Sonic Foundry Inc.
Annual Report 2008

Plain-text annual report

To our shareholders, Rimas Buinevicius Chairman and CEO (cid:63)(cid:81)(cid:92)(cid:80)(cid:81)(cid:86)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:93)(cid:86)(cid:75)(cid:77)(cid:90)(cid:92)(cid:73)(cid:81)(cid:86)(cid:92)(cid:81)(cid:77)(cid:91)(cid:3)(cid:87)(cid:78) (cid:3)(cid:92)(cid:87)(cid:76)(cid:73)(cid:97)(cid:188)(cid:91)(cid:3)(cid:77)(cid:75)(cid:87)(cid:86)(cid:87)(cid:85)(cid:81)(cid:75)(cid:3)(cid:75)(cid:84)(cid:81)(cid:85)(cid:73)(cid:92)(cid:77)(cid:20)(cid:3)(cid:95)(cid:77)(cid:3)(cid:197)(cid:86)(cid:76)(cid:3)(cid:59)(cid:87)(cid:86)(cid:81)(cid:75)(cid:3) Foundry positioned with a unique business and social opportunity. Forced out of work, millions are reevaluating their career paths as they now seek new employment. As a result, there is a growing demand for education and training. And therein lies the opportunity we see ahead. While it’s not necessarily an accomplishment I would like to see often repeated, more than a year ago we decided to streamline our operations and began taking action immediately. It was the right time to do so. In late 2007, we began experiencing a noticeable slowdown in corporate (cid:49)(cid:60)(cid:3)(cid:88)(cid:93)(cid:90)(cid:75)(cid:80)(cid:73)(cid:91)(cid:81)(cid:86)(cid:79)(cid:20)(cid:3)(cid:77)(cid:91)(cid:88)(cid:77)(cid:75)(cid:81)(cid:73)(cid:84)(cid:84)(cid:97)(cid:3)(cid:88)(cid:90)(cid:87)(cid:86)(cid:87)(cid:93)(cid:86)(cid:75)(cid:77)(cid:76)(cid:3)(cid:81)(cid:86)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:197)(cid:86)(cid:73)(cid:86)(cid:75)(cid:81)(cid:73)(cid:84)(cid:3)(cid:91)(cid:77)(cid:75)(cid:92)(cid:87)(cid:90)(cid:22) (cid:46)(cid:81)(cid:90)(cid:91)(cid:92)(cid:20)(cid:3)(cid:95)(cid:77)(cid:3)(cid:85)(cid:73)(cid:76)(cid:77)(cid:3)(cid:73)(cid:3)(cid:75)(cid:73)(cid:84)(cid:75)(cid:93)(cid:84)(cid:73)(cid:92)(cid:77)(cid:76)(cid:3)(cid:76)(cid:77)(cid:75)(cid:81)(cid:91)(cid:81)(cid:87)(cid:86)(cid:3)(cid:92)(cid:87)(cid:3)(cid:78)(cid:87)(cid:75)(cid:93)(cid:91)(cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:90)(cid:77)(cid:91)(cid:87)(cid:93)(cid:90)(cid:75)(cid:77)(cid:91)(cid:3)(cid:91)(cid:88)(cid:77)(cid:75)(cid:81)(cid:197)(cid:75)(cid:73)(cid:84)(cid:84)(cid:97)(cid:3) on the education and training markets. Next, we made tough choices regarding the resources necessary to execute on that new strategy. And last, we made the necessary cost cutting moves that (cid:95)(cid:87)(cid:93)(cid:84)(cid:76)(cid:3)(cid:76)(cid:90)(cid:81)(cid:94)(cid:77)(cid:3)(cid:93)(cid:91)(cid:3)(cid:92)(cid:87)(cid:3)(cid:88)(cid:90)(cid:87)(cid:197)(cid:92)(cid:73)(cid:74)(cid:81)(cid:84)(cid:81)(cid:92)(cid:97)(cid:3)(cid:81)(cid:86)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:89)(cid:93)(cid:81)(cid:75)(cid:83)(cid:77)(cid:91)(cid:92)(cid:3)(cid:85)(cid:73)(cid:86)(cid:86)(cid:77)(cid:90)(cid:3)(cid:88)(cid:87)(cid:91)(cid:91)(cid:81)(cid:74)(cid:84)(cid:77)(cid:20)(cid:3)(cid:95)(cid:80)(cid:81)(cid:84)(cid:77) deploying our resources and product development efforts to match this strategic objective. While it was a transition year, 2008 ended for us with a business model (cid:95)(cid:77)(cid:84)(cid:84)(cid:21)(cid:88)(cid:87)(cid:91)(cid:81)(cid:92)(cid:81)(cid:87)(cid:86)(cid:77)(cid:76)(cid:3)(cid:78)(cid:87)(cid:90)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:92)(cid:81)(cid:85)(cid:77)(cid:91)(cid:3)(cid:95)(cid:77)(cid:3)(cid:78)(cid:73)(cid:75)(cid:77)(cid:22)(cid:3)(cid:42)(cid:97)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:77)(cid:86)(cid:76)(cid:3)(cid:87)(cid:78) (cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:197)(cid:91)(cid:75)(cid:73)(cid:84)(cid:3)(cid:97)(cid:77)(cid:73)(cid:90)(cid:20)(cid:3) we had accomplished many of our goals, among them achieving (cid:88)(cid:90)(cid:87)(cid:78)(cid:87)(cid:90)(cid:85)(cid:73)(cid:3)(cid:88)(cid:90)(cid:87)(cid:197)(cid:92)(cid:73)(cid:74)(cid:81)(cid:84)(cid:81)(cid:92)(cid:97)(cid:22)(cid:3)(cid:63)(cid:81)(cid:92)(cid:80)(cid:3)(cid:92)(cid:80)(cid:81)(cid:91)(cid:3)(cid:75)(cid:73)(cid:85)(cid:77)(cid:3)(cid:91)(cid:92)(cid:73)(cid:74)(cid:81)(cid:84)(cid:81)(cid:98)(cid:73)(cid:92)(cid:81)(cid:87)(cid:86)(cid:3)(cid:87)(cid:78) (cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:74)(cid:73)(cid:84)(cid:73)(cid:86)(cid:75)(cid:77) (cid:91)(cid:80)(cid:77)(cid:77)(cid:92)(cid:3)(cid:73)(cid:86)(cid:76)(cid:3)(cid:85)(cid:87)(cid:90)(cid:77)(cid:3)(cid:198)(cid:77)(cid:96)(cid:81)(cid:74)(cid:84)(cid:77)(cid:3)(cid:84)(cid:77)(cid:86)(cid:76)(cid:81)(cid:86)(cid:79)(cid:3)(cid:92)(cid:77)(cid:90)(cid:85)(cid:91)(cid:3)(cid:92)(cid:87)(cid:3)(cid:80)(cid:77)(cid:84)(cid:88)(cid:3)(cid:78)(cid:93)(cid:86)(cid:76)(cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:79)(cid:90)(cid:87)(cid:95)(cid:81)(cid:86)(cid:79)(cid:3) receivable base as the merits of our business and the plan we set forth continued to be demonstrated. (cid:46)(cid:90)(cid:87)(cid:91)(cid:92)(cid:3)(cid:73)(cid:86)(cid:76)(cid:3)(cid:59)(cid:93)(cid:84)(cid:84)(cid:81)(cid:94)(cid:73)(cid:86)(cid:3)(cid:90)(cid:77)(cid:75)(cid:77)(cid:86)(cid:92)(cid:84)(cid:97)(cid:3)(cid:76)(cid:87)(cid:75)(cid:93)(cid:85)(cid:77)(cid:86)(cid:92)(cid:77)(cid:76)(cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:85)(cid:73)(cid:90)(cid:83)(cid:77)(cid:92)(cid:3)(cid:91)(cid:80)(cid:73)(cid:90)(cid:77)(cid:3)(cid:79)(cid:90)(cid:87)(cid:95)(cid:92)(cid:80) (cid:95)(cid:81)(cid:92)(cid:80)(cid:3)(cid:73)(cid:86)(cid:3)(cid:77)(cid:91)(cid:92)(cid:81)(cid:85)(cid:73)(cid:92)(cid:77)(cid:3)(cid:92)(cid:80)(cid:73)(cid:92)(cid:3)(cid:59)(cid:87)(cid:86)(cid:81)(cid:75)(cid:3)(cid:46)(cid:87)(cid:93)(cid:86)(cid:76)(cid:90)(cid:97)(cid:3)(cid:75)(cid:93)(cid:90)(cid:90)(cid:77)(cid:86)(cid:92)(cid:84)(cid:97)(cid:3)(cid:80)(cid:87)(cid:84)(cid:76)(cid:91)(cid:3)(cid:87)(cid:94)(cid:77)(cid:90)(cid:3)(cid:28)(cid:24)(cid:3)(cid:88)(cid:77)(cid:90)(cid:75)(cid:77)(cid:86)(cid:92)(cid:3) of the lecture capture market. One of our strategic objectives remains building upon this success. As such, 2008 included a number of key account wins. We now count over 600 education institutions among our customers. Leading the way were various MBA schools that include many of the top business programs in the country. Business schools tend to (cid:74)(cid:77)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:197)(cid:90)(cid:91)(cid:92)(cid:3)(cid:87)(cid:86)(cid:3)(cid:75)(cid:73)(cid:85)(cid:88)(cid:93)(cid:91)(cid:3)(cid:92)(cid:87)(cid:3)(cid:77)(cid:96)(cid:88)(cid:84)(cid:87)(cid:90)(cid:77)(cid:3)(cid:86)(cid:77)(cid:95)(cid:3)(cid:92)(cid:77)(cid:75)(cid:80)(cid:86)(cid:87)(cid:84)(cid:87)(cid:79)(cid:97)(cid:3)(cid:81)(cid:86)(cid:81)(cid:92)(cid:81)(cid:73)(cid:92)(cid:81)(cid:94)(cid:77)(cid:91)(cid:3)(cid:78)(cid:87)(cid:90)(cid:3)(cid:92)(cid:80)(cid:77) (cid:75)(cid:84)(cid:73)(cid:91)(cid:91)(cid:90)(cid:87)(cid:87)(cid:85)(cid:20)(cid:3)(cid:75)(cid:87)(cid:86)(cid:197)(cid:90)(cid:85)(cid:81)(cid:86)(cid:79)(cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:74)(cid:77)(cid:84)(cid:81)(cid:77)(cid:78) (cid:3)(cid:92)(cid:80)(cid:73)(cid:92)(cid:3)(cid:95)(cid:77)(cid:3)(cid:90)(cid:77)(cid:85)(cid:73)(cid:81)(cid:86)(cid:3)(cid:73)(cid:92)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:94)(cid:77)(cid:90)(cid:97)(cid:3)(cid:77)(cid:73)(cid:90)(cid:84)(cid:97) (cid:91)(cid:92)(cid:73)(cid:79)(cid:77)(cid:91)(cid:3)(cid:87)(cid:78) (cid:3)(cid:90)(cid:77)(cid:94)(cid:87)(cid:84)(cid:93)(cid:92)(cid:81)(cid:87)(cid:86)(cid:81)(cid:98)(cid:81)(cid:86)(cid:79)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:85)(cid:87)(cid:76)(cid:77)(cid:90)(cid:86)(cid:3)(cid:73)(cid:75)(cid:73)(cid:76)(cid:77)(cid:85)(cid:81)(cid:75)(cid:3)(cid:77)(cid:96)(cid:88)(cid:77)(cid:90)(cid:81)(cid:77)(cid:86)(cid:75)(cid:77)(cid:22)(cid:3) While it was a transition year, 2008 ended for us with a well- positioned business model for the times we face. Even amidst the current economic conditions, with many universities contemplating budget cuts, we continue to make important progress in deploying our technology across the entire campus footprint. Our best form of marketing remains our existing customers and their willingness to host a prospect from the other side of their own cam- pus to witness Mediasite in action. What can possibly be better and more convincing than seeing the technology really work within their (cid:87)(cid:95)(cid:86)(cid:3)(cid:77)(cid:86)(cid:94)(cid:81)(cid:90)(cid:87)(cid:86)(cid:85)(cid:77)(cid:86)(cid:92)(cid:3)(cid:73)(cid:86)(cid:76)(cid:3)(cid:80)(cid:77)(cid:73)(cid:90)(cid:81)(cid:86)(cid:79)(cid:3)(cid:197)(cid:90)(cid:91)(cid:92)(cid:3)(cid:80)(cid:73)(cid:86)(cid:76)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:74)(cid:77)(cid:86)(cid:77)(cid:197)(cid:92)(cid:91)(cid:3)(cid:81)(cid:92)(cid:3)(cid:73)(cid:76)(cid:94)(cid:77)(cid:90)(cid:92)(cid:81)(cid:91)(cid:77)(cid:91)(cid:39) Mediasite can now be found in the halls of education throughout (cid:92)(cid:80)(cid:77)(cid:3)(cid:95)(cid:87)(cid:90)(cid:84)(cid:76)(cid:20)(cid:3)(cid:86)(cid:87)(cid:92)(cid:3)(cid:82)(cid:93)(cid:91)(cid:92)(cid:3)(cid:92)(cid:80)(cid:77)(cid:3)(cid:61)(cid:22)(cid:59)(cid:22)(cid:3)(cid:60)(cid:80)(cid:81)(cid:91)(cid:3)(cid:73)(cid:76)(cid:87)(cid:88)(cid:92)(cid:81)(cid:87)(cid:86)(cid:3)(cid:75)(cid:93)(cid:90)(cid:94)(cid:77)(cid:3)(cid:81)(cid:91)(cid:3)(cid:76)(cid:90)(cid:81)(cid:94)(cid:77)(cid:86)(cid:3)(cid:74)(cid:97)(cid:3) (cid:79)(cid:84)(cid:87)(cid:74)(cid:73)(cid:84)(cid:81)(cid:98)(cid:73)(cid:92)(cid:81)(cid:87)(cid:86)(cid:3)(cid:73)(cid:91)(cid:3)(cid:95)(cid:77)(cid:84)(cid:84)(cid:3)(cid:73)(cid:91)(cid:3)(cid:73)(cid:3)(cid:86)(cid:77)(cid:77)(cid:76)(cid:3)(cid:92)(cid:87)(cid:3)(cid:80)(cid:73)(cid:94)(cid:77)(cid:3)(cid:77)(cid:76)(cid:93)(cid:75)(cid:73)(cid:92)(cid:81)(cid:87)(cid:86)(cid:3)(cid:73)(cid:86)(cid:76)(cid:3)(cid:92)(cid:90)(cid:73)(cid:81)(cid:86)(cid:81)(cid:86)(cid:79)(cid:3) occur in the native language and with the cultural references of the customers we serve. Plus, we all face the same economic and time challenges, thus driving the need for rapid education and training to redeploy a global workforce. As corporations adapt to this new market, they use Mediasite to provide rapid training of employees and customers as primarily an (cid:87)(cid:93)(cid:92)(cid:91)(cid:87)(cid:93)(cid:90)(cid:75)(cid:77)(cid:76)(cid:3)(cid:91)(cid:77)(cid:90)(cid:94)(cid:81)(cid:75)(cid:77)(cid:3)(cid:87)(cid:78)(cid:78)(cid:77)(cid:90)(cid:81)(cid:86)(cid:79)(cid:22)(cid:3)(cid:63)(cid:80)(cid:77)(cid:92)(cid:80)(cid:77)(cid:90)(cid:3)(cid:92)(cid:80)(cid:77)(cid:97)(cid:3)(cid:90)(cid:77)(cid:84)(cid:97)(cid:3)(cid:87)(cid:86)(cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:45)(cid:94)(cid:77)(cid:86)(cid:92)(cid:3)(cid:59)(cid:77)(cid:90)(cid:94)(cid:81)(cid:75)(cid:77)(cid:91)(cid:3) (cid:87)(cid:90)(cid:3)(cid:87)(cid:93)(cid:90)(cid:3)(cid:80)(cid:87)(cid:91)(cid:92)(cid:81)(cid:86)(cid:79)(cid:3)(cid:91)(cid:87)(cid:84)(cid:93)(cid:92)(cid:81)(cid:87)(cid:86)(cid:91)(cid:20)(cid:3)(cid:92)(cid:80)(cid:77)(cid:91)(cid:77)(cid:3)(cid:75)(cid:93)(cid:91)(cid:92)(cid:87)(cid:85)(cid:77)(cid:90)(cid:91)(cid:3)(cid:73)(cid:90)(cid:77)(cid:3)(cid:197)(cid:86)(cid:76)(cid:81)(cid:86)(cid:79)(cid:3)(cid:53)(cid:77)(cid:76)(cid:81)(cid:73)(cid:91)(cid:81)(cid:92)(cid:77)(cid:3)(cid:73)(cid:86) economically sensible way to accomplish their online training needs without adding internal personnel or equipment. This is a trend we believe will continue and clearly matches the preference of our existing business users. As the post-dotcom bubble evaporated, we repositioned the company and began marketing Mediasite at the tail end of the last recession. The product provided a vision of modern learning for a 21st century lifestyle. And while bandwidth and accessibility weren’t (cid:89)(cid:93)(cid:81)(cid:92)(cid:77)(cid:3)(cid:92)(cid:80)(cid:77)(cid:90)(cid:77)(cid:3)(cid:97)(cid:77)(cid:92)(cid:20)(cid:3)(cid:95)(cid:77)(cid:3)(cid:83)(cid:86)(cid:77)(cid:95)(cid:3)(cid:81)(cid:92)(cid:3)(cid:95)(cid:87)(cid:93)(cid:84)(cid:76)(cid:3)(cid:87)(cid:86)(cid:84)(cid:97)(cid:3)(cid:74)(cid:77)(cid:3)(cid:73)(cid:3)(cid:85)(cid:73)(cid:92)(cid:92)(cid:77)(cid:90)(cid:3)(cid:87)(cid:78) (cid:3)(cid:92)(cid:81)(cid:85)(cid:77)(cid:22)(cid:3)(cid:59)(cid:81)(cid:96)(cid:3)(cid:97)(cid:77)(cid:73)(cid:90)(cid:91) (cid:84)(cid:73)(cid:92)(cid:77)(cid:90)(cid:20)(cid:3)(cid:92)(cid:80)(cid:90)(cid:87)(cid:93)(cid:79)(cid:80)(cid:3)(cid:75)(cid:87)(cid:86)(cid:92)(cid:81)(cid:86)(cid:93)(cid:77)(cid:76)(cid:3)(cid:90)(cid:77)(cid:197)(cid:86)(cid:77)(cid:85)(cid:77)(cid:86)(cid:92)(cid:91)(cid:3)(cid:73)(cid:86)(cid:76)(cid:3)(cid:81)(cid:85)(cid:88)(cid:90)(cid:87)(cid:94)(cid:77)(cid:85)(cid:77)(cid:86)(cid:92)(cid:91)(cid:20)(cid:3)(cid:95)(cid:81)(cid:92)(cid:80)(cid:3)(cid:75)(cid:87)(cid:86)- stant feedback from our customers and countless hours of market research, we are now the best technology provider in this emerging space with the largest market share, and most importantly, massive potential for growth. We stand ready to meet both the incredible challenges presented by today’s economy and the needs of our society as we embark on the next growth phase of our business. Rimas Buinevicius Chairman and CEO SONIC FOUNDRY, INC. 222 West Washington Avenue Madison, Wisconsin 53703 NOTICE OF ANNUAL MEETING OF STOCKHOLDERS To Be Held March 5, 2009 The Annual Meeting of Stockholders of SONIC FOUNDRY, INC., a Maryland corporation (“Sonic”) will be held at the Monona Terrace Community and Convention Center, One John Nolen Drive, Madison, Wisconsin 53703 on March 5, 2009 at 9:00 a.m. local time, for the following purposes: 1. 2. 3. 4. To elect two directors to hold office for a term of five years, and until their successors are duly elected and qualified. To vote on a Proposal to adopt the 2009 Stock Incentive Plan. To ratify the appointment of Grant Thornton LLP as our independent auditors for the fiscal year ending September 30, 2009. To transact such other business as may properly come before the meeting or any adjournments thereof. All the above matters are more fully described in the accompanying Proxy Statement. Only holders of record of Common Stock at the close of business on January 12, 2009 are entitled to notice of, and to vote at, this meeting or any adjournment or adjournments thereof. Please complete and return the enclosed proxy in the envelope provided or follow the instructions on the proxy card to authorize a proxy by telephone or over the Internet, whether or not you intend to be present at the meeting in person. By Order of the Board of Directors, Madison, Wisconsin January 28, 2009 Kenneth A. Minor Secretary (cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326) If you cannot personally attend the meeting, it is earnestly requested that you promptly indicate your vote on the issues included on the enclosed proxy and date, sign and mail it in the enclosed self-addressed envelope, which requires no postage if mailed in the United States or, follow the instructions on the proxy card to authorize a proxy by telephone or over the Internet. Doing so will save us the expense of further mailings. If you sign and return your proxy card without marking choices, your shares will be voted in accordance with the recommendations of the Board of Directors. (cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326)(cid:326) SONIC FOUNDRY, INC. 222 W. Washington Avenue Madison, Wisconsin 53703 PROXY STATEMENT January 28, 2009 The Board of Directors of Sonic Foundry, Inc., a Maryland corporation (“Sonic”), hereby solicits the enclosed proxy. Unless instructed to the contrary on the proxy, it is the intention of the persons named in the proxy to vote the proxies: FOR the election of David C. Kleinman and Paul S. Peercy as Directors for terms expiring in 2014; and FOR the proposal to adopt the 2009 Stock Incentive Plan; and FOR the ratification of the appointment of Grant Thornton LLP as independent auditors of Sonic for the fiscal year ending September 30, 2009. In the event that either nominee for director becomes unavailable to serve, which management does not anticipate, the persons named in the proxy reserve full discretion to vote for any other person who may be nominated. Proxies may also be authorized by telephone or over the Internet by following the instructions on the proxy card. Any stockholder giving a proxy may revoke the same at any time prior to the voting of such proxy. This Proxy Statement and the accompanying proxy are being mailed on or about February 5, 2009. Each stockholder will be entitled to one vote for each share of Common Stock standing in his or her name on our books at the close of business on January 12, 2009 (the “Record Date”). Only holders of issued and outstanding shares of Sonic's common stock as of the close of business on the Record Date are entitled to notice of and to vote at the Annual Meeting, including any adjournment or postponement thereof. On that date, we had outstanding and entitled to vote 35,769,950 shares of Common Stock, held by approximately 9,000 stockholders, of which approximately 8,500 were held in street name. QUORUM; VOTES REQUIRED Votes cast by proxy or in person at the Annual Meeting will be tabulated by the inspector of elections appointed for the Annual Meeting and will determine whether or not a quorum is present. Where, as to any matter submitted to the stockholders for a vote, proxies are marked as abstentions (or stockholders appear in person but abstain from voting), such abstentions will be treated as shares that are present and entitled to vote for purposes of determining the presence of a quorum but as unvoted for purposes of determining the approval of any matter submitted to the stockholders for a vote. If a broker indicates on the proxy that it does not have discretionary authority as to certain shares to vote on a particular matter and has not received instructions from the beneficial owner, which is known as a broker non-vote, those shares will not be considered as present and entitled to vote with respect to that matter; however, such shares will be considered present for purposes of a quorum. A majority of the shares of Common Stock issued, outstanding and entitled to vote at the Annual Meeting, present in person or represented by proxy, shall constitute a quorum at the Annual Meeting. The election of the Directors requires a plurality of the votes present and entitled to vote. The adoption of the 2009 Stock Incentive Plan requires the approval of a majority of the outstanding shares of Common Stock considered as present at the meeting and entitled to vote. The approval of the other proposals requires the affirmative vote of the holders of a majority of the votes cast at the Annual Meeting. DATE, TIME AND PLACE OF ANNUAL MEETING The Annual Meeting will be held on March 5, 2009 at 9:00 a.m. (Central time) at the Monona Terrace Community and Convention Center, One John Nolen Drive, Madison, Wisconsin 53703. 1 PROPOSAL ONE: ELECTION OF DIRECTORS Our Amended and Restated Articles of Incorporation and Bylaws provide that the Board of Directors shall be divided into five classes, with each class having a five-year term. Directors are assigned to each class in accordance with a resolution or resolutions adopted by the Board of Directors, each class consisting, as nearly as possible, of one-fifth the total number of directors. Vacancies on the Board of Directors resulting from death, resignation, disqualification, removal or other causes may be filled by either the affirmative vote of the holders of a majority of the then-outstanding shares or by the affirmative vote of a majority of the remaining directors then in office, even if less than a quorum of the Board of the Directors. Newly created directorships resulting from any increase in the number of directors may, unless the Board of Directors determines otherwise, be filled only by the affirmative vote of the directors then in office, even if less than a quorum of the Board of Directors. A director elected by the Board of Directors to fill a vacancy (including a vacancy created by an increase in the number of directors) shall serve for the remainder of the full term of the class of directors in which the vacancy occurred and until such director’s successor is elected and qualified. Our Amended and Restated Articles of Incorporation provide that the number of directors, which shall constitute the whole Board of Directors, shall be fixed exclusively by one or more resolutions adopted from time to time by the Board of Directors. Our currently authorized number of directors is seven. The seats on the Board of Directors currently held by David C. Kleinman and Paul S. Peercy are designated as Class I Board seats, with terms expiring as of the Annual Meeting. Mssrs. Kleinman and Peercy will stand for re-election at this Annual Meeting. Mssrs. Kleinman and Peercy are currently Board members of Sonic who were previously elected by the stockholders. If elected at the Annual Meeting, Mssrs. Kleinman and Peercy would serve until the 2014 Annual Meeting and until their successors are elected and qualified or until their earlier death, resignation or removal. Nominees for Director for a Five-Year term expiring on the 2014 Annual Meeting David C. Kleinman Mr. Kleinman, age 73, has been a Director of Sonic since December 1997 and has taught at the Graduate School of Business at the University of Chicago since 1971, where he is now Adjunct Professor of Strategic Management. Mr. Kleinman has been a Director (trustee) of the Acorn Funds since 1972 (of which he is also Chair of the Audit Committee, and a member of the Committee on Investment Performance and the Compliance Committee); a Director since 1984 of North Lime Holdings and its wholly owned subsidiary, Irex Corporation, a contractor and distributor of insulation materials (where he is chairman of the Board of Directors); and a Director since 1993 of Plymouth Tube Company, a manufacturer of metal tubing and metal extrusions (where he serves on the Audit Committee). From 1999 to 2006, he was a member of the Advisory Board of DSC Logistics, a logistics management and warehousing firm. From May 1997 to February 2004, Mr. Kleinman served as a Director of AT&T Latin America and predecessor companies, a facilities-based provider of telecom services in Brazil, Argentina, Chile, Peru and Columbia (where he was chair of the Audit Committee and a member of the Compensation Committee). From 1994 to 2005, he was a director of Wisconsin Paper and Products Company, a jobber of paper and paper products. From 1964 to 1971, Mr. Kleinman was a member of the finance staff of the Ford Motor Company. Paul S. Peercy Mr. Peercy, age 68, has been a Director of Sonic since February 2004. Since September 1999, Mr. Peercy has served as dean of the University of Wisconsin-Madison College of Engineering. Since 2001 Mr. Peercy has been a member of the National Academy of Engineering. In 2000, then-Wisconsin Governor Tommy Thompson named Mr. Peercy to the Wisconsin Technology and Entrepreneurship Council. From August 1995 to September 1999, Mr. Peercy served as president of SEMI/SEMATECH, an Austin, Texas-based non-profit consortium of more than 160 2 of the nation’s suppliers to the semiconductor industry. Prior to that position he was director of Microelectronics and Photonics at Sandia National Laboratories in Albuquerque, New Mexico. He is the author or co-author of more than 175 technical papers and the recipient of two patents. Mr. Peercy is a Director and member of the audit committee of Bemis Company, Inc, a manufacturer of flexible packaging and pressure sensitive materials. Mr. Peercy received a BA degree in Physics from Berea College and MS and PhD degrees in Physics from the University of Wisconsin - Madison. The election of a Director requires the approval of a plurality of the votes cast by holders of the shares of Sonic's common stock. Any shares not voted, whether by broker non-vote or otherwise, will have no impact on the outcome of the election. The Board of Directors unanimously recommends a vote FOR the election of Mssrs. Kleinman and Peercy as Class I Directors. DIRECTORS CONTINUING IN OFFICE Arnold B. Pollard Term Expires in 2010 Mr. Pollard, age 66, has been a Director of Sonic since December 1997. From 1993 until January 2002, he was the President and Chief Executive Officer of Chief Executive Group, which published "Chief Executive" magazine. For over 25 years, he has been President of Decision Associates, a management consulting firm specializing in organizational strategy and structure. Mr. Pollard has served as a director and a member of the audit and compensation committees of Delta Financial Corporation, a public company engaged in the business of home mortgage lending, since 2005. From 1989 to 1991, Mr. Pollard served as Chairman and Chief Executive Officer of Biopool International, a biodiagnostic public company focusing on blood related testing; and from 1972 to 1973, served as President and CEO of IDS, an information services company serving the savings bank market. He previously served on the boards of GKN Corporation, Sentigen Holding Corp, Lillian Vernon Corp. and DEBE Systems Corp. From 1970 to 1973, Mr. Pollard taught at the Graduate School of Business at Columbia University where he was adjunct Professor of Decision Sciences. Mr. Pollard received a BS in Engineering Physics from Cornell University, and both an MS in Engineering Sciences and a PhD in Engineering-Economics Systems from Stanford University. Frederick H. Kopko, Jr. Term Expires in 2011 Mr. Kopko, age 53, has been corporate Secretary from April 1997 to February 2001 and has been a Director since December 1995. Mr. Kopko is a partner of the law firm of McBreen & Kopko, Chicago, Illinois, and has been a partner of that firm since January 1990. He has been a Director of Mercury Air Group, Inc. since 1992. Mr. Kopko received a B.A. degree in economics from the University of Connecticut, a J.D. degree from the University of Notre Dame Law School, and an M.B.A. degree from the University of Chicago. Rimas P. Buinevicius Term Expires in 2012 Mr. Buinevicius, age 46, has been the Chairman of the Board since October 1997 and Chief Executive Officer since January 1997. In addition to his organizational duties, Mr. Buinevicius is a recognized figure in the rich media industry focused on the convergence of technology, digital media and entertainment. Mr. Buinevicius joined Sonic in 1994 as General Manager and Director of Marketing. Prior to joining Sonic, Mr. Buinevicius spent the majority of his professional career in the fields of biomedical and industrial control research and development. Mr. Buinevicius earned an M.B.A. degree from the University of Chicago; a Master's degree in Electrical Engineering from the University of Wisconsin, Madison; and a Bachelor's degree in Electrical Engineering from the Illinois Institute of Technology, Chicago. Mr. Buinevicius is a recipient of Ernst and Young’s Entrepreneur of the Year award. 3 Monty R. Schmidt Term Expires in 2013 Mr. Schmidt, age 44, has been the Chief Technology Officer since July 2003 and served as President from March 1994 to July 2003 and as a Director since February 1994. Throughout his tenure at Sonic Foundry, Mr. Schmidt has spearheaded a variety of engineering and strategic initiatives that have helped grow Sonic from the one person startup he founded in 1991. In addition to acting as an industry liaison, Mr. Schmidt is responsible for managing and facilitating technology development and utilization. Prior to joining Sonic, Mr. Schmidt served in software and hardware engineering capacities for companies in the medical and food service equipment industries. Mr. Schmidt has a B.S. degree in Electrical Engineering from the University of Wisconsin, Madison. Gary R. Weis Term Expires in 2013 Mr. Weis, age 61, has been a Director of Sonic since February 2004 and was President, Chief Executive Officer and a Director of Cometa Networks, a wireless broadband Internet access company from March 2003 to April 2004. From May 1999 to February 2003 he was Senior Vice President of Global Services at AT&T where he was responsible for one of the world's largest data and IP networks, serving more than 30,000 businesses and providing Internet access to more than one million individuals worldwide. While at AT&T, Mr. Weis also was CEO of Concert, a joint venture between AT&T and British Telecom. Previously, from January 1995 to May 1999 he was General Manager of IBM Global Services, Network Services. Mr. Weis served as a Director from March 2001 to February 2003 of AT&T Latin America, a facilities-based provider of telecom services in Brazil, Argentina, Chile, Peru and Columbia. Mr. Weis earned BS and MS degrees in Applied Mathematics and Computer Science at the University of Illinois, Chicago. Director Independence CORPORATE GOVERNANCE Through its listing requirements for companies with securities listed on the NASDAQ Capital Market, the NASDAQ Stock Market (“NASDAQ”) requires that a majority of the members of our Board be independent, as defined under NASDAQ’s rules. The NASDAQ rules have both objective tests and a subjective test for determining who is an “independent director.” The objective tests state, for example, that a director is not considered independent if he or she is an employee of the Company or has engaged in various types of business dealings with the Company. The subjective test states that an independent director must be a person who lacks a relationship that in the opinion of the Board would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The Board has made a subjective determination as to each independent director that no relationship exists which, in the opinion of the Board, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. In making these determinations, the Board reviews information provided by the directors in an annual questionnaire with regard to each director’s business and personal activities as they relate to the Company. Based on this review and consistent with NASDAQ’s independence criteria, the Board has affirmatively determined that the following directors are independent: Gary R. Weis, David C. Kleinman, Paul S. Peercy and Arnold B. Pollard. Related Person Transaction The Board has adopted a Related Person Transaction Policy (the “Policy”), which is a written policy governing the review and approval or ratification of Related Person Transactions, as defined in SEC rules. Under the Policy, each of our directors and executive officers must notify the Chairman of the Audit Committee in writing of any potential Related Person Transaction involving such person or an immediate family member. The Audit Committee will review the relevant facts and circumstances and will approve or ratify the transaction only if 4 it determines that the transaction is in, or is not inconsistent with, the best interests of the Company. The Related Party Transaction must then be approved by the independent directors. In determining whether to approve or ratify a Related Person Transaction, the Audit Committee and the independent directors may consider, among other things, the benefits to the Company; the impact on the director’s independence (if the Related Person is a director or an immediate family member); the availability of other sources for comparable products or services; the terms of the transaction; and the terms available to unrelated third parties or to employees generally. There were no Related Person Transactions in the fiscal year ended September 30, 2008 (“Fiscal 2008”). Board Structure and Meetings The Board met eight times during Fiscal 2008. The Board also acted by written consent from time to time. All directors attended at least 75% of the total number of Board meetings and committee meetings on which they serve (during the period in which each director served). In addition, NASDAQ marketplace rules contemplate that the independent members of our Board will meet during the year in separate closed meetings referred to as “executive sessions” without any employee director or executive officer present. Executive sessions were usually held after regularly scheduled Board meetings during 2008. The Board of Directors has four standing committees, the Audit Committee, the Executive Compensation Committee, the Nominating Committee and the Operations Analysis Committee. Sonic has a standing audit committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Messrs. Kleinman (chair), Weis and Peercy serve on the Audit Committee. Sonic’s Board of Directors has determined that all members of Sonic’s Audit Committee are “independent” as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act and as defined under Nasdaq listing standards. The Audit Committee provides assistance to the Board in fulfilling its oversight responsibility including: (i) internal and external financial reporting, (ii) risks and controls related to financial reporting, and (iii) the internal and external audit process. The Audit Committee is also responsible for recommending to the Board the selection of our independent public accountants and for reviewing all related party transactions. The Audit Committee met five times in Fiscal 2008. A copy of the charter of the Audit Committee is available on Sonic’s website. Sonic's Board of Directors has determined that, due to his affiliation with the Graduate School of Business at the University of Chicago, and due to his serving as a director on numerous company boards, along with his other academic and business credentials, Mr. Kleinman has the requisite experience and applicable background to meet Nasdaq standards requiring financial sophistication of at least one member of the audit committee. Sonic's Board of Directors has also determined that neither Mr. Kleinman nor any other member of the Audit Committee is an audit committee financial expert as defined by applicable SEC regulations The Executive Compensation Committee consists of Messrs. Kleinman (chair), Weis and Peercy. The Board of Directors has determined that all of the members of the Executive Compensation Committee are “independent” as defined under Nasdaq listing standards. The Executive Compensation Committee makes recommendations to the Board with respect to salaries of employees, the amount and allocation of any incentive bonuses among the employees, and the amount and terms of stock options to be granted to executive officers. The Executive Compensation Committee met three times in Fiscal 2008. A copy of the charter of the Executive Compensation Committee is available on Sonic’s website. The Nominating Committee consists of Messrs. Pollard (chair) and Kleinman. The Board of Directors has determined that all of the members of the Nominating Committee are “independent” as defined under Nasdaq listing standards. The purpose of the Nominating Committee is to evaluate and recommend candidates for election as directors, make recommendations concerning the size and composition of the Board of Directors, develop specific criteria for director independence, and assess the effectiveness of the Board of Directors. Our Board of Directors has adopted a charter for the Nominating Committee, which is available on Sonic’s website. The Nominating Committee will review all candidates in the same manner regardless of the source of the recommendation. Stockholder recommendations of 5 candidates for Board membership will be considered when submitted with sufficient detail including the candidate’s name, principal occupation during the past 5 years, listing of directorships, a statement that such nominee has consented to the submission of the nomination, amount of common stock of Sonic held by the nominee and qualification addressed to Corporate Secretary, Sonic Foundry, Inc., 222 W. Washington Ave., Madison, WI 53703 The Operations Analysis Committee consists of Messrs. Weis (chair) and Pollard. The Operations Analysis Committee was established in May 2008 to facilitate communication and provide advisory leadership in planning and strategic growth. The Operations Analysis Committee met in person and held numerous informal and telephonic meetings in fiscal 2008. DIRECTORS COMPENSATION Our directors, who are not also our full-time employees, receive an annual retainer of $20,000 in addition to a fee of $1,500 for attendance at each meeting of the Board of Directors and $1,000 per committee meeting attended, other than the chair of our Audit Committee, Mr. Kleinman, who receives $2,000 per Audit Committee meeting attended. In addition, the chair of our Operations Analysis Committee, Mr. Weis, receives compensation of a $12,000 retainer per year and Mr. Pollard receives an annual retainer of $6,000 per year as compensation as a member of the Operations Analysis Committee. In addition, Mr. Pollard received in Fiscal 2008 an additional $30,000 cash compensation for his services on the Strategy Committee, which was discontinued in March 2008, and $24,998 cash compensation for consulting services provided through March 2008.The cash compensation paid to the five non- employee directors combined in Fiscal 2008 was approximately $243,000. When traveling from out-of-town, the members of the Board of Directors are also eligible for reimbursement for their travel expenses incurred in connection with attendance at Board meetings and Board Committee meetings. Directors who are also employees do not receive any compensation for their participation in Board or Board Committee meetings. Pursuant to the 2008 Sonic Foundry Non-Employee Directors Stock Option Plan (the “Directors Plan”) we grant to each non-employee director who is reelected or who continues as a member of the Board of Directors at each annual stockholders meeting a stock option to purchase 20,000 shares of Common Stock. Further, the chair of our Audit Committee receives an additional stock option grant to purchase 5,000 shares of Common Stock per year and the chair of our Operations Analysis Committee received a one-time stock option grant to purchase 50,000 shares of common stock which vest 25% immediately, and 25% on each of 4 months, 16 months and 28 months from the date of grant for his role in managing the activities of the Operations Analysis Committee pursuant to Sonic’s Non Qualified Stock Option Plan. The exercise price of each stock option granted was equal to the market price of Common Stock on the date the stock option was granted. Stock options issued under the Directors Plan vest fully on the first anniversary of the date of grant and expire after ten years from date of grant. An aggregate of 500,000 shares are reserved for issuance under the Directors Plan. If any change is made in the stock subject to the Directors Plan, or subject to any option granted thereunder, the Directors Plan and options outstanding thereunder will be appropriately adjusted as to the type(s), number of securities and price per share of stock subject to such outstanding options. The options and warrants set forth above have an exercise price equal to the fair market value of the underlying common stock on the date of grant. The term of all such options is ten years. 