).
The final
Exchange Ratio will be determined based on the Company’s consolidated revenues
for the quarter ended May 31, 2008 (as adjusted pursuant to the terms of the
Merger Agreement) and may not be known prior to the Effective
Time. Accordingly, the Merger Agreement provides that the Shares to
be Converted will receive an aggregate of 10,500,000 shares of Onstream Common
Stock (the “Minimum Exchange Ratio”) upon consummation of the
Merger. In the event that the final Exchange Ratio exceeds the
Minimum Exchange Ratio, former holders of Shares to be Converted will receive
additional shares of Onstream Common Stock within 30 days after the final
determination of the Exchange Ratio. No assurance can be given that
the Exchange Ratio will exceed the Minimum Exchange Ratio.
In the
Merger, outstanding shares of the Company’s Series A Preferred Stock, par value
$.000001 per share, will be converted into an aggregate of 600,000 shares of
Onstream Common Stock.
In
connection with the Merger, the Surviving Corporation will assume the Company’s
obligations under its outstanding warrants. From and after the
Merger, except as summarized below, holders of warrants will have the right to
exercise their warrants for a number of shares of Onstream Common Stock and at
exercise prices appropriately adjusted to give effect to the greater of the
Exchange Ratio and the Minimum Exchange Ratio. Holders of warrants to
acquire an aggregate of 22,726,400 shares of Company Common Stock issued by the
Company in August 2007 (the “2007 Warrants”) will have the right to exercise
their 2007 Warrants for cash only for an aggregate of 1,000,000 shares of
Onstream Common Stock at an exercise price of $3.50 per share. In the
event that any of the warrants are exercised prior to the Final Exercise Date
(as defined in the CVR Agreement referenced below), an exercising holder will
also be entitled to receive Contingent Value Rights in an amount equal to the
number of Contingent Value Rights such holder would have received had its
warrants been exercised immediately prior to the Effective Time. In
connection with the Merger Agreement, holders of a majority of the 2007 Warrants
have entered into an Amendment and Waiver Agreement with the Company (the
“Amendment and Waiver Agreement”) pursuant to which such holders, on behalf of
themselves and all other holders of the 2007 Warrants, agreed to amend the terms
of the 2007 Warrants as provided above and to waive certain antidilution and
other rights.
The
Contingent Value Rights will be issued pursuant to the terms of a Contingent
Value Rights Agreement to be entered into among Onstream, Mr. Lewis as the CVR
Representative and Interwest Transfer Co., as Rights Agent, in the form attached
to the Merger Agreement (the “CVR Agreement”). Pursuant to the terms
and subject to the conditions set forth in the CVR Agreement, the Contingent
Value Rights will be converted into shares of Onstream Common Stock in the event
that the Company reaches certain revenue targets for the initial 12-month and
subsequent 6-month periods following the Merger; provided, however, that the
maximum number of shares of Onstream Common Stock issuable in the Merger,
including those pursuant to the Contingent Value Rights and the conversion of
the Company’s Series A Preferred Stock, will not exceed
20,000,000. The number of shares of Onstream Common Stock issuable
upon the conversion of each Contingent Value Right will depend on a number of
factors, including the Company’s business meeting the revenue targets set forth
in the CVR Agreement and the number of warrants, if any, exercised prior to the
final determination of the consideration, if any, to be paid pursuant to the CVR
Agreement. The conversion of Contingent Value Rights into Onstream
Common Stock will occur in two stages, shortly following the final determination
of whether the initial 12-month and subsequent 6-month targets have been
met.
The
Contingent Value Rights will not be transferable by the holders thereof except
by operation of law in limited circumstances. The Company does not
expect a market to develop for the Contingent Value Rights. No
assurance can be given that the Contingent Value Rights will result in the
issuance of additional shares of Onstream Common Stock.
The
Merger Agreement contains customary representations and warranties of the
Company, Onstream and Merger Sub. The Merger Agreement also contains
customary covenants, including covenants regarding operation of the business of
the Company and its subsidiaries prior to the closing of the
Merger.
