Sonic Foundry Inc.
Annual Report 2012

Plain-text annual report

©2013 Sonic Foundry, Inc. All rights reserved. Sonic Foundry and the Sonic Foundry logo are registered trademarks of Sonic Foundry, Inc. Mediasite and the Mediasite logo are registered trademarks of Sonic Foundry, Inc. All other trademarks are the property of their respective owners. sonic foundry annual report 2012Dear Fellow Shareholders, As I reflect on fiscal 2012 I see it as a year of recommitment. We recommitted to innovation, shoring up our existing product line and expanding the breadth of our technology. This allowed us to deliver the most robust product offerings to date, and the ability to explore new markets and reach our customers in new ways. We expect to see the benefits of that investment in 2013 and 2014. We recommitted to our customers. They have a choice on where they spend their dollars, and our strong relationships continue to give us a competitive advantage. By democratizing content creation and giving them the tools to work smarter in more dynamic, connected environments, we are deepening those mutually beneficial relationships. I believe the resources spent in these critical areas will ultimately serve to improve the fundamentals of the company. And that is our recommitment to you, our shareholders. Increasing value to you over the long term is the top priority of the management team and board of directors. We laid the groundwork over fiscal 2012 to strengthen revenue and net income growth in the next year. Our three-year objective is to grow revenues to greater than $40 million and achieve a 15% net pre-tax income rate and all signs indicate we are on the path to success. In spite of being on track to show great progress in 2013, last year was not without its challenges. Revenue generation lagged for several reasons including: • Lengthened sales cycles meant the delay of closing several deals from fiscal 2012 to 2013. I’m pleased to tell you that those opportunities have now closed and our results for the first quarter of fiscal 2013 reaffirms that the industry is growing. • While we continue to cultivate several large international deals in the pipeline, none of them closed in fiscal 2012. However all of these opportunities are still active and are likely to begin producing revenue in 2013. • We are selling against the headwinds of an uncertain global economy. • Higher education, in a post-stimulus world, has been challenged to find resources to be able to adopt technology. Throughout 2012 we made great progress on several key initiatives and achieved many successes. • Our investment in innovation increased by 30% over the year prior. We reached our development plan while achieving net income improvements. • With the release of Mediasite 6.1 we have the strongest, broadest, most versatile product offering in our history. • Our Japanese partner, Mediasite KK, continues to show strong revenue growth and profit. • The most highly respected organizations in our key verticals endorse us as the best option for preserving their video content, including EDUCAUSE, InfoComm, UBTech, Professional Convention Management Association (PCMA) and Meeting Planners International (MPI). • Frost&Sullivan named Sonic Foundry the Market Share Leader in Lecture Capture Solutions for the sixth consecutive year. • We sponsored the first comprehensive research on hybrid events with Meeting Professionals International Foundation. The industry of video is poised for change. Video is being created at an astronomical rate and the enterprise is challenged to secure, search and manage those assets. The explosion of mobile devices and changing video standards will require customers to be more flexible when it comes to format, resolution and size when transmitting video over diverse networks. Online education is growing rapidly and traditional brick-and-mortar schools are working to enhance their curriculums to retain students and improve their outcomes. Higher education is adopting new teaching methodologies that fly in the face of what happens in traditional classrooms. The industry is buzzing about Massive Open Online Courses, otherwise known as MOOCS, which allow anyone with an internet connection to attend for free, and flipped classroom instruction, a method of teaching that involves students watching a pre-recorded lecture before class so that class time is dedicated to dynamic discussions. We have emerged as a trusted advisor for our customers looking to find their place in this new landscape. When and if they decide to adopt these trends, Mediasite will be part of that story for them. We’ve advocated and perfected wide-scale capture of the knowledge shared in classrooms and conference rooms for more than a decade. We know what is required for widespread adoption of user-generated content creation, and because of that, we’ve removed most of the barriers that have been keeping online video from reaching its full potential. Which brings me to a final point about recommitment – that of our customers to