6 The following table summarizes cash and equity compensation provided our non-employee directors during the fiscal year ended September 30, 2008. Fees Earned Or Paid In Cash ($)(1) (b) Stock Awards ($) (c) Option Awards ($)(2) (d) Non-Stock Incentive Plan Compensation ($) (e) Name (a) David C. Kleinman Frederick H. Kopko Paul S. Peercy Arnold B. Pollard Gary R. Weis $ 45,000 32,000 40,000 86,998 39,000 — — — — — $ 28,543 22,834 22,834 61,554 22,834 — — — — — Change in Pension Value and Non-qualified Deferred Compensation Earnings ($) (f) — — — — — All Other Compensation ($) (g) Total ($) (h) — — — — — $ 73,543 54,834 62,834 148,552 61,834 (1) (2) The amount reported in column (b) is the total of retainer fees and meeting attendance fees, and with respect to Mr. Pollard, consulting fees. The amount reported in column (d) is the dollar amount recognized for financial reporting purposes for the fiscal year ended September 30, 2008 in accordance with FAS 123(R). Each director received an option award of 20,000 shares on March 6, 2008 at an exercise price of $0.80 with a grant date fair value of $8,734. In addition, Mr. Kleinman received a grant of 5,000 shares on March 6, 2008 at an exercise price of $0.80 with a grant date fair value of $2,184 in connection with his position as chair of the Audit Committee and Mr. Pollard received a grant of 68,000 shares on December 27, 2007 at an exercise price of $1.28 with a grant date fair value of $38,719 in connection with his position as chair of the Strategy Committee and Mr. Weis received a grant of 50,000 shares on November 3, 2008 at an exercise price of $0.50 with a grant date fair value of $13,814 in connection with his position as chair of the Operations Analysis Committee. EXECUTIVE OFFICERS OF SONIC Our executive officers, who are appointed by the Board of Directors, hold office for one-year terms or until their respective successors have been duly elected and have qualified. There are no family relationships between any of the executive officers of Sonic. Rimas P. Buinevicius is our Chairman of the Board of Directors and Chief Executive Officer. . (See " Directors Continuing in Office ".) Monty R. Schmidt is our Chief Technology Officer and a Director. (See " Directors Continuing in Office ".) Kenneth A. Minor, age 46, has been our Chief Financial Officer since June 1997, Assistant Secretary from December 1997 to February 2001 and Secretary since February 2001. From September 1993 to April 1997, Mr. Minor was employed as Vice President and Treasurer for Fruehauf Trailer Corporation, a manufacturer and global distributor of truck trailers and related after market parts and service where he was responsible for financial, treasury and investor relations functions. Prior to 1993, Mr. Minor served in various senior accounting and financial positions for public and private corporations as well as the international accounting firm of Deloitte Haskins and Sells. Mr. Minor is a certified public accountant and has a B.B.A. degree in accounting from Western Michigan University. Robert M. Lipps, age 37, has been Executive Vice President of Sales since April 2008, joining Sonic Foundry in April 2006 as Vice President of International Sales and assuming expanded responsibility for U.S. central sales in 2007. Mr. 7 Lipps leads the company’s global sales organization including oversight of domestic, international and channel sales. He holds 15 years of sales leadership, business development and emerging market entry expertise in the technology and manufacturing sectors, including sales and channel management. From Jan 2004 to Mar 2006 he served as General Manager of Natural Log Homes LLC, a New Zealand based manufacturer of log homes, from July 1999 to Dec 2002 he served as Latin America Regional Manager of Adaytum, a software publisher of planning and performance management solutions, (acquired by Cognos Software, an IBM Company, in January 2003) and from May 1996 to July 1999 he served as International Sales Manager for Persoft, a software publisher of host access and mainframe connectivity solutions (acquired by Esker software in 1998). Mr. Lipps has a B.S. degree in Marketing from the University of Wisconsin at La Crosse. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table shows information known to us about the beneficial ownership of our Common Stock as of January 12, 2009, by each stockholder known by us to own beneficially more than 5% of our Common Stock, each of our executive officers named in the Summary Compensation Table (“Named Executive Officers”), each of our directors, and all of our directors and executive officers as a group. Unless otherwise noted, the mailing address for these stockholders is 222 West Washington Avenue, Madison, Wisconsin 53703. Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting or investment power with respect to shares. Shares of common stock issuable upon the exercise of stock options or warrants exercisable within 60 days after January 12, 2009, which we refer to as Presently Exercisable Options, are deemed outstanding for computing the percentage ownership of the person holding the options but are not deemed outstanding for computing the percentage ownership of any other person. Unless otherwise indicated below, to our knowledge, all persons named in the table have sole voting and investment power with respect to their shares of common stock, except to the extent authority is shared by spouses under applicable law. The inclusion of any shares in this table does not constitute an admission of beneficial ownership for the person named below. 8 Based on currently available Schedules 13D and 13G filed with the SEC, we do not know of any beneficial owners of more than 5% of our Common Stock, other than listed below. Name of Beneficial Owner(1) Common Stock Monty R. Schmidt (3) Rimas P. Buinevicius(4) Arnold B. Pollard(5) 733 Third Avenue New York, NY 10017 Kenneth A. Minor(6) Frederick H. Kopko, Jr.(7) 20 North Wacker Drive Chicago, IL 60606 David C. Kleinman(8) 1101 East 58th Street Chicago, IL 60637 Gary R. Weis(9) P.O. Box 272 Deerfield, IL 60015 Paul S. Peercy(10) 1415 Engineering Dr Madison, WI 53706 Robert M. Lipps(11) Number of Shares of Class Beneficially Owned 3,379,604 2,569,075 Percent of Class(2) 9.4% 6.9 610,830 443,941 366,275 275,000 170,000 120,400 77,416 1.7 1.2 1.0 * * * * All Executive Officers and Directors as a Group (9 persons)(12) 8,012,541 20.6% * (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) less than 1% Sonic believes that the persons named in the table above, based upon information furnished by such persons, have sole voting and investment power with respect to the number of shares indicated as beneficially owned by them. Applicable percentages are based on 35,769,950 shares outstanding, adjusted as required by rules promulgated by the Securities and Exchange Commission. Includes 236,468 shares subject to Presently Exercisable Options. Includes 1,236,666 shares subject to Presently Exercisable Options. Consists of 610,830 shares subject to Presently Exercisable Options. Includes 421,941 shares subject to Presently Exercisable Options. Includes 80,000 shares subject to Presently Exercisable Options. Includes 245,000 shares subject to Presently Exercisable Options. Includes 145,000 shares subject to Presently Exercisable Options. Includes 120,000 shares subject to Presently Exercisable Options. Includes 76,666 shares subject to Presently Exercisable Options. Includes an aggregate of 3,172,571 Presently Exercisable Options. 9 Introduction Compensation Discussion and Analysis This Compensation Discussion and Analysis describes our compensation strategy, policies, programs and practices for the executive officers identified in the Summary Compensation Table. Throughout this proxy statement, we refer to these individuals, who serve as our Chief Executive Officer, Chief Financial Officer, Chief Technology Officer and Executive Vice President of Sales as the “executive officers.” The Compensation Committee (“Committee”) establishes and oversees our compensation and employee benefits programs and approves the elements of total compensation for the executive officers. The day-to-day design and administration of our retirement and employee benefit programs available to our employees are handled by our Human Resources and Finance Department employees. The Committee is responsible for reviewing these programs with management and approving fundamental changes to them. Overview and Objectives of our Executive Compensation Program The compensation program for our executive officers is designed to attract, motivate, reward and retain highly qualified individuals who can contribute to Sonic’s growth with the ultimate objective of improving stockholder value. Our compensation program consists of several forms of compensation: base salary, annual bonus, long-term incentives and limited perquisites and benefits. Base salary and annual bonus are cash-based while long-term incentives consist of stock option awards. The Committee does not have a specific allocation goal between cash and equity-based compensation or between annual and long-term incentive compensation. Instead, the Committee relies on the process described in this discussion and analysis in its determination of compensation levels and allocations for each executive officer. The Committee does not utilize objective guidelines or formulae, performance targets or short-term changes in our stock price to determine the elements and levels of compensation for our executive officers. Instead, it relies upon its collective judgment as applied to the challenges confronting Sonic, together with advice from independent consultants, information provided by Sonic and independent sources, and the recommendations of our Chief Executive Officer. The Committee also uses subjective information when considering the credentials, length of service, experience, consistent performance, and available competitive alternatives of our executive officers. The Committee receives and reviews a variety of information throughout the year to assist it in directing the executive compensation program. Throughout the year, the Committee reviews financial reports comparing Sonic’s performance on a year-to-date basis versus budget and at each meeting of the Board of Directors the executive officers present an operating report. The recommendations of the Chief Executive Officer play a significant role in the compensation-setting process. The Chief Executive Officer provides the Committee with an annual overall assessment of Sonic’s achievements and performance, his evaluation of individual performance and his recommendations for annual compensation, bonus and long-term incentive awards. The Committee has discretion to accept, reject or modify the Chief Executive Officer’s recommendations. The Committee determines the compensation for each executive officer in an executive session. Market Competitiveness The Committee’s target is for total cash compensation to average between the 50th and 75th percentile of published compensation data derived from two sources: (i) a peer group of companies that are in our industry, competitors for key talent, or with similar financial characteristics; and (ii) published market survey data for companies within our revenue range. The peer group data was obtained from the most recently filed proxy statement of 14 publicly-traded technology companies with annual revenues ranging from $16.5 million to $30 million; market capitalization of $5 million to $75 million, five year revenue growth of at least 15% and employees of 200 or less. The following companies comprised the peer group for the study: A.D.A.M., Inc., Altus Pharmaceuticals, Inc., Anadys Pharmaceuticals, Inc., Bitstream, Inc., Carbiz, Inc., CarGuide, Inc., Glowpoint, Inc., I.D. Systems, Inc., Icagen, 10 Inc., Global Medical Technologies, Inc., Unigene Laboratories, Inc., Onvia, Inc., Pharsight Corporation, and Voxware, Inc. Given competitive recruiting pressures, the Committee retains its discretion to deviate from this target under appropriate circumstances. The Committee periodically receives updates of the published compensation data. Pay for Performance The Committee believes that both long and short term compensation of executive officers should correlate to Sonic’s overall financial performance. Incentive payouts will be larger with strong performance and smaller if Sonic’s financial results decline. From time to time, extraordinary Board-approved initiatives in a fiscal year, such as a restructuring, acquisition, or divestiture, are considered by the Committee in its overall evaluation of Sonic’s performance. Competitive Benchmarking/Peer Group Analysis The Committee reviewed market data from the American Electronics Association (“AeA”) in various size and industry stratifications similar to that of Sonic. The second source of compensation data came from a peer group of fourteen public companies that we consider similar to our market for sales, or for key talent, or with similar financial or other characteristics such as number of employees. The companies in the peer group ranged in market capitalization between $5 million and $75 million, had fewer than 200 employees, revenues between $16.5 million and $30 million and exhibited long-term revenue growth in excess of 15%. Components of Executive Compensation Base Salary The Committee seeks to pay the executive officers a competitive base salary in recognition of their job responsibilities for a publicly held company. As noted above, the target compensation range for an executive’s total cash compensation (salary and bonus) is between the 50th and 75th percentile of the market data reviewed by the Committee. As part of determining annual increases, the Committee also considers the Chief Executive Officer’s recommendation regarding individual performance as well as internal equitable considerations. In evaluating individual performance, the Committee considers initiative, leadership, tenure, experience, skill set for the particular position, knowledge of industry and business, and execution of strategy in placing the individual within the range outlined. In response to increased losses Sonic initiated cost reduction efforts in January 2008, including voluntary reductions in base compensation of certain executives. Mr. Buinevicius reduced his base compensation from $331,000 to $231,000 while Mr. Schmidt reduced his base compensation from $258,000 to $183,000 and Mr. Minor from $232,000 to $162,000. Following improved results in our second and third fiscal quarters, the base compensation was restored to previous levels in July 2008. On November 3, 2008, the Committee approved base salary increases of approximately 4% effective immediately for Mr. Buinevicius from $331,000 to $344,000 and for Mr. Schmidt from $258,000 to $268,000. On November 10, 2008 the Committee similarly approved a 4% increase for Mr. Minor from $232,000 to $241,000. After its review of all sources of market data as described above, the Committee believes that the adjusted base salaries and the bonuses described below are within its targeted range for total cash compensation. 11 Bonus The Committee typically targets an annual cash bonus as a percentage of total cash compensation within the 50th to 75th percentile of market data as noted above. Recognizing that Sonic’s internal budgets are based on pre- established financial goals, the evaluation of individual performance reflects a discretionary assessment by the Committee of each officer’s contribution during the year. The Committee may consider factors such as general economic conditions, acquisitions, divestitures, or restructuring initiatives that may not have been contemplated when the financial budgets were developed. To aid in this evaluation, the Chief Executive Officer provides an overview of Sonic’s financial metrics and performance, new product introductions, strategic initiatives, and investor relations activities for the year. In an effort to conserve cash, the Chief Executive Officer recommended to the Committee that bonuses be granted in a way that is cash neutral to Sonic. The Committee therefore considered and approved bonus awards equal to the exercise price of a corresponding grant of options to purchase common stock. Such bonus award would only be awarded upon the ultimate exercise of such option. Accordingly, on November 3, 2008, based on the recommendations of the Chief Executive Officer and the Committee’s assessment of individual performance and contribution to the improved financial performance of Sonic for fiscal 2008 the Committee approved grants of options to purchase 60,000 shares of common stock for each of Mssrs. Buinevicius and Schmidt with a corresponding agreement to award cash equal to the exercise price of such options, or $30,000 ($0.50 market price of common stock on the date of grant for 60,000 shares) upon such exercise. Similarly, on November 10, 2008 the Committee approved an option grant to purchase 60,000 shares of common stock for Mr. Minor and a corresponding award of a bonus equal to the exercise of such options or $31,800 ($0.53 market price of common stock on the date of grant for 60,000 shares). The Committee also granted an option to purchase 60,000 shares to Mr. Lipps on November 10, 2008 at an exercise price of $0.53 per share. Mr. Lipps receives bonuses quarterly based upon achieving predetermined targets for product and services billings set at the date of his promotion to Executive Vice President of Sales. Total bonus amounts paid to Mr. Lipps during fiscal 2008 totaled $65,888. Stock Options The Committee has a long-standing practice of providing long-term incentive compensation grants to the executive officers. The Committee believes that such grants, in the form of stock options, help align our executive officers’ interests with Sonic’s stockholders. All stock options have been granted under either our 1995 Stock Option Plan or the 1999 Non-Qualified Plan (“Employee Plans”). The Committee reviews option grant recommendations by the Chief Executive Officer for each executive officer, but retains full discretion to accept, reject or revise each recommendation. The Committee’s policy is to grant options on the date it approves them. The exercise price is determined in accordance with the terms of the Employee Plan and cannot be less than the Fair Market Value, as defined in the Plan, of Sonic’s common stock. The Committee typically grants options once a year, but may grant options to newly hired executives at other times. In making its determinations, the Committee considers the number of options or shares owned by the executive officers. In December 2007, the Committee approved option grants to purchase 50,000, 120,000 and 50,000 for Mssrs. Buinevicius, Minor and Schmidt. Mr. Lipps further received options to purchase 100,000 shares of common stock upon his promotion to Executive Vice President of Sales in April 2008 and incentive grants of 25,000 and 15,000 in March 2008 and December 2007, respectively, as described in the “Grant of Plan-Based Awards” table in this Proxy Statement. In November 2008, the Committee awarded stock options to purchase 60,000 shares each to Mssrs. Buinevicius, Schmidt, Minor and Lipps. 12 Health and Welfare Benefits Our officers are covered under the same health and welfare plans, including our 401(k) plan, as salaried employees. Employment Agreements We entered into employment agreements with Rimas P. Buinevicius and Monty R. Schmidt on substantially the same terms as the prior agreements in January 2001. The employment agreements automatically renew every two years for successive two year terms and were last automatically renewed on January 1, 2007. The salaries of each of Messrs. Buinevicius and Schmidt are subject to increase each year at the discretion of the Board of Directors. Messrs. Buinevicius and Schmidt are also entitled to incidental benefits of employment under the agreements. Each of the employment agreements provides that if (i) Sonic Foundry breaches its duty under such employment agreement, (ii) the employee's status or responsibilities with Sonic Foundry has been reduced, (iii) Sonic Foundry fails to perform its obligations under such employment agreement, or (iv) after a Change in Control of Sonic Foundry, Sonic Foundry’s financial prospects have significantly declined, the employee may terminate his employment and receive all salary and bonus owed to him at that time, prorated, plus three times the highest annual salary and bonus paid to him in any of the three years immediately preceding the termination. If the employee becomes disabled, he may terminate his employment and receive all salary owed to him at that time, prorated, plus a lump sum equal to the highest annual salary and bonus paid to him in any of the three years immediately preceding the termination. Pursuant to the employment agreements, each of Messrs. Buinevicius and Schmidt has agreed not to disclose our confidential information and not to compete against us during the term of his employment agreement and for a period of two years thereafter. Such non-compete clauses may not be enforceable, or may only be partially enforceable, in state courts of relevant jurisdictions. A "Change in Control" is defined in the employment agreements to mean: (i) a change in control of a nature that would have to be reported in our proxy statement, ; (ii) Sonic Foundry is merged or consolidated or reorganized into or with another corporation or other legal person and as a result of such merger, consolidation or reorganization less than 75% of the outstanding voting securities or other capital interests of the surviving, resulting or acquiring corporation or other legal person are owned in the aggregate by our stockholders immediately prior to such merger, consolidation or reorganization; (iii) Sonic Foundry sells all or substantially all of its business and/or assets to any other corporation or other legal person, less than 75% of the outstanding voting securities or other capital interests of which are owned in the aggregate by our stockholders, directly or indirectly, immediately prior to or after such sale; (iv) any person (as the term "person" is used in Section 13(d) (3) or Section 14(d) (2) of the Securities Exchange Act of 1934 (the "Exchange Act") had become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) of 25% or more of the issued and outstanding shares of our voting securities; or (v) during any period of two consecutive years, individuals who at the beginning of any such period constitute our directors cease for any reason to constitute at least a majority thereof unless the election, or the nomination or election by our stockholders, of each new director was approved by a vote of at least two- thirds of such directors then still in office who were directors at the beginning of any such period. We entered into employment agreements with Kenneth A. Minor in October 2007 and Robert M. Lipps in August 2008. The salaries of each of Messrs. Minor and Lipps are subject to increase each year at the discretion of the Board of Directors. Messrs. Minor and Lipps are also entitled to incidental benefits of employment under the agreements. Each of the employment agreements provide that a cash severance payment be made upon termination, other than for cause. In the case of Mr. Minor, such cash severance is equal to the highest cash compensation paid in any of the last three fiscal years immediately prior to termination and with respect to Mr. Lipps, such cash severance payment is equal to the cash compensation paid in the previous fiscal year immediately prior to termination. In addition, Mssrs. Minor and Lipps will receive immediate vesting of all previously unvested common stock and stock options and have the right to voluntarily terminate their employment, and receive the same severance arrangement detailed above following (i) any “person” becoming a “ beneficial” owner of stock of Sonic Foundry representing 50% or more of the total voting power of Sonic Foundry’s then outstanding stock; or, (ii) Sonic Foundry is acquired by another entity through the 13 purchase of substantially all of its assets or securities and following such acquisition, Rimas Buinevicius does not remain as Chief Executive Officer and Chairman of the Board of Directors of Sonic Foundry or the acquisition is without the written consent of the Board of Directors of Sonic Foundry; or (iii) Sonic Foundry is merged with another entity, consolidated with another entity or reorganized in a manner in which any “person” is or becomes a “beneficial” owner of stock of the surviving entity representing 50% or more of the total voting power of the surviving entity’s then outstanding stock; and Messrs. Minor or Lipps is demoted without cause or their duties are substantially altered. Pursuant to the employment agreements, each of Messrs. Minor and Lipps has agreed not to disclose our confidential information and not to compete against us during the term of his employment agreement and for a period of one year thereafter. Such non-compete clauses may not be enforceable, or may only be partially enforceable, in state courts of relevant jurisdictions. For illustrative purposes, if Sonic terminated the employment of Messrs. Buinevicius, Schmidt, Minor and Lipps (not for cause) on September 30, 2008 or if Messrs. Buinevicius, Schmidt, Minor and Lipps elected to terminate their employment following a demotion or alteration of duties on September 30, 2008, and a change of control as defined in the employment agreements had occurred, Sonic would be obligated to pay $1,529,000, $1,165,000, $312,000 and $222,000 to of Messrs. Buinevicius, Schmidt, Minor and Lipps, respectively. In addition, any non-vested rights of Messrs. Buinevicius, Schmidt, Minor and Lipps under the Employee Plans, would vest as of the date of employment termination. The value of the accelerated vesting of the options under these circumstances would be $22,000 for Messrs. Buinevicius and Schmidt; $53,000 for Mr. Minor and $51,000 Mr. Lipps. Personal Benefits Our executives receive a limited number of personal benefits certain of which are considered taxable income to them and which are described in the footnotes to the section of this Proxy Statement entitled “Summary Compensation Table ”. Internal Revenue Code Section 162(m) Internal Revenue Code Section 162(m) limits the ability of a public company to deduct compensation in excess of $1 million paid annually to each of the Chief Executive Officer and each of the other executive officers named in the Summary Compensation Table. There are exemptions from this limit, including compensation that is based on the attainment of performance goals that are established by the Committee and approved by the Company stockholders. No executive officer was affected by this limitation in fiscal 2008. COMPENSATION COMMITTEE REPORT The Compensation Committee of Sonic has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in the Proxy Statement. COMPENSATION COMMITTEE David C. Kleinman, Chair Gary R. Weis Paul S. Peercy 14 The following table sets forth the compensation of our principal executive officer, our principal financial officer and our other two executive officers for the fiscal year ended September 30, 2008. Summary Compensation Salary ($) (c) 277,539 309,534 198,243 212,310 217,952 238,170 Year (b) 2008 2007 2008 2007 2008 2007 Bonus ($)(1) (d) 30,000 60,000 31,800 60,000 30,000 60,000 Stock Awards ($) (e) Option Awards ($)(2) (f) Non-Equity Incentive Plan Compensation ($) (g) — — — — — — 21,997 7,770 51,402 7,770 21,997 7,770 — — — — — — 2008 156,346 — — 34,165 65,888 Name and Principal Position (a) Rimas P. Buinevicius Chairman and Chief Executive Officer Kenneth A. Minor Chief Financial Officer and Secretary Monty R. Schmidt Chief Technology Officer Robert M. Lipps(4) Executive Vice President - Sales Change in Pension Value and Non-qualified Deferred Compensation Earnings ($) (h) — — — — — — — All Other Compen- sation ($)(3) (i) Total ($) (j) 1,610 10,314 338,143 387,618 7,841 16,457 289,286 296,537 8,856 16,049 283,799 321,989 6,735 263,134 (1) The amounts in column (d) represent the cash bonuses described under the section of this Proxy Statement entitled “Compensation Discussion and Analysis”. These cash bonuses were awarded for performance during the prior fiscal year. Fiscal year 2008 bonuses are payable at a future date at the discretion of the executive and coincident with the payment to the Company of an equal amount for the exercise of certain options to purchase common stock. See Compensation Discussion and Analysis. (2) The option awards in column (f) represent stock option grants for which Sonic recorded compensation expense during the fiscal year. Under the required FAS 123(R) methodology, the compensation expense reflected is for grants made in the fiscal year and grants made in prior years which continued to be expensed in the fiscal year. The full FAS 123(R) grant date fair value of the option awards granted in fiscal 2008 is included in column (l) in the “Grants of Plan-Based Awards” table included below in this Proxy Statement. The assumptions and methodology used in calculating the FAS 123(R) compensation expense of the option awards are provided in Sonic’s Form 10- K. See Note 1, “Stock Based Compensation” in the Notes to the Consolidated Financial Statements in Sonic’s Form 10-K. The amounts in this column represent our accounting expense for these awards and not necessarily the actual value that will be realized by the executive. There can be no assurance that the options will ever be exercised (in which case no value will be realized by the executive) or that the value on exercise will equal the FAS123(R) value. (3) The amount shown under column (i) includes Sonic’s matching contribution under our 401(k) plan of $355, $2,641, $6,050 and 6,735 for Messrs Buinevicius, Minor, Schmidt and Lipps. In addition, Mr. Buinevicius receives a car allowance equal to $713 per month of which the taxable personal portion of $1,255 is included in this column. Messrs. Minor and Schmidt receive $650 per month as a car allowance of which the taxable personal portions were $5,200 and $2,806, respectively. Mr. Lipps receives a car allowance of $700 per month of which there was no taxable personal portion. (4) Mr. Lipps became an executive officer in April 2008. 15 The Following table shows the plan-based awards granted to the Named Executive Officers during fiscal 2008. Grants of Plan-Based Awards Estimated Future Payouts Under Non-Equity Incentive Plan Awards Target ($) (d) — — — Maximum ($) (e) — — — Threshold ($) (c) — — — Name (a) Grant Date (b) Rimas P. Buinevicius 12/4/07 12/4/07 Kenneth A. Minor 12/4/07 Monty R. Schmidt 4/16/08 Robert M. Lipps 3/10/08 12/4/07 Estimated Future Payouts Under Equity Incentive Plan Awards Target ($) (g) — — — Maximum ($) (h) — — — Threshold ($) (f) — — — All other stock awards: Number of Shares of stock or units (#) (i) — — — All other option awards: Number of Securities Underlyin g Options (#) (j) 50,000 120,000 50,000 100,000 25,000 15,000 Exercise or base price of option awards ($/Sh) (1) (k) 1.55 1.55 1.55 0.78 0.75 1.55 Grant Date fair Value of Stock and option awards ($) (2) (l) 42,953 103,088 42,953 45,854 10,727 12,887 (1) Sonic grants employee stock options with exercise prices equal to the closing stock price on the date of grant. (2) The amount reported in column (l) represents the grant date fair value of the award following the required FAS 123(R) compensation methodology. Grant date fair value is calculated using the Lattice method. See Note 1, “Stock Based Compensation” in the Notes to the Consolidated Financial Statements in Sonic’s Form 10-K for the fiscal year ended September 30, 2008 for an explanation of the methodology and assumptions used in the FAS 123(R) valuation. With respect to the option grants, there can be no assurance that the options will ever be exercised (in which case no value will be realized by the executive) or that the value on exercise will equal the FAS 123(R) value. Sonic grants options to its executive officers under our employee stock option plans. As of September 30, 2008, options to purchase a total of 6,240,477 shares were outstanding under the plans, and options to purchase 1,153,327 shares remained available for grant thereunder. No options were exercised by Named Executive Officers during fiscal 2008. 16 Outstanding Equity Awards at Fiscal Year-End The following table shows information concerning outstanding equity awards as of September 30, 2008 held by the Named Executive Officers. Option Awards Stock Awards Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#) (i) Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($) (j) Market Value of Shares or Units of Stock That Have Not Vested ($) (h) Number of Shares or Units of Stock That Have Not Vested (#) (g) Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) (d) None None None None Number of Securities Underlying Unexercised Options (#) Exercisable (1) (b) 20,000 10,000 100,000 1,000,000 50,000 0 10,000 13,000 10,000 63,000 5,941 80,000 100,000 50,000 0 20,000 10,000 80,000 19,802 50,000 0 16,666 2,500 0 0 0 Number of Securities Underlying Unexercised Options (#) Unexercisabl (1) (c) e 0 0 0 0 0 50,000 0 0 0 0 0 0 0 0 120,000 0 0 0 0 0 50,000 8,334 5,000 15,000 25,000 100,000 Option Exercise Price ($) (1) (e) 4.19 1.09 1.09 1.12 1.45 1.55 3.13 5.91 1.09 1.09 1.01 1.12 0.42 1.45 1.55 4.19 1.09 1.09 1.01 1.45 1.55 2.26 3.71 0.75 0.75 0.78 Option Expiration Date (1) (f) 03/10/2009 12/20/2010 12/20/2010 10/25/2011 11/26/2014 12/04/2017 10/21/2008 12/13/2009 12/20/2010 12/20/2010 10/09/2011 10/25/2011 05/09/2013 11/26/2014 12/04/2017 03/10/2009 12/20/2010 12/20/2010 10/09/2011 11/26/2014 12/04/2017 04/10/2016 12/07/2016 12/04/2017 03/10/2018 04/16/2018 Name (a) Rimas P. Buinevicius Kenneth A. Minor Monty R. Schmidt Robert M. Lipps (1) All options were granted under either our shareholder approved Employee Stock Option Plan or the Non-Qualified Stock Option Plan. All unexercisable options listed in the table become exercisable over a three-year period in equal annual installments beginning one year from the date of grant. 17 Equity Compensation Plan Information Plan category Equity compensation plans approved by security holders (1) Equity compensation plans not approved by security holders (2) Total Number of securities to be issued upon exercise of outstanding options, warrants and rights Weighted average exercise price of outstanding options, warrants and rights Number of securities remaining available for future issuance (a) (b) (c) 3,978,000 $ 2.48 1,553,327 2,262,477 6,240,477 1.28 219,992 $ 2.05 1,773,319 (1) Consists of the Employee Stock Option Plan and the Directors Stock Option Plan. For further information regarding these plans, reference is made to Sonic’s 2008 Form 10-K in Note 5 of the financial statements. (2) Consists of the Non-Qualified Stock Option Plan. For further information regarding this plan, reference is made to Sonic’s 2008 Form 10-K in Note 5 of the financial statements. Compensation Committee Interlocks and Insider Participation The members of the Executive Compensation Committee of Sonic's Board of Directors for Fiscal 2008 were those named in the Executive Compensation Committee Report. No member of the Committee was at any time during Fiscal 2008 or at any other time an officer or employee of Sonic Foundry, Inc. No executive officer of Sonic Foundry, Inc. has served on the board of directors or compensation committee of any other entity that has or has had one or more executive officers serving as a member of the Board of Directors of Sonic Foundry. PROPOSAL 2: PROPOSAL TO ADOPT THE 2009 STOCK INCENTIVE PLAN We are asking our stockholders to approve the 2009 Stock Incentive Plan at the Annual Meeting (in this proposal, the “2009 Plan”). On January 26, 2009, the Board approved the 2009 Plan, subject to stockholder approval. If approved by the stockholders, the 2009 Plan will, beginning in Fiscal 2010, replace our 1995 Incentive Stock Option Plan, as amended (the “1995 ISO Plan”), and the Non-Qualified Stock Option Plan, as amended (the “Non-Qualified Plan”). The purpose of the 2009 Plan is to promote the interests of the Company and its stockholders by strengthening the Company's ability to attract and retain experienced and knowledgeable employees and to furnish additional incentives to those employees upon whose judgment, initiative and efforts the Company largely depends. The 2009 Plan will, beginning October 1, 2009, replace our1995 ISO Plan and our Non-Qualified Stock Option Plan. The 1995 ISO Plan provided for the grant of up to 7,000,000 stock options and the Non-Qualified Plan provided for the grant of up to 3,800,000 stock options. Since adoption of the 1995 ISO Plan and through September 30, 2008, the Company had granted options for 9,446,016 shares under the 1995 ISO Plan and cancelled 3,599,343 options, leaving a balance at September 30, 2008 of 1,153,327, and had granted options for 5,133,146 shares under the Non-Qualified Plan and cancelled 1,553,138, leaving a balance at September 30, 2008 of 219,992. During the quarter ended December 31, 2008, the Company granted options for 989,500 shares under the 1995 ISO Plan and cancelled 91,334 options, leaving a balance at December 31, 2008 of 255,161 and granted options for 50,000 shares under the Non-Qualified Plan and 18 cancelled 11,408, leaving a balance at December 31, 2008 of 181,400. We recommend adoption of the 2009 Plan with an aggregate number of shares that may be subject to awards under the 2009 Plan of 4,000,000. We presently anticipate that the number of Available Shares under the 2009 Plan will be sufficient for issuance of awards under our equity compensation for at least three years. If the 2009 Plan is approved by the stockholders, the 1995 ISO Plan and the Non-Qualified Plan (the “Prior Plans”) will, beginning October 1, 2009, be suspended, and no additional awards will be made under the Prior Plans subsequent to September 30, 2009. If the 2009 Plan as proposed is not approved by our stockholders, awards will continue to be made under the Prior Plans. Why You Should Vote for the 2009 Plan There are a Limited Number of Options Remaining to be Granted Under the Prior Plans Equity awards are currently made to officers and employees from our 1995 ISO Plan and our Non-Qualified Plan. As of December 31, 2008, we had a balance of 255,161 options remaining to be granted under our 1995 ISO Plan and 181,400 options remaining to be granted under our Non-Qualified Plan. We currently grant approximately 1,000,000 options per year. If we do not adopt the 2009 Plan we will be unable to issue a significant number of equity awards unless our stockholders approve a new stock plan. We anticipate that we will have difficulty attracting, retaining, and motivating officers and employees if we were unable to make equity awards to them. In addition, we believe that equity awards are an effective compensation vehicle because they offer significant potential value with a smaller impact on current income and cash flow. Therefore, we are asking our stockholders to approve the 2009 Plan. Equity Incentives are an Important Part of our Compensation Philosophy Approval of the 2009 Plan is critical to our ongoing effort to create stockholder value. As discussed in the Compensation Discussion and Analysis earlier in this Proxy Statement, equity-based incentives are an integral part of our compensation program. We grant stock options to substantially all of our employees. We believe we must continue to offer a competitive equity compensation plan in order to attract, retain and motivate the talent necessary to successfully grow the Company. The 2009 Plan Creates More Flexibility Than our Prior Plans The 2009 Plan expands eligibility to include non-employee directors and consultants. In addition, the 2009 Plan provides for grants of restricted shares or units, as well as incentive or non-qualified stock options. These and other features of the 2009 Plan are discussed in “Description of the 2009 Plan” below. The 2009 Plan Combines Compensation and Governance Best Practices Some of the key features of the 2009 Plan that are designed to protect our stockholders’ interest and to reflect corporate governance best practices are as follows: (cid:120) (cid:120) Continued broad-based eligibility for equity awards. We grant equity awards to substantially all of our employees. By doing so, we link employee interests with stockholder interests throughout the organization and motivate our employees to act as owners of the Company. Reasonable share counting provisions. In general, when awards granted under the 2009 Plan expire or are cancelled, the shares reserved for those awards will be returned to the share reserve and be available for future issuance under the 2009 Plan. However, shares of common stock received from the exercise of stock options or withheld for taxes will not be returned to the share reserve. 