In
addition, the Company has agreed to use its commercially reasonable efforts to
operate its business in accordance with a restructuring plan attached as an
exhibit to the Merger Agreement (the “Restructuring Plan”), which is designed to
significantly reduce or eliminate substantial costs related to Company’s
facility leases, selling, general and administrative expenses, public company
and headquarters costs, and other professional fees and
services. Specifically, the Restructuring Plan is a transitional
business plan that the Company will follow until the close of the
Merger. The Restructuring Plan includes a detailed four month cash
operating budget for the Company beginning June 2008. The budget
consists of a breakdown of cash proceeds to the Company from customer
receivables, equipment sales and additional investments and a breakdown of
various cash operating expenses and other cash payments out from the
Company. The Restructuring Plan also lists certain employees and
contractors that will be terminated prior to the closing of the Merger as well
as certain employees that will enter into one-year employment contracts with the
Company. The Company is responsible for the funding of all salaries
and benefits for the terminated employees and consultants, as well as the cost
of any severance, from pre-closing cash. The Restructuring Plan
further sets forth an approval process that the Company will follow for travel,
telephone, communication and other various operating expense
purchases. The Restructuring Plan also requires that the Company send
its weekly reports, such as accounts receivable, payroll and accounts payable,
to Onstream for review at least three days prior to payment. Pursuant
to the Restructuring Plan, the Company may not enter into any contracts, hire
any new employees or make any purchases greater than $1,000.00 without first
obtaining Onstream’s approval. The Restructuring Plan also effects a
reorganization of management in that certain of the Company’s departments are
required to report to the senior manager of the equivalent department at
Onstream. The Restructuring Plan also requires that, at the closing
of the Merger, the Company’s current assets (excluding cash) will exceed the
Company’s current liabilities, as determined on a basis consistent with the
Company’s previously issued financial statements. Lastly, the
Restructuring Plan states that proceeds from the sale of equipment (as set forth
in the operating budget described above) will be limited to equipment located at
the Company’s California POP (Point of Presence) located in the Company’s
internal content delivery network (CDN), which was shut down during April
2008.
In
connection with the conditions to closing set forth in the Merger Agreement, we
have entered into subscription agreements (the “Subscription Agreements”) with
three of our major stockholders, including Mr. Lewis and David C. McCourt, our
Chairman and Interim Chief Executive Officer. Under the Subscription
Agreements, the three stockholders agreed to purchase immediately prior to the
Merger shares of a to-be-established Series A Preferred Stock at a purchase
price of $100,000 per stockholder. In connection therewith, each such
stockholder is expected to receive 10,000 shares of Series A Preferred
Stock. Holders of the Series A Preferred Stock will be entitled to
such dividends, if any, as may be declared by our Board of Directors out of
funds legally available therefore (no such dividends are expected to be paid
under the terms of the Restructuring Plan), will not have any voting rights
(except to the extent required by applicable law), will have no right to convert
the Series A Preferred Stock into shares of our common stock or any other of our
securities and will have no right to force our redemption or repurchase of the
Series A Preferred Stock. It is expected that we will file a
certificate of designations establishing the terms of the Series A Preferred
Stock with the Secretary of State of Delaware shortly prior to the closing of
the Merger. The sale of the Series A Preferred Stock pursuant to the
Subscription Agreements is exempt from registration pursuant to Section 4(2) of
the Securities Act of 1933, as amended, and Regulation D promulgated
thereunder.
The
Merger is subject to customary closing conditions, including obtaining the
approval of the Company’s and Onstream’s stockholders. The Merger
Agreement may be terminated under certain specified events, including by either
Onstream or the Company if the Effective Time has not occurred on or prior to
October 31, 2008. If the Merger Agreement is terminated under certain
circumstances specified in the Merger Agreement, the Company may be required to
pay a termination fee of $377,000 to Onstream. Both the Company and
Onstream have entered into voting agreements (“Voting Agreements”) pursuant to
which several significant stockholders have agreed to vote their shares in favor
of the adoption of the Merger Agreement. Pursuant to the Voting
Agreements, the holders of approximately 35% of the Company’s common stock
presently outstanding and approximately 42% of the Onstream Common Stock
presently outstanding have agreed to vote their shares in favor of the adoption
of the Merger Agreement.
