- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended November 30, 2008

o 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	33-1010941
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

116 Village Blvd, Suite 200

Princeton, New Jersey 08540

United States

(Address of principal executive offices)

(609) 945-1772

(Issuer’s telephone number)

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

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

Large accelerated filer o Accelerated filer o

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

Smaller reporting company x

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

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 136,907,977 shares of common stock, $0.000001 par value.

PART 1 - FINANCIAL INFORMATION

Item 1 - Financial Statements

NARROWSTEP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	November 30, 2008			February 29, 2008
	(Unaudited)
	$			$
Assets
Current assets:
Cash and cash equivalents		667,702			4,170,850
Accounts receivable, net of allowance for doubtful accounts of $689,821
and $767,470 at November 30, 2008 (unaudited) and February 29, 2008, respectively		826,126			923,850
Prepaid expenses and other current assets		159,573			411,110
Total current assets		1,653,401			5,505,810
Property and equipment, net		871,188			1,995,504
Software development costs, net		588,041			682,060
Other assets		-			281,790
Total Assets		3,112,630			8,465,164

Liabilities and Stockholders' Equity
Liabilities
Current liabilities:
Unearned revenue		78,784			31,536
Accounts payable		903,198			735,776
Net obligations under capital leases, current		101,533			153,322
Accrued expenses and other current liabilities		308,420			814,214
Total current liabilities		1,391,935			1,734,848
Net obligations under capital leases, long-term		37,455			143,408
Total Liabilities		1,429,390			1,878,256
Commitments and Contingencies

Stockholders' Equity
Common stock, $0.000001 par value 450,000,000 shares authorized,		137			137
136,907,977 (unaudited) issued and outstanding at November 30, 2008 and
137,561,227 issued and outstanding at February 28, 2008
Additional paid-in capital		41,450,640			40,745,085
Accumulated deficit		( 39,379,348	)		( 34,196,475	)
Accumulated other comprehensive income		( 388,189	)		38,161
Total Stockholders' Equity		1,683,240			6,586,908
Total Liabilities and Stockholders' Equity		3,112,630			8,465,164

See Notes to Condensed Consolidated Financial Statements.

NARROWSTEP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS

AND COMPREHENSIVE LOSS (Unaudited)

	Three Months Ended						Nine Months Ended
	November 30, 2008			November 30, 2007			November 30, 2008			November 30, 2007
	$			$			$			$
Revenue
Narrowcasting and other		771,567			1,735,539			2,391,981			4,294,654
Production services		-			(20,828	)		-			296,707
Total revenue		771,567			1,714,711			2,391,981			4,591,361
Costs and Expenses
Operating		643,456			1,516,689			2,356,568			4,104,004
Selling, general and administrative		779,952			2,321,760			4,436,725			8,419,421
Research & development		191,198			716,406			727,788			2,298,454
Loss (Gain) on disposal of assets		4,592			856			69,022			(1,979	)
Total operating expenses		1,619,198			4,555,711			7,590,103			14,819,900
Operating Loss		(847,631	)		(2,841,000	)		(5,198,122	)		(10,228,539	)
Interest income		4,551			63,487			35,740			150,011
Interest expense		(8,610	)		(8,813	)		(23,408	)		(874,260	)
Currency exchange income (loss)		3,729			(4,864	)		2,917			(20,803	)
Net Loss		(847,961	)		(2,791,190	)		(5,182,873	)		(10,973,591	)
Foreign currency translation adjustment		(252,536	)		88,850			(426,350	)		125,285
Comprehensive Loss		(1,100,497	)		(2,702,340	)		(5,609,223	)		(10,848,306	)

Net Loss per Common Share - Basic and Diluted		(0.006	)		(0.02	)		(0.04	)		(0.14	)
Weighted-Average Number of Shares Outstanding, Basic and Diluted		137,003,235			125,033,232			138,136,029			79,247,649

See Notes to Condensed Consolidated Financial Statements.