19 (cid:120) Option exercise price. Under the 2009 Plan, the exercise price per share of stock options may not be less than 100% of the fair market value on the date of grant. (cid:120) (cid:120) Repricing is not allowed. Under the 2009 Plan, repricing of stock options (including reduction in the exercise price of stock options or replacement of an award with cash or another award type) is prohibited without prior shareholder approval. Limitations on Amendments. The 2009 Plan requires stockholder approval for material amendments to the Plan, including (i) a material increase to the benefits accrued to participants under the Plan, (ii) a material increase to the number of securities which may be issued under the Plan, (iii) a material expansion of the class of individuals eligible to participate in the Plan, or (iv) an extension to the term of the Plan. Description of the 2009 Plan A description of the principal features of the 2009 Plan is set forth below. The summary is qualified in its entirety by the detailed provisions of the 2009 Plan, a copy of which is attached to this Proxy Statement as Annex A. Purpose. The 2009 Plan is intended to provide incentives to the Company’s officers, directors, and employees by providing them with opportunities to acquire a direct proprietary interest in the operations and future success of the Company. Effective Date. The 2009 Plan will become effective on the date on which it is approved by the stockholders (the “Effective Date”). Types of Awards. The 2009 Plan provides for the following types of awards: (i) incentive stock options, (ii) non- qualified stock options, (iii) restricted stock awards, (iv) restricted stock units, (v) performance stock awards, (v) and other stock-based awards (collectively, “Awards”). Administration. Our Board, or a committee of the Board consisting of at least two members of the Board, will administer the 2009 Plan. The Board may delegate responsibility for administration of the Plan to different committees, subject to any limitations the Board deems appropriate. The Board, or any two member committee of the Board (hereinafter, the “Committee”), has full authority to administer the Plan, including authority to interpret and construe any relevant provisions of the Plan, to adopt rules and regulations that it deems necessary, to determine which individuals are eligible to participate and/or receive Awards under the Plan, to determine the amount and/or number of shares subject to the Award, and to determine the terms of the Award (which need not be identical). The Committee may delegate its authority to grant Awards under the 2009 Plan to one or more of the Company’s executive officers to the extent permitted by applicable law, provided the grantees are not executive officers or directors of the Company. The Committee has the power to approve the form of Award agreements, and to amend or adopt sub-plans to permit employees who reside outside the United States to participate in the 2009 Plan. The Committee does not have authority under the 2009 Plan to reduce the exercise or purchase price of any outstanding Award or to cancel and re- grant an outstanding Award if such action would reduce the exercise or purchase price of the Award, in either case, absent prior approval of the stockholders for such an action. The Board has delegated administration of the 2009 Plan to the Executive Compensation Committee, subject to stockholder approval of the 2009 Plan. Stock Subject to the 2009 Plan. The common stock issued or to be issued under the 2009 Plan consists of authorized but unissued shares or issued shares that have been reacquired by the Company in any manner. Subject to adjustment made in connection with a recapitalization, change in control and certain other events set forth in the 20 2009 Plan, the maximum number of shares subject to Awards which may be issued pursuant to the Plan is 4,000,000 shares of common stock. In addition, if any Award granted under the 2009 Plan is not exercised or is forfeited, lapses or expires, or otherwise terminates without delivery of any common stock subject thereto, the shares subject to such Award will again be available for future grants of Awards under the Plan. The number of shares of common stock available for issuance under the 2009 Plan will not be increased by any shares tendered or Awards surrendered in connection with the purchase of shares of common stock upon exercise of an option or any shares of common stock deducted or forfeited from an Award in connection with our withholding obligations. Eligibility and Limitations on Grants. Awards under the 2009 Plan may be made to employees, officers, directors and consultants of the Company or any present or future parent or subsidiary of the Company or other business venture in which the Company has a substantial interest (“Related Entities”). Awards made to non-employee directors under the 2009 Plan may only be granted and administered by a committee meeting the independence requirements of the exchange on which the Company’s common stock is listed. Terms of Options. The 2009 Plan permits grants of stock options intended to qualify as incentive stock options (“ISOs”) under Section 422 of the Internal Revenue Code (the “Code”) and stock options that do not qualify as ISOs (“non-qualified” options). Options granted under the 2009 Plan will be non-qualified options if they fail to qualify as ISOs or exceed the annual limit on ISOs. Only employees of the Company may receive ISOs. Non- qualified options may be granted to any persons eligible to receive ISOs and to directors and consultants of the Company. The exercise price of a stock option may not be less than 100% of the fair market value of the stock subject to the option on the date of grant (for an incentive stock option, 110% if the optionee is a 10% holder of our common stock). The term of option will not be longer than ten years (or, in the case of a 10% owner of our common stock, five years if the option is an ISO) and may be subject to restrictions on transfer. Options may be exercised in whole or in part with written or electronic notice to the Company’s delegate for receipt of such notice, accompanied by full payment of the exercise price for the number of shares being purchased. Subject to the discretion of the Committee, the exercise price may be paid in cash, by check, pursuant to a broker-assisted cashless exercise, by delivery of other shares of common stock, by a “net exercise arrangement”, or any other form of legal consideration deemed acceptable by the Committee. Options generally terminate ninety days after termination of an optionee’s service or as set forth in the option agreement. The optionee may have longer to exercise when termination is due to disability or death. No option may be exercised beyond the expiration of its term. The ability to exercise options may be accelerated by the Committee, subject to compliance with the provisions of the 2009 Plan. Terms of Restricted Stock. The 2009 Plan permits grants of restricted stock entitling recipients to acquire shares of the Company’s common stock, subject to the right of the Company to require forfeiture of such shares in the event that conditions specified by the Committee in the applicable award agreement are not satisfied. Subject to the provisions of the 2009 Plan, the Committee will determine the terms and conditions of any restricted stock award, including the grant date and vesting schedule for the award. Terms of Restricted Stock Units. The 2009 Plan permits awards of restricted stock units entitling recipients to acquire shares of the Company’s common stock (or the cash equivalent) in the future. Subject to the provisions of the 2009 Plan, the Committee will determine the terms and conditions of any restricted stock unit award, including the grant date and vesting schedule for the award. Other Stock-Based Awards. The 2009 Plan permits awards of shares of the Company’s common stock, and other awards that are valued by reference to, or are otherwise based on, shares of the Company’s common stock or property, including awards entitling recipients to receive shares of the Company’s common stock in the future. Such awards may also be available as a form of payment in the settlement of other awards granted under the 2009 Plan or as payment in lieu of compensation to which a participant is otherwise entitled. Subject to the discretion of the 21 Committee, the awards may be paid in shares of common stock or cash. Subject to the provisions of the 2009 Plan, the Committee will determine the terms and conditions of such other stock-based awards, including any purchase price that may be applicable to the award. Performance Awards. Under the 2009 Plan, certain restricted stock awards, restricted stock unit awards and other stock-based awards may be subject to the achievement of performance goals. For performance awards that are intended to qualify as performance-based compensation under Section 162(m) of the Code, the vesting and/or delivery of shares for such awards will occur upon achievement of one or more of the following objective performance measures, as determined by the Committee in its discretion: earnings per share, return on average equity or average assets in relation to a peer group of companies designated by the Committee, earnings, earnings growth, earnings before interest, taxes and amortization (EBITA), operating income, gross or product margins, revenues, expenses, stock price, market share, reductions in non-performing assets, return on sales, assets, equity or investment, regulatory compliance, satisfactory internal or external audits, improvement of financial ratings, achievement of balance sheet or income statement objectives, net cash provided from continuing operations, stock price appreciation, total shareholder return, cost control, strategic initiatives, net operating profit after tax, pre-tax or after-tax income, cash flow, or a combination of one or more of these measures, which may be absolute in their terms or measured against or in relationship to other companies comparably, similarly or otherwise situated. These performance measures may be adjusted to exclude the effect of various events that may occur during the performance period, including: extraordinary items and any other unusual or non-recurring items; discontinued operations; gains or losses on the dispositions of discontinued operations; the cumulative effects of changes in accounting principles; the writedown of any asset; and charges for restructuring and rationalization programs. In addition, such performance measures: (cid:120) may vary by participant and may be different for different performance awards; (cid:120) may be particular to a participant or the department, branch, line of business, subsidiary or other unit in which the participant works and may cover such period as may be specified by the Committee; and (cid:120) shall be set by the Committee within the time period prescribed by, and shall otherwise comply with the requirements of Section 162(m) of the Code. Notwithstanding any other provision of the Plan, the Committee may adjust downwards, but not upwards, the cash or number of shares payable pursuant to performance awards intended to qualify as performance-based compensation under 162(m) of the Code, and the Committee may not waive the achievement of the applicable performance measures except in the case of the death or disability of the participant or a change in control of the Company. Awards that are not intended to qualify as performance-based compensation under 162(m) of the Code may be based on these or such other performance measures as the Committee may determine. Adjustments and Recapitalization. In the event that any change is made to the shares of common stock issuable under the 2009 Plan, whether through merger, consolidation, stock split, stock dividend, extraordinary cash dividend, recapitalization, combination of shares, exchange of shares, or other similar event, then appropriate adjustments will be made to (i) the maximum number and/or class of securities issuable under the Plan, (ii) the number and/or class of securities and, if applicable, price per share in effect under each outstanding Award under the Plan, and (iii) the maximum number of shares issuable to one individual in a calendar year under the Plan. Change in Control Provisions. In the event of a change in control of the Company, outstanding Awards may be assumed, continued or substituted by the successor corporation. If the successor corporation does not assume, continue or substitute such Awards, then all Awards held by a participant, immediately prior to the effectiveness of the change in control, will become fully vested and exercisable. 22 Notwithstanding the foregoing, in the event of a change in control, all outstanding Awards held by the participant will, immediately prior to the effectiveness of the change in control, become vested and exercisable as to an additional number of shares equal to the number of shares that would have become vested and exercisable on the date twelve months after the effectiveness of the change in control. If the participant has been employed by the Company for less than twelve months immediately prior to the change in control, the number of vested and exercisable shares will be increased by the number of shares that would have become vested and exercisable on the date six months after the consummation of the change in control. In addition, if, within six months following the change in control, the successor corporation terminates the employment of a participant without cause, all Awards held by the participant will become fully vested and exercisable. Under the 2009 Plan, a “change in control” generally means any of the following events: (i) a person (as defined by Sections 13(d) and 14(d) of the Exchange Act, as amended) becomes the beneficial owner of securities representing 35% or more of the combined voting power of the Company’s then outstanding securities; (ii) the Company’s incumbent directors cease to constitute a majority of the Board; (iii) a consummated merger or consolidation of the Company with any other corporation; or (iv) the stockholders approve a plan of liquidation or dissolution or an agreement for the sale of all or substantially all of the Company’s assets. Term and Amendment of the Plan. The 2009 Plan is scheduled to expire ten years from the Effective Date of the Plan. The Board may amend or modify the 2009 Plan in any respect to the extent the amendment or modification does not adversely affect a holder’s rights under any outstanding Award without the holder’s consent; however, stockholder approval is required for any amendment that (i) materially increases the benefits accrued to participants under the Plan, (ii) materially increases the number of securities which may be issued under the Plan, (iii) materially expands the class of individuals eligible to participate in the Plan, or (iv) extends the term of the Plan. In addition, certain amendments may, as determined by the Board in its discretion, require stockholder approval pursuant to applicable laws, rules or regulations, including any applicable exchange on which our common stock is listed. Tax Withholding. Participants in the 2009 Plan are responsible for the payment of any foreign, federal or state tax that we are required by law to withhold upon any exercise or vesting of an Award. Subject to the discretion of the Committee, participants may satisfy such tax obligations by delivery of shares of common stock, including shares retained from the Award creating the tax obligations, valued at their fair market value. The Company may, to the extent permitted by law, deduct such tax obligations from any payment of any kind otherwise due to the participant. Federal Income Tax Consequences The following is a summary of the principal U.S. federal income tax consequences to participants and the Company with respect to participation in the 2009 Plan. It does not describe all federal tax consequences under the 2009 Plan, nor does it discuss state, local or foreign tax consequences. Incentive Stock Options. An optionee who is granted an incentive stock option does not recognize taxable income at the time the option is granted or upon its exercise, although the exercise is an adjustment item for alternative minimum tax purposes and may subject the optionee to the alternative minimum tax. Upon a disposition of the shares more than two years after grant of the option and more than one year after the exercise of the option, any gain or loss is treated as long-term capital gain or loss. If these holding periods are not satisfied, the optionee recognizes ordinary income at the time of disposition equal to the difference between the exercise price and the lower of (a) the fair market value of the shares at the date of the option exercise or (b) the sale price of the shares. Any gain or loss recognized on such a premature disposition of the shares in excess of the amount treated as ordinary income is treated as long-term or short-term capital gain or loss, depending on the holding period. Unless limited by Section 162(m) of the Code, we are generally entitled to a deduction in the same amount as the ordinary income recognized by the optionee. 23 Nonstatutory Stock Options. No taxable income is recognized by an optionee upon the grant of a nonstatutory stock option. Upon exercise, the optionee will recognize ordinary income equal to the excess of the fair market value of the purchased shares on the exercise date over the exercise price paid for those shares. Assuming we comply with Section 162(m) of the Code, we will be entitled to an income tax deduction in the tax year in which the optionee recognizes the ordinary income. When the optionee disposes of shares granted as a nonstatutory stock option, any difference between the sale price and the optionee’s exercise price, to the extent not recognized as taxable income as provided above, is treated as long-term or short-term capital gain or loss, depending on the holding period. Restricted Stock. A grantee who is awarded restricted stock will not recognize any taxable income for federal income tax purposes in the year of the award, provided that the shares of common stock are subject to restrictions (that is, the restricted stock is nontransferable and subject to a substantial risk of forfeiture). However, the grantee may elect under Section 83(b) of the Code to recognize compensation in the year of the award in an amount equal to the fair market value of the common stock on the date of the award (less the purchase price, if any), determined without regard to the restrictions. If the grantee does not make such a Section 83(b) election, the fair market value of the common stock on the date the restrictions lapse (less the purchase price, if any) will be treated as compensation income to the grantee and will be taxable in the year the restrictions lapse and dividends paid while common stock is subject to restrictions will be subject to withholding taxes. If we comply with the restrictions of Section 162(m) of the Code, we will be entitled to a tax deduction in the same amount and generally at the same time as the grantee recognizes ordinary income. Restricted Stock Units. There are no immediate tax consequences of receiving an award of restricted stock units under the 2009 Plan. A grantee who is awarded restricted stock units will be required to recognize ordinary income in an amount equal to the fair market value of shares issued to such grantee at the end of the restriction period or, if later, the payment date. If we comply with the restrictions of Section 162(m) of the Code, we will be entitled to a tax deduction in the same amount and generally at the same time as the grantee recognizes ordinary income. Performance Awards. The award of a performance award will have no federal income tax consequences for us or the grantee. The payment of the award is taxable to a grantee as ordinary income. If we comply with the restrictions of Section 162(m) of the Code, we will be entitled to a tax deduction in the same amount and generally at the same time as the grantee recognizes ordinary income. Section 280(G). To the extent payments that are contingent on a change in control are determined to exceed certain Code limitations, they may be subject to a 20% nondeductible excise tax and our deduction with respect to the associated compensation expense may be disallowed in whole or in part. Section 409A. The Company intends for awards granted under the 2009 Plan to comply with Section 409A of the Code. New Plan Benefits Because the 2009 Plan will not be effective unless and until it is approved by the stockholders, no Awards have been granted under the 2009 Plan. The participants and types of Awards under the 2009 Plan are subject to the discretion of the Committee and, as a result, the benefits or amounts that will be received by any participant or groups of participants if the 2009 Plan is approved are currently not determinable. As of January 26, 2009 there were five executive officers, five non-employee directors, and approximately 85 employees who were eligible to participate in the 2009 Plan. As of the Record Date, the closing price per share of our common stock was $0.66. Recommendation of the Board of Directors THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR PROPOSAL 2, ADOPTING THE 2009 STOCK INCENTIVE PLAN. 24 PROPOSAL THREE: RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS The Board of Directors, upon the recommendation of the Audit Committee, has appointed the firm of Grant Thornton LLP (“GT”) as independent auditors to audit our financial statements for the year ending September 30, 2009, and has further directed that management submit the selection of independent public accountants for certification by the stockholders at the annual meeting. Representatives of GT are expected to be present at the annual meeting to respond to stockholders' questions and to have the opportunity to make any statements they consider appropriate. Stockholder ratification of the selection of GT as our independent auditors is not required by our Bylaws or otherwise. However, the Board is submitting the selection of GT to the stockholders for ratification as a matter of good corporate practice. If the stockholders fail to ratify the selection, the Board and the Audit Committee will reconsider whether or not to retain that firm. Even if the selection is ratified, the Board and the Audit Committee in their discretion may direct the appointment of a different independent accounting firm at any time during the year if they determine that such a change would be in the best interests of Sonic and its stockholders. The ratification of the appointment of GT as independent public accountants requires the approval of a majority of the votes cast by holders of our shares. Shares may be voted for or withheld from this matter. Shares that are withheld and broker non-votes will have no effect on this matter because ratification of the appointment of GT requires a majority of the shares cast. Recommendation of Board of Directors THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR PROPOSAL 3 RATIFYING THE APPOINTMENT OF GT AS INDEPENDENT AUDITORS FOR SONIC FOUNDRY. Relations with Independent Auditors GT has served as our independent public accountants since its appointment in July 2004. As stated in Proposal 3, the Board has selected GT to serve as our independent auditors for the fiscal year ending September 30, 2009. Audit services performed by GT for fiscal years 2008 and 2007 consisted of the examination of our financial statements, review of fiscal quarter results, services related to filings with the Securities and Exchange Commission (SEC) and in 2007, examination of our internal controls pursuant to section 404 of the Sarbannes - Oxley Act. We also retained GT to perform certain audit related services associated with the audit of our benefit plan, and tax preparation and consultative services associated with the preparation of Federal and State tax returns. Fiscal 2008 and 2007 tax fees also included international tax services and additional sales and use tax services. All fees paid to GT were reviewed, considered for independence and upon determination that such payments were compatible with maintaining such auditors’ independence, approved by Sonic’s audit committee prior to performance. Fiscal Years 2008 and 2007 Audit Firm Fee Summary During fiscal years 2008 and 2007, we retained GT to provide services in the following categories and amounts: Years Ended September 30, 2007 2008 $ 165,049 10,920 45,035 (cid:326) $ 191,982 10,400 60,973 (cid:326) Audit Fees Audit Related Tax Fees Other Fees 25 All of the services described above were approved by Sonic’s audit committee prior to performance. The Audit Committee may, in its discretion, delegate to one or more of its members the authority to pre-approve any audit or non- audit services to be performed by the independent auditors, provided that any such approvals are presented to the Audit Committee at its next scheduled meeting. The audit committee has determined that the payments made to its independent accountants for these services are compatible with maintaining such auditors’ independence. REPORT OF THE AUDIT COMMITTEE 1 The Audit Committee's role includes the oversight of our financial, accounting and reporting processes, our system of internal accounting and financial controls and our compliance with related legal and regulatory requirements, the appointment, engagement, termination and oversight of our independent auditors, including conducting a review of their independence, reviewing and approving the planned scope of our annual audit, overseeing the independent auditors' audit work, reviewing and pre-approving any audit and non-audit services that may be performed by them, reviewing with management and our independent auditors the adequacy of our internal financial controls, and reviewing our critical accounting policies and the application of accounting principles. The Audit Committee held five meetings during fiscal 2008. Mssrs. Kleinman, Weis and Peercy meet the rules of the SEC for audit committee membership and are "independent" as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act and under Nasdaq listing standards. In April 2004, the Board approved revisions to the Audit Committee Charter to reflect new rules and standards set forth in certain SEC regulations as well as changes to Nasdaq listing standards. A copy of the Audit Committee Charter is available on Sonic’s website. As set forth in the Audit Committee Charter, management of Sonic is responsible for the preparation, presentation and integrity of Sonic’s financial statements and for the effectiveness of internal control over financial reporting. Management and the accounting department are responsible for maintaining Sonic’s accounting and financial reporting principles and internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. The independent auditors are responsible for auditing Sonic’s financial statements and expressing an opinion as to their conformity with generally accepted accounting principles. We have reviewed and discussed with our independent auditors, GT, matters required to be discussed pursuant to Statement on Auditing Standards No. 61 (Communications with Audit Committees). We have received from the auditors a formal written statement describing the relationships between the auditor and Sonic that might bear on the auditor's independence consistent with applicable requirements of the Public Company Accounting Oversight Board. We have discussed with GT matters relating to its independence, including a review of both audit and non-audit fees, and considered the compatibility of non-audit services with the auditors' independence. The members of the Audit Committee are not full-time employees of Sonic and are not performing the functions of auditors or accountants. As such, it is not the duty or responsibility of the Audit Committee or its members to conduct “field work” or other types of auditing or accounting reviews or procedures or to set auditor independence standards. Members of the Committee necessarily rely on the information provided to them by management and the independent accountants. Accordingly, the Audit Committee’s considerations and discussions referred to above do not assure that the audit of Sonic’s financial statements has been carried out in accordance with generally accepted auditing standards, that the financial statements are presented in accordance with generally accepted accounting principles or that Sonic’s auditors are in fact “independent”. We have reviewed and discussed with management and GT the audited financial statements. We discussed with GT the 1 The material in this report is not “soliciting material”, is not deemed filed with the SEC, and is not to be incorporated by reference in any of our filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in such filing. 26 overall scope and plans of their audit. We met with GT, with and without management present, to discuss results of their examination, their evaluation of Sonic’s internal controls, and the overall quality of Sonic’s financial reporting. Based on the reviews and discussions referred to above and our review of Sonic’s audited financial statements for fiscal 2008, we recommended to the Board that the audited financial statements be included in the Annual Report on Form 10-K for the fiscal year ended September 30, 2008, for filing with the SEC. Respectfully submitted, AUDIT COMMITTEE David C. Kleinman, Chair Gary R. Weis Paul S. Peercy CERTAIN TRANSACTIONS Frederick H. Kopko, Jr., a director and stockholder of Sonic Foundry, is a partner in McBreen & Kopko. Pursuant to the 1997 Directors' Stock Option Plan, Mr. Kopko has been granted options to purchase 60,000 shares of Common Stock at exercise prices ranging from $1.74 to $59.88 and was granted options to purchase 20,000 shares of Common Stock at an exercise price of $0.80 pursuant to the 2008 Non-Employee Directors Plan. During fiscal 2008, we paid the Chicago law firm of McBreen & Kopko certain compensation for legal services rendered subject to standard billing rates. Section 16(a) Beneficial Ownership Reporting Compliance Section 16(a) of the Securities Exchange Act of 1934 requires Sonic's officers and directors, and persons who own more than ten percent of the Common Stock, to file reports of ownership and changes in ownership with the Securities and Exchange Commission. Based solely upon a review of Forms 3 and Forms 4 furnished to us pursuant to Rule 16a-3 under the Exchange Act during our most recent fiscal year, to Sonic Foundry's knowledge, all reporting persons complied with all applicable filing requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, except with respect with Mssrs. Buinevicius, Lipps, Minor, Schmidt and Weis, who each inadvertently filed one late Form 4 report. Code of Ethics Sonic has adopted a Code of Ethics (as defined in Item 406 of Regulation S-K) that applies to its principal executive, financial and accounting officers. Sonic Foundry will provide a copy of its code of ethics, without charge, to any investor that requests it. Requests should be addressed in writing to Mr. Kenneth Minor, Corporate Secretary, 222 West Washington Ave, Madison, WI 53703. COMMUNICATIONS WITH THE BOARD OF DIRECTORS Any stockholder who desires to contact our Board or specific members of our Board may do so electronically by sending an email to the following address: directors@sonicfoundry.com. Alternatively, a stockholder can contact our Board or specific members of our Board by writing to: Secretary, Sonic Foundry Incorporated, 222 West Washington Avenue, Madison, WI 53703. Each communication received by the Secretary will be promptly forwarded to the specified party following normal business procedures. The communication will not be opened but rather will be delivered unopened to the intended recipient. In the case of communications to the Board or any group or committee of Directors, the Secretary will open the communication and will make sufficient copies of the contents to send to each Director who is a member of the group or committee to which the envelope is addressed. 27 STOCKHOLDER PROPOSALS In order for a stockholder proposal to be considered for inclusion in our proxy statement and form of proxy relating to the Annual Meeting of Stockholders during fiscal year 2010, the proposal must be received by us no later than September 30, 2009 unless we change next year’s annual meeting date by more than 30 days from March 5, 2010, in which event the deadline would be a reasonable time before we begin to print and mail our proxy materials. Additionally, Sonic will be authorized to exercise discretionary voting authority with respect to any stockholder proposal not disclosed in Sonic’s 2009 proxy statement if Sonic has not received written notice of such proposal by December 14, 2009, unless we change next year’s annual meeting date by more than 30 days from March 5, 2010, in which event we must receive the proposal within a reasonable time before we mail our proxy materials. OTHER MATTERS The Board of Directors has at this time no knowledge of any matters to be brought before this year's Annual Meeting other than those referred to above. However, if any other matters properly come before this year's Annual Meeting, it is the intention of the persons named in the proxy to vote such proxy in accordance with their judgment on such matters. GENERAL A copy of our Annual Report to Stockholders for the fiscal year ended September 30, 2008 is being mailed, together with this Proxy Statement, to each stockholder. Additional copies of such Annual Report and of the Notice of Annual Meeting, this Proxy Statement and the accompanying proxy may be obtained from us. We will, upon request, reimburse brokers, banks and other nominees, for costs incurred by them in forwarding proxy material and the Annual Report to beneficial owners of Common Stock. In addition, directors, officers and regular employees of Sonic and its subsidiaries, at no additional compensation, may solicit proxies by telephone, telegram or in person. All expenses in connection with soliciting management proxies for this year's Annual Meeting, including the cost of preparing, assembling and mailing the Notice of Annual Meeting, this Proxy Statement and the accompanying proxy are to be paid by Sonic. Sonic will provide without charge (except for exhibits) to any record or beneficial owner of its securities, on written request, a copy of Sonic's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended September 30, 2008, including the financial statements and schedules thereto. Exhibits to said report, and exhibits to this proxy statement, will be provided upon payment of fees limited to Sonic's reasonable expenses in furnishing such exhibits. Written requests should be directed to Investor Relations, 222 West Washington Avenue, Madison, Wisconsin 53703. We also make available, free of charge, at the “Investor Information” section of our website, our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, our proxy statement, amendments and exhibits to such reports as soon as practicable after the filing of such reports, exhibits and proxy statements with the Securities and Exchange Commission. In order to assure the presence of the necessary quorum at this year's Annual Meeting, and to save Sonic the expense of further mailings, please date, sign and mail the enclosed proxy promptly in the envelope provided. No postage is required if mailed within the United States. The signing of a proxy will not prevent a stockholder of record from voting in person at the meeting. By Order of the Board of Directors, January 28, 2009 Kenneth A. Minor, Secretary 28 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) FORM 10-K (cid:95) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal period ended September 30, 2008 OR (cid:134) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-14007 SONIC FOUNDRY, INC. (Exact name of registrant as specified in its charter) MARYLAND (State or other jurisdiction of incorporation or organization) 39-1783372 (I.R.S. Employer Identification No.) 222 W. Washington Ave, Madison, WI 53703 (Address of principal executive offices) (608) 443-1600 (Issuer's telephone number) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common stock par value $0.01 per share Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes No (cid:57) Yes No (cid:57) 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 (cid:57) No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes No (cid:57) Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. Large accelerated filer Accelerated filer Non-accelerated filer Smaller reporting company (cid:57) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No (cid:57) The aggregate market value of the registrant’s common stock held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $19,000,000. The number of shares outstanding of the registrant's common equity was 35,601,670 as of December 3, 2008. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the 2008 Annual Meeting of Stockholders are incorporated by reference into Part III. A definitive Proxy Statement pursuant to Regulation 14A will be filed with the Commission no later than January 28, 2009.  TABLE OF CONTENTS PAGE NO. PART I Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Business ................................................................................................................................. Risk Factors ........................................................................................................................... Unresolved Staff Comments .................................................................................................. Properties ............................................................................................................................... Legal Proceedings.................................................................................................................. Submission of Matters to a Vote of Security Holders............................................................ PART II Item 5. Item 6. Item 7. Item 7A. Item 8. Item 9. Item 9A. Item 9B. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities............................................................................................... Selected Consolidated Financial Data.................................................................................... Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................................................................................................. Quantitative and Qualitative Disclosures About Market Risk ............................................... Consolidated Financial Statements and Supplementary Data: Report of Grant Thornton LLP, Independent Registered Public Accounting Firm ............... Consolidated Balance Sheets ................................................................................................. Consolidated Statements of Operations ................................................................................. Consolidated Statements of Stockholders' Equity.................................................................. Consolidated Statements of Cash Flows ................................................................................ Notes to Consolidated Financial Statements.......................................................................... Changes in and Disagreements with Accountants on Accounting and Financial Disclosure .............................................................................................................................. Controls and Procedures ........................................................................................................ Other Information .................................................................................................................. PART III Item 10. Item 11. Item 12. Item 13. Item 14. Directors, Executive Officers and Corporate Governance..................................................... Executive Compensation ....................................................................................................... Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ............................................................................................................... Certain Relationships and Related Transactions, and Director Independence....................... Principal Accountant Fees and Services ................................................................................ 4 16 26 26 26 26 27 30 31 41 42 42 43 44 45 46 47 62 62 63 63 64 64 64 64 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 When used in this Report, the words “anticipate”, “expect”, “plan”, “believe”, “seek”, “estimate” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements about the features, benefits and performance of our Rich Media products, our ability to introduce new product offerings and increase revenue from existing products, expected expenses including those related to selling and marketing, product development and general and administrative, our beliefs regarding the health and growth of the market for Rich Media products, anticipated increase in our customer base, expansion of our products functionalities, expected revenue levels and sources of revenue, expected impact, if any, of legal proceedings, the adequacy of liquidity and capital resources, and expected growth in business. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, market acceptance for our products, our ability to attract and retain customers and distribution partners for existing and new products, our ability to control our expenses, our ability to recruit and retain employees, the ability of distribution partners to successfully sell our products, legislation and government regulation, shifts in technology, global and local business conditions, our ability to effectively maintain and update our products and service portfolio, the strength of competitive offerings, the prices being charged by those competitors, and the risks discussed elsewhere herein. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward- looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. ITEM 1. BUSINESS Who We Are PART I Sonic Foundry, Inc. is a technology leader in the emerging web communications marketplace, providing enterprise solutions for more than 1,500 customers in education, business and government. Powered by our core solution Mediasite®, the patented webcasting platform which automates the recording, management, delivery and search of lectures, online training and briefings, Sonic Foundry empowers people to transform the way they communicate. Through the Mediasite platform and its Events Services group, the company helps customers connect a dynamic, evolving world of shared knowledge and envisions a future where learners and workers around the globe use webcasting to bridge time and distance, accelerate research and improve performance. The Mediasite solution family includes: (cid:120) Mediasite Recorders to capture multimedia presentations (cid:120) Mediasite EX Server Platform to stream, archive and manage online presentation content Sonic Foundry Services to provide hosting, event webcasting, training, installation and custom development (cid:120) (cid:120) Mediasite Customer Assurance to provide annual hardware and software maintenance and technical support Currently, we have nearly 3,000 Mediasite Recorders installed in presentation venues around the world. These Recorders are capturing hundreds of thousands of rich media presentation hours for our customers. Sonic Foundry, Inc., the parent company of Sonic Foundry Media Systems, Inc., our web communications business, was founded in 1991, incorporated in Wisconsin in March 1994 and merged into a Maryland corporation of the same name in October 1996. Our executive offices are located at 222 West Washington Ave., Madison, Wisconsin, 53703 and our telephone number is (608) 443-1600. Our corporate website is www.sonicfoundry.com. We make available, free of charge, at the “Investor Information” section of our website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports required to be filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the filing of such reports with the Securities and Exchange Commission. 4 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Market Need Every organization faces a fundamental need to communicate information efficiently to individuals who need it. Universities and colleges need to connect lecturers with students for advanced learning. Corporations strive for successful communication and collaboration between colleagues to provide value to customers. Government agencies must keep partners, stakeholders and constituents informed to operate effectively. And yet, significant communication challenges remain, including: Enabling students to review complicated material repeatedly at their convenience Capturing complex graphics where visual clarity is essential for learning Providing distance learners with the same quality education as on-campus students Ensuring student retention and academic success (cid:120) (cid:120) (cid:120) (cid:120) Helping adult students balance career, family and education Increasing enrollment without new classrooms and facilities (cid:120) Simultaneously addressing people in multiple locations Connecting with a geographically-dispersed audience (cid:120) (cid:120) Holding meetings where it is not feasible for everyone to attend (cid:120) (cid:120) Transmitting timely information that is crucial for all employees to receive Requiring employees, regardless of time zone or schedule, to attend company training sessions Improving productivity and corporate logistics Reducing travel expenses and carbon footprints (cid:120) Eliminating the need to repeat the same presentation to different audiences (cid:120) (cid:120) Allowing participants to avoid leaving their desks to go to a meeting space (cid:120) Maintaining employee productivity while in training (cid:120) (cid:120) Increasing retention by avoiding distractions, interruptions or absence Reducing repeated costs for printing, mailing and meeting expenses Coordinating multiple project teams (cid:120) Keeping everyone on the same page at the same time Reducing time off task to get new hires trained (cid:120) (cid:120) Documenting past meeting content for later review (cid:120) Preserving organizational initiatives by preventing false starts and forgotten directives Avoiding cumbersome and restrictive technologies (cid:120) Maintaining the way presenters present without requiring them to have technical expertise in presentation systems Capturing and sharing knowledge in real-time without pre-authoring or pre-uploading of content or needing substantial post-production time Removing the need for significant time and specialized expertise to manage existing presentation systems (cid:120) (cid:120) The Mediasite Solution Sonic Foundry’s technology is changing the way organizations share and use information. The Mediasite solution family includes: (cid:120) Mediasite Recorders to capture multimedia presentations (cid:120) Mediasite EX Server Platform to stream, archive and manage online presentation content (cid:120) Sonic Foundry Services to provide managed services, event webcasting, training, installation, and custom development (cid:120) Mediasite Customer Assurance to provide annual hardware and software maintenance and technical support 5 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Mediasite Recorders streamline the recording and creation of multimedia presentations for people who need to share their information or message with others. Mediasite Recorders capture all the elements of a multimedia presentation—video, audio and high-resolution presentation graphics—and combine these into an interactive media- rich presentation that can be immediately viewed via the web. The simple workflow of the Mediasite Recorder is unobtrusive and instantaneous allowing presenters to share their knowledge online without changing how they normally present and without requiring time-consuming content production. We offer Mediasite Recorders for the following environments: (cid:120) A room-based Mediasite Recorder (RL Series) for presentation facilities like conference and training rooms, lecture halls, auditoriums and classrooms (cid:120) A mobile Mediasite Recorder (ML Series) for portability to off-site events, conferences, trade shows, or multiple venues throughout an organization Accompanying all Mediasite Recorders is the Mediasite Editor, a desktop software tool allowing users to edit their presentations, if desired, before publishing them to the web. Mediasite EX Server Platform is the unified platform for webcasting live and on-demand rich media presentations captured by Mediasite Recorders. It greatly simplifies content management by providing a single system to schedule, organize, index, customize, secure and track recorded presentations. As online multimedia libraries grow, effective management and security of this institutional knowledge becomes critical. Mediasite EX Server allows organizations to: Save time and staffing by scheduling recurring presentations to be automatically recorded without an operator (cid:120) (cid:120) Automatically create customizable and searchable online content catalogs without web development or integration skills Secure presentations and Mediasite system access for authorized users Customize and brand their presentation content and incorporate audience interactivity through polls and Q&A Centrally monitor and report on viewing activity and systems use to see who is watching what presentations, when and for how long Enable closed captioning for users with hearing disabilities (cid:120) (cid:120) Manage and remotely control Mediasite Recorders (cid:120) Integrate Mediasite content into other learning or course management systems, content management systems or custom portals Leverage existing network technologies for content distribution efficiency and performance Reliably scale to meet the webcasting needs of departmental and enterprise-wide implementations alike Choose the deployment model that best suits their environment, whether on-premise or hosted in the Sonic Foundry datacenter (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Sonic Foundry Services enable organizations to quickly and easily take advantage of the Mediasite platform, without having to wade through the IT or network complexities associated with their own infrastructure. Sonic Foundry Services include: (cid:120) Hosting: The Company’s pay-as-you-go service offerings provide hosting, delivery and management of online multimedia content using Sonic Foundry’s hosting data center and infrastructure. Managed services allow organizations of all sizes to jump start their web communications initiatives quickly and simply. They provide a low-risk way to implement online multimedia communications before bringing hosting requirements in-house and can offer a hassle-free long-term solution. Event Webcasting: A team of trained technicians work on-site or as project managers with event AV service providers to webcast rich media events, conferences and meetings. Sonic Foundry hosts each customer’s customized online catalogs, which provide their audiences ongoing access to the recorded content. Training: To maximize customers’ return on investments, skilled trainers provide the necessary knowledge transfer so organizations feel confident in using, managing and leveraging Mediasite’s capabilities. On-site training is customized to specific requirements and skill levels, while online training provides convenient anytime access to a web-based catalog of training modules. Installation: Sonic Foundry provides onsite services to integrate Mediasite within organizations’ existing AV and IT infrastructures. (cid:120) (cid:120) (cid:120) 6 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 (cid:120) Custom Development: Sonic Foundry streamlines how Mediasite interfaces with internal policies, workflow and content delivery systems. Software upgrades and updates for Mediasite Recorders and Servers Mediasite Customer Assurance provides Mediasite customers annually renewable maintenance and support plans on their Mediasite solution—giving them access to Sonic Foundry technical expertise and Mediasite software updates. With a Mediasite Customer Assurance contract, customers are entitled to: (cid:120) (cid:120) Unlimited technical support assistance (cid:120) (cid:120) Advance Recorder hardware replacement (cid:120) Authorized access to the Mediasite Customer Assurance Portal where they can access software downloads, Extension of their Recorder hardware warranty documentation, knowledge base articles, tutorials, online training and technical resources at any time. The majority of our customers purchase Mediasite Customer Assurance contracts when they purchase Mediasite. What Sets Mediasite Apart? (cid:120) Easy to use – We believe that presenters should not need to know anything about the technology that is facilitating their online communication. One-button or even fully automated, schedule-based recording simplifies what has previously been a technical and complex workflow. As a result, presenters can present as they normally do, which enables non-technical, line of business and subject matter experts to feel comfortable communicating via Mediasite. Similarly, viewers need nothing more than a web browser to watch Mediasite presentations. (cid:120) Comprehensive content management – We understand the need to bring order to a growing presentation library so content can be found, used, re-used and re-purposed to derive maximum value. Organizations must find ways to manage that content, and Sonic Foundry believes a complete solution focuses not only on the recording of knowledge, but also the retention and management of that knowledge in a system specifically designed for rich media. Mediasite automatically creates searchable online content catalogs that index and organize presentations with customizable playback experiences. With integration support leading enterprise directories, all content can be secured to allow/deny access to specific groups or individuals based on roles and permissions. Mediasite also allows organizations to monitor and generate reports for every presentation and/or user of the system, letting them see exactly who is watching what, when and how long. (cid:120) (cid:120) Reliable - Whether starting at the department level with a couple rooms or at the enterprise level with a campus- or company-wide implementation, Mediasite was developed to be the single platform to confidently and reliably scale to organizations’ webcasting needs. More than 1,500 customers around the world depend on Mediasite and its proven design to webcast critical information, enrich daily communications and retain their organizational knowledge . Interactive, rich media experience – The Mediasite experience takes into account different individual learning styles – auditory, visual and kinesthetic – providing an interactive format that engages the viewer via different modalities to increase content comprehension and retention. We understand that learning materials and supporting visuals come in many different forms, and Mediasite Recorders have flexible capture options supporting input from any laptop application, tablet PC, electronic whiteboard, document camera, medical instrumentation, and more. (Many other rich media communication solutions focus on PowerPoint as the predominant source of e-learning or training content.) In addition, Mediasite includes the ability to incorporate polls, Q&A and links to other related reference materials supporting the learning process. For hearing-impaired viewers, Mediasite supports the video closed captioning. In November 2006, the United States Patent and Trademark Office granted Sonic Foundry a patent on Mediasite’s unique method to capture and automatically index and synchronize what the presenter says (audio and video) with visual aids (RGB-based presentation content) and instantly stream them both over the Internet. Software as a Service (SaaS) deployment option – To minimize IT challenges, network infrastructure issues and expertise required to install, configure and maintain Mediasite within the enterprise, Sonic Foundry’s hosted service option provides organizations a low-risk method of using the complete Mediasite platform within a state-of-the-art datacenter. (cid:120) 7 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Customers and Applications The Mediasite platform is rapidly emerging as the standard for capturing, archiving and delivering one-to-many multimedia presentations online. Popular applications in our primary vertical markets include: Higher education (cid:120) Online lectures: students review content outside of in-class instruction (cid:120) Distance learning: off-campus students learn remotely online (cid:120) (cid:120) (cid:120) (cid:120) University business: leadership meetings, alumnae relations Continuing education: professionals learn online or supplement classroom experiences Research and collaboration: present findings, facility training Recruitment and orientation: campus tours, financial aid instructions Executive communications: state of the enterprise speeches, all-hands meetings Corporate (cid:120) (cid:120) Workforce development: training, HR briefings, policy documentation Program management: technical training, research collaboration (cid:120) Sales and marketing: sales demonstrations, webinars, channel relations (cid:120) Customer support: product tutorials, self-guided troubleshooting (cid:120) Investor relations: earnings calls, analyst briefings, annual reports (cid:120) Government (cid:120) (cid:120) (cid:120) (cid:120) Program management: relief work, military coordination, emergency preparedness Community outreach: committee meetings, public safety announcements Training, workshops and events: just-in-time, on-demand and remote learning Executive and legislative communications: constituent relations, public speeches, debates Benefits and Value of Mediasite In many cases, our customers deploy Mediasite to easily and cost-effectively build large-scale knowledge libraries of presentations. Through interviews, many customers report the following benefits of Mediasite: Cuts costs and boosts productivity (cid:120) (cid:120) (cid:120) Decreases work interruption and downtime while increasing the reach, retention and availability of important Reduces the need for travel and meeting accommodations Eliminates the need to choose between meetings by allowing executives to time-shift information Recaptures time that would have been spent repeating the same information to multiple audiences (cid:120) (cid:120) Keeps sales people informed while in the field interacting with customers (cid:120) Enables quick and efficient briefing of time-sensitive information to employees, regardless of geographic location Lets students watch and re-watch presentations at their convenience, leading to better retention Replicates in-class experience for those unable to attend class Promotes greater in-class interactivity rather than copious note-taking Caters to different learning modalities – audio, visual, kinesthetic Enhances student learning outcomes Enhances academic learning (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Helps adult and non-traditional students balance education, career and family (cid:120) Makes it possible to reuse and repurpose knowledge that could not otherwise be revisited 8 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Extends the life of conferences and events (cid:120) Makes presentations available to those not able to attend on-site (cid:120) (cid:120) (cid:120) (cid:120) Offers sample content to entice new people to participate Creates a real-time record of what took place, while remaining unobtrusive to presenters Eliminates the need for costly and time-consuming post-production Enables multiple proceedings in different locations to be captured Enhances collaboration and morale (cid:120) (cid:120) Creates opportunities for executive face time and interaction between management and staff Fosters a level of direct communication not possible before as presenters convey the significance of their message first hand Enables non-technical people to create their own webcasts through highly-automated equipment Improves employee morale through efficient, more inclusive communication so audiences at home and abroad feel more a part of the team Improves the reliability and frequency of internal and external communication (cid:120) (cid:120) (cid:120) Market Demand Web communication is coming of age, now regarded by education, business and government as an essential communication tool for the enterprise. We believe the recent surge in adoption is fueled by the lower cost of bandwidth and storage, as well as growing consumer awareness of internet video with the proliferation of online multimedia advertising and websites like YouTube and Google Video. We believe the market for this new medium will build at an increasing rate as more Mediasite systems are installed, more users begin webcasting and additional viewers come online. Three forms of communication – audio, visual and kinesthetic – each play a unique role in an individual’s ability to communicate and learn. We believe another reason people embrace the webcasting medium so fully is because it incorporates these combined ways of processing information: audio, video and visual aids, plus interactive navigation. Mediasite in education: We believe that adoption of web communications in educational enterprises is outpacing that in corporate enterprises. According to the Compass Intelligence U.S. Education IT Market report, IT spending in education will reach $47.7 billion by the end of 2008 and is expected to top $56 billion by 2012. Higher education accounts for the majority (64.8 percent) of education IT spending in 2008, and over half of the Education IT decision-makers surveyed believe their industry is experiencing growth regardless of how the overall economy is performing. Internet and electronic learning tools will account for $9.1 billion in spending in 2008 and are expected to grow to $12.9 billion by 2012. This growth is being fueled by expenditures in telecommunications, collaborative technologies and outsourced IT services. The report states schools are utilizing collaboration technologies and applications for distance learning, multi-campus lectures, laboratory and international research collaboration. Given the technology pedigree of today’s college students, this move to online learning makes perfect sense as most of these students have never known a world without personal computers and the web. The delivery options for a modern education are akin to the electronic delivery of music that emerged approximately five years ago. Students want to get their courses as they get their music: go online, download what is needed and consume it on the go. They demand immediate access to their coursework regardless of time or place. Tomorrow’s students may never actually miss a class because they will be able to watch it later on-demand with the added bonus of replaying the highlights if they need a refresher. In September 2008, Sonic Foundry sponsored a research project with the University of Wisconsin E-Business Institute which resulted in the study, “Insights Regarding Undergraduate Preference for Lecture Capture.” A survey was sent to 29,078 undergraduate and graduate students at the University of Wisconsin-Madison in April 2008. Average response rate exceeded 25 percent. Of the survey participants, a significant number of undergraduates (47 percent) have taken a class in which lectures were recorded and made available online. 82 percent of the undergraduates in the sample strongly preferred a course that records and streams lecture content online vs. courses that only feature in-room instruction. Students reported better retention, improved ability to review for exams and greater engagement during classes with lecture capture. Over half of the undergraduates indicated that, even after 9 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 course completion, having course material available online would be important and that there was interest in accessing online material in their professional lives. Over 60 percent of the sample were willing to pay for lecture capture services. Of those willing to pay, the majority of undergraduates (69 percent) expressed a preference to pay on a course-by-course basis rather than having lecture capture fees bundled with existing technology fees. Several universities have also conducted studies to assess the impact of Mediasite on student performance. Penn State Hershey Medical Center and College of Medicine, a Mediasite campus since January 2004, deployed a pilot program at the onset of the 2007-2008 academic year to record lectures to first year medical students. During this academic year, lectures to the first year students were viewed a total of 22,451 times, averaging 59.1 views per lecture by a class of 154 students. Student Mediasite use increased throughout the academic year, with 97 percent of students using Mediasite to review lectures by the semester's end. Almost half of the students surveyed (41 percent) cited reviewing complicated material as the number one motivator for using Mediasite. The majority (88 percent) agreed that Mediasite helps them achieve their educational goals. Much fewer (25 percent) said podcasting had the same effect. Faculty members reported that recording their lectures did not decrease class attendance. The survey also revealed a correlation between the grading method and the use of Mediasite. Students watch lectures more often via Mediasite for classes where grades are awarded as honors, high pass, pass and fail, vs. pass/fail. The Paul Merage School of Business at the University of California, Irvine, surveyed students in its 2007-2008 MBA program for Executives and MBA for Health Care Executives. Ninety one percent used Mediasite to view lectures, 71 percent found they were more engaged in lectures when they didn’t have to focus on taking copious notes and 83 percent said they learned more in courses when lectures were available on demand. The survey also determined that 93 percent of the students would choose an MBA program that mediasites course content over a school with traditional in-class instruction alone, and 82 percent would pay higher tuition for a program that streams and archives instruction, with almost half willing to pay between $2,000 and $5,000 more for their two-year degree. To remain relevant, colleges and universities are striving to differentiate themselves through technical leadership as a means to attract these tech-savvy students, while balancing their campus technology improvements with systems that faculty will embrace and adopt. As a result, the education market is beginning to restructure and increase investments around online learning. We believe the visible integration of rich media learning content into core university applications and the success of bundled online learning technology solutions are two healthy indicators for the widespread adoption of online campus lectures. To date, Sonic Foundry has installed Mediasite in the larger lecture halls and classrooms of campuses nationwide. We now see more and broader expansions and integrations of Mediasite at the campus-wide level. Course and learning management systems like Blackboard®, Desire2Learn®, Angel, Moodle and Sakai are ubiquitous in the education enterprise. As the foundation for e-learning, these systems are rapidly moving beyond simply aggregating related course documents (handouts, assignments, course syllabi) to becoming the students’ single-source portal for all course-related materials including recorded multimedia content like online lectures. Mediasite’s packaged integration with Blackboard, the leading course management system used in higher education, addresses the need to make learning content accessible to students when and where they need it. Mediasite in the enterprise: Less than a decade ago, the only people in the enterprise talking openly about online multimedia were AV specialists in IT or media services units, and even these people were skeptical about what benefits streaming would hold for the enterprise. Now, knowledge workers and line of business managers, people in executive communications, training, sales, human resources, and research and development, are pushing for online multimedia communications because they have a business need to be seen and heard by their colleagues. Claire Schooley, senior analyst with Forrester Research, Inc., wrote in the January 2007 report, Webcasting Grabs Corporate Attention, “The need for better, faster communications and learning opportunities will increase because of worker globalization and the desire to reach a broader customer base. Use webcasts to help your organization get its message out to a broad internal or external audience, increase revenue from new audiences, and control the costs of presentations, trainings, support, and travel. To be prepared, carry out the following: Develop the right content. Develop content that adapts well to the web and creates a compelling presentation. Don’t forget — content is still king; the technology is merely the delivery mechanism. Prepare for a mix of on-premise and services. Use a service vendor for the few large live external events your organization may conduct throughout the year, and look for on- 10 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 premise technology support for employee webcasts and on-demand webcasts made available on your web sites. A new culture will embrace webcasts as an expected online resource. But a cultural change is happening quickly in the way information and knowledge is communicated. Within three years, webcasts will be an essential part of business productivity tools.” The 2008 Corporate Learning Factbook: Benchmarks, Facts and Analysis in U.S. Corporate Learning & Development, published by Bersin and Associates in January 2008, determined the corporate learning market grew slightly from 2006 to 2007, increasing from $55.8 billion to $58.5 billion, with $16.3 billion budgeted for external products and services in 2007. E-learning has grown dramatically, with the use of self-study e-learning now accounting for 20 percent of student hours, up from 15 percent last year. This growth is driven largely by an increase in online training among small organizations (100-199 employees), which are acquiring the skills and technology to make online training a reality. The younger generation of learners is also driving changes in learning strategies, evidenced by a sharp increase in new web-based and collaborate learning resources. According to the publication, over half of all companies report using virtual classroom technologies, and between 20 and 30 percent are using application simulation and rapid e-learning tools. While many enterprises begin their web communications with live events, the majority move to live and on-demand, or on-demand only, as their webcasting experience grows. With that move, they report a spike in comprehension, productivity, strategic alignment around business goals, and even morale. We believe the feeling that the presenter is talking directly to the listener helps people feel more a part of the team and fosters more intimate communication between management and employees. In August 2007, Forrester® Consulting (“Forrester”) conducted a commissioned study on behalf of Sonic Foundry titled “The Total Economic Impact™ of Mediasite” to examine the financial impact and potential return on investment (ROI) enterprises may realize by deploying Mediasite. Sonic Foundry selected Forrester for this project because of its industry expertise in elearning and its Total Economic Impact (TEI) methodology. Forrester’s TEI helps companies demonstrate, justify and realize the tangible value of IT initiatives to both senior management and other key business stakeholders. It not only measures costs and cost reduction (areas that are typically accounted for within IT) but also weighs the enabling value of a technology in increasing the effectiveness of overall business processes. The study illustrates the financial impact of adopting Mediasite for a North American research and development organization with a focus on science-based technologies that support national security. The organization employs more than 10,000 employees and contractors on multiple campuses and has been using Mediasite since 2004 to create an enterprise-wide knowledge management system that integrates within its existing online environment. Based on in-depth interviews with the customer, Forrester constructed a TEI framework for a composite organization and found that the Mediasite webcasting platform yielded a 155 percent risk-adjusted ROI and paid for itself within 16 months of use. According to the study, key factors driving an organization’s Mediasite adoption include: (cid:120) “The ability to manage multimedia assets. End users can access content live or on-demand and have the flexibility to watch at their convenience and review as many times as they wish.” “Improved content capturing. This allows the training team to communicate in real-time and to reduce the time to market for new materials and enhancements.” “The ability to reduce the operational cost of training by reducing teleconferencing costs while improving the quality and relevance of training.” (cid:120) (cid:120) 11 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Future Product and Service Directions Because webcasting is becoming an everyday part of the way people work and learn, we are driven to shorten the time it takes people not only to share their information but also to find the information they need. While today leading-edge universities use Mediasite for lecture capture and corporations webcast training modules, we envision a future where people around the globe use webcasting to accelerate research and improve performance. As a company, we are helping create the libraries of tomorrow with technology that does not compound the world’s information overload. We are working to put a human face on all knowledge online, and we believe the world will be more knowledgeable, more connected as a result. Supporting this vision, our ongoing engineering efforts center on: (cid:120) Developing deployment options to meet the webcasting needs for organizations of all sizes. This includes: - - Significant investment, innovation and evolution of our current Mediasite Hosting platform in a Software as a Service (SaaS) model. This alternative to traditional on-premise deployments provides an ideal way to minimize IT challenges and potential webcasting risks while affordably extending high performance, fault tolerant webcasting to small and large customers alike. Content capture innovations that economically scale across entire organizations, allowing anyone to record and share their knowledge or expertise. Integrating with and embedding Mediasite content into other enterprise applications like enterprise portals, blogs, learning and course management systems and other content management repositories. Supporting content playback experiences on additional platforms and popular mobile computing devices. Evolving Mediasite’s content management capabilities to accommodate organizations’ existing digital video libraries. Further enabling Mediasite content to be accessible and meaningful to viewers with visual or hearing disabilities. Continual development and prototyping of key-word search within archived multimedia presentations, powered by our in-house technologies for understanding and analyzing images, language and speech. (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) The Importance of Search We believe search will lie at the heart of efficient, web-based communication. Faced with tens of thousands of hours of online streamed information, users could easily be overwhelmed with the need to find that one minute of content they require. Furthermore, organizations are not just going to need powerful tools to help workers internally find what they need, when they need it; leading businesses and education institutions will also want to be found by external audiences to help build their brands, customer base and reputation online. Growing presentation repositories are expected to drive future interest in deploying advanced search technology. Our work on search technology began back in the early 1990s through the initial efforts of Carnegie Mellon University and its Informedia project. In December 2005, Sonic Foundry launched Mediasite.com to aggregate and showcase the vast number of publicly available Mediasite presentations created by customers worldwide. Mediasite.com also served as a beta testing environment for some of our multi-modal search innovations involving phonetic speech recognition, optical character recognition, language processing and contextual analysis to identify key words found within the graphics, audio and video of online multimedia presentations. Our ongoing development for advanced search technologies continues in a closed lab setting where we explore and test innovations that will allow us to economically bring this resource-intensive search processing capability to customers. Segment Information We have determined that in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131), we operate in only one segment as we do not disaggregate profit and loss information on a segment basis for internal management reporting purposes to our chief operating decision maker. Therefore, such information is not presented. 