NOTE 4. SALE OF COMMON
STOCK
On August 8, 2007, we closed a private
financing with a number of accredited investors for the sale of common stock and
warrants for a total purchase price of $10,510,000. Pursuant to the financing we
sold a total of 42,040,000 shares of common stock at a purchase price of $0.25
per share. We also issued warrants to purchase an aggregate of 21,020,000 shares
of common stock at an exercise price of $0.50 per share, subject to
adjustment. The warrants are exercisable at any time on or prior to
August 8, 2012. The warrants contain customary anti-dilution
provisions in the event of any stock split, reverse stock split,
reclassification or recapitalization of the Company. In addition, the
exercise price and the number of shares issuable upon the exercise of the
warrants are subject to adjustment on a full-ratchet basis in the event that we
issue or are deemed to have issued shares of common stock at an effective
purchase price of less than $0.50 per share, subject to certain
exceptions. In the financing, we issued to the placement agents
warrants to purchase an aggregate of 1,706,400 shares of common
stock. Those warrants have the same terms as the warrants issued in
the financing, except that the warrants issued to the placement agents have a
cashless exercise right.
NOTE 5. CONVERTIBLE NOTES
PAYABLE
On March 2, 2007, the Company entered
into a Purchase Agreement (the “Purchase Agreement”) with a number of accredited
investors (the “Investors”) for the sale of its 12% Mandatorily Convertible
Notes (the “Notes”) and Warrants (the “Warrants”) for a total purchase price of
$7,110,000. The Notes, which mature on March 2, 2009, bear interest
at 12% per annum, payable at maturity. The Notes will mandatorily
convert at a 10% discount into the securities issued by the Company in any
subsequent private placement that results in gross proceeds to the Company of at
least $3,000,000 or, in the event of a sale of the Company prior thereto, shares
of common stock valued at a discount of 10% of the per share price to be paid in
the Company sale. The Warrants are exercisable at any time on or
prior to March 2, 2012 for an aggregate of 3,555,000 shares of common stock at
an exercise price of $0.60 per share, subject to adjustment. The
Company has the right to force the cash exercise of the Warrants if the common
stock trades at or above $1.80 per share for at least 20 consecutive trading
days. Both the Notes and the Warrants contain customary anti-dilution
provisions in the event of any stock split, reverse stock split,
reclassification or recapitalization of the Company. In connection
with the August 8, 2007 financing, the full amount of the Notes was
automatically converted into an aggregate of 35,392,003 shares of common stock
at a conversion price of $0.225 per share.
NOTE 6. RELATED PARTY
TRANSACTIONS
Options granted to current
directors.
On January 10, 2008, the Company granted Jon Harrington, a
member of the board of directors, 300,000 restricted shares which he transferred
to Omni Capital. The Company also granted 300,000 restricted shares
to Roger L. Werner, Jr. and 500,000 to Jack Whyte. All the shares
granted on January 10, 2008 have the following vesting schedule: 25% vested upon
grant, the remaining vest in equal installments on the first of every month
beginning February 1, 2008 with the last vesting date to be September 1,
2008.
Options granted to current
officers.
On February 8, 2007, the Company granted options to
purchase 200,000 shares to Lisa VanPatten, the Company’s Chief Financial
Officer, at an exercise price of $0.92 per share. These options vest
over a three-year period and expire on February 8, 2017. On April 30,
2007, the Company granted options to purchase 250,000 shares to Lou Holder, the
Company’s Chief Technology Officer, at an exercise price of $0.68 per
share. These options vest over a three-year period and expire on
April 30, 2017.