NARROWSTEP INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended
	November 30, 2008			November 30, 2007
	$			$
Cash Flows from Operating Activities
Net loss		(5,182,873	)		(10,973,591	)
Adjustments to reconcile net loss to net cash used in operating activities:
Allowance for doubtful accounts		(77,649	)		404,358
Depreciation and amortization		745,224			676,603
Loss on disposal of property and equipment		69,022			-
Stock-based compensation expense		705,555			2,165,658
Fair value of options and warrants granted to third party suppliers		-			19,625
Interest on debt issuance		-			853,200
Changes in net cash attributable to changes in operating assets and liabilities:
Accounts receivable		175,373			(262,415	)
Prepaid expenses and other current assets		251,537			(126,116	)
Unearned revenue		47,248			(226,225	)
Accounts payable, accrued expenses and other current liabilities		(338,372	)		(355,351	)
Net Cash Used in Operating Activities		(3,604,935	)		(7,824,254	)
Cash Flows from Investing Activities
Purchases of property and equipment		(110,018	)		(2,177,084	)
Repayment of security deposit		281,790
Purchase of restricted cash-security deposit					(281,790	)
Payments for software development costs		(168,247	)		(435,688	)
Net proceeds from sale of property and equipment		409,469			-
Net Cash Provided by (Used in) Investing Activities		412,994			(2,894,562	)
Cash Flows from Financing Activities
Net proceeds from issuance of common stock		-			10,094,920
Retirement of Narrowstep shares		-			(177,491	)
Payments on capital leases		(157,742	)		(71,716	)
Net Proceeds from issuance of debt instrument		-			6,950,130
Net Cash Provided by (Used in) Financing Activities		(157,742	)		16,795,843
Net Increase (Decrease) in Cash and Cash Equivalents		(3,349,683	)		6,077,027
Effect of exchange rates on change in cash		(153,465	)		14,978
Cash and cash equivalents at the beginning of period		4,170,850			466,870
Cash and Cash Equivalents at the End of the Period		667,702			6,558,875

Supplemental disclosure of non-cash investing activities:
Property and equipment acquired under capital leases		-			196,702

Supplemental disclosure of non-cash financing activities:
Debt converted to equity		-			6,950,130
Interest on debt issuance was paid out with common shares		-			853,200

See Notes to Condensed Consolidated Financial Statements.

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 $39.4 million as of November 30, 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). Through November 30, 2008, while we have reduced costs and streamlined operations pursuant to the Merger Agreement, 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. MERGER

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. 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.

Merger Agreement-Amendment

On August 13, 2008, Narrowstep, Onstream and Merger Sub entered into an amendment to the Merger Agreement (the "Amendment"). Pursuant to the Amendment, among other things, the aggregate number of shares of Onstream Common Stock initially issuable in the Merger in exchange for each outstanding share of Company Common Stock, other than Shares to be Converted was reduced from 10,500,000 to 9,100,000 shares. In addition, the calculation of the aggregate number of Onstream Common Stock initially issuable in the Merger in exchange for the Shares to be Converted was modified to limit the value attributed to Narrowstep's cash balances at closing to a maximum of $600,000. Further, Narrowstep agreed to increase the aggregate value of its Series A Preferred Stock, from at least $300,000 to $1,000,000 and to increase the number of shares of Onstream Common Stock from 600,000 to 2,000,000 shares into which the Series A Preferred Stock will convert. In order to assure that this condition would be satisfied, the Company entered into additional subscription agreements (the "Additional Subscription Agreements") with five of its existing stockholders. The sale of the Series A Preferred Stock pursuant to the Additional Subscription Agreements is exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder.

In accordance with the terms of the Amendment, the CVR Agreement was revised. Pursuant to those revisions, among other things, the relevant revenue measurement time periods were changed so that the initial revenue measurement time period will now commence on the 180th day following the date of closing of the Merger, rather than at closing and the second year revenue period will now commence on the 18th month anniversary of the closing date. In addition, the revenue target for the first revenue time period was reduced from $4,500,000 to $4,250,000, if the Minimum Exchange Ratio is used. The definition of Second Year Revenue Shares was also revised so that if the First Year Revenue is less than $4,250,000, no additional shares of Onstream Common Stock will be issuable in respect of Second Year Revenue.

The Amendment also extends the date by which the parties may terminate the Merger Agreement (the "Termination Date") if the Merger has not been completed by November 30, 2008.

On September 15, 2008, Narrowstep, Onstream and Merger Sub entered into a second amendment to the Merger Agreement ("the Second Amendment"), dated effective September 12, 2008. Pursuant to the Second Amendment, among other things, the aggregate number of shares of Onstream Common Stock, initially issuable in the Merger in exchange for each outstanding share of Narrowstep Common Stock, other than the Shares to be Converted was amended from 9,100,000 to 8,100,000 shares. There was no change in the potential total share consideration of 20,000,000 shares, including the shares potentially available under the CVR Agreement (9,900,000), and the additional number of shares of Onstream Common Stock (2,000,000) into which the shares of Narrowstep's Series A Preferred Stock, will convert at the time of the Merger.

In accordance with the terms of the Second Amendment, the CVR Agreement was revised. Pursuant to those revisions, among other things, the revenue target for the first revenue measurement time period (the twelve months commencing on the 180th day following the date of closing of the Merger) was reduced from $4,250,000 to $4,000,000, if the Minimum Exchange Ratio (as defined in the Merger Agreement) is used. The definition of Second Year Revenue Shares was also revised so that if the First Year Revenue is less than $4,000,000, additional shares of Onstream Common Stock might be issuable in respect of Second Year Revenue, but only to the extent that Second Year Revenue, which is for a six month period commencing on the 18th month anniversary of the closing date, exceeds $2,000,000 (50% of the $4,000,000 annual threshold).

In accordance with the terms of the Second Amendment, and notwithstanding anything to the contrary contained in the CVR Agreement, Onstream may require Narrowstep to promptly make certain identified adjustments to its operations and the entity prior to the Effective Time, based solely upon Onstream's evaluation of certain items identified in the Second Amendment. In the event that the certain identified adjustments are made prior to the Effective Time as a result of Onstream's directives, the $4,000,000 thresholds discussed in the previous paragraph will be replaced with $2,000,000, provided that Narrowstep takes all reasonable actions within its power to carry out those directives. In addition, the waiting period` of three months after the Effective Date (in the CVR Agreement provision that provides the amounts that the future projected revenues from the Narrowstep business, as determined in good faith by Onstream's Board of Directors, if not exceeded would allow Onstream to terminate the Narrowstep business) was eliminated, subject to Onstream's evaluation of certain items identified in the Second Amendment.

On September 23, 2008, Onstream filed Form S-4 Registration Statement under the Securities Act of 1933 with the Securities and Exchange Commission, however, such Registration Statement has not yet been declared as effective.

As indicated in the Second Merger Amendment, the Merger Agreement may be terminated under certain specified events, including by either Onstream or Narrowstep if the Effective Time has not occurred on or prior to November 30, 2008. Onstream and Narrowstep are currently negotiating to extend this termination date, which negotiations may result in changes to other terms of the transaction.

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 former officers. On February 8, 2007, the Company granted options to purchase 200,000 shares to Lisa VanPatten, the Company’s then Chief Financial Officer, at an exercise price of $0.92 per share. All such options shall be expired as of January 31, 2009, On April 30, 2007, the Company granted options to purchase 250,000 shares to Lou Holder, the Company’s then Chief Technology Officer, at an exercise price of $0.68 per share. All such options expired as of December 1, 2008.

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 in 2007 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 Lisa VanPatten 500,000 shares of restricted stock, Lou Holder 750,000 shares of restricted stock, David C. McCourt 900,000 shares of restricted stock and Barak Bar-Cohen 1,000,000 shares of restricted stock which vest upon $4M EBITDA attainment, or upon change of control in the event of separation of employment. Also on this date, pursuant to the June 8, 2007 employment agreement between the Company and Mr. McCourt, the Company granted 2,500,000 shares of restricted stock to Mr. McCourt which are subject to vesting upon the Company’s meeting certain targets established by the Company’s Compensation Committee. None of these shares of restricted stock have vested to date. On March 24, 2008, pursuant to the employment agreement, the Company granted Mr. McCourt 1,250,000 shares of restricted stock units which vest monthly up until November 1, 2009. On March 25, 2008, the Company granted Barak Bar-Cohen an additional 1,000,000 shares of restricted stock which had the same vesting schedule as those restricted shares granted on January 10, 2008, however such shares were canceled on July 2, 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, $51,136 for the nine months ended November 30, 2008 and the balance in accounts receivable at November 30, 2008 is $5,500.

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. LOSS (GAIN) ON DISPOSAL OF ASSETS

Loss (Gain) on disposal of assets includes the write off of computer equipment disposed of due to the reduction of employees, the termination of office space leased at Carnegie Center in New Jersey and the sale of production equipment associated with Sportshows Ltd. during the first three quarters.

NOTE 8. CONCENTRATIONS

The largest four customers in the aggregate accounted for $480,684, or 62% of our revenues for the three months ended November 30, 2008 and $902,912 or 38% of our revenues for the nine months ended November 30, 2008. The largest four customers in the aggregate accounted for $769,722, or 45% of our revenues for the three months ended November 30, 2007 and $1,656,458 or 36% of our revenues for the nine months ended November 30, 2007. The accounts receivable balance for the largest four customers during the quarter was $274,879 as of November 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. One 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 November 30, 2008 decreased by $943,144, or 55%, to $771,567 as compared to $1,714,711 for the three months ended November 30, 2007. Consolidated revenues for the nine months ended November 30, 2008 decreased by $2,199,380 or 48%, to $2,391,981as compared to $4,591,361 for the nine months ended November 30, 2007 as follows:

Narrowcasting revenues for the three months ended November 30, 2008 decreased by $963,972, or 56%, to $771,567 as compared to $1,735,539 for the three months ended November 30, 2007. Narrowcasting revenues for the nine months ended November 30, 2008 decreased by $1,902,673, or 44%, to $2,391,981 as compared to $4,294,654 for the nine months ended November 30, 2007. The decrease in revenue resulted primarily from an increase in net customers lost, particularly in Europe. Revenues were negatively impacted by the non-renewal of several large customer contracts which expired during the first quarter. The Company re-negotiated the contract of its largest customer which resulted in a significant decrease in the overall value of the contract as compared to the previous year. Revenues also declined as a result of our previously announced exit from the production services business.

Geographical distribution of consolidated revenues (unaudited):

	Nine Months Ended
	November 30, 2008		November 30, 2007		Percent
	$		$		Change
United States		756,452		671,467		13	%
Europe, Middle-East and Africa		1,537,881		3,789,082		-59	%
Asia Pacific		88,204		109,908		-20	%
Internet Sales		9,444		20,904		-55	%
Total		2,391,981		4,591,361		-48	%

Consolidated costs and expenses for the three months ended November 30, 2008 decreased by $2,936,513, or 64% to $1,619,198 as compared to $4,555,711 for the three months ended November 30, 2007. Consolidated costs and expenses for the nine months ended November 30, 2008 decreased by $7,229,797, or 49%, to $7,590,103 as compared to $14,819,900 for the nine months ended November 30, 2007 as follows:

Operating expenses include the cost of bandwidth, direct labor, sub-contracted labor, consulting fees and depreciation. For the three months ended November 30, 2008, these costs were $643,456, a 58% decrease over the $1,516,689 reported in the three months ended November 30, 2007. Operating expenses for the nine months ended November 30, 2008 were $2,356,568, a 43% decrease over the $4,104,004 reported in the nine months ended November 30, 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 November 30, 2008, these costs were $779,952, a 66% decrease over the $2,321,760 reported for the three months ended November 30, 2007. Selling, general and administrative expenses for the nine months ended November 30, 2008 were $4,436,725, a 47% decrease over the $8,419,421 reported for the nine months ended November 30, 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 during the first quarter. 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 November 30, 2008, these costs were $191,198 a 73% decrease over the $716,406 reported for the three months ended November 30, 2007. Research & development expenses for the nine months ended November 30, 2008, were $727,788 and a 68% decrease over the $2,298,454 reported for the nine months ended November 30, 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.

Loss (Gain) on disposal of assets includes the write off of computer equipment disposed of due to the reduction of employees, the termination of office space leased at Carnegie Center in New Jersey, and the sale of production equipment associated with Sportshows Ltd during the first three quarters.

Liquidity and Capital Resources

Net cash used in operating activities was $3,604,935 for the nine months ended November 30, 2008, compared to $7,824,254 for the nine months ended November 30, 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 provided by ( used in ) investing activities was $412,994 for the nine months ended November 30, 2008, compared to $2,894,562 for the nine months ended November 30, 2007. This increase resulted primarily from the reduction in our capital equipment purchases as well as proceeds from the sale of assets no longer in operation.

Net cash provided by (used in) financing activities was ($157,742) for the nine months ended November 30, 2008, compared to $16,795,843 for the nine months ended November 30, 2007. The decrease is primarily attributable to the issuance of the Company’s 12% mandatorily convertible notes issued March 2, 2007 and the private equity raise on August 8, 2007 as described below.

We had $667,702 in cash and cash equivalents available at November 30, 2008 and available bank overdraft facilities of $15,368.

We have financed our operations primarily through private sales of our equity and convertible debt securities since inception. From our inception date through November 30, 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 as 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 November 30, 2008, we had an accumulated deficit of approximately $39.4 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 November 30, 2008 and February 29, 2008, the overdraft facilities consisted of approximately $15,368 with Barclays Bank PLC (“Barclays”) and $34,400 with Barclays and $39,700, respectively, with National Westminster Bank PLC (“NatWest”). Neither facility was utilized on November 30, 2008 or February 29, 2008 and as of November 30, 2008, the NatWest facility has been canceled. 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 November 30, 2008). The Barclays overdraft facility was renewed on March 20, 2008 and shall expire on March 20, 2009.

Our current ratio (current assets divided by current liabilities) relates to our ability to pay our short-term debts as they become due. At November 30, 2008, our current ratio was 1.2, compared to 4.4 at November 30, 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 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 believe we will have sufficient working capital to fund our operations for the next two to three months. In the event that the Merger Agreement is terminated, we will need to raise further funds to continue operations thereafter. We are unable to determine if such funding will be available, and if available, what terms such funding may require.

As of November 30, 2008, our principal capital commitments consisted of obligations outstanding under capital leases as shown in the table below (unaudited):

	November 30, 2008
	$
Amounts payable:
Within 12 months		110,515
Between one and two years		38,948
Between two and three years		-
Total future commitment		149,463
Less: finance charges allocated to future periods		( 10,475	)
Present Value		138,988

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 principal 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 principal financial officer have concluded that our disclosure controls and procedures were effective as of November 30, 2008.

Due to changes in staffing level, the Company has addressed control procedures and 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

While Narrowstep has historically held its Annual Meeting of Shareholders in September of each year, Narrowstep did not hold an annual meeting in 2008 due to the pending merger with Onstream. The Company expects to administer any relevant business in conjunction with a special meeting of the shareholders where a vote on the merger is to take place. Narrowstep expects to file a notice of the special meeting of the shareholders immediately following the Securities and Exchange Commission’s declaration of Onstream S-4 Registration Statement as effective.

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	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 32.1	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

	EXHIBIT 32.2	CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER FURNISHED PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

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.

	By:	/s/ David C. McCourt
Dated: 1/14/2009		David C. McCourt
		Interim Chief Executive Officer


	By:	/s/ Richard Lepik
Dated: 1/14/2009		Richard Lepik
		Principal Financial Officer

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