Mediasite. As we spent the last year preparing for the changing video landscape, we’ve been gratified that our customers have decided to recommit to us. The next step on the journey, upgrading to Mediasite 6, required investment. They had to renew licenses, refresh hardware and increase server power to prepare for the advanced feature set in our product. They stayed with us and doubled down, committing to expand even more in 2013 and beyond. The groundwork has been laid, and the next three years holds enormous promise for Sonic Foundry. There is no question that our industry is at the brink of major growth and change and with our investment in advancing webcasting and video content management we are positioned to deliver. We will see more video transformed into dynamic, interactive, indexed rich media with the use of Mediasite, making video as useful as text. Through our innovative User Generated Content module, we’ll see more flexibility in creation, workflow and management, giving more enterprises than ever the opportunity to purchase and standardize on Mediasite. Our long-term focus on innovation, including the ability to stream and capture multiple video streams and advanced search, will help our customers achieve their goals, drive our success and deliver long-term value to the shareholders. Respectfully, Gary Weis, CEO of Sonic Foundry SONIC FOUNDRY, INC. 222 West Washington Avenue Madison, Wisconsin 53703 NOTICE OF ANNUAL MEETING OF STOCKHOLDERS To Be Held March 7, 2013 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 7, 2013 at 9:00 a.m. local time, for the following purposes: 1. 2. To elect two directors to hold office for a term of five years, and until their successors are duly elected and qualified. To ratify the appointment of Grant Thornton LLP as our independent auditors for the fiscal year ending September 30, 2013. 3. 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 10, 2013 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 25, 2013 Kenneth A. Minor Secretary ───────────────────────────────────── 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. ───────────────────────────────────── (This page intentionally left blank) SONIC FOUNDRY, INC. 222 W. Washington Avenue Madison, Wisconsin 53703 PROXY STATEMENT January 25, 2013 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 Gary R. Weis and Brian T. Wiegand. as Directors for a term expiring in 2017; FOR the ratification of the appointment of Grant Thornton LLP as independent auditors of Sonic for the fiscal year ending September 30, 2013. In the event that the nominees for director become unavailable to serve, which management does not anticipate, the persons named in the proxy reserve full discretion to vote for any other persons 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 January 31, 2013. 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 10, 2013 (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 3,905,514 shares of Common Stock, held by approximately 5,000 stockholders, of which approximately 4,600 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. 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, such shares will also be considered present for purposes of a quorum, provided that the broker exercises discretionary authority on any other matter in the Proxy. 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 Director requires a plurality of the votes present and entitled to vote. Therefore, the director who receives the most votes will be elected. Neither an abstention nor a withheld vote will affect the outcome of the election. The ratification of the appointment of Grant Thornton LLP requires the affirmative vote of the holders of a majority of the votes cast at the Annual Meeting. If you abstain from voting on this proposal, it will have no effect on the outcome of such proposal. 1 The New York Stock Exchange ("NYSE") has rules that govern brokers who have record ownership of listed company stock held in brokerage accounts for their clients who beneficially own the shares. Under these rules, brokers who do not receive voting instructions from their clients have the discretion to vote uninstructed shares on certain discretionary matters but do not have discretion to vote uninstructed shares as to certain other non- discretionary matters. A broker may return a proxy card on behalf of a beneficial owner from whom the broker has not received instructions that casts a vote with regard to discretionary matters but expressly states that the broker is not voting as to non-discretionary matters. The broker's inability to vote with respect to the non-discretionary matters with respect to which the broker has not received instructions from the beneficial owner is referred to as a "broker non-vote". Under current NYSE interpretations, the proposal to ratify the appointment of Grant Thornton, LLP as our independent auditor is considered a discretionary matter. DATE, TIME AND PLACE OF ANNUAL MEETING The Annual Meeting will be held on March 7, 2013 at 9:00 a.m. (Central time) at the Monona Terrace Community and Convention Center, One John Nolen Drive, Madison, Wisconsin 53703. 