On June
8, 2007, the Company entered into an employment agreement with David C. McCourt
pursuant to which the Company granted Mr. McCourt 1,250,000 shares of restricted
stock units which vested monthly until November 30, 2007 and 2,500,000 shares of
restricted stock which vested based on the Company’s meeting certain performance
milestones. All of the restricted stock units and shares of
restricted stock granted to Mr. McCourt pursuant to his employment agreement
have fully vested as of November 30, 2007, as determined by the Company’s
Compensation Committee. Mr. McCourt elected to issue back to the
Company 336,000 shares of restricted stock with an approximate value of $177,000
to cover the taxes due on the vested restricted stock that the Company paid for
on behalf of Mr. McCourt. On December 18, 2007, the Company granted
Mr. McCourt 1,250,000 restricted shares which fully vested. Mr.
McCourt elected to issue back to the Company 992,000 shares of restricted stock
with an approximate value of $140,000 to cover the taxes due on the vested
restricted stock that the Company paid for on behalf of Mr.
McCourt. On January 10, 2008, the Company granted David C. McCourt
2,500,000 restricted shares which are subject to vesting upon the Company’s
meeting certain targets established by the Company’s Compensation
Committee.
On
January 10, 2008, the Company granted Lisa VanPatten 500,000 shares of
restricted stock, Lou Holder 750,000 shares of restricted stock, Barak Bar-Cohen
1,000,000 shares of restricted stock and David C. McCourt 900,000 shares of
restricted stock which vest upon termination of employment in connection with a
change of control of the Company, or upon $4M EBITDA attainment. None
of these shares of restricted stock have vested to date.
On March 25, 2008, the
Company granted Barak Bar-Cohen 1,000,000 shares of restricted stock which have
the same vesting schedule as those restricted shares granted on January 10,
2008. On March 24, 2008, the Company granted Mr. McCourt 1,250,000
restricted stock units pursuant to his employment agreement which vest monthly
up until November 1, 2008.
Transactions with companies in which
certain persons hold an interest.
Outdoor Channel, a customer
of the Company, began utilizing the Company’s services in May
2007. The Chief Executive Officer and President of Outdoor Channel is
Roger L. Werner Jr., a member of the Company’s board of
directors. The Company billed Outdoor Channel, $67,705 for the fiscal
year ended February 29, 2008 and the balance in accounts receivable at February
29, 2008 is $6,459. The Company billed Outdoor Channel, $17,994 for
the three months ended May 31, 2008 and the balance in accounts receivable at
May 31, 2008 is $11,776.
In
connection with the Company’s August 2007 financing, Mr. McCourt purchased
4,000,000 shares of common stock and warrants to purchase 2,000,000 shares of
common stock for a total purchase price of $1,000,000. In addition,
Mr. McCourt entered into a lock up agreement pursuant to which he and certain
entities controlled by him agreed for a period of nine months from August 8,
2007 not to sell, dispose or otherwise transfer any shares of common stock owned
by them, subject to certain exceptions.
On May
29, 2008, we entered into a definitive merger agreement pursuant to which our
company will be acquired by Onstream Media Corporation. In connection
with the conditions to closing set forth in the Merger Agreement, we have
entered into subscription agreements (the “Subscription Agreements”) with three
of our major stockholders, including Mr. Lewis and David C. McCourt, our
Chairman and Interim Chief Executive Officer for the purchase of preferred stock
upon the consummation of the Merger. For a more complete discussion regarding
the Merger, see Note 3.
NOTE 7.
CONCENTRATIONS
The largest four customers in the
aggregate accounted for $314,565, or 33% of our revenues for the three months
ended May 31, 2008 and approximately $566,675, or 36% of our revenues for the
three months ended May 31, 2007. The accounts receivable balance for
the largest four customers was $394,574 as of May 31, 2008.