12 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Total billings for Mediasite product and support outside the United States totaled 19 percent, 14 percent and 17 percent in 2008, 2007 and 2006, respectively. Our largest individual customers are typically value added resellers (“VARs”) and distributors since the majority of our end users require additional products and services which we do not provide. Accordingly, in fiscal 2008 and 2007 a master distributor, Synnex Corporation (“Synnex”), contributed 44 percent and 46 percent, respectively, of total world-wide billings. As a master distributor, Synnex fulfills transactions to VARs, end users and other distributors. No individual customer was over 10 percent in 2006. No other customer represented over 10 percent in 2006, 2007, or 2008. Sales We sell and market our offerings through a sales force that manages a reseller channel of value-added resellers, system integrators, consultants and distributors. These third party representatives specialize in understanding both audio/video systems and IT networking. In fiscal 2008, we utilized one master distributor in the U.S. and over 100 resellers, and sold our products to nearly 900 total end users. Our focus has been primarily in the United States and primarily to customers we have identified as having the greatest potential for high use; that is, organizations with presenters, trainers, lecturers, marketers and leaders who have a routine need to communicate to many people in the higher education, government, health industry and certain corporate markets. Despite our primary attention on the North American market, reseller and customer interest outside of North America has grown and accordingly, we allocated three sales professionals to address international demand. To date, we have sold our products to customers in 35 countries outside the United States. Total billings for Mediasite product and support outside the United States totaled 19 percent, 14 percent and 17 percent in fiscal 2008, 2007 and 2006, respectively. Vertical market expansion: Currently, just over half our revenue is realized from the education and distance learning markets. Recent trends such as high gas prices and the slowing economy are driving more students, particularly adult learners, to seek online education options. Similarly, demand for lecture capture within undergraduate, community college and blended learning programs is beginning to demonstrate growth. This development represents an emerging trend beyond the traditional academic customer base for the company, which has primarily consisted of graduate, distance learning and technical degree programs. For both our higher education and corporate, government and association clients, we anticipate weakening economic conditions will expand market demand for more outsourced services versus licensed sales. Over the last two years, the company has made extensive capital and technology investments to advance its services model with comprehensive hosting, webcasting-as-a-service, content processing and e-commerce capabilities that position the Company well to deliver more diversified business services. With the launch of our Event Services group in 2007, we continue to see growing demand for conference and event webcasting. These event-based communication, education and training applications, combined with outsourced webcasting services, are expected to drive the company’s corporate sales activities going forward. Repeat orders: Many customers initially purchase Mediasite based on a small number of Mediasite Recorders, to test or pilot in a department, school or business unit. A successful pilot project and the associated increase in webcasting demand from other departments or schools leads to follow up, multiple-Recorder orders as well as increased Mediasite Server capacity. In fiscal 2008, 59 percent of billings were to preexisting customers compared to 55 percent and 50 percent, respectively, in fiscal 2007 and 2006. Renewals: As is typical in the industry, we offer annual support and maintenance service contract extensions for a fee to our customer base. Marketing Marketing efforts span the spectrum of product demonstrations, tradeshows, websites, webinars, brochures, direct mail, e-mail campaigns, newsletters, print and online advertising, sponsorships, white papers and analyst relations. We often request and receive press release quotes and written or multimedia testimonials from satisfied, high-profile 13 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 reference customers, particularly those that demonstrate innovative and valuable uses of the Mediasite platform and Event Services. We solicit respected industry magazines and trade organizations to review our product and use advisors as introductions to new channels or customers. We have a large, growing database of potential customers in the education, government and corporate marketplaces and have established a process of targeting specific verticals that have a direct and demonstrated need for our offerings. Operations We contract with a third party to build the hardware of our Mediasite Recorders and purchase quantities sufficient to fill specific customer orders, including purchases of inventory by resellers. Quantities are maintained in inventory by our third party provider and shipped directly to the end customer or reseller. The hardware manufacturer provides a limited one-year warranty on the hardware, which we pass on to our customers who purchase a Mediasite Customer Assurance support and maintenance plan. We have an alternate source of manufacturing for some of the products we produce and believe there are numerous additional sources and alternatives to the existing production process. To date, we have not experienced any material difficulties or delays in the manufacture and assembly of our products or material returns due to product defects. OTHER INFORMATION Competition In the market for online multimedia web communication solutions, we face competition from other companies that provide related, but different, applications. (cid:120) Web conferencing includes solutions from Adobe, Cisco (WebEx), Microsoft and Citrix. Although part of the overall online multimedia communications landscape, these solutions are designed primarily for collaborative communications versus one-to-many communications like Mediasite. Many organizations acknowledge that they need both technologies – one-to-many webcasting and collaborative web conferencing – to appropriately address their different communication requirements. (cid:120) Video conferencing includes solutions from Polycom, Tandberg, Cisco and Sony. These solutions are designed primarily for one-to-one or group communications with high levels of interactivity and collaboration. Like web conferencing, many organizations use both video conferencing and webcasting. Mediasite integrates with videoconferencing endpoints from Polycom and Tandberg to record and manage interactive meetings, discussions and distance learning courses alongside other Mediasite content. (cid:120) Authoring tools include solutions like Accordent PresenterPLUS, Camtasia Studio and Microsoft Producer. Unlike webcasting, web conferencing or video conferencing, which are forms of online multimedia communication that capture and distribute/stream content, these solutions are production-oriented tools designed to create and edit multimedia content only. Some organizations will use these desktop tools to create training content by manually integrating existing audio, video, images, branding and other visual elements into a multimedia presentation which can then be published to a web or streaming server for distribution. This process can require a significant amount of production effort and user expertise in presentation authoring. Other vendors do provide presentation authoring and capture capabilities, such as Echo360, Tegrity, Accordent Technologies and Panopto, but we believe these companies currently lack the breadth or depth of content management capabilities required for online multimedia presentations in a campus- or enterprise-wide deployment. Some current and potential customers have developed their own home-grown webcasting or lecture capture solutions which may compete with Mediasite. However, we often find many of these organizations are now looking for a solution that requires less internal maintenance and effort, offers comprehensive management capabilities and a less cumbersome workflow. 14 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The more successful we are in the growing market for online multimedia, the more competitors are likely to emerge. We believe that the principal competitive factors in our market include: Ease of use and application transparency to the user Content management and scalability to address enterprise requirements Reliability and performance Security of content, applications and services (cid:120) (cid:120) (cid:120) (cid:120) (cid:120) Ability to integrate with third-party solutions and services (cid:120) (cid:120) (cid:120) A significant reference-able customer base (cid:120) Ability to introduce new products and services to the market in a timely manner Flexible deployment and acquisition options to suit various budgets Customer service and support Intellectual Property The status of United States patent protection in the Internet industry is not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents. We currently have two U.S patents that have been issued to us and five U.S. patent applications that are pending. We may seek additional patents in the future. We do not know if our pending patent applications or any future patent application will result in any patents being issued with the scope of the claims we seek, if such patents are issued at all. We do not know whether the patents which were recently approved or any patents we may receive in the future will be challenged, invalidated or be of any value. It is difficult to monitor unauthorized use of technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States, and our competitors may independently develop technology similar to ours. We will continue to seek patent and other intellectual property protections, when appropriate, for those aspects of our technology that we believe constitute innovations providing significant competitive advantages. Our pending, and any future, patent applications may not result in the issuance of valid patents. Our success depends in part upon our rights to proprietary technology. We rely on a combination of copyright, trade secret, trademark and contractual protection to establish and protect our proprietary rights. We have registered seven U.S. and four foreign country trademarks. We require our employees to enter into confidentiality and nondisclosure agreements upon commencement of employment. Before we will disclose any confidential aspects of our services, technology or business plans to customers, potential business distribution partners and other non- employees, we routinely require such persons to enter into confidentiality and nondisclosure agreements. In addition, we require all employees, and those consultants involved in the deployment of our services, to agree to assign to us any proprietary information, inventions or other intellectual property they generate, or come to possess, while employed by us. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our services or technology. These precautions may not prevent misappropriation or infringement of our intellectual property. Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. In addition, we may be subject to claims of alleged infringement of patents and other intellectual property rights of third parties. We may be unaware of filed patent applications which have not yet been made public and which relate to our services. Intellectual property claims may be asserted against us in the future. Intellectual property litigation is expensive and time-consuming and could divert management’s attention away from running our business. Intellectual property litigation could also require us to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on acceptable terms, if at all. Our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business. 15 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Research and Development We believe that our future success will depend in part on our ability to continue to develop new business, and to enhance our existing business. Accordingly, we invest a significant amount of our resources in research and development activities. During the fiscal years ended September 30, 2008, 2007 and 2006, we spent $3.5 million, $3.1 million and $2.2 million on internal research and development activities in our business. These amounts represent 23%, 19% and 18% of total revenue in each of those years. Employees As of September 30, 2008, 2007 and 2006, we had 91, 108 and 72 full-time employees, respectively. Our employees are not represented by a labor union, nor are they subject to a collective bargaining agreement. We have never experienced a work stoppage and believe that our employee relations are satisfactory. ITEM 1A. RISK FACTORS YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT PRESENTLY AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OR ALL OF THESE RISKS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE SIGNIFICANTLY DUE TO ANY OF THESE RISKS, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. IN ASSESSING THESE RISKS, YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES. Economic conditions could materially adversely affect the Company. The Company’s operations and performance depend significantly on worldwide economic conditions. Uncertainty about current global economic conditions poses a risk as businesses, educational institutions and the government may postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values, which could have a material negative effect on the demand for the Company’s products and services and on the Company’s financial condition and operating results. The current financial turmoil affecting the banking system and financial markets and the possibility that financial institutions may consolidate or go out of business have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets. There could be a number of follow-on effects from the credit crisis on the Company’s business, including insolvency of key suppliers resulting in products delays, inability of customers, including channel partners, to obtain credit to finance purchases of the Company’s products and/or customer, including channel partner, insolvencies; and inability of our channel partners and other customers to pay accounts receivable owed to us, or delays in the payment of such receivables. Additionally, if these economic conditions persist, our intangible assets may be impaired. Economic conditions may have a disproportionate affect on the sale of our products. Many of our customers will look at the total A/V equipment and labor cost to outfit a typical conference room or lecture hall as one amount for budgetary purposes. Consequently, although our products represent only a portion of the total cost, the entire project of outfitting a room or conference hall may be considered excessive and may not survive budgetary constraints. Alternatively, our resellers may modify their quotes to end customers by eliminating our products or substituting less expensive competitive products in order to win opportunities within budget constraints. Event service partners may similarly suggest that customers eliminate recording and webcasting as a means of reducing event cost. Consequently, declines in spending by government, educational or corporate 16 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 institutions due to budgetary constraints may have a disproportionate impact on the Company and result in a material adverse impact on our financial condition. We may need to raise additional capital if we do not quickly become profitable. At September 30, 2008 we had cash of $3.6 million and availability under our line of credit facility with Silicon Valley Bank of $2.3 million. The Company has historically financed its operations primarily through cash from sales of equity securities, cash from operations, and to a limited extent, through bank credit facilities. The Company has incurred losses from operations in each of the last three fiscal years. In response to the recurring operating losses, the Company initiated cost reduction efforts in January 2008. These efforts achieved a 24% reduction in quarterly operating expenses. The Company anticipates operating expenses to remain at or near these reduced levels in fiscal 2009. Although the Company anticipates growth in billings in fiscal 2009, it believes its cash position is adequate to accomplish its business plan through at least the next twelve months even if billings remain unchanged and therefore has no plans to seek additional debt or equity financing or to issue additional shares previously registered in its available shelf registration. We may evaluate further operating or capital lease opportunities to finance equipment purchases in the future and may utilize the Company’s revolving line of credit to support working capital needs, if the Company deems it advisable to do so. While the Company anticipates limited use of the line of credit and that it will be in compliance with all provisions of the agreement, there can be no assurance that the existing Loan Agreement will remain available to the Company nor that additional financing will be available or on terms acceptable to the Company. The business environment is not currently conducive to raising additional debt or equity financing and may not improve in the near term. If we borrow money, we may incur significant interest charges, which could harm our profitability. Holders of debt would also have rights, preferences or privileges senior to those of existing holders of our common stock. If we raise additional equity, the terms of such financing may dilute the ownership interests of current investors and cause our stock price to fall significantly. We may not be able to secure financing upon acceptable terms, if at all. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results, and financial condition We have a history of losses. For the year ended September 30, 2008, we had a gross margin of $11.4 million on revenue of $15.6 million with which to cover selling, marketing, product development and general administrative costs. Our selling, marketing, product development and general administration costs have historically been a significant percentage of our revenue, due partly to the expense of developing leads and the relatively long period required to convert leads into sales associated with selling products that are not yet considered "mainstream" technology investments. For the year ended September 30, 2008, our operating expenses exceeded our gross margin by 69%. Although we expect our operating losses as a percentage of revenue to decline during fiscal 2009, we may never achieve or sustain profitability on a quarterly or annual basis. We could lose revenues if there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools and other education providers. Most of our customers and potential customers are public colleges, universities, schools and other education providers who depend substantially on government funding. Accordingly, any general decrease, delay or change in federal, state or local funding for colleges, universities, schools and other education providers could cause our current and potential customers to reduce their purchases of our products and services, or to decide not to renew service contracts, either of which could cause us to lose revenues. In addition, a specific reduction in governmental funding support for products such as ours would also cause us to lose revenues. Also, public and some private colleges and higher education institutions have been significantly and adversely affected by the financial market downturn, which may adversely impact sales of our products. 17 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 If we are unable to comply with Nasdaq’s continued listing requirements, our common stock could be delisted from the Nasdaq Capital Market. Since March 2008, our common stock has failed to maintain a minimum bid price of $1.00 for at least 10 consecutive days, which caused our stock price to fail to meet one of the minimum standards required by the Nasdaq Stock Market for continued listing as a Nasdaq Global Market security. On March 10, 2008 we received a letter from Nasdaq indicating that we need to regain compliance with the minimum bid price requirement by September 8, 2008 in order to remain on the Nasdaq Global Market. On September 9, 2008 we were notified by Nasdaq that we had failed to regain compliance with the minimum bid price during the 180 days provided and our securities were therefore subject to delisting from the Nasdaq Global Market. In response, we applied for and were notified on September 12, 2008 by Nasdaq that Nasdaq approved our request to transfer the listing of our shares to the Nasdaq Capital Market. Transfer to the Nasdaq Capital Market and compliance with its initial listing standards affords an additional 180 day period for our stock to attain the minimum $1.00 bid price for at least 10 consecutive business days until March 9, 2009. In response to weak market conditions, Nasdaq suspended enforcement of the minimum bid price requirement on October 16, 2008 through January 16, 2009. Nasdaq notified us on October 22, 2008 that the suspension extends the period for us to regain compliance with the minimum bid price rule until June 9, 2009. We may not regain compliance with the minimum $1.00 bid price requirement during the additional period and our stock may be delisted, which may have a material adverse effect on the price of our common stock and the levels of liquidity currently available to our stockholders. Delisting would also make it more difficult for us to raise capital in the future or impact customer confidence. If our common stock is removed from the Nasdaq Capital Market, an investor could find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common shares. Additionally, our stock may then be subject to "penny stock" regulations. If a sufficient number of customers do not accept our products, our business may not succeed. We cannot predict how the market for our products will develop, and part of our strategic challenge will be to convince enterprise customers of the productivity, improved communications, cost savings, suitability and other benefits of our products. Our future revenue and revenue growth rates will depend in large part on our success in delivering these products effectively, creating market acceptance for these products, and meeting customer’s needs for new or enhanced products. If we fail to do so, our products will not achieve widespread market acceptance, and we may not generate significant revenue to offset our product development and selling and marketing costs, which will hurt our business. We may not be able to innovate to meet the needs of our target market. Our future success will continue to depend upon our ability to develop new products or product enhancements that address future needs of our target markets and to respond to these changing standards and practices. Our revenue could be reduced if we do not capitalize on our current market leadership by timely developing innovative new products or product enhancements that will increase the likelihood that our products will be accepted in preference to the products of our current and future competitors. Multiple unit sales may fail to materialize. We need to sell multiple units to educational, corporate and government institutions in order to sell most efficiently and become profitable. In fiscal 2008, 59% of recorder revenue were to existing customers compared to 55% in fiscal 2007. At September 30, 2008, 543 customers had purchased multiple units compared to 286 customers at September 30, 2007. In particular, selling multiple units to corporate customers has lagged results achieved in the higher education market; consequently, we have allocated more resources to the higher education market. While we have addressed a strategy to leverage existing customers and close multiple unit transactions, a customer may choose not to make expected purchases of our products. The failure of our customers to make expected purchases will harm our business. 18 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 If our marketing and lead generation efforts are not successful, our business will be harmed. We believe that continued marketing efforts will be critical to achieve widespread acceptance of our products. Our marketing campaign may not be successful given the expense required. For example, failure to adequately generate and develop sales leads could cause our future revenue growth to decrease. In addition, our inability to generate and cultivate sales leads into large organizations, where there is the potential for significant use of our products, could have a material effect on our business. We may not be able to identify and secure the number of strategic sales leads necessary to help generate marketplace acceptance of our products. If our marketing or lead-generation efforts are not successful, our business and operating results will be harmed. The length of our sales and deployment cycle is uncertain, which may cause our revenue and operating results to vary significantly from quarter to quarter and year to year. During our sales cycle, we spend considerable time and expense providing information to prospective customers about the use and benefits of our products without generating corresponding revenue. Our expense levels are relatively fixed in the short-term and based in part on our expectations of future revenue. Therefore, any delay in our sales cycle could cause significant variations in our operating results, particularly because a relatively small number of customer orders represent a large portion of our revenue. We anticipate that some of our largest sources of revenue will be educational institutions, large corporations and government entities that often require long testing and approval processes before making a decision to purchase our products, particularly when evaluating our products for inclusion in new buildings under construction or high dollar transactions. In general, the process of selling our products to a potential customer may involve lengthy negotiations, collaborations with consultants, designers and architects, time consuming installation processes and changes in network infrastructure in excess of what we or our VARs are able to provide. As a result, we anticipate that our sales cycle will be unpredictable. Our sales cycle will also be subject to delays as a result of customer-specific factors over which we have little or no control, including budgetary constraints and internal approval procedures. Our products are aimed toward a broadened user base within our key markets. These products are relatively early in their product life cycles and we are relatively inexperienced with their sales cycle. We cannot predict how the market for our products will develop and part of our strategic challenge will be to convince targeted users of the productivity, improved communications, cost savings and other benefits. Accordingly, it is likely that delays in our sales cycles with these products will occur and this could cause significant variations in our operating results. Sales of some of our products have experienced seasonal fluctuations which have affected sequential growth rates for these products, particularly in our first fiscal quarter. For example, there is generally a slowdown for sales of our products in the higher education and corporate markets in the first fiscal quarter of each year. Seasonal fluctuations could negatively affect our business, which could cause our operating results to fall short of anticipated results for such quarters. Our operating results are hard to predict as a significant amount of our sales typically occur at the end of a quarter and the mix of product and service orders may vary significantly. Revenue for any particular quarter is extremely difficult to predict with any degree of certainty. We typically ship products within a short time after we receive an order and therefore, we typically do not have an order backlog with which to estimate future revenue. In addition, orders from our channel partners are based on the level of demand from end-user customers. Any decline or uncertainty in end-user demand could negatively impact end-user orders, which could in turn significantly negatively affect orders from our channel partners in any given quarter. Accordingly, our expectations for both short and long-term future revenue is based almost exclusively on our own estimate of future demand based on the “pipeline” of sales opportunities we manage, rather than on firm channel partner orders. Our expense levels are based largely on these estimates. In addition, the majority of our orders are received in the last month of a quarter, typically the last few weeks of that quarter; thus, the unpredictability of the receipt of these orders could negatively impact our future results. We historically have received a majority of our channel partner orders in the last month of a quarter and often in the last few days of the quarter. Accordingly, any 19 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 significant shortfall in demand for our products in relation to our expectations would have an adverse impact on our operating results. We have experienced growing demand for our hosting and event services as well as a growing preference from our corporate customers in purchasing our solution as a service (SaaS). As a result, we expect that service billings as a percentage of total billings will continue to grow which we believe will ultimately lead to higher gross margins and more recurring revenue. The percentage of billings represented by service is also likely to fluctuate from quarter to quarter due to seasonality of event services and other factors. Since services are typically billed in advance of providing the service, revenue is initially deferred, leading to reduced current period revenue with a corresponding negative impact to profits or losses in periods of significant growth in billings for deferred services. An increase, or significant fluctuation, in service billings as a percentage of total billings may therefore lead to a temporary decline in our reported revenue. We are subject to risks associated with our channel partners’ product inventories and product sell-through. We sell a significant amount of our products to Synnex and other channel partners who maintain their own inventory of our products for sale to dealers and end-users. If these channel partners are unable to sell an adequate amount of their inventory of our products in a given quarter to dealers and end-users or if channel partners decide to decrease their inventories for any reason, such as a recurrence of global economic uncertainty and downturn in technology spending, the volume of our sales to these channel partners and our revenue would be negatively affected. In addition, if channel partners decide to purchase more inventory, due to product availability or other reasons, than is required to satisfy end-user demand or if end-user demand does not keep pace with the additional inventory purchases, channel inventory could grow in any particular quarter, which could adversely affect product revenue in the subsequent quarter. In addition, we also face the risk that some of our channel partners have inventory levels in excess of future anticipated sales. If such sales do not occur in the time frame anticipated by these channel partners for any reason, these channel partners may substantially decrease the amount of product they order from us in subsequent periods, which would harm our business. If stock balancing returns or price adjustments exceed our reserves, our operating results could be adversely affected. We provide some of our distributors with stock balancing return rights, which generally permit our distributors to return products, subject to ordering an equal dollar amount of alternate products. We also provide price protection rights to most of our distributors. Price protection rights require that we grant retroactive price adjustments for inventories of our products held by distributors if we lower our prices for those products within a specified time period. To cover our exposure to these product returns and price adjustments, we establish reserves based on our evaluation of historical product trends and current marketing plans. However, we cannot be assured that our reserves will be sufficient to cover our future product returns and price adjustments. If we inadequately forecast reserves, our operating results could be adversely affected. Manufacturing disruption or capacity constraints would harm our business. We subcontract the manufacture of our products to a third-party contract manufacturer in Alabama. Although we believe there are multiple sources of supply from other contract manufacturers as well as multiple suppliers of component parts to the contract manufacturer, a short term disruption of supply of component parts or completed products near the end of a quarter would have a negative impact on our revenues. Moreover, any incapacitation of the manufacturing site due to destruction, natural disaster or similar events could result in a loss of product inventory. As a result of any of the foregoing, we may not be able to meet demand for our products, which could negatively affect revenues in the quarter of the disruption or longer depending upon the magnitude of the event, and could harm our reputation. Our cash flow could fluctuate due to the potential difficulty of collecting our receivables. A significant portion of our sales are fulfilled by VARs, regional distributors or master distributors. As an example, 44% of our billings in 2008 were to Synnex, a master distributor who fulfills demand from other distributors, VARs 20 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 or end users. While our distributors and VARs typically maintain payment terms consistent with other end users, a delay in payment may occur as a result of a number of factors including changes in demand, general economic factors, financial performance, inventory levels or disputes over payments. Any delay from Synnex, or other large distributors or VARs could have a material impact on the collections of our receivables during a particular quarter. Over the past year we have begun to expand the level of sales representation in Europe and Asia as well as other international regions. We offer credit terms to some of our international customers; however, payments tend to go beyond terms in certain countries. Therefore, as Europe, Asia and other international regions grow as a percentage of our revenue, accounts receivable balances will likely increase as compared to previous years. Accounting regulations and related interpretations and policies, particularly those related to revenue recognition, cause us to defer revenue recognition into future periods for portions of our products and services. Revenue recognition for our products and services is complex and subject to multiple sources of authoritative guidance as well as varied interpretations and implementation practices for such rules. These rules require us to defer revenue recognition in certain situations. Factors that are considered in revenue recognition include those such as vendor specific objective evidence (VSOE), the inclusion of other services and contingencies to payment terms. We expect that we will continue to defer portions of our product and service billings