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. 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 a majority vote of the entire 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 until the next annual meeting of stockholders or 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 not be less than three or more than twelve. Our currently authorized number of directors is seven. The seats on the Board of Directors currently held by Gary R. Weis and Brian T. Wiegand are designated as Class V Board seats, with terms expiring as of the Annual Meeting. The Board of Directors has nominated Gary R. Weis and Brian T. Wiegand as Class V Directors for election at the Annual Meeting. If elected at the Annual Meeting, Mssrs. Weis and Wiegand would serve until the 2018 Annual Meeting and until their successors are elected and qualified or until their earlier death, resignation or removal. Gary R. Weis Mr. Weis, age 65, has been Chief Executive Officer since March 2011, Chief Technology Officer since September 2011 and a Director of Sonic since February 2004. Prior to joining Sonic, he served as 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. 2 Brian T. Wiegand Mr. Wiegand, age, 43, has been a director of the Company since July 2012, and is a serial entrepreneur who successfully founded and sold several internet-based companies. He is currently the founder and CEO of Hopster, a company that links digital marketing efforts with real-world shopping behavior by rewarding consumer purchase loyalty, engagement and advocacy. Mr. Wiegand is also the co-founder and executive chair of the board of Alice.com, an online retail platform that connects manufacturers and consumers in the consumer packaged goods market. Prior to Alice.com, Mr. Wiegand co-founded Jellyfish.com, a shopping search engine, in June of 2006. He served as CEO until October 2007 when the company was sold to Microsoft. Mr. Wiegand continued with Microsoft as the General Manager of Social Commerce until May 2008. He also co-founded NameProtect, a trademark research and digital brand protection services company in August 1997 which was sold to Corporation Services Company in March 2007. In addition, Mr. Wiegand founded BizFilings in 1996, the Internet’s leading incorporation Services Company. He served as the president and CEO until 2002 when the company was acquired by Wolters Kluwer. Mr. Wiegand attended the University of Wisconsin – Madison. On September 22, 2003, the SEC approved a settlement of an investigation into certain financial accounting matters occurring in the years 2000 and 2001 and involving Homestore, Inc., NameProtect, Inc., and Business Filings, Inc, along with certain officers and directors of NameProtect, Inc. and Business Filings, Inc., including Mr. Wiegand. As part of the settlement, the SEC instituted a cease and desist administrative proceeding and entered a cease and desist order and also filed a civil action in federal district court pursuant to which, without admitting or denying the allegations in the complaint, Mr. Wiegand consented to pay civil money penalties. Without admitting or denying the charges in the administrative proceeding, Mr. Wiegand agreed to cease and desist from committing or causing the violations charged as well as any future violations of these provisions. Additionally, Mr. Wiegand agreed to pay disgorgement in the amount of $1 and civil penalties in the amount of $35,000. Nominees for Director for a Five-Year term expiring on the 2018 Annual Meeting The members of the Board of Directors unanimously recommend a vote FOR the election of Mssrs. Weis and Wiegand as Class V Directors. David C. Kleinman Term Expires in 2014 DIRECTORS CONTINUING IN OFFICE Mr. Kleinman, age 77, has been a Director of Sonic since December 1997 and has taught at the Chicago Booth School of Business at the University of Chicago since 1971, where he is now Adjunct Professor of Strategic Management. Mr. Kleinman was a Director (trustee) of the Columbia Acorn Trust, and its predecessors from 1972 to December 2010 (where he was a member of the Committee on Investment Performance and past chair, a member and past chair of the Audit Committee and a member of the Compliance Committee); a Director (trustee) of the Wanger Advisors Trust from 2005 to December 2010; a Director and non-executive chair of the Board since 1984 of North Lime Holdings and its wholly owned subsidiary, Irex Corporation, a contractor and distributor of insulation materials; 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. Mr. Kleinman received a MS degree in Mathematics and a PHD in Business from the University of Chicago. 