NOTE 8. SUBSEQUENT
EVENTS
Consistent with the Merger Agreement,
Narrowstep Inc. separated employment with Barak Bar-Cohen, President and Chief
Operating Officer of the Company, effective June 30, 2008.
Item
2.
Management’s
Discussion and Analysis or Plan of Operation.
For ease of reading, Narrowstep Inc. is
referred to as “Narrowstep,” “we” or the “Company” throughout this document and
the names of the particular subsidiaries providing the services generally have
been omitted. Narrowstep is a holding company whose subsidiaries
operate in the TV over the Internet services industry both domestically and
internationally providing distribution services and equipment. You
should read this discussion in conjunction with the interim condensed
consolidated financial statements, accompanying notes and management’s
discussion and analysis of financial condition and results of operations
included in our Annual Report on Form 10-KSB for the year ended February 29,
2008.
Consolidated revenues
for the three months ended
May 31, 2008 decreased by $629,712, or 40%, to $961,081 as compared to
$1,590,793 for the three months ended May 31, 2007 as
follows:
Revenues
for the three months ended May 31, 2008
decreased by $454,079, or 32%, to $961,081 as compared to $1,415,160 for the
three months ended May 31, 2007. The decrease in revenue resulted
primarily in an increase in net customer turnover,
particularly
in Europe.
Revenues were negatively impacted by the
non-renewal of several large customer contracts which expired during the
quarter. We renewed our contract with our largest customer during the
quarter, on terms which resulted in significantly lower revenues during the
three-months ended May 31, 2008, as compared to the comparable period in
2007. In addition, revenues decreased as a result of continuing high
levels of non-payment. Revenues also declined as a result of our
previously announced exit from the production services
business.
Geographical distribution of
consolidated revenues (unaudited):
|
|
Three Months
Ended
|
|
|
|
May 31,
2008
|
|
|
May 31,
2007
|
|
|
Percent
|
|
|
|
$
|
|
|
$
|
|
|
Change
|
|
United
States
|
|
|
189,857
|
|
|
|
226,349
|
|
|
|
-16
|
%
|
Europe,
Middle-East and Africa
|
|
|
696,100
|
|
|
|
1,339,108
|
|
|
|
-48
|
%
|
Asia
Pacific
|
|
|
74,959
|
|
|
|
-
|
|
|
|
0
|
%
|
Internet
Sales
|
|
|
165
|
|
|
|
25,336
|
|
|
|
-99
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
961,081
|
|
|
|
1,590,793
|
|
|
|
-40
|
%
|
Consolidated costs
and expenses
for the three
months ended May 31, 2008 decreased by $1,179,515, or 25%, to $3,490,650 as
compared to $4,670,165 for the three months ended May 31, 2007 as
follows:
Operating expenses
include the cost of
bandwidth, direct labor, sub-contracted labor, consulting fees and
depreciation. For the three months ended May 31, 2008, these costs
were $938,547, a 23% decrease over the $1,225,791 reported in the three months
ended May 31, 2007. The decrease resulted primarily from headcount
reductions in customer support and production services related to the
restructuring and streamlining of sales support and our previously announced
decision to exit the production business.
Selling, general and
administrative expenses
include employee compensation and
related costs for personnel engaged in marketing, direct and reseller sales
support functions, the executive team and back office help. For the
three months ended May 31, 2008, these costs were $2,306,674, a 13% decrease
over the $2,645,624 reported for the three months ended May 31,
2007. The decrease resulted primarily from headcount reductions in
sales and administrative staff. Due to our efforts in establishing
policies and procedures to lower bad debt expense, there was also a significant
reduction in bad debt expenses as compared to the previous
year.
Partially offsetting this decrease was a
settlement payment made in connection with the cancellation of our lease at
Carnegie Center. The Company decided to exit this lease because of
the reduction in headcount and to reduce facility expenses going
forward.