because of these factors. The amounts deferred may be significant and will vary each quarter depending on the mix of products sold in each market and geography, as well as the actual contract terms. Additional changes in authoritative guidance or changes in practice in applying such rules could also cause us to defer the recognition of revenue to future periods or recognize lower revenue Because most of our service contracts are renewable on an annual basis, a reduction in our service renewal rate could significantly reduce our revenues. Our clients have no obligation to renew their content hosting agreements, customer support contracts or other annual service contracts after the expiration of the initial period, which is typically one year, and some clients have elected not to do so. A decline in renewal rates could cause our revenues to decline. We have limited historical data with respect to rates of renewals, so we cannot accurately predict future renewal rates. Our renewal rates may decline or fluctuate as a result of a number of factors, including client dissatisfaction with our products and services, our failure to update our products to maintain their attractiveness in the market or budgetary constraints or changes in budget priorities faced by our clients. Because we generally recognize revenues ratably over the term of our service contracts, downturns or upturns in service transactions will not be fully reflected in our operating results until future periods. We recognize most of our revenues from service contracts monthly over the terms of their agreements, which are typically 12 months, although terms can range from less than one month to over 36 months. As a result, much of the service revenue we report in each quarter is attributable to agreements entered into during previous quarters. Consequently, a decline in sales, client renewals, or market acceptance of our products in any one quarter will not necessarily be fully reflected in the revenues in that quarter, and will negatively affect our revenues and profitability in future quarters. This ratable revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as revenues from new clients must be recognized over the applicable agreement term. There is a great deal of competition in the market for our products, which could lower the demand for our products. The market for one-to-many multimedia web communication is relatively new, and we face competition from other companies that provide related digital media applications, such as Apple. Companies like Cisco (WebEx), Microsoft and Citrix offer web conferencing applications. Although part of the overall web communications landscape, these solutions are designed primarily for smaller group collaborative communications versus one-to-many communications. Accordent Technologies, Tegrity, Echo360, Panopto and other vendors provide presentation authoring and capture capabilities, but 21 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 currently we believe they lack the breadth or depth of content management capabilities required for online multimedia presentations in an enterprise-wide deployment. Current and potential customers may choose to develop their own home-grown web communications software and services which may compete with Mediasite. We may also compete indirectly with larger system integrators who embed or integrate competing technologies into their custom-built product offerings. If one of these alternative approaches is received more favorably in the marketplace, a new approach or technology is developed or an existing or new competitor markets more effectively than we do or we otherwise do not compete effectively, our business will be harmed. In addition, the more successful we are in the emerging markets our products address, the more competitors are likely to emerge, including turnkey media application, streaming media platform developers, digital music infrastructure providers, and digital media applications service providers (including for digital musical subscription). Many of our competitors have far greater financial resources than we do, and could easily overtake the marketplace and severely harm our business. We may also face competition from foreign suppliers and competition from Course Management Systems (CMS) or education information technology (IT) companies. The presence of these competitors could reduce the demand for our systems, and we may not have the financial resources to compete successfully. Our customers may use our products to share confidential and sensitive information, and if our system security is breached, our reputation could be harmed and we may lose customers. Our customers may use our products to share confidential and sensitive information, the security of which is critical to their business. Third parties may attempt to breach our security or that of our customers. Customers may take inadequate security precautions with their sensitive information and we may inadvertently make that information public on our www.mediasite.com website. We may be liable to our customers for any breach in security, and any breach could harm our reputation and cause us to lose customers. In addition, customers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources to further protect against security breaches or to resolve problems caused by any breach, including litigation-related expenses if we are sued. Operational failures in our network infrastructure could disrupt our remote hosting services, could cause us to lose clients and sales to potential clients and could result in increased expenses and reduced revenues. Unanticipated problems affecting our network systems could cause interruptions or delays in the delivery of the hosting services we provide to some of our clients. We provide remote hosting through computer hardware, some of which is within our facility and some of which is currently located in a third-party co-location facility. We do not control the operation of this co-location facility. Lengthy interruptions in our hosting service could be caused by the occurrence of a natural disaster, power loss, vandalism or other telecommunications problems at the co-location facility or if this co-location facility were to close without adequate notice. We currently do not have adequate computer hardware and systems to provide alternative service for most of our hosted clients in the event of an extended loss of service at the co-location facility. We are not equipped to provide full disaster recovery to all of our hosted clients. If there are operational failures in our network infrastructure that cause interruptions, slower response times, loss of data or extended loss of service for our remotely hosted clients, we may be required to issue credits or pay penalties, current clients may terminate their contracts or elect not to renew them, and we may lose sales to potential clients. If we determine that we need additional hardware and systems, we may be required to make further investments in our network infrastructure. The technology underlying our products and services is complex and may contain unknown defects that could harm our reputation, result in product liability or decrease market acceptance of our products. The technology underlying our products is complex and includes software that is internally developed, software licensed from third parties and hardware purchased from third parties. These products may contain errors or defects, particularly when first introduced or when new versions or enhancements are released. We may not discover defects that affect our current or new applications or enhancements until after they are sold and our insurance coverage may not be sufficient to cover our complete liability exposure. Any defects in our products and services could: 22 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 (cid:131) Damage our reputation; (cid:131) (cid:131) (cid:131) (cid:131) Delay market acceptance of our products. Cause our customers to initiate product liability suits against us; Increase our product development resources; Cause us to lose sales; and If we are viewed only as a commodity supplier, our margins and valuations will shrink. We need to provide value-added services in order to avoid being viewed as a commodity supplier. This entails building long-term customer relationships and developing features that will distinguish our products. Our technology is complex and is often confused with other products and technologies in the market place, including video conferencing, streaming and collaboration. If we fail to build long-term customer relationships and develop features that distinguish our products in the market place, our margins will shrink, and our stock may become less valued to investors. Our success depends upon the proprietary aspects of our technology. Our success and ability to compete depend to a significant degree upon the protection of our proprietary technology. We currently have two U.S. patents that have been issued to us and five U.S. patent applications that are pending. We may seek additional patents in the future. Our current patent applications cover different aspects of the technology used in our products which is important to our ability to compete. However, it is possible that: (cid:131) (cid:131) (cid:131) (cid:131) (cid:131) our pending patent applications may not result in the issuance of patents; any patents acquired by or issued to us may not be broad enough to protect us; any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents; current and future competitors may independently develop similar technology, duplicate our services or design around any of our patents; and effective patent protection, including effective legal-enforcement mechanisms against those who violate our patent-related assets, may not be available in every country in which we do or plan to do business. We also rely upon trademarks, copyrights and trade secrets to protect our technology, which may not be sufficient to protect our intellectual property. We also rely on a combination of laws, such as copyright, trademark and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our technology. We have registered seven U.S. and four foreign country trademarks. These forms of intellectual property protection are critically important to our ability to establish and maintain our competitive position. However, (cid:131) (cid:131) (cid:131) (cid:131) (cid:131) third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights; laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or to deter others from developing similar technologies; effective trademark, copyright and trade secret protection, including effective legal-enforcement mechanisms against those who violate our trademark, copyright or trade secret assets, may be unavailable or limited in foreign countries; other companies may claim common law trademark rights based upon state or foreign laws that precede the federal registration of our marks; and policing unauthorized use of our services and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business. 23 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 If other parties bring infringement or other claims against us, we may incur significant costs or lose customers. Other companies may obtain patents or other proprietary rights that would limit our ability to conduct our business and could assert that our technologies infringe their proprietary rights. We could incur substantial costs to defend any legal proceedings, even if without merit, and intellectual property litigation could force us to cease using key technology, obtain a license, or redesign our products. In the course of our business, we may sell certain systems to our customers, and in connection with such sale, we may agree to indemnify these customers from claims made against them by third parties for patent infringement related to these systems. In particular, claims are currently being made by holders of patents against educational institutions using streaming in their curriculum. We could be subject to similar claims, which could harm our business. If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired. Our future success depends upon the continued service of our key management, technical, sales, and other critical personnel. Certain of our officers and certain of our other key personnel are employees-at-will, and we cannot assure that we will be able to retain them. Key personnel have left our company in the past, sometimes to accept employment with companies that sell similar products or services to existing or potential customers of ours. There will likely be additional departures of key personnel from time to time in the future and such departures could result in additional competition, loss of customers or confusion in the marketplace. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives, and the results of our operations. In particular, the loss of the services of our Chief Executive Officer, Rimas Buinevicius, or our co-founder and Chief Technology Officer, Monty Schmidt, would harm our business. Although we do have employment agreements with Messrs. Buinevicius and Schmidt, we do not have life insurance policies on any of our key employees. In addition, the integration of replacement personnel could be time consuming, may cause disruptions to our operations, and may be unsuccessful. Because our business is susceptible to risks associated with international operations, we may not be able to maintain or increase international sales of our products. International product and service revenue ranged from 14% to 19% of our total billings in each of the past three years. Our international operations are expected to continue to account for a significant portion of our business in the future. However, in the future we may be unable to maintain or increase international sales of our products and services. International sales are subject to a variety of risks, including: (cid:131) (cid:131) (cid:131) difficulties in establishing and managing international distribution channels; difficulties in selling, servicing and supporting overseas products and in translating products into foreign languages; the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property; (cid:131) multiple and possibly overlapping tax structures; currency and exchange rate fluctuations; and (cid:131) economic or political changes in international markets. (cid:131) We face risks associated with government regulation of the internet, and related legal uncertainties. Currently, few existing laws or regulations specifically apply to the Internet, other than laws generally applicable to businesses. Many Internet-related laws and regulations, however, are pending and may be adopted in the United States, in individual states and local jurisdictions and in other countries. These laws may relate to many areas that impact our business, including encryption, network and information security, and the convergence of traditional communication services, such as telephone services, with Internet communications, taxes and wireless networks. These types of regulations could differ between countries and other political and geographic divisions both inside 24 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 and outside the United States. Non-U.S. countries and political organizations may impose, or favor, more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. In addition, state and local governments within the United States may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for, and the costs associated with, our products and services. The adoption of such laws and regulations may harm our business. Exercise of outstanding options and warrants will result in further dilution. The issuance of shares of common stock upon the exercise of our outstanding options and warrants will result in dilution to the interests of our stockholders, and may reduce the trading price of our common stock. At September 30, 2008, we had 566 thousand of outstanding warrants and 6.2 million of outstanding stock options granted under our 1995 Employee Stock Option Plan, our 1999 Non-Qualified Stock Option Plan and our Non- Employee Director Stock Option Plans, 4.8 million of which are immediately exercisable. To the extent that these stock options or warrants are exercised, dilution to the interests of our stockholders will likely occur. Additional options and warrants may be issued in the future at prices not less than 85% of the fair market value of the underlying security on the date of grant. Exercises of these options or warrants, or even the potential of their exercise may have an adverse effect on the trading price of our common stock. The holders of our options or our warrants are likely to exercise them at times when the market price of the common stock exceeds the exercise price of the securities. Accordingly, the issuance of shares of common stock upon exercise of the options and warrants will likely result in dilution of the equity represented by the then outstanding shares of common stock held by other stockholders. Holders of our options and warrants can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms, which are more favorable to us than the exercise terms provided, by these options and warrants. We may need to make acquisitions or form strategic alliances or partnerships in order to remain competitive in our market, and potential future acquisitions, strategic alliances or partnerships could be difficult to integrate, disrupt our business and dilute stockholder value. We may acquire or form strategic alliances or partnerships with other businesses in the future in order to remain competitive or to acquire new technologies. As a result of these acquisitions, strategic alliances or partnerships, we may need to integrate products, technologies, widely dispersed operations and distinct corporate cultures. The products, services or technologies of the acquired companies may need to be altered or redesigned in order to be made compatible with our software products and services, or the software architecture of our customers. These integration efforts may not succeed or may distract our management from operating our existing business. Our failure to successfully manage future acquisitions, strategic alliances or partnerships could seriously harm our operating results. In addition, our stockholders would be diluted if we finance the acquisition, strategic alliances or partnerships by incurring convertible debt or issuing equity securities. Our corporate compliance program cannot guarantee that we are in compliance with all potentially applicable regulations. As a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices and continue to update the program in response to newly implemented regulatory requirements and guidance, we cannot assure that we are or will be in compliance with all potentially applicable regulations. Although our non-affiliate market capitalization was less than $75 million at March 31, 2008 and we are no longer required to be fully compliant with both the management assessment and auditor attestations, current SEC rules would require us to be fully compliant at September 30, 2010. We cannot assure that in the future our management will not find a material weakness in connection with its annual review of our internal control over financial reporting 25 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot assure that we could correct any such weakness to allow our management to assess the effectiveness of our internal control over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in our Annual Report on Form 10-K to be filed with the Securities and Exchange Commission or attest that we have maintained effective internal control over financial reporting as of the end of our fiscal year. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines, or other sanctions or litigation. In addition, if we must disclose any material weakness in our internal control over financial reporting, this may cause our stock price to decline. Provisions of our charter documents and Maryland law could also discourage an acquisition of our company that would benefit our stockholders. Provisions of our articles of incorporation and by-laws may make it more difficult for a third party to acquire control of our company, even if a change in control would benefit our stockholders. Our articles of incorporation authorize our board of directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Furthermore, our articles of incorporation provide for a classified board of directors, which means that our stockholders may vote upon the retention of only one or two of our seven directors each year. Moreover, Maryland corporate law restricts certain business combination transactions with “interested stockholders” and limits voting rights upon certain acquisitions of “control shares.” ITEM 1B. UNRESOLVED STAFF COMMENTS None ITEM 2. PROPERTIES Our principal office is located in Madison, Wisconsin in a leased facility of approximately 19,000 square feet. The building serves as our corporate headquarters, accommodating our general and administrative, product development and selling and marketing departments. We believe this facility is adequate and suitable for our needs. The current lease term for this office expires on October 1, 2011. In addition, we lease 2,500 square feet in a building in downtown Pittsburgh, Pennsylvania which we no longer utilize and plan to terminate on January 31, 2009. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter ended September 30, 2008. 26 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES Our common stock was initially traded on the American Stock Exchange under the symbol "SFO," beginning with our initial public offering in April of 1998. On April 24, 2000, our common stock began trading on the Nasdaq Global Market under the symbol "SOFO." Effective September 16, 2008, we transferred the listing of our common stock to the Nasdaq Capital Market. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported on the Nasdaq Global or Capital Markets. Year Ended September 30, 2009: First Quarter (through December 3, 2008) High Low $ 0.65 $ 0.32 Year Ended September 30, 2008: First Quarter Second Quarter Third Quarter Fourth Quarter Year Ended September 30, 2007: First Quarter Second Quarter Third Quarter Fourth Quarter 2.85 1.49 0.95 0.90 5.15 4.77 4.08 2.85 1.18 0.61 0.60 0.50 2.24 3.46 2.02 1.61 Since March 2008, our common stock has failed to maintain a minimum bid price of $1.00 for at least 10 consecutive days, which caused our stock price to fail to meet one of the minimum standards required by the Nasdaq Stock Market for continued listing as a Nasdaq Global Market security. On March 10, 2008 we received a letter from Nasdaq indicating that we need to regain compliance with the minimum bid price requirement by September 8, 2008 in order to remain on the Nasdaq Global Market. On September 9, 2008 we were notified by Nasdaq that we had failed to regain compliance with the minimum bid price during the 180 days provided and our securities were therefore subject to delisting from the Nasdaq Global Market. In response, we applied for and were notified on September 12, 2008 by Nasdaq that Nasdaq approved our request to transfer the listing of our shares to the Nasdaq Capital Market. Transfer to the Nasdaq Capital Market and compliance with its initial listing standards affords an additional 180 day period for our stock to attain the minimum $1.00 bid price for at least 10 consecutive business days until March 9, 2009. In response to weak market conditions, Nasdaq suspended enforcement of the minimum bid price requirement on October 16, 2008 through January 16, 2009. Nasdaq notified us on October 22, 2008 that the suspension extends the period for us to regain compliance with the minimum bid price rule until June 9, 2009. We may not regain compliance with the minimum $1.00 bid price requirement during the additional period and our stock may be delisted, which may have a material adverse effect on the price of our common stock and the levels of liquidity currently available to our stockholders. Delisting would also make it more difficult for us to raise capital in the future or impact customer confidence. If our common stock is removed from the Nasdaq Capital Market, an investor could find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common shares. Additionally, our stock may then be subject to "penny stock" regulations. The Company has not paid any cash dividends and does not intend to pay any cash dividends in the foreseeable future. The Company is prohibited from paying any cash dividends pursuant to the terms of the loan and security agreements with Silicon Valley Bank. At December 3, 2008 there were 471 common stockholders of record and approximately 9,000 total shareholders. Many shares are held by brokers and other institutions on behalf of shareholders. 27 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Equity Compensation Plan Information Plan category Equity compensation plans approved by security holders (1) Equity compensation plans not approved by security holders (2) Total Number of securities to be issued upon exercise of outstanding options, warrants and rights Weighted average exercise price of outstanding options, warrants and rights Number of securities remaining available for future issuance (a) (b) (c) 3,978,000 $ 2.48 1,553,327 2,262,477 6,240,477 1.28 219,992 $ 2.05 1,773,319 (1) Consists of the Employee Stock Option Plan and the Directors Stock Option Plan. For further information regarding these plans, reference is made to Note 5 of the financial statements. (2) Consists of the Non-Qualified Stock Option Plan. For further information regarding this plan, reference is made to Note 5 of the financial statements. 28 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The graph below compares the cumulative total stockholder return on our common stock from September 30, 2003 through and including September 30, 2008 with the cumulative total return on The Nasdaq Stock Market (US only) and the RDG Technology Composite. The graph assumes that $100 was invested in our common stock on September 30, 2003 for each of the indexes and that all dividends were reinvested. Unless otherwise specified, all dates refer to the last day of each month presented. The comparisons in the graph below are based on historical data, with our common stock prices based on the closing price on the dates indicated, and are not intended to forecast the possible future performance of our common stock. COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* Among Sonic Foundry, Inc., The NASDAQ Composite Index And The RDG Technology Composite Index $180 $160 $140 $120 $100 $80 $60 $40 $20 $0 9/03 9/04 9/05 9/06 9/07 9/08 Sonic Foundry, Inc. NASDAQ Composite RDG Technology Composite *$100 invested on 9/30/03 in stock & index-including reinvestment of dividends. Fiscal year ending September 30. (A) RECENT SALES OF UNREGISTERED SECURITIES None (B) USE OF PROCEEDS FROM REGISTERED SECURITIES None (C) ISSUER PURCHASES OF EQUITY SECURITIES None 29 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected financial and operating data were derived from our consolidated financial statements. The selected financial data set forth below is qualified in its entirety by, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our financial statements and notes thereto appearing elsewhere in this annual report on Form 10-K (in thousands except per share data). 2008 $ 15,601 4,205 11,396 19,279 (7,883) 10 Years Ended September 30, 2006 2007 2005 $ 16,737 4,133 12,604 19,222 (6,618) 248 $ 12,564 3,215 9,349 12,909 (3,560) 77 $ 8,342 2,754 5,588 9,944 (4,356) 187 2004 $ 4,413 1,759 2,654 8,261 (5,607) 99 (7,873) (6,370) (3,483) (4,169) (5,508) (cid:326) $ (7,873) (cid:326) $ (6,370) (cid:326) $ (3,483) (cid:326) $ (4,169) 132 $ (5,376) $ (0.22) $ (0.18) $ (0.11) $ (0.14) $ (0.18) Statement of Operations Data: Revenue Cost of revenue Gross margin Operating expenses Loss from operations Other income, net Loss from continuing operations Gain on disposal of discontinued operations Net loss Basic net loss per common share Diluted net loss per common share $ (0.22) $ (0.18) $ (0.11) $ (0.14) $ (0.18) Weighted average common shares: - Basic - Diluted Balance Sheet Data at September 30: Cash and cash equivalents Working capital Total assets Long-term liabilities Stockholders' equity 35,580 35,580 34,688 34,688 32,015 32,015 30,363 30,363 29,457 29,457 2008 2007 2006 2005 2004 $ 3,560 774 17,474 502 9,563 $ 8,008 7,940 23,981 973 16,760 $ 2,751 2,198 16,912 519 11,601 $ 4,271 4,205 16,245 49 13,121 $ 7,583 7,560 18,631 (cid:326) 16,566 30 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The financial and business analysis below provides information that Sonic Foundry, Inc. (the Company) believes is relevant to an assessment and understanding of the Company's consolidated financial position and results of operations. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes. When used in this Report, the words “anticipate”, “expect”, “plan”, “believe”, “seek”, “estimate” and similar expressions are intended to identify forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements about the features, benefits and performance of our products, our ability to introduce new product offerings and increase revenue from existing products, expected expenses including those related to selling and marketing, product development and general and administrative, our beliefs regarding the health and growth of the market for products, anticipated increase in our customer base, expansion of our products functionalities, expected revenue levels and sources of revenue, expected impact, if any, of legal proceedings, the adequacy of liquidity and capital resources, and expected growth in business. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, market acceptance for our products, our ability to attract and retain customers and distribution partners for existing and new products, our ability to control our expenses, our ability to recruit and retain employees, the ability of distribution partners to successfully sell our products, legislation and government regulation, shifts in technology, global and local business conditions, our ability to effectively maintain and update our products and service portfolio, the strength of competitive offerings, the prices being charged by those competitors, and the risks discussed elsewhere herein. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based. Overview Sonic Foundry, Inc. is a technology leader in the emerging web communications marketplace, providing enterprise solutions and services that link an information-driven world. The company’s principal product line, Mediasite® is a web communication and content management system that automatically and cost-effectively webcasts lectures and presentations. Trusted by Fortune 500 companies, top education institutions and Federal, state and local government agencies for a variety of critical communication needs, Mediasite is the leading one-to-many multimedia communication solution for capturing knowledge and sharing it online. Critical Accounting Policies We have identified the following as critical accounting policies to our Company and have discussed the development, selection of estimates and the disclosure regarding them with the audit committee of the board of directors: Revenue recognition, allowance for doubtful accounts, and reserves; Impairment of long-lived assets; (cid:131) (cid:131) (cid:131) Valuation allowance for net deferred tax assets; and (cid:131) Accounting for stock-based compensation. Revenue Recognition, Allowance for Doubtful Accounts and Reserves General Revenue is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price is fixed or determinable and collectibility is reasonably assured. Revenue is deferred when undelivered products or services are essential to the functionality of delivered products, customer acceptance is uncertain, significant obligations remain, or the fair value of undelivered elements is unknown. The Company does 31 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 not offer customers the right to return product, other than for exchange or repair pursuant to a warranty or stock rotation. The Company’s policy is to reduce revenue if it incurs an obligation for price rebates or other such programs during the period the obligation is reasonably estimated to occur. The following policies apply to the Company’s major categories of revenue transactions. Products Products are considered delivered, and revenue is recognized, when title and risk of loss have been transferred to the customer. Under the terms and conditions of the sale, this occurs at the time of shipment to the customer. Product revenue currently represents sales of our Mediasite recorders and Mediasite related products such as server software revenue. Services We sell support contracts to our customers, typically one year in length, and record the related revenue ratably over the contractual period. Our support contracts cover phone and electronic technical support availability over and above the level provided by our distributors, software upgrades on a when and if available basis, advance hardware replacement and an extension of the standard hardware warranty from 90 days to one year. The manufacturer we contract with to build the units performs hardware warranty service. We also sell installation, training, event webcasting, and customer content hosting services. Revenue for those services is recognized when performed in the case of installation, training and event webcasting services and is recognized ratably over the contract period for content hosting services. Service amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met. Revenue Arrangements that Include Multiple Elements Revenue for transactions that include multiple elements such as hardware, software, installation, training, and post customer support is allocated to each element based on vendor-specific objective evidence of the fair value “VSOE” in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2. Revenue is recognized for each element when the revenue recognition criteria have been met for that element. VSOE is based on the price charged when the element is sold separately. If VSOE of fair value does not exist for all elements in a multiple element arrangement, revenue is allocated first to the fair value of the undelivered elements and the residual revenue to the delivered elements. The Company recognizes revenue for delivered elements only when all of the following criteria are satisfied: undelivered elements are not essential to the functionality of delivered elements, uncertainties regarding customer acceptance are resolved, and the fair value for all undelivered elements is known. For revenue arrangements with multiple elements outside the scope of SOP 97-2, the Company accounts for the arrangements in accordance with Emerging Issues Task Force (“EITF”) Issue 00-21, Revenue Arrangements with Multiple Elements, and allocates the arrangement’s fees into separate units of accounting based on fair value. The Company supports fair value of the elements based upon the prices the Company charges when it sells similar elements separately. Reserves We record reserves for stock rotations, price adjustments, rebates, and sales incentives to reduce revenue and accounts receivable for these and other credits we may grant to customers. Such reserves are recorded at the time of sale and are calculated based on historical information (such as rates of product stock rotations) and the specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, additional reserves may be required. Also, if we determine that we can no longer accurately estimate amounts for stock rotations and sales incentives, we would not be able to recognize revenue until the customers exercise their rights, or such rights lapse, whichever is later. 32 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Shipping and Handling The Company’s shipping and handling costs billed to customers are included in other revenue. Costs related to shipping and handling are included in cost of revenue and are recorded at the time of shipment to the customer. Credit Evaluation and allowance for doubtful accounts We perform ongoing credit evaluations of our customers’ financial condition and generally do not require collateral. We maintain allowances for potential credit losses and such losses have been within our expectations. Impairment of long-lived assets We assess the impairment of goodwill and capitalized software development costs on an annual basis or whenever events or changes in circumstances indicate that the fair value of these assets is less than the carrying value. If we determine that the fair value of goodwill is less than its carrying value, based upon the annual test or the existence of one or more indicators of impairment, we would then measure impairment based on a comparison of the implied fair value of goodwill with the carrying amount of goodwill. To the extent the carrying amount of goodwill is greater than the implied fair value of goodwill, we would record an impairment charge for the difference. We evaluate all of our long-lived assets, including intangible assets other than goodwill, for impairment in accordance with the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". We evaluate all of our long-lived assets and intangible assets, including intangible assets other than goodwill, for impairment. Long- lived assets and intangible assets other than goodwill are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. Should events indicate that any of our long-lived assets are impaired; the amount of such impairment will be measured as the difference between the carrying value and the fair value of the impaired asset and recorded in earnings during the period of such impairment. Valuation allowance for net deferred tax assets Deferred income taxes are provided for temporary differences between financial reporting and income tax basis of assets and liabilities, and are measured using currently enacted tax rates and laws. Deferred income taxes also arise from the future benefits of net operating loss carryforwards. A valuation allowance equal to 100% of the net deferred tax assets has been recognized due to uncertainty regarding future realization. Accounting for stock-based compensation The Company adopted SFAS 123R using the modified prospective method. Under this transition method, compensation cost recognized in the years ended September 30, 2008, 2007 and 2006 include the cost for all stock options granted prior to, but not yet vested as of October 1, 2005. This cost was based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123. The cost for all share-based awards granted subsequent to September 30, 2005, represent the grant-date fair value that was estimated in accordance with the provisions of SFAS 123R. Results for prior periods have not been restated. Compensation cost for options will be recognized in earnings, net of estimated forfeitures, on a straight-line basis over the requisite service period. Upon the adoption of SFAS 123R, the Company changed its option valuation model from the Black-Scholes model to a lattice valuation model for all stock options granted subsequent to September 30, 2005. The lattice valuation model is a more flexible analysis to value employee options because of its ability to incorporate inputs that change over time, such as actual exercise behavior of option holders. The Company used historical data to estimate the option exercise and employee departure behavior used in the lattice valuation model. Expected volatility is based on historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogenous groups for valuation. The expected term of options granted is derived from the output of the option pricing model and represents the period of time that options granted 33 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 are expected to be outstanding. The risk-free rate for periods within the contractual term of the options is based on the U.S. Treasury yields in effect at the time of grant. Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The Standard does not expand the use of fair value in any new circumstances. In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which defers the effective date for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually), to fiscal years beginning after November 15, 2008. Early adoption is permitted. The adoption of this standard is not expected to have a material effect on the Company's results of operations or financial position. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”) including an Amendment of SFAS 115, which permits but does not require the Company to measure financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position. In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations ("SFAS 141(R)"), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard is not expected to have a material effect on the Company's results of operations or financial position. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”) -- an amendment of ARB No. 51. SFAS 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Among other requirements, this statement requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard is not expected to have a material effect on the Company's results of operations or financial position. In April 2008, the FASB issued FASB Staff Position 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”), which amends the list of factors an entity should consider in developing renewal or extension assumptions in determining the useful life of recognized intangible assets under FAS No. 142, Goodwill and Other Intangible Assets. The new guidance applies to (1) intangible assets that are acquired individually or with a group of other assets and (2) intangible assets acquired in both business combinations and asset acquisitions. Under FSP FAS 142-3, entities estimating the useful life of a recognized intangible asset must consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension. FSP FAS 142-3 will require certain additional disclosures beginning October 1, 2009 and prospective application to useful life estimates prospectively for intangible assets acquired after September 20, 2009. The Company is in the process of evaluating the impact that the adoption of FSP FAS 142-3 may have on its financial statements and related disclosures. In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the 34 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with GAAP. SFAS 162 directs the GAAP hierarchy to the entity, not the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to remove the GAAP hierarchy from the auditing standards. SFAS 162 is not expected to have a material impact on our financial statements. RESULTS OF OPERATIONS You should read the following discussion of our results of operations and financial condition in conjunction with our consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. Revenue Revenue from our business include the sales of Mediasite recorders and server software products and related services contracts, such as customer support, installation, training, content hosting and event services sold separately. We market our products to educational institutions, corporations and government agencies that need to deploy, manage, index and distribute video content on Internet-based networks. We reach both our domestic and international markets through reseller networks, a direct sales effort and partnerships with system integrators. Revenue in 2008 totaled $15.6 million, compared to $16.7 million in 2007. Revenue consisted of the following: 2008 compared to 2007 (cid:131) (cid:131) Product revenue from the sale of Mediasite recorders units and server software decreased from $12.4 million in 2007 to $8.4 million in 2008. The decrease is primarily due to a reduction in the average sales price per unit and an increase in the percentage of revenue from higher margin and largely recurring service offerings. Additionally, $498 thousand of revenue for product not installed was deferred at September 30, 2008. There was no such deferral at September 30, 2007. Units sold Mobile to rack ratio Average sales price, excluding support (000’s) 2008 776 0.8 to 1 $11.3 2007 720 1.0 to 1 $13.7 Services revenue represent the portion of fees charged for Mediasite customer assurance service contracts amortized over the length of the contract, typically 12 months, as well as training, installation, event and content hosting services. Services revenue increased from $4.3 million in 2007 to $7.0 million in 2008 due primarily to an increase in event and content hosting services as well as support contracts on new Mediasite recorder units and renewals of support contracts entered into in prior years. At September 30, 2008 $4.7 million of deferred revenue remained in unearned revenue, of which we expect to recognize approximately $2.2 million in the quarter ending December 31, 2008. (cid:131) Other revenue relates to freight charges billed separately to our customers. 35 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 2007 compared to 2006 Revenue in 2007 totaled $16.7 million, compared to $12.6 million in 2006. Revenue consisted of the following: (cid:131) (cid:131) Product sales of Mediasite recorders increased from $9.9 million in 2006 to $12.4 million in 2007. Units sold Mobile to rack ratio Average sales price, excluding support (000’s) 2007 720 1.0 to 1 $13.7 2006 553 1.0 to 1 $14.1 Services revenue represent the portion of fees charged for Mediasite customer assurance service contracts amortized over the length of the contract, typically 12 months, as well as training, installation, event and content hosting services. Services revenue increased from $2.5 million in 2006 to $4.3 million in 2007 due primarily to support contracts on new Mediasite recorder units as well as renewals of support contracts entered into in prior years. At September 30, 2007 $3.3 million of unrecognized support revenue remained in unearned revenue. (cid:131) Other revenue relates to freight charges billed separately to our customers. Gross Margin 2008 compared to 2007 Total gross margin for 2008 was $11.4 million or 73% compared to $12.6 million or 75% in 2007. Gross margin decreased due to discount pricing related to an increase in higher volume transactions and end of life hardware upgrades. Gross margin was also negatively impacted by a decrease in the mix of server software licensing and an increase in the mix of billings from service contracts, which will be recognized over the life of the contract. Our service operations generally result in higher gross margin when they are ultimately recognized. The significant components of cost of revenue include: (cid:131) Material and freight costs for the Mediasite recorders. Costs for 2008 Mediasite recorder hardware and other costs totaled $3.4 million, along with $148 thousand of freight costs, and $357 thousand of labor and allocated costs compared to fiscal 2007 Mediasite recorder costs of $3.5 million for hardware, $94 thousand freight and $207 thousand labor and allocated costs. Services costs. Staff wages and other costs allocated to cost of service revenues were $319 thousand in fiscal 2008 and $308 thousand in fiscal 2007, resulting in gross margin on services of 95% in fiscal 2008 and 93% in fiscal 2007. (cid:131) Gross margin is expected to increase in fiscal 2009 as total revenue increases and as the mix of revenue continues to reflect a significant percentage of higher margin services revenue. 2007 compared to 2006 Total gross margin for 2007 was $12.6 million or 75% compared to $9.3 million or 74% in 2006. Increasing customer support revenue and licensing of server software applications accounted for the majority of the increase in gross margin dollars over 2006 levels. The significant components of cost of revenue include: (cid:131) Material and freight costs for the Mediasite recorder units. Costs for 2007 Mediasite recorder hardware and other costs amounted to $3.5 million, along with $94 thousand of freight costs, and $207 thousand of labor and allocated costs. This resulted in Mediasite gross margins – including support revenue – of 75%. The gross margin on Mediasite recorder sales varies with product mix (cid:131) Due to the increasing significance of our services, the time devoted by internal staff to customer services has increased and we therefore began allocating a percentage of staff salaries and wages to cost of revenue in fiscal 2007. Such costs were $308 thousand in fiscal 2007. The cost of revenue for services in 2006 is immaterial and is included in selling and marketing expense. 36 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 (cid:131) Costs associated with the acquisition of Mediasite in 2001 assigned to purchased technology and other identified intangibles were fully amortized as of December 31, 2006. Amortization expense was approximately $53 thousand in fiscal 2007 and $368 thousand in fiscal 2006. Operating Expenses Selling and Marketing Expenses Selling and marketing expenses include wages and commissions for sales, marketing, business development and technical support personnel, print advertising and various promotional expenses for our products. Timing of these costs may vary greatly depending on introduction of new products and services, entrance into new markets or participation in major tradeshows. 2008 compared to 2007 Selling and marketing expense increased $669 thousand, or 5% from $12.2 million in 2007 to $12.9 million in 2008. Significant differences include: (cid:131) (cid:131) (cid:131) Salaries, incentive compensation, and benefits increased $1.4 million over prior year due to higher staff levels through Q2 2008. The average staff size within selling and marketing was 55 during fiscal 2007 compared to 64 in fiscal 2008. Severance payouts also contributed to the increase in salaries during 2008. These increases were partially offset by a reduction in travel expenses of $301 thousand, recruiting costs of $135 thousand, and advertising and tradeshows of $169 thousand compared to prior year. The Company initiated a plan in January 2008 to focus its selling and marketing efforts on the higher education market resulting in reductions, beginning in Q2-2008, to tradeshow and other marketing efforts focused on the corporate markets as well as a reduction in selling and marketing staff. As of September 30, 2008 we had 59 employees in Selling and Marketing, a decrease of 9 employees or 13% from 68 employees at September 30, 2007. We reduced our headcount in Selling and Marketing in January 2008 from 73 and expect our headcount to remain at or near current levels in fiscal 2009. 2007 compared to 2006 Selling and marketing expense increased $4.6 million, or 60% from $7.6 million in 2006 to $12.2 million in 2007. Significant differences include: (cid:131) Growth in revenue and sales staff led to an increase of $3.9 million in wages, commissions, benefits, recruiting, travel and related administrative costs. Our sales staff increased from 42 at September 30, 2006 to 68 at September 30, 2007. (cid:131) Advertising and tradeshow expenses increased $354 thousand over the prior year due to increased presence at tradeshows and additional conference sponsorships. (cid:131) Non-cash stock compensation of $504 thousand compared to $296 thousand in the prior year. (cid:131) These increases were partially offset by a $308 thousand allocation of customer service expenses to cost of sales. General and Administrative Expenses General and administrative (“G&A”) expenses consist of personnel and related costs associated with the facilities, finance, legal, human resource and information technology departments, as well as other expenses not fully allocated to functional areas. G&A expenses decreased $1.1 million, or 27%, from $3.9 million in 2007 to $2.8 million in 2008. Major components of the change include: 2008 compared to 2007 37 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 (cid:131) (cid:131) Salaries, incentive compensation, and benefits decreased by $636 thousand over the prior year due to a reduction in headcount, lower bonus payments, and voluntary reductions in executive compensation. Professional services decreased $157 thousand due in part to a reduction in accounting, consulting and legal costs associated with Sarbanes-Oxley section 404 compliance. (cid:131) During 2008 we recorded a benefit of $200 thousand due to the reversal of certain accruals in which (cid:131) payment is now deemed remote. In response to more timely collections, the Company decreased the reserve for uncollectible accounts receivable and recorded a benefit of $120 thousand in fiscal 2008. As of September 30, 2008 we had 7 full-time employees in G&A. We do not anticipate significant growth in G&A headcount in fiscal 2008. 2007 compared to 2006 G&A expenses increased $845 thousand, or 28%, from $3.0 million in 2006 to $3.9 million in 2007. Major components of the change include: (cid:131) Incentive compensation increased $559 thousand due primarily to no accrual of certain bonuses at September 30, 2006. (cid:131) (cid:131) Non-cash stock compensation associated with SFAS 123R of $107 thousand contributed to the increase in salary and wage expense. Non-cash stock compensation expense was $70 thousand in the prior year. Professional services increased $312 thousand due to increased accounting and legal costs, including costs associated with initial Sarbanes-Oxley section 404 compliance. In response to growing revenue and customer accounts receivable, the Company increased the reserve for uncollectible accounts receivable and recorded a charge of $110 thousand in fiscal 2007. Facilities and depreciation expense increased $585 thousand due in part to the expansion of office space completed early in fiscal 2007. These increases were partially offset by increased allocation to other functional areas. (cid:131) (cid:131) As of September 30, 2007 we had 14 full-time employees in G&A. Product Development Expenses Product development (R&D) expenses include salaries and wages of the software research and development staff and an allocation of benefits, facility and administrative expenses. Fluctuations in product development expenses correlate directly to changes in headcount. 2008 compared to 2007 R&D expenses increased $431 thousand, or 14%, from $3.1 million in 2007 to $3.5 million in 2008. Salaries, incentive compensation, and benefits were the primary reason for the increase, accounting for $274 thousand of the increase over the prior year. Included in this increase were severance costs related to the cost reduction plan initiated in January 2008. Professional services and facilities expense accounted for $136 thousand of the increase over the prior year primarily related to one time costs of the cost reduction plan including a charge for an early lease termination. As of September 30, 2008 we had 25 employees, excluding interns, in Research and Development compared to 26 as of September 30, 2007. We do not anticipate significant growth in R&D headcount in fiscal 2009. No fiscal 2008 software development efforts qualify for capitalization under SFAS No. 86 “Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed.” R&D expenses increased $862 thousand, or 39%, from $2.2 million in 2006 to $3.1 million in 2007. Salaries, incentive compensation and benefits were the primary reason for the increase, accounting for $625 thousand of the 2007 compared to 2006 38 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 increase over the prior year. Non-cash stock compensation of $173 thousand associated with SFAS 123R, compared to $119 thousand in the prior year, also contributed to the increase. In 2007, 76% of R&D expenses related to salaries and benefits. As of September 30, 2007 we had 26 employees, excluding interns, in Research and Development compared to 21 as of September 30, 2006. No fiscal 2007 software development efforts qualified for capitalization under SFAS No. 86 “Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed.” Other Income Other income included primarily interest income from investments in certificates of deposit and overnight investment vehicles. LIQUIDITY AND CAPITAL RESOURCES We have funded our operations to date primarily from public and private placement offerings of equity securities and debt. On September 30, 2008, 2007 and 2006, we had cash and cash equivalents of $3.6, $8.0 and $2.8 million, respectively. 2008 compared to 2007 Cash used in operating activities totaled $3.9 million in 2008 compared to $5.9 million in 2007, an improvement of $2.0 million or 34%. Cash used in 2008 was impacted by an increase in the net loss of $1.5 million from $6.4 million to $7.9 million and offset by changes in non-cash charges and working capital. Working capital changes included the positive effects of an increase in unearned revenue, reductions in accounts receivable, and reductions in prepaid expenses of $1.5 million, $1.3 million, and $306 thousand, respectively. During 2007, working capital adjustments included the negative effects of $1.7 million, $381 thousand, and $289 thousand, respectively, due to an increase in accounts receivable, an increase in prepaid expenses, and a decrease in accounts payable, accrued liabilities and other liabilities. Cash used in investing activities totaled $218 thousand in 2008 compared to cash used in investing activities of $394 thousand in 2007. Investing activities for each of these two years were due to the purchases of property and equipment. The Company has historically financed its operations primarily through cash from sales of equity securities, cash from operations, and to a limited extent, through bank credit facilities. Cash used in financing activities in 2008 totaled $361 thousand compared to cash provided of $11.5 million in 2007. During 2007, financing activities included $10.7 million from the issuance of common stock and from exercise of common stock purchase options and warrants, partially offset by notes payable and capital lease payments. The Company has incurred losses from operations in each of the last three fiscal years. In response to the recurring operating losses, the Company initiated cost reduction efforts in January 2008. These efforts achieved a 24% reduction in quarterly operating expenses. The Company anticipates operating expenses to remain at or near these reduced levels in fiscal 2009. Although the Company anticipates growth in billings in fiscal 2009, it believes its cash position is adequate to accomplish its business plan through at least the next twelve months even if billings remain unchanged and therefore has no plans to seek additional debt or equity financing or to issue additional shares previously registered in its available shelf registration. On May 2, 2007, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank providing for a credit facility in the form of a $3,000,000 secured revolving line of credit and a $1,000,000 term loan. The Loan Agreement was modified on December 17, 2007 and March 31, 2008 and was amended and restated on June 16, 2008. We may evaluate further operating or capital lease opportunities to finance equipment purchases in the future and may utilize the Company’s revolving line of credit to support working capital needs, if the Company deems it advisable to do so. While the Company anticipates limited use of the line of credit and that it will be in compliance with all provisions of the agreement, there can be no assurance that the existing 39 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Loan Agreement will remain available to the Company nor that additional financing will be available or on terms acceptable to the Company. 2007 compared to 2006 Cash used in operating activities totaled $5.9 million in 2007 compared to $2.4 million in 2006. Cash used in 2007 included a $1.7 million increase in accounts receivable due to increased revenue and a $381 thousand increase in prepaid expenses and other current assets associated with expanded marketing programs allocated to future periods. Changes in working capital components in 2006 included a $1.3 million increase in receivables and an $86 thousand increase in prepaid expenses and other current assets. In 2007 the increased cash use was partially offset by a $1.2 million increase in unearned revenue and $176 thousand in reduced cash requirements in inventories. In 2006, unearned revenue increased $1.0 million. Cash used in investing activities totaled $394 thousand in 2007 compared to cash used in investing activities of $582 thousand in 2006. Investing activities for each of these two years were due to the purchases of property and equipment. Cash provided by financing activities in 2007 totaled $11.5 million compared to $1.5 million in 2006. Financing activities included $10.7 million from the issuance of common stock and from exercise of common stock purchase options and warrants, partially offset by notes payable and capital lease payments. In December 2006, we issued 3 million shares of common stock in a public offering, and received net proceeds of $10.4 million for support of continuing research and development efforts and capital expenditures, intellectual property protection, as well as other business development activities, working capital needs, and general corporate purposes. In November 2005, we issued 747 thousand shares of common stock and 149 thousand common stock purchase warrants to certain individual investors in a private placement, and received net proceeds of $731 thousand. Contractual Obligations The following summarizes our contractual obligations at September 30, 2008 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in thousands): Contractual Obligations: Purchase commitments Operating lease obligations Capital lease obligations (a) Notes payable (a) Total $ 284 1,470 77 598 Less than 1 Year $ 284 479 51 368 Years 2-3 $ (cid:326) 991 26 230 Years 4-5 $ (cid:326) (cid:326) (cid:326) (cid:326) Over 5 years $ (cid:326) (cid:326) (cid:326) (cid:326) (a) Includes fixed and determinable interest payments 40 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Derivative Financial Instruments We are not party to any derivative financial instruments or other financial instruments for which the fair value disclosure would be required under SFAS No. 133, "Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments." Our cash equivalents consist of overnight investments in money market funds that are carried at fair value. Accordingly, we believe that the market risk of such investments is minimal. Interest Rate Risk Our cash equivalents are subject to interest rate fluctuations, however, we believe this risk is immaterial due to the short-term nature of these investments. Foreign Currency Exchange Rate Risk All international sales of our products are denominated in US dollars. 41 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Sonic Foundry, Inc. We have audited the accompanying consolidated balance sheets of Sonic Foundry, Inc. and subsidiary (a Maryland Corporation) (the Company) as of September 30, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2008. Our audits of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Sonic Foundry, Inc. as of September 30, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therin. /s/ GRANT THORNTON LLP Madison, Wisconsin December 5, 2008 42 Sonic Foundry, Inc. Consolidated Balance Sheets (in thousands except for share and per share data) Assets Current assets: Cash and cash equivalents Accounts receivable, net of allowances of $150 and $270 Inventories Prepaid expenses and other current assets Total current assets Property and equipment: Leasehold improvements Computer equipment Furniture and fixtures Total property and equipment Less accumulated depreciation and amortization Net property and equipment Other assets: September 30, 2008 2007 $ 3,560 3,864 330 429 8,183 $ 8,008 5,001 204 975 14,188 980 2,476 461 3,917 2,223 1,694 975 2,267 461 3,703 1,520 2,183 Goodwill and other intangible assets, net of amortization of $19 and $6 Total assets 7,597 $ 17,474 7,610 $ 23,981 Liabilities and stockholders' equity Current liabilities: Accounts payable Accrued liabilities Unearned revenue Current portion of capital lease obligations Current portion of notes payable Total current liabilities Long-term portion of capital lease obligations Long-term portion of notes payable Other liabilities Total liabilities Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value, authorized 5,000,000 shares; none issued 5% preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 10,000,000 shares, none issued Common stock, $.01 par value, authorized 100,000,000 shares; 35,728,837 and 35,684,503 shares issued and 35,601,670 and 35,557,336 shares outstanding Additional paid-in capital Accumulated deficit Receivable for common stock issued Treasury stock, at cost, 127,167 shares Total stockholders' equity Total liabilities and stockholders' equity See accompanying notes 43 $ 1,256 1,113 4,661 46 333 7,409 24 223 255 7,911 $ 1,512 1,023 3,314 66 333 6,248 69 556 348 7,221 (cid:326) (cid:326) (cid:326) (cid:326) 357 184,204 (174,803) (26) (169) 9,563 $ 17,474 357 183,528 (166,930) (26) (169) 16,760 $ 23,981 Sonic Foundry, Inc. Consolidated Statements of Operations (in thousands except for share and per share data) Revenue: Product Services Other Total revenue Cost of revenue: Product Services Total cost of revenue Gross margin Operating expenses: Selling and marketing General and administrative Product development Total operating expenses Loss from operations Interest expense Other income, net Total other income Net loss Loss per common share: Basic net loss per common share Diluted net loss per common share Weighted average common shares – Basic – Diluted See accompanying notes Years Ended September 30, 2007 2008 2006 $ 8,439 7,037 125 15,601 $ 12,445 4,254 38 16,737 $ 9,902 2,506 156 12,564 3,886 319 4,205 11,396 12,905 2,843 3,531 19,279 (7,883) (89) 99 10 3,825 308 4,133 12,604 12,236 3,886 3,100 19,222 (6,618) (37) 285 248 3,215 (cid:326) 3,215 9,349 7,630 3,041 2,238 12,909 (3,560) (6) 83 77 $ (7,873) $ (6,370) $ (3,483) $ (0.22) $ (0.22) 35,579,665 35,579,665 $ (0.18) $ (0.18) $ (0.11) $ (0.11) 34,688,039 34,688,039 32,015,310 32,015,310 44 Sonic Foundry, Inc. Consolidated Statements of Stockholders' Equity For the Years Ended September 30, 2008, 2007 and 2006 (in thousands) Common stock Additional paid-in capital Accumulated Deficit Receivable for common stock issued Treasury stock Total $ 309 $ 170,083 $ (157,077) $ (26) $ (168) $ 13,121 (cid:326) 7 (cid:326) 6 (cid:326) 485 668 245 552 (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (3,483) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) 485 675 245 558 (3,483) 322 172,033 (160,560) (26) (168) 11,601 (cid:326) 30 (cid:326) 5 (cid:326) 784 10,362 18 331 (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (6,370) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (1) (cid:326) 784 10,392 18 335 (6,370) 357 183,528 (166,930) (26) (169) 16,760 (cid:326) (cid:326) (cid:326) (cid:326) 639 7 30 (cid:326) (cid:326) (cid:326) (cid:326) (7,873) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) (cid:326) 639 7 30 (7,873) $ 357 $ 184,204 $ (174,803) $ (26) $ (169) $ 9,563 Balance, September 30, 2005 Stock compensation Issuance of common stock Issuance of common stock warrants and options Exercise of common stock warrants and options Net loss Balance, September 30, 2006 Stock compensation Issuance of common stock Issuance of common stock warrants and options Exercise of common stock warrants and options Net loss Balance, September 30, 2007 Stock compensation Issuance of common stock warrants and options Exercise of common stock warrants and options Net loss Balance, September 30, 2008 See accompanying notes 45 Sonic Foundry, Inc. Consolidated Statements of Cash Flows (in thousands) Operating activities Net loss Adjustments to reconcile net loss to net cash used in operating activities: Amortization of other intangibles Depreciation and amortization of property and equipment Loss on sale of fixed assets Provision for doubtful accounts Share-based compensation expense related to stock warrants and options Other non-cash items Changes in operating assets and liabilities: Accounts receivable Inventories Prepaid expenses and other assets Accounts payable, accrued liabilities and other long-term liabilities Unearned revenue Net cash used in operating activities Investing activities Purchases of property and equipment Net cash used in investing activities Financing activities Proceeds from issuance of common stock, net of issuance costs Proceeds from issuance of common stock warrants and options Proceeds from exercise of common stock warrants and options Proceeds from notes payable Payments of capitalized loan fees Payments on notes payable Payments on capital leases Net cash (used in) provided by financing activities Years Ended September 30, 2007 2008 2006 $ (7,873) $ (6,370) $ (3,483) 13 702 5 (120) 639 98 1,257 (126) 306 (259) 1,489 (3,869) (218) (218) — 7 30 — — (333) (65) (361) 58 649 1 110 784 (32) (1,669) 176 (381) (382) 1,164 (5,892) (394) (394) 10,392 18 335 1,000 (40) (111) (51) 11,543 330 364 — — 485 45 (1,255) 16 (86) 94 1,048 (2,442) (582) (582) 731 245 552 — — — (24) 1,504 Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period (4,448) 8,008 $ 3,560 5,257 2,751 $ 8,008 (1,520) 4,271 $ 2,751 Supplemental cash flow information: Interest paid Non-cash transactions: Capital lease acquisitions Property and equipment financed by accounts payable or other accrued liabilities 89 — — 37 67 78 6 101 968 46 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 1. Basis of Presentation and Significant Accounting Policies Business Sonic Foundry, Inc. (the Company) is in the business of providing enterprise solutions and services for the web communications market. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its subsidiary. All significant intercompany transactions and balances have been eliminated. In 2008, 2007 and 2006, net loss equaled comprehensive loss as there were no items of comprehensive income. Use of Estimates In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the period. Actual results could differ from those estimates. Revenue Recognition General Revenue is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price is fixed or determinable and collectibility is reasonably assured. Revenue is deferred when undelivered products or services are essential to the functionality of delivered products, customer acceptance is uncertain, significant obligations remain, or the fair value of undelivered elements is unknown. The Company does not offer customers the right to return product, other than for exchange or repair pursuant to a warranty or stock rotation. The Company’s policy is to reduce revenue if it incurs an obligation for price rebates or other such programs during the period the obligation is reasonably estimated to occur. The following policies apply to the Company’s major categories of revenue transactions. Products Products are considered delivered, and revenue is recognized, when title and risk of loss have been transferred to the customer. Under the terms and conditions of the sale, this occurs at the time of shipment to the customer. Product revenue currently represents sales of our Mediasite recorder and Mediasite related products such as server software revenue. Services We sell support contracts to our customers, typically one year in length and record the related revenue ratably over the contractual period. Our support contracts cover phone and electronic technical support availability over and above the level provided by our distributors, software upgrades on a when and if available basis, advance hardware replacement and an extension of the standard hardware warranty from 90 days to one year. The manufacturer we contract with to build the units performs hardware warranty service. We also sell installation, training, event webcasting, and customer content hosting services. Revenue for those services is recognized when performed in the case of installation, training and event webcasting services and is recognized ratably over the contract period for content hosting services. Service amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met. 47 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Revenue Arrangements that Include Multiple Elements Revenue for transactions that include multiple elements such as hardware, software, installation, training, and post customer support is allocated to each element based on vendor-specific objective evidence of the fair value (“VSOE”) in accordance with Statement of Position (“SOP”) 97-2, Software Revenue Recognition, and SOP 98-9, Modification of SOP 97-2. Revenue is recognized for each element when the revenue recognition criteria have been met for that element. VSOE is based on the price charged when the element is sold separately. If VSOE of fair value does not exist for all elements in a multiple element arrangement, revenue is allocated first to the fair value of the undelivered elements and the residual revenue to the delivered elements. The Company recognizes revenue for delivered elements only when all of the following criteria are satisfied: undelivered elements are not essential to the functionality of delivered elements, uncertainties regarding customer acceptance are resolved, and the fair value for all undelivered elements is known. For revenue arrangements with multiple elements outside the scope of SOP 97-2, the Company accounts for the arrangements in accordance with Emerging Issues Task Force (“EITF”) Issue 00-21, Revenue Arrangements with Multiple Elements, and allocates the arrangement’s fees into separate units of accounting based on fair value. The Company supports fair value of the elements based upon the prices the Company charges when it sells similar elements separately. Reserves We record reserves for stock rotations, price adjustments, rebates, and sales incentives to reduce revenue and accounts receivable for these and other credits we may grant to customers. Such reserves are recorded at the time of sale and are calculated based on historical information (such as rates of product stock rotations) and the specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, additional reserves may be required. Also, if we determine that we can no longer accurately estimate amounts for stock rotations and sales incentives, we would not be able to recognize revenue until resellers sell the inventory to the final end user. Shipping and Handling The Company’s shipping and handling costs billed to customers are included in other revenue. Costs related to shipping and handling are included in cost of revenue and are recorded at the time of shipment to the customer. Concentration of Credit Risk and Other Risks and Uncertainties The Company’s cash and cash equivalents are deposited with two major financial institutions. At times, deposits in these institutions exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on such amounts and believes that it is not exposed to any significant credit risk on these balances. We perform ongoing credit evaluations of our customers’ financial condition and generally do not require collateral. We maintain allowances for potential credit losses and such losses have been within our expectations. We had billings for Mediasite product and support services as a percentage of total billings to one distributor of approximately 44% in 2008 and 46% in 2007. There were no customers with billings over 10% in 2006. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents include amounts invested in certificates of deposit of $6.5 and $1.0 million at September 30, 2007 and 2006. There were no amounts invested in certificates of deposit at September 30, 2008. 48 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Trade Accounts Receivable The majority of the Company’s accounts receivable are due from entities in, or distributors or value added resellers to, the education, corporate and government sectors. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered to be past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Interest is not accrued on past due receivables. Inventory Valuation Inventory consists of raw materials and supplies used in the assembly of Mediasite recorders and finished units. Inventory of completed units and spare parts are carried at the lower of cost or market, with cost determined on a first-in, first-out basis. Inventory consists of the following (in thousands): Raw materials and supplies Finished goods Software Development Costs September 30, 2008 2007 $ 10 320 $ 330 $ 10 194 $ 204 Internal software development costs are capitalized after technological feasibility is established. The capitalized cost is then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenue to total projected product revenue, whichever is greater. To date, the period between achieving technological feasibility, which the Company has defined as the establishment of a working model which typically occurs when the beta testing commences, and the general availability of such software has been short and software development costs qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any internal software development costs. 49 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Property and Equipment Property and equipment are recorded at cost and are depreciated using the straight-line method for financial reporting purposes. The estimated useful lives used to calculate depreciation are as follows: Leasehold improvements Computer equipment Furniture and fixtures Impairment of Long-Lived Assets Years 5 to 10 years 3 to 5 years 7 years In accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment of Long-lived Assets, the Company reviews long-lived assets, including property and equipment, capitalized software development costs and other intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Goodwill is reviewed for impairment annually. Recoverability of an asset is measured by comparing its carrying value to the expected undiscounted cash flows. An impairment is measured by the amount by which the carrying value of the related asset or group of assets exceeds the expected undiscounted cash flows. As of September 30, 2008 the Company has recognized no such losses. Advertising Expense Advertising costs included in selling and marketing, are expensed when the advertising first takes place. Advertising expense was $306, $246 and $114 thousand for years 2008, 2007, and 2006, respectively. Research and Development Costs Research and development costs are expensed in the period incurred. Income Taxes Deferred income taxes are provided for temporary differences between financial reporting and income tax basis of assets and liabilities, and are measured using currently enacted tax rates and laws. Deferred income taxes also arise from the future benefits of net operating loss carryforwards. A valuation allowance equal to 100% of the net deferred tax assets has been recognized due to uncertainty regarding the future realization of these assets. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and debt instruments. The book values of cash and cash equivalents, accounts receivable, debt and accounts payable are considered to be representative of their respective fair values. The carrying value of capital lease obligations, including the current portion, approximates fair market value as the fixed rate approximates the current market rate of interest available to the Company. Stock-Based Compensation Effective October 1, 2005, the Company adopted the provisions of SFAS No. 123R, Share-Based Payment – an Amendment of FASB Statement Nos. 123 and 95 (SFAS 123R) for its stock option plans. The Company previously accounted for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations and disclosure requirements established by SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure. 50 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The Company adopted SFAS 123R using the modified prospective method. Under this transition method, compensation cost recognized for the years ended September 30, 2008, 2007 and 2006 include the cost for all stock options granted prior to, but not yet vested as of October 1, 2005. This cost was based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123. The cost for all share-based awards granted subsequent to September 30, 2005, represents the grant-date fair value that was estimated in accordance with the provisions of SFAS 123R. Results for prior periods have not been restated. Compensation cost for options will be recognized in earnings, net of estimated forfeitures, on a straight-line basis over the requisite service period. Stock- based compensation expense in the table below does not reflect any income tax effect, which is consistent with the Company’s treatment of net deferred tax assets and offsetting valuation allowance. Upon the adoption of SFAS 123R, the Company changed its option valuation model from the Black-Scholes model to a lattice valuation model for all stock options granted subsequent to September 30, 2005. The lattice valuation model is a more flexible analysis to value options because of its ability to incorporate inputs that change over time, such as actual exercise behavior of option holders. The Company uses historical data to estimate the option exercise and employee departure behavior in the lattice valuation model. Expected volatility is based on historical volatility of the Company’s stock. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogenous groups for valuation. The expected term of options granted is derived from the output of the option pricing model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods the options are expected to be outstanding is based on the U.S. Treasury yields in effect at the time of grant. The fair value of each option grant is estimated using the assumptions in the following table: Method Expected life (years) Risk-free interest rate Expected volatility Expected dividend yield 2008 Years Ended September 30, 2007 2006 Lattice 5.7 – 6.0 years 2.2% - 3.4% 63.1% - 76.4% 0% Lattice 5.7 - 5.8 years 4.5% - 4.8% 62.5% - 65.4% 0% Lattice 4.9 - 5.5 years 4.5% - 5.0% 69.4% - 71.1% 0% 51 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 Per Share Computation Basic and diluted net loss per share information for all periods is presented under the requirements of SFAS No. 128, Earnings per Share. Basic earnings per share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares that may be repurchased, and excludes any dilutive effects of options and warrants. If the Company had reported net income during the periods presented below, diluted net income per share would have been computed using common equivalent shares related to outstanding options and warrants to purchase common stock. The numerator for the calculation of basic and diluted earnings per share is net income (loss). The following table sets forth the computation of basic and diluted weighted average shares used in the earnings per share calculations: Years ended September 30, 2008 2007 2006 Denominator for basic earnings per share - weighted average common shares 35,579,665 34,688,039 32,015,310 Effect of dilutive options and warrants (treasury method) (cid:326) (cid:326) (cid:326) Denominator for diluted earnings per share - adjusted weighted average common shares 35,579,665 34,688,039 32,015,310 Securities outstanding during each year, but not included in the computation of diluted earnings per share because they are antidilutive: 6,806,885 Options and warrants 5,271,000 5,264,000 Recent Accounting Pronouncements In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”), which provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The Standard does not expand the use of fair value in any new circumstances. In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date of FASB Statement No. 157, which defers the effective date for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (that is, at least annually), to fiscal years beginning after November 15, 2008. Early adoption is permitted. The adoption of this standard is not expected to have a material effect on the Company's results of operations or financial position. In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”) including an Amendment of SFAS 115, which permits but does not require the Company to measure financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position. In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations ("SFAS 141(R)"), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS 141(R) is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard is not expected to have a material effect on the Company's results of operations or financial position. In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements (“SFAS 160”) -- an amendment of ARB No. 51. SFAS 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It 52 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. Among other requirements, this statement requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited. The adoption of this standard is not expected to have a material effect on the Company's results of operations or financial position. In April 2008, the FASB issued FASB Staff Position 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”), which amends the list of factors an entity should consider in developing renewal or extension assumptions in determining the useful life of recognized intangible assets under FAS No. 142, Goodwill and Other Intangible Assets. The new guidance applies to (1) intangible assets that are acquired individually or with a group of other assets and (2) intangible assets acquired in both business combinations and asset acquisitions. Under FSP FAS 142-3, entities estimating the useful life of a recognized intangible asset must consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension. FSP FAS 142-3 will require certain additional disclosures beginning October 1, 2009 and prospective application to useful life estimates prospectively for intangible assets acquired after September 20, 2009. The Company is in the process of evaluating the impact that the adoption of FSP FAS 142-3 may have on its financial statements and related disclosures. In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with GAAP. SFAS 162 directs the GAAP hierarchy to the entity, not the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. SFAS 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to remove the GAAP hierarchy from the auditing standards. SFAS 162 is not expected to have a material impact on our financial statements. Reclassifications Certain reclassifications have been made to the 2007 financial statements to conform to the 2008 presentation. 2. Commitments The Company leases certain equipment under capital lease agreements expiring through April 2010. Such leases are included in fixed assets with a cost of $168 thousand and accumulated depreciation of $101 thousand at September 30, 2008. Minimum lease payments, including principal and interest, are summarized in the table below. Fiscal Year (in thousands) 2009 2010 Total payments Less interest Total Capital $ 51 26 77 (7) $ 70 The Company leases certain facilities and equipment under operating lease agreements expiring at various times through September 30, 2011. Total rent expense related to continuing operations on all operating leases was approximately $622, $509, and $332 thousand for the years ended September 30, 2008, 2007, and 2006, respectively. 53 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The Company enters into unconditional purchase commitments on a regular basis for the supply of Mediasite recorders. The Company has an obligation to purchase a remaining $284 thousand over the next fiscal quarter, which is not recorded on the Company's Balance Sheet. At September 30, 2007, the Company had unconditional purchase commitments of $1.3 million. The Company enters into license agreements that generally provide indemnification against intellectual property claims for its customers as well as indemnification agreements with certain service providers, landlords and other parties in the normal course of business. The Company has not incurred any material costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the consolidated financial statements. The following is a schedule by year of future minimum lease payments under operating leases: Fiscal Year (in thousands) 2009 2010 2011 2012 and thereafter Total 3. Liquidity Operating $ 479 490 501 - $ 1,470 The Company has incurred losses from operations in each of the last three fiscal years. In response to the recurring operation losses, the Company initiated cost reduction efforts in January 2008. These efforts achieved a 24% reduction in quarterly operating expenses. The Company anticipates operating expenses to remain at or near these reduced levels in fiscal 2009. Although the Company anticipates growth in billings in fiscal 2009, it believes its cash position is adequate to accomplish its business plan through at least the next twelve months even if billings remain unchanged and therefore has no plans to seek additional debt or equity financing or to issue additional shares previously registered in its available shelf registration. On May 2, 2007, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank providing for a credit facility in the form of a $3,000,000 secured revolving line of credit and a $1,000,000 term loan. The Loan Agreement was modified on December 17, 2007 and March 31, 2008 and was amended and restated on June 16, 2008. We may evaluate further operating or capital lease opportunities to finance equipment purchases in the future and may utilize the Company’s revolving line of credit to support working capital needs, if the Company deems it advisable to do so. While the Company anticipates limited use of the line of credit and that it will be in compliance with all provisions of the agreement, there can be no assurance that the existing Loan Agreement will remain available to the Company nor that additional financing will be available or on terms acceptable to the Company. 4. Credit Arrangements On May 2, 2007, the Company and its wholly-owned subsidiary, Sonic Foundry Media Systems, Inc. (collectively, the “Companies”) entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank providing for a credit facility in the form of a $3,000,000 secured revolving line of credit and a $1,000,000 term loan. The ability to borrow up to the maximum $3,000,000 amount of the revolving line of credit is determined by applying an applicable percentage to eligible accounts receivable, which, following the Loan Amendment, is reduced by a reserve equal to the balance of the term loan. At September 30, 2008, there was $2.3 million available under this credit facility for advances. Until the recent amendment on June 16, 2008 (“Amended Agreement”), the revolving line of credit was to accrue interest at a per annum rate equal to the greater of (i) one percentage point (1%) above Silicon Valley Bank’s Prime Rate, or (ii) seven percent (7%). The term loan accrues interest at a per annum rate equal to the greater of (i) one percent (1%) above Silicon Valley Bank’s Prime Rate, or (ii) eight and three quarters percent (8.75%). Interest on the revolving line of credit and interest on the term loan is payable 54 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 monthly. Until the Amended Agreement, the revolving line of credit matured in April 2009, at which time all outstanding borrowings and any unpaid interest thereon must be repaid, and all outstanding letters of credit must be cash collateralized. Until the amended agreement, principal on the term loan was to be repaid in thirty-six (36) equal monthly installments, and will be repaid in full on May 1, 2010. At September 30, 2008, a balance of $556 thousand was remaining on the term loan with no outstanding balance on the revolving line of credit. The annual principal payments are as follows: Fiscal Year (in thousands) 2009 2010 Total $ 333 223 $ 556 Until Amended Agreement, the Loan Agreement contained certain financial covenants, including a covenant requiring the Companies to maintain certain of their depository, operating and securities accounts with Silicon Valley Bank, maintain a tangible net worth covenant, and maintain a ratio of quick assets to current liabilities minus deferred revenue. The Loan Agreement also contains certain other restrictive loan covenants, including covenants limiting the Companies’ ability to dispose of assets, make acquisitions, be acquired, incur indebtedness, grant liens, make investments, pay dividends, and repurchase stock. The Loan Agreement contains events of default that include, among others, non-payment of principal or interest, inaccuracy of any representation or warranty, violation of covenants, bankruptcy and insolvency events, material judgments, cross defaults to certain other indebtedness, and material adverse changes. The occurrence of an event of default could result in the acceleration of the Companies’ obligations under the Loan Agreement. Pursuant to the Loan Agreement, the Company and its wholly-owned subsidiary pledged as collateral to the Bank substantially all non-intellectual property business assets, and entered into an Intellectual Property Security Agreement with respect to intellectual property assets. On December 17, 2007, the Companies executed the First Loan Modification Agreement (the “December 2007 Agreement”) with Silicon Valley Bank. The December 2007 Agreement, among other things, a) removed a sub-limit of maximum indebtedness under the revolving line of credit of $1,000,000 prior to completion of a collateral audit; b) modified certain covenants including a reduction of the tangible net worth covenant as of September 30, 2007 from $8,000,000 to $5,500,000; and c) adjusted the definition of Eligible Accounts to, among other things, (i) include certain international accounts up to a maximum of $750,000, (ii) adjust the concentration limit with respect to a certain Account Debtor and (iii) remove the ineligibility of accounts reflected in deferred revenue. On March 31, 2008, the Companies entered into a letter agreement dated March 25, 2008 (the “March 2008 Agreement”) with Silicon Valley Bank. The March 2008 Agreement reduced the tangible net worth covenant as of March 31, 2008 from $5,500,000 to $2,800,000, plus, in each case, fifty percent (50%) of the Company’s net income and new equity or subordinated debt (as defined). On June 16, 2008, the Companies entered into the Amended Agreement with Silicon Valley Bank. Under the Amended Agreement, the revolving line of credit will accrue interest at a per annum rate equal to the following: (i) during such period that Sonic Foundry maintains an Adjusted Quick Ratio (as defined) of greater than 2.00 to 1.00, the greater of one percentage point (1.0%) above Silicon Valley’s prime rate, or seven percent (7.0%); or (ii) during such period that Sonic Foundry maintains an Adjusted Quick Ratio equal to or less than 2.00 to 1.00, the greater of one and one-half percent (1.5%) above Silicon Valley’s prime rate, or seven and one-half percent (7.5%). Under the Amended Agreement, the term loan will continue to accrue interest at a per annum rate equal to the greater of (i) one percentage point (1.0%) above Silicon Valley’s prime rate; or (ii) eight and three quarters percent (8.75%). Further, under the Amended Agreement, (i) the tangible net worth covenant has been removed, (ii) a covenant relating to EBITDA (“EBITDA Covenant”) has been added; however, the EBITDA Covenant will not 55 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 have to be satisfied provided that Sonic Foundry maintains an Adjusted Quick Ratio (as defined) greater than or equal to 1.75 to 1.00; (iii) a reserve equal to the outstanding balance of the term loan will apply against borrowing availability during each (6) six-month period the Company maintains less than $200,000 of EBITDA; and (iv) the maturity of both the term loan and the revolving line of credit was extended to June 1, 2010. At September 30, 2008 the Company was in compliance with all covenants in the Amended Agreement. 5. Common Stock Warrants The Company has issued restricted common stock purchase warrants to various consultants and other third parties. Each warrant represents the right to purchase one share of common stock. All warrants are currently exercisable. The Company granted 7,500 warrants in fiscal 2008 with a weighted average fair value of $2.35. Exercise Prices September 30, 2008 Expiration Date Warrants Outstanding at $ 0.99 to 1.81 2.11 to 3.71 11.23 424,508 133,000 8,900 566,408 2008 to 2011 2009 to 2017 2010 6. Stock Options and Employee Stock Purchase Plan The Company maintains a qualified employee stock option plan under which the Company may grant options to acquire up to 7.0 million shares of common stock. The Company also maintains a non-qualified plan under which 3.8 million shares of common stock can be issued and a non-employee directors' stock option plan under which 500 thousand shares of common stock may be issued to non-employee directors. In addition, the Company has 640 thousand options outstanding pursuant to a previous non-employee directors’ stock option plan. Each non-employee director who is re-elected or who is continuing as a member of the Board of Directors on the annual meeting date and on each subsequent meeting of stockholders is granted options to purchase 20 thousand shares of common stock. Each option entitles the holder to purchase one share of common stock at the specified option price. The exercise price of each option granted under the plans was set at the market price of the Company's common stock at the close of trading on the respective grant date. Options vest at various intervals and expire at the earlier of termination of employment, discontinuance of service on the board of directors, ten years from the grant date or at such times as are set by the Company at the date of grant. 56 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The number of shares available for grant under these plans at September 30 is as follows: Employee Stock Option Plan Non- Qualified Stock Option Plan Director Stock Option Plans Shares available for grant at September 30, 2005 Options granted Options forfeited Shares available for grant at September 30, 2006 Options granted Options forfeited Shares available for grant at September 30, 2007 Shareholder approval of 2008 Director Plan Options granted Options forfeited Options remaining at expiration of plan Shares available for grant at September 30, 2008 2,868,648 (612,000) 260,001 2,516,649 (488,334) 132,001 2,160,316 – (1,870,750) 863,761 – 1,153,327 603,475 (99,000) 255,000 759,475 (35,751) 1,768 725,492 – (705,500) 200,000 – 219,992 300,000 (100,000) – 200,000 (100,000) – 100,000 500,000 (100,000) 40,000 (140,000) 400,000 The following table summarizes information with respect to outstanding stock options. 2008 Weighted Average Exercise Price Options Years Ended September 30, 2007 Weighted Average Exercise Price Options Options 2006 Weighted Average Exercise Price Outstanding at beginning of year Granted Exercised Forfeited Outstanding at end 4,712,322 2,676,250 (44,334) (1,103,761) $ 2.41 1.15 0.69 1.91 4,602,174 624,085 (380,168) (133,769) $ 2.17 3.49 1.37 2.40 4,587,764 811,000 (281,589) (515,001) $ 2.28 1.51 0.99 2.74 of year 6,240,477 $ 2.05 4,712,322 $ 2.41 4,602,174 $ 2.17 Exercisable at end of year 4,268,029 3,639,128 3,477,660 Weighted average fair value of options granted during the year $ 0.55 $ 1.86 $ 0.82 57 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The options outstanding at September 30, 2008 have been segregated into six ranges for additional disclosure as follows: Options Outstanding Options Exercisable Exercise Prices $ 0.42 to $0.99 1.00 to 1.94 2.00 to 2.90 3.00 to 3.95 4.00 to 6.61 15.50 to 59.88 Options Outstanding at September 30, 2008 1,189,250 4,162,369 271,750 354,666 200,942 61,500 6,240,477 Weighted Average Remaining Contractual Life 8.2 5.0 7.1 6.1 2.6 1.5 Weighted Average Exercise Price $ 0.68 1.32 2.28 3.71 4.62 58.80 Options Exercisable at September 30, 2008 302,083 3,318,607 143,578 257,322 184,939 61,500 4,268,029 Weighted Average Exercise Price $ 0.46 1.26 2.22 3.71 4.67 58.80 As of September 30, 2008, there was $645 thousand of total unrecognized compensation cost related to non-vested share-based compensation, net of $265 thousand of estimated forfeitures. The cost is expected to be recognized over a weighted-average life of 1.5 years. A summary of the status of the company’s non-vested shares as of September 30, 2008 and for the year then ended is presented below: Non-vested shares at October 1, 2007 Granted Vested Forfeited Non-vested shares at September 30, 2008 Weighted Average Grant Date Fair Value $ 1.41 0.55 0.70 1.06 $ 0.77 Shares 1,073,194 2,676,250 (1,093,819) (683,177) 1,972,448 Stock-based compensation recorded in the year ended September 30, 2008 of $639 thousand was allocated $352 thousand to selling and marketing expenses, $90 thousand to general and administrative expenses and $197 thousand to product development expenses. Stock-based compensation recorded in the year ended September 30, 2007 of $784 thousand was allocated $504 thousand to selling and marketing expenses, $107 thousand to general and administrative expenses and $173 thousand to product development expenses. Cash received from option exercises under all stock option plans for the years ended September 30, 2008 and 2007 was $30 thousand and $280 thousand, respectively. There were no tax benefits realized for tax deductions from option exercises for the years ended September 30, 2008 and 2007. The Company currently expects to satisfy share-based awards with registered shares available to be issued. 7. Income Taxes Income tax expense (benefit) consists of the following (in thousands): Federal income tax Deferred income tax expense (benefit) Change in valuation allowance Income tax expense (benefit) Years Ended September 30, 2007 2008 2006 $ (cid:326) $ (cid:326) $ (cid:326) (3,079) 3,079 (2,585) 2,585 (1,522) 1,522 $ (cid:326) $ (cid:326) $ (cid:326) 58 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The reconciliation of income tax expense (benefit) computed at the U.S. federal statutory rate to income tax expense (benefit) is as follows (in thousands): Years Ended September 30, 2007 2008 2006 Income tax expense (benefit) at U.S. statutory rate of 34% State income tax expense (benefit) Permanent differences, net Adjustment of temporary differences to income tax returns Change in valuation allowance Income tax benefit $ (2,677) (409) 19 (12) 3,079 $ (cid:326) $ (2,166) (331) (59) (29) 2,585 $ (cid:326) $ (1,184) (174) (70) (94) 1,522 $ (cid:326) The significant components of the deferred tax accounts recognized for financial reporting purposes are as follows (in thousands): Deferred tax assets: Net operating loss and other carryforwards Common stock warrants Allowance for doubtful accounts Other Total deferred tax assets Deferred tax liabilities: Amortization of goodwill and other intangibles Net deferred tax liabilities Valuation allowance Net deferred tax assets September 30, 2008 2007 $ 33,750 1,769 59 67 35,645 $ 30,666 1,520 105 19 32,310 (1,108) (1,108) (34,537) $ (cid:326) (852) (852) (31,458) $ (cid:326) At September 30, 2008, the Company had net operating loss carryforwards of approximately $85 million for both U.S. Federal and state tax purposes, which expire in varying amounts between 2013 and 2028. Utilization of the Company’s net operating loss may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization. In addition, the Company has research and development tax credit carryforwards of approximately $561 thousand, which expire in varying amounts beginning 2011. The Company’s net deferred tax asset has been offset by a valuation allowance of the same amount. The valuation allowance has been recorded due to the uncertainty of realization of the deferred tax asset. In June 2006, the Financial Accounting Standards Board ("FASB") issued Financial Interpretation ("FIN 48") No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with SFAS No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. 59 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The Company adopted the provisions of FIN 48 on October 1, 2007. The total amount of unrecognized tax benefits as of the date of adoption was not significant. As such, there are no unrecognized tax benefits included in the balance sheet that would, if recognized, affect the effective tax rate. The Company's practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accruals for interest and penalties on the Company's Balance Sheets at September 30, 2008 and 2007, and has not recognized any interest or penalties in the Statement of Operations for the years ended September 30, 2008, 2007, or 2006. The Company is subject to taxation in the U.S. and various state jurisdictions. All of the Company's tax years are subject to examination by the U.S. and state tax authorities due to the carryforward of unutilized net operating losses. 8. Savings Plan The Company's defined contribution 401(k) savings plan covers substantially all employees meeting certain minimum eligibility requirements. Participating employees can elect to defer a portion of their compensation and contribute it to the plan on a pretax basis. The Company may also match certain amounts and/or provide additional discretionary contributions, as defined. The Company made discretionary contributions of $293, $260 and $168 thousand during the years ended September 30, 2008, 2007 and 2006, respectively. In March 2008, the Company’s stockholders approved the 2008 Sonic Foundry Employee Stock Purchase Plan (Stock Purchase Plan), which allows for the issuance of 500 thousand shares of common stock. There were no shares issued under the plan for the year ended September 30, 2008. All employees of the Company who have completed ninety days of employment are eligible to participate in the Stock Purchase Plan, provided the employee would not hold 5% or more of the total combined voting power or value of the Company. Shares may be purchased at the end of a specified period at the lower of 85% of the market value at the beginning or the end of the specified period through accumulation of payroll deductions. 9. Related-Party Transactions The Company incurred fees of $249, $241 and $153 thousand during the years ended September 30, 2008, 2007 and 2006, respectively, to a law firm whose partner is a director and stockholder of the Company. The Company had accrued liabilities for unbilled services of $86 thousand at September 30, 2007 to the same law firm. There were no unbilled services at September 30, 2008. The Company recorded Mediasite product and customer support revenue related to $580, $583 and $602 thousand of billings during the years ended September 30, 2008, 2007 and 2006 to Mediasite KK, a Japanese reseller in which the Company has an equity interest. Mediasite KK owed the Company $108 and $132 thousand on such billings at September 30, 2008 and 2007, respectively. During 2007, the Company entered into two transactions with an entity in which a member of the Company’s Board of Directors is a significant shareholder. The transactions included billings of $236 thousand for the Company’s products and services in exchange for advertising services. The Company recognized $137 thousand of revenue during the year ended September 30, 2007 and deferred $99 thousand of revenue at September 30, 2007. The deferral was recognized in full in 2008. No sales were recorded during the years ended September 30, 2008 and 2006. During the years ended September 30, 2008, 2007 and 2006, the Company had a loan outstanding to an executive totaling $26. The loan is collateralized by company stock. 60 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 10. Goodwill and Other Intangible Assets The Company accounts for goodwill and other intangible assets in accordance with SFAS No. 142 Goodwill and Other Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets that have indefinite useful lives not be amortized but, instead, tested at least annually for impairment. We assess the impairment of goodwill and capitalized software development costs on an annual basis or whenever events or changes in circumstances indicate that the fair value of these assets is less than the carrying value. If we determine that the fair value of goodwill is less than its carrying value, based upon the annual test or the existence of impairment, we would then measure impairment based on a comparison of the implied fair value of goodwill with the carrying amount of goodwill. To the extent the carrying amount of goodwill is greater than the implied fair value of goodwill, we would record an impairment charge for the difference. On July 1, 2008, the Company performed its annual goodwill impairment test and tested goodwill recognized in connection with the acquisition of Mediasite and determined it was not impaired. Subsequent impairment charges for Mediasite or other acquisitions, if any, will be reflected as an operating expense in the statement of operations. The following tables present details of the Company’s total intangible assets at September 30, 2008 and 2007: Life (years) Gross Accumulated Amortization at September 30, 2008 Balance at September 30, 2008 (in thousands) Amortizable: Loan origination fees Non-amortizable goodwill Total 7,576 $ 7,616 - $ 19 3 $ 40 40 $ 19 19 $ 21 21 7,576 $ 7,597 Life (years) Gross Accumulated Amortization at September 30, 2007 Balance at September 30, 2007 3 $ 40 40 $ 6 6 $ 34 34 7,576 $ 7,616 - $ 6 7,576 $ 7,610 (in thousands) Amortizable: Loan origination fees Non-amortizable goodwill Total 11. Segment Information The Company has determined that it operates in only one segment in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS 131) as it does not disaggregate profit and loss information on a segment basis for internal management reporting purposes to its chief operating decision maker. The Company’s long-lived assets maintained outside the United States are insignificant. 61 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 The following summarizes revenue by geographic region (in thousands): United States Europe Asia Other Total 12. Customer Concentration Years Ended September 30, 2007 2006 2008 $ 12,599 1,676 626 700 $ 15,601 $ 14,400 1,062 674 601 $ 16,737 $ 10,481 911 640 532 $ 12,564 In the fiscal year ended September 30, 2008 and 2007, one distributor represented 44% and 46% of total billings, with no other customer representing more than 10% in 2008, 2007, or 2006. 13. Quarterly Financial Data (unaudited) The following table sets forth selected quarterly financial information for the years ended September 30, 2008 and 2007. The operating results are not necessarily indicative of results for any future period. (in thousands except per share data) Revenue Gross margin Loss from operations Net loss Basic and diluted net loss per share Quarterly Financial Data Q4-’08 Q3-’08 Q2-’08 Q1-’08 Q4-’07 Q3-’07 Q2-’07 Q1-’07 4,065 2,940 $ 5,087 3,783 $ 3,929 2,775 $ 2,520 1,898 $ 4,741 3,498 $ 4,702 3,476 $ 3,821 2,930 $ 3,473 2,700 (1,218) (1,226) (820) (829) (2,273) (2,278) (3,572) (3,540) (1,479) (1,439) (1,667) (1,590) (2,023) (1,912) (1,449) (1,429) $ (0.03) $ (0.02) $ (0.06) $ (0.10) $ (0.04) $ (0.04) $ (0.05) $ (0.04) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ITEM 9A. CONTROLS AND PROCEDURES Disclosure Controls and Procedures Based on evaluations as of the end of the period covered by this report, our principal executive officer and principal financial officer, with the participation of our management team, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e), and 15d-15(e) under the Securities Exchange Act) were effective. Limitations on the effectiveness of Controls and Permitted Omission from Management’s Assessment Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent 62 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 limitations, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even effective internal controls can only provide reasonable assurance with respect to financial statement preparation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management’s Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management believes that, as of September 30, 2008, our internal control over financial reporting was effective based on those criteria. Changes in Internal Control Over Financial Reporting During the period covered by this report, we have not made any change to our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION None. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE The information required by Item 10 of Form 10-K with respect to directors and executive officers is incorporated herein by reference to the information contained in the section entitled “Proposal One: Election of Directors” and “Executive Officers of Sonic”, respectively, in the Company’s definitive Proxy Statement to be filed with the Securities and Exchange Commission in connection with the solicitation of proxies for the Company’s 2008 Annual Meeting of Stockholders, which will be filed no later than January 28, 2009 (the “Proxy Statement”). Item 405 of Regulation S-K calls for disclosure of any known late filings or failure by an insider to file a report required by Section 16(a) of the Securities Act. This information is contained in the Section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement and is incorporated herein by reference. Item 401 of Regulation S-K calls for disclosure of whether or not the Company has a financial expert serving on the audit committee of its Board of Directors, and if so who that individual is. This information is contained in the Section entitled “Meetings and Committees of Directors” in the Proxy Statement and is incorporated herein by reference. Item 407 of Regulation S-K calls for disclosure of whether or not the Company has an audit committee and a financial expert serving on the audit committee of the Board of Directors, and if so, who that individual is. Item 407 also requires disclosure regarding the Company’s nominating committee and the director nomination process. This 63 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2008 information is contained in the section entitled “Meetings and Committees of Directors” in the Proxy Statement and is incorporated herein by reference. Sonic Foundry has adopted a code of ethics that applies to all officers and employees, including Sonic Foundry’s principal executive officer, its principal financial officer, and persons performing similar functions. This code of ethics is available, without charge, to any investor who requests it. Request should be addressed in writing to Mr. Kenneth A. Minor, Corporate Secretary, 222 West Washington Avenue, Madison, Wisconsin 53703. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 of Form 10-K is incorporated herein by reference to the information contained in the sections entitled “Directors Compensation”, “Executive Compensation and Related Information” and “Compensation Committee Interlocks and Insider Participation” in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by Item 12 of Form 10-K is incorporated herein by reference to the information contained in the sections entitled “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement. Information related to equity compensation plan is set forth in Item 5 herein. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS , AND DIRECTOR INDEPENDENCE The information required by Item 13 of Form 10-K is incorporated herein by reference to the information contained in the section entitled “Certain Transactions” and “Meetings and Committees of Directors” in the Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by Item 14 of Form 10-K is incorporated herein by reference to the information contained in the section entitled “Ratification of Appointment of Independent Auditors – Fiscal 2007 and 2008 Audit Fee Summary” in the Proxy Statement. 64 

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