3 Paul S. Peercy Term Expires in 2014 Mr. Peercy, age 72, 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 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. Mark D. Burish Term Expires in 2015 Mr. Burish, age 59, is a founder and shareholder of the law firm of Hurley, Burish & Stanton, Madison, WI, which he helped start in 1983. He is the founder and CEO of Our House Senior Living, LLC, Milestone Senior Living, LLC and Milestone Management Services, LLC which he started in 1997. Mr. Burish received his BA degree in communications from Marquette University in 1975 and his JD degree from the University of Wisconsin in 1978. Frederick H. Kopko, Jr. Term Expires in 2016 Frederick H. Kopko, age 57, has been Sonic Foundry’s 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. Mr. Kopko practices in the area of corporate law. He is the Managing Director, Neltjeberg Bay Enterprises LLC, a merchant banking and business consulting firm and 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. Michael H. Janowiak Term Expires in 2017 Mr. Janowiak, age 49, has been a director of Sonic since April 2011 and is a Principal at Pinnacle Investments, a boutique private equity and financial consulting group. He has 26 years of experience in the information industry, with focus on education, training, research publications and trade conferences for professionals in the communications and semiconductor sectors. Mr. Janowiak was President of the International Engineering Consortium (IEC)’s online learning and publishing group, co-founder and Principal of Professional Education International (PEI), where in concert with academia and companies such as Microsoft he led product development of online training and education. He has served on the Board of Directors of Mercury Air Group from September 2002 until September 2005, the Advisory Board of the Midtown Foundation since January 2001, as Industry Advisor to the Illinois Institute of Technology since January 1999, as the Subsidiary Director of CIB Marine Bancshares since November 2001, as member of Liquio Corporation since August 2002, and as member of the Advisory Board of Idynta Systems since December 2001. Janowiak was the co-founder and president of HRDRive, Inc., which is the North American subsidiary of SMR technologies, a publicly-traded, human resources software company based in Kuala Lampur, Malaysia and Chennai, India. Mr. Janowiak attended the University of Arizona’s Business School and the Stanford University Executive Program. When considering whether the Board of Directors and nominees thereto have the experience, qualifications, attributes and skills, taken as a whole, to enable the Board of Directors to satisfy its oversight responsibilities effectively in light of our business and structure, the Board of Directors focused primarily on the information discussed in each of the Board members' biographical information set forth above. Each of the Company's directors possess high ethical standards, act with integrity and exercise careful, mature judgment. Each is committed to 4 employing his skills and abilities to aid the long-term interests of the stakeholders of the Company. In addition, each of our directors has exhibited judgment and skill, and has either been actively involved with the Company for a considerable period of time or has experience with other organizations of comparable or greater size. In particular, Mr. Kopko has had extensive experience with companies comparable in size to Sonic Foundry, including currently serving as a director of Mercury Air Group, Inc. and fills a valuable need with experience in securities and other business law. Mr. Weis has had experience in both developing and established companies, having served as a CEO and Director of Cometa Networks and in several positions at AT&T and IBM, including Senior Vice President of Global Services. While at AT&T, Weis also was CEO of Concert, a joint venture between AT&T and British Telecom. Mr. Weis has served as CEO of the Company since March 2011. Mr. Kleinman has significant experience serving on boards of directors of various companies and has significant experience in finance and strategic management through his employment with the Chicago Booth School of Business at the University of Chicago where he also obtained valuable market insight to the Company’s largest customer base. Mr. Peercy shares that same market expertise through serving the University of Wisconsin in his role as Dean of the engineering school and also has significant business and technical experience obtained at positions including his role as director of Microelectronics and Photonics at Sandia National Laboratories and through his role as president of SEMI/SEMATECH. Mr. Burish brings additional valuable legal experience to the Board as well as experience obtained through founding multiple companies. Mr. Janowiak brings valuable experience with his deep connections to the on-line education industry, and with his previous involvement on the boards of public companies. Mr. Wiegand has significant experience in founding and operating technology companies and building brand awareness with both businesses and consumers. CORPORATE GOVERNANCE Director Independence 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 that, 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 Mark D. Burish, Michael H. Janowiak, David C. Kleinman, Paul S. Peercy and Brian T. Wiegand are independent. 