Research &
development expenses
include employee compensation, stock
options and depreciation and any related costs for personnel primarily focused
on research and development efforts. For the three months ended May
31, 2008, these costs were $245,429, a 69% decrease over the $798,750 reported
for the three months ended May 31, 2007. The decrease came primarily
from reductions in consulting costs and in employee headcount. Many
of the projects launched last year were completed in the third and fourth
quarter of the fiscal year ended February 29, 2008. Current
initiatives are being managed by the existing staff.
Liquidity
and Capital Resources
Net cash used in
operating activities
was
$2,054,278 for the three months ended May 31, 2008, compared to $2,551,202 for
the three months ended May 31, 2007. The decrease in cash used in
operations was due primarily to the decrease in our net loss. Our net
loss for the period decreased significantly for the reasons described
above.
Net cash used in
investing activities
was
$201,179 for the three months ended May 31, 2008, compared to $528,637 for the
three months ended May 31, 2007. This
decrease
resulted primarily from the
reduction
in our capital equipment purchases
offset by an increase in internal software development costs and the purchase of
short term investments.
Net cash provided by
(used in) financing activities
was ($39,263) for the three months ended
May 31, 2008, compared to $6,930,248 for the three months ended May 31,
2007. The decrease is primarily attributable to the issuance of the
Company’s 12% mandatorily convertible notes issued March 2, 2007 as described
below.
We had $1,908,135 in cash and cash
equivalents available at May 31, 2008 and available bank overdraft facilities of
$59,300.
We
have financed our operations primarily
through private sales of our equity and convertible debt securities
since inception
.
From our inception date
through May 31, 2008, we issued an
aggregate of 122,780,977 shares of our common stock for gross proceeds of
approximately $32.4 million. In addition, we have granted options and
issued shares in lieu of cash in payment to third parties for services rendered.
To a lesser extent, we have also used
capital
leases to fund some of our equipment
acquisitions. We have incurred significant losses since our
inception and at May 31, 2008, we had an accumulated deficit of approximately
$36.7 million.
An
overdraft facility is a line of credit arrangement, negotiated with a bank and
usually reviewable on an annual basis, whereby the bank’s customer is permitted
to take its checking account into a debit balance on a pre-agreed interest basis
up to an agreed amount. Amounts utilized under overdraft facilities are payable
on demand. At May 31, 2008 and February 29, 2008, the overdraft
facilities consisted of approximately $19,800 and $19,800, respectively, with
Barclays Bank PLC (“Barclays”) and $39,500 and $39,700, respectively, with
National Westminster Bank PLC (“NatWest”). Neither facility was
utilized on May 31, 2008 or February 29, 2008. The interest rate on
the Barclays facility is 5.75% above Barclays’ variable base rate (which base
rate was 5.0% per annum as of May 31, 2008). The interest rate on the
NatWest facility is 5.75% above NatWest’s variable base rate (which base rate
was 5.25% per annum as of May 31, 2008). The Barclays overdraft
facility was renewed on March 20, 2008. The NatWest overdraft
facility was renewed on October 10, 2007 and it will expire in one year
.
Our current ratio (current assets
divided by current liabilities) relates to our ability to pay our short-term
debts as they become due. At May 31, 2008, our current ratio was 2.5,
compared to 3.2 at May 31, 2007. Our current ratio fluctuates
primarily because we use cash to develop our business and raise additional funds
from private financing from time to time.
On August 8, 2007, we closed a private
financing with a number of accredited investors for the sale of common stock and
warrants for a total purchase price of $10,510,000. Pursuant to the financing we
sold a total of 42,040,000 shares of common stock at a purchase price of $0.25
per share. We also issued warrants to purchase an aggregate of 21,020,000 shares
of common stock at an exercise price of $0.50 per share, subject to
adjustment. The warrants are exercisable at any time on or prior to
August 8, 2012. The warrants contain customary anti-dilution
provisions in the event of any stock split, reverse stock split,
reclassification or recapitalization of the Company. In addition, the
exercise price and the number of shares issuable upon the exercise of the
warrants are subject to adjustment on a full-ratchet basis in the event that we
issue or are deemed to have issued shares of common stock at an effective
purchase price of less than $0.50 per share, subject to certain
exceptions. In the financing, we issued to the placement agents
warrants to purchase an aggregate of 1,706,400 shares of common
stock. Those warrants have the same terms as the warrants issued in
the financing, except that the warrants issued to the placement agents have a
cashless exercise right.
On March 2, 2007, the Company entered
into a Purchase Agreement (the “Purchase Agreement”) with a number of accredited
investors (the “Investors”) for the sale of its 12% Mandatorily Convertible
Notes (the “Notes”) and Warrants (the “Warrants”) for a total purchase price of
$7,110,000. The Notes, which mature on March 2, 2009, bear interest
at 12% per annum, payable at maturity. The Notes will mandatorily
convert at a 10% discount into the securities issued by the Company in any
subsequent private placement that results in gross proceeds to the Company of at
least $3,000,000 or, in the event of a sale of the Company prior thereto, shares
of common stock valued at a discount of 10% to the per share price to be paid in
the Company sale. The Warrants are exercisable at any time on or
prior to March 2, 2012 for an aggregate of 3,555,000 shares of common stock at
an exercise price of $0.60 per share, subject to adjustment. The
Company has the right to force the cash exercise of the Warrants if the common
stock trades at or above $1.80 per share for at least 20 consecutive trading
days. Both the Notes and the Warrants contain customary anti-dilution
provisions in the event of any stock split, reverse stock split,
reclassification or recapitalization of the Company. In connection
with the August 8, 2007 financing, the full amount of the Notes was
automatically converted into an aggregate of 35,392,003 shares of common stock
at a conversion price of $0.225 per share.
We will
have sufficient working capital to fund our operations for the next five to six
months. In the event that the Merger Agreement is terminated, we will
need to raise further funds to continue operations thereafter.
As of May 31, 2008, our principal
capital commitments consisted of obligations outstanding under capital leases as
shown in the table below (unaudited):
|
|
|
|
|
May
31, 2008
|
|
|
$
|
|
Amounts
payable:
|
|
|
|
|
Within
12 months
|
|
|
167,426
|
|
Between
one and two years
|
|
|
101,844
|
|
Between
two and three years
|
|
|
12,705
|
|
|
|
|
|
|
Total
future commitment
|
|
|
281,975
|
|
Less:
finance charges allocated to future periods
|
|
|
(
24,508
|
)
|
|
|
|
|
|
Present
Value
|
|
|
257,467
|
|
Off balance sheet
arrangements
We have no off-balance sheet
arrangements that have had or are reasonably likely to have a current or future
effect on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources.
Item 3.
Controls and Procedures
We
maintain disclosure controls and procedures designed to ensure that information
required to be disclosed in the reports filed or submitted under
Securities Exchange Act of 1934,
as amended (the “Exchange
Act”)
is
recorded, processed, summarized and reported, within the time period specified
in the SEC’s rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in the reports filed under the Exchange Act
is accumulated and communicated to management, including Mr. McCourt, the
Company’s Interim Chief Executive Officer, as appropriate, to allow timely
decisions regarding required disclosure. In establishing and
maintaining the disclosure controls and procedures, management recognized that
any controls and procedures have inherent limitations. Therefore,
even those systems determined to be effective can provide only reasonable
assurance with respect to financial statement preparation and
presentation.
As of the
end of the period covered by this report, the Company's management, under the
supervision of and with the participation of the Company's interim chief
executive officer and chief financial officer, evaluated the effectiveness of
the Company's disclosure controls and procedures
(as such term is defined in Rule
13a-15(e) under
the
Exchange
Act).
Based on such
evaluation, our interim chief executive officer and chief financial officer have
concluded that our disclosure controls and procedures were effective as of May
31, 2008.
There has
been no significant change in the Company’s internal controls over financial
reporting during our most recent fiscal quarter that has materially affected, or
is reasonably likely to affect, our internal controls over financial
reporting.
CAUTIONARY NOTE REGARDING
FORWARD-LOOKING STATEMENTS
This report contains forward-looking
statements including, without limitation, in the discussion under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." Any and all statements contained in this report that are not
statements of historical fact may be deemed forward-looking statements. Terms
such as may, might, would, should, could, project, estimate, pro forma, predict,
potential, strategy, anticipate, attempt, develop, plan, help, believe,
continue, intend, expect, future, and similar terms and terms of similar import
(including the negative of any of the foregoing) may be intended to identify
forward-looking statements. However, not all forward-looking statements may
contain one or more of these identifying terms. Forward-looking statements in
this report may include, without limitation, statements regarding (i) a
projection of revenues, income (including income/loss), earnings (including
earnings/loss) per share, capital expenditures, dividends, capital structure, or
other financial items, (ii) the plans and objectives of management for future
operations, including plans or objectives relating to our products or
services, (iii) our future financial performance, including any such
statement contained in a discussion and analysis of financial condition by
management or in the results of operations included pursuant to the rules and
regulations of the Securities and Exchange Commission, and (iv) the assumptions
underlying or relating to any statement described in subparagraphs (i), (ii), or
(iii).
The forward-looking statements are not
meant to predict or guarantee actual results, performance, events, or
circumstances and may not be realized because they are based upon our current
projections, plans, objectives, beliefs, expectations, estimates, and
assumptions and are subject to a number of risks and uncertainties and other
influences, many of which we have no control over. Actual results and the timing
of certain events and circumstances may differ materially from those described
by the forward-looking statements as a result of these risks and uncertainties.
Factors that may influence or contribute to the inaccuracy of the
forward-looking statements or cause actual results to differ materially from
expected or desired results may include, without limitation, our inability to
obtain adequate financing, insufficient cash flows and resulting illiquidity,
our dependence upon significant customers, our inability to expand our business,
government regulations, increased competition, changing customer preferences,
stock illiquidity, failure to implement our business plans or strategies, and
ineffectiveness of our marketing program and our acquisition opportunities. A
description of some of the risks and uncertainties that could cause our actual
results to differ materially from those described by the forward-looking
statements in this report appears under the caption "Risk Factors" and elsewhere
in the most recent Form 10-KSB that we have filed with the Securities and
Exchange Commission.
Because of the risks and uncertainties
related to these factors and the forward-looking statements, readers are
cautioned not to place undue reliance on the forward-looking statements. We
disclaim any obligation to update these forward-looking statements or to
announce publicly the results of any revisions to any of the forward-looking
statements contained in this report to reflect any new information or future
events or circumstances or otherwise unless required to do so under applicable
federal securities laws.
Readers should read this report and the
following discussion and analysis in conjunction with the financial statements
and the related notes contained in this report and the other documents we file
from time to time with the Securities and Exchange Commission.
PART II - OTHER
INFORMATION
None.
Item 6. Exhibits
|
EXHIBIT
31.1
|
CERTIFICATION FILED PURSUANT TO
EXCHANGE ACT RULES 13a-14 AND 15d-14 AS ADOPTED PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
|
|
|
|
|
EXHIBIT
31.2
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CERTIFICATION FILED PURSUANT TO
EXCHANGE ACT RULES 13a-14 AND 15d-14 AS ADOPTED PURSUANT TO SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
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EXHIBIT
32.1
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CERTIFICATION OF CHIEF EXECUTIVE
OFFICER FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
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EXHIBIT
32.2
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CERTIFICATION OF CHIEF FINANCIAL
OFFICER FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF
2002
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SIGNATURES
In accordance with the requirements of
the Exchange Act, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
NARROWSTEP INC.
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By:
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/s/ David
McCourt
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Dated: July 8,
2008
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David
McCourt
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Interim Chief Executive
Officer
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By:
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/s/ Lisa
VanPatten
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Dated: July 8,
2008
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Lisa
VanPatten
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Chief Financial
Officer
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