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 new 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 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 5 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 new Related Person Transactions in the fiscal year ended September 30, 2012 (―Fiscal 2012‖). Board Leadership Structure and Role in Risk Oversight In fiscal 2011 the Company separated the positions of Chairman of the Board and Chief Executive Officer. Mark D. Burish serves as Non-Executive Chairman of the Board and Gary R. Weis serves as our Chief Executive Officer and Chief Technical Officer. The Company believes that separating the positions provides an appropriate leadership structure. Our business and affairs are managed under the direction of our board, which is the Company’s ultimate decision- making body, except with respect to those matters reserved to our stockholders. Our Board’s key mission is to maximize long-term stockholder value. Our Board establishes our overall corporate policies, selects and evaluates our executive management team (which is charged with the conduct of our business), and acts as an advisor and counselor to executive management. Our board also oversees our business strategy and planning, as well as the performance of management in executing its business strategy and assessing and managing risks. What is the Board’s role in risk oversight? The board takes an active role in monitoring and assessing the Company’s risks, which include risks associated with operations, credit, financing and capital investments. Management is responsible for the Company’s day-to-day risk management activities and our board’s role is to engage in informed risk oversight. Management, through its disclosure committee, compiles an annual ranking of risks to which the Company could be subjected and reviews the results of this risk assessment with the audit committee. Any significant risks are then reviewed by the board and assigned for oversight. In fulfilling this oversight role, our board focuses on understanding the nature of our enterprise risks, including our operations and strategic direction, as well as the adequacy of our risk management process and overall risk management system. There are a number of ways our board performs this function, including the following: • at its regularly scheduled meetings, the board receives management updates on our business operations, financial results and strategy and discusses risks related to the business; • • the audit committee assists the board in its oversight of risk management by discussing with management, particularly, the Chief Financial Officer, our guidelines and policies regarding financial and enterprise risk management and risk appetite, including major risk exposures, and the steps management has taken to monitor and control such exposures; and through management updates and committee reports, the board monitors our risk management activities, including the annual risk assessment process, risks relating to our compensation programs, and financial and operational risks being managed by the Company. The board of directors also has oversight responsibility for risks and exposures related to employee compensation programs and management succession planning, and assesses whether the organization’s compensation practices encourage risk taking that would have a material adverse effect on the Company. The compensation committee periodically reviews the structure and elements of our compensation programs and its policies and practices that manage or mitigate such risk, including the balance of short-term and long-term incentives, use of multiple performance measures, and a multi-year vesting schedule for long-term incentives. Based on these reviews, the committee believes our compensation programs do not encourage excessive risk taking. 6 Board Structure and Meetings The Board met five times during Fiscal 2012. 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 Fiscal 2012. The Board of Directors has five standing committees, the Audit Committee, the Executive Compensation Committee, the New Markets Committee, the Governance Committee and the Nominations 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‖). Members of the Audit Committee are Messrs. Kleinman (chair), Burish, Peercy (until his resignation effective January 23, 2012) and Janowiak (effective January 23, 2012). 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 2012. 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 Chicago Booth School of Business at the University of Chicago, and due to his current and past service as a director on numerous company boards, and membership on numerous audit committees, including past or present chair, 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 Compensation Committee consists of Messrs. Kleinman (chair), Burish, Janowiak (effective January 23, 2012) and Peercy (until his resignation effective January 23, 2012). The Board of Directors has determined that all of the members of the Compensation Committee are ―independent‖ as defined under Nasdaq listing standards. The 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 Compensation Committee met once in Fiscal 2012. A copy of the charter of the Compensation Committee is available on Sonic’s website. The New Markets Committee consists of Messrs. Peercy (chair) and Kleinman. The New Markets Committee was established on January 24, 2013 to assist management in developing new market entry plans, providing access to contacts that may facilitate entry, assessing risk and monitoring outcomes. Mr. Peercy will receive an annual retainer of $10,000 and Mr. Kleinman will receive an annual retainer of $3,000. The Governance Committee consists of Messrs. Burish (chair), Kopko and Peercy. The Governance Committee was established on January 24, 2013 to consider board terms and other governance issues related to enhancing shareholder value. The Nominations Committee consists of Messrs. Peercy (chair), Burish, Janowiak and Kleinman. The Board of Directors has determined that all of the members of the Nominations Committee are ―independent‖ as defined under Nasdaq listing standards. Mr. Janowiak joined the Nominations Committee following the Committee’s recommendation to the Board that he be nominated for election at the Annual Meeting. The purpose of the Nominations Committee is to evaluate and recommend candidates for election as directors, make recommendations 7 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 Nominations Committee, which is available on Sonic’s website. The Nominations Committee will review all candidates in the same manner regardless of the source of the recommendation. In recommending candidates for election to the Board of Directors, the Nominations Committee reviews each candidate’s qualifications, including whether a candidate possesses any of the specific qualities and skills desirable in certain members of the Board of Directors. Evaluations of candidates generally involve a review of background materials, internal discussions and interviews with selected candidates as appropriate. Generally the Nominations Committee will consider various criteria in considering whether to make a recommendation. These criteria include expectations that directors have substantial accomplishments in their professional backgrounds and are able to make independent, analytical inquiries and exhibit practical wisdom and mature judgment. Director candidates should possess the highest personal and professional ethics, integrity and values, be committee to promoting the long-term interest of our stockholders and be able and willing to devote the necessary time to carrying out their duties and responsibilities as members of the Board. While the Board of Directors has not adopted a policy regarding diversity, we also believe our directors should come from diverse backgrounds and experience bases in order to promote the representation of diverse views on the Board of Directors. Stockholder recommendations of candidates for Board membership will be considered when submitted to Corporate Secretary, Sonic Foundry, Inc., 222 W. Washington Ave., Madison, WI 53703. When submitting candidates for nomination to be elected at Sonic's annual meeting of stockholders, stockholders must also follow the notice procedures and provide the information required by Sonic's bylaws. In particular, for a stockholder to nominate a candidate for election at the 2014 Annual Meeting of Stockholders, the nomination must be delivered or mailed to and received by Sonic's Secretary between November 8, 2013 and December 8, 2013 (or, if the 2014 annual meeting is advanced by more than 30 days or delayed by more than 60 days from March 7, 2014, not earlier than the close of business on the 120th day prior to such annual meeting and not later than the close of business on the later of the 90th day prior to such annual meeting or the tenth calendar day following the date on which public announcement of the date of the annual meeting is first made). The nomination must include the same information as is specified in Sonic's bylaws for stockholder nominees to be considered at an annual meeting, including the following: • The stockholder's name and address and the beneficial owner, if any, on whose behalf the nomination is proposed; • The stockholder's reason for making the nomination at the annual meeting, and the signed consent of the nominee to serve if elected; • The number of shares owned by, and any material interest of, the record owner and the beneficial owner, if any, on whose behalf the record owner is proposing the nominee; • A description of any arrangements or understandings between the stockholder, the nominee and any other • person regarding the nomination; and Information regarding the nominee that would be required to be included in Sonic's proxy statement by the rules of the Securities and Exchange Commission, including the nominee's age, business experience for the past five years and any other directorships held by the nominee. The Operations Analysis Committee consisted of Messrs. Weis (chair) and Kleinman. 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 was disbanded upon the appointment of Mr. Weis as Chief Executive Officer on March 31, 2011. 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. In addition, Mr. Kleinman receives an Audit Committee annual retainer of $8,000 and a Compensation Committee annual retainer of $3,000 for his services as chairman of each committee and Mr. Burish receives an annual retainer of $35,000 as compensation for his services as Chairman of the Board of Directors. The cash compensation paid to the five non- 8 employee directors combined in Fiscal 2012 was $232,687. When traveling from out-of-town, the members of the Board of Directors are also eligible for reimbursement for their travel expenses incurred in connection with attendance at Board meetings and Board Committee meetings. Directors who are also employees do not receive any compensation for their participation in Board or Board Committee meetings. Pursuant to the 2008 Sonic Foundry Non-Employee Amended Directors Stock Option Plan (the ―Directors Plan‖) we grant to each non-employee director who is reelected or who continues as a member of the Board of Directors at each annual stockholders meeting a stock option to purchase 2,000 shares of Common Stock. Further, the chair of our Audit Committee receives an additional stock option grant to purchase 500 shares of Common Stock per year pursuant to Sonic’s Non-Employee Amended Directors Stock Option Plan. The exercise price of each stock option granted was equal to the market price of Common Stock on the date the stock option was granted. Stock options issued under the Directors Plan vest fully on the first anniversary of the date of grant and expire after ten years from date of grant. An aggregate of 100,000 shares are reserved for issuance under the Directors Plan. If any change is made in the stock subject to the Directors Plan, or subject to any option granted thereunder, the Directors Plan and options outstanding thereunder will be appropriately adjusted as to the type(s), number of securities and price per share of stock subject to such outstanding options. The options and warrants set forth above have an exercise price equal to the fair market value of the underlying common stock on the date of grant. The term of all such options is ten years. The following table summarizes cash and equity compensation provided our non-employee directors during the fiscal year ended September 30, 2012. Fees Earned Or Paid In Cash ($)(1) (b) Stock Awards ($) (c) Option Awards ($)(2) (d) Non-Equity Incentive Plan Compen- sation ($) (e) Name (a) Mark D. Burish Michael H. Janowiak David C. Kleinman Frederick H. Kopko Paul S. Peercy Brian T. Wiegand 83,747 31,500 46,500 27,500 29,500 13,940 — — — — — — 3,340 3,340 4,175 3,340 3,340 3,120 — — — — — — Change in Pension Value and Non-qualified Deferred Compen- sation Earnings ($) (f) — — — — — — All Other Compensation ($) (g) — — — — — — Total ($) (h) 87,087 34,840 50,675 30,840 32,840 17,060 (1) (2) The amount reported in column (b) is the total of retainer fees and meeting attendance fees. The amount reported in column (d) is the aggregate grant date fair value of options granted during the fiscal year ended September 30, 2012 in accordance with FASB ASC Topic 718. Each director, other than Mr. Wiegand, received an option award of 2,000 shares on March 7, 2012 at an exercise price of $7.39 with a grant date fair value of $3,340. In addition, Mr. Kleinman received a grant of 500 shares on March 7, 2012 at an exercise price of $7.39 with a grant date fair value of $835 in connection with his position as chair of the Audit Committee. Mr. Wiegand received a grant of 2,000 shares on July 23, 2012 upon his appointment to the board at an exercise price of $6.99 per share with a grant date fair value of $3,120. 9 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. Gary R. Weis serves as both our Chief Executive and Chief Technology Officer. (See " Directors Continuing in Office ".) Kenneth A. Minor, age 50, 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 aftermarket 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 41, 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. 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 January 2004 to March 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 10, 2013, 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 10, 2013, 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. 10 Name of Beneficial Owner(1) Common Stock Wealth Trust Axiom LLC (3) 4 Radnor Corp Center, suite 520 Radnor PA 19087 Number of Shares of Class Beneficially Owned Percent of Class(2) 297,677 7.6% Mark D. Burish(4) 33 East Main St. Madison, WI 53703 Andrew D. Burish(5) 8020 Excelsior Drive Madison, WI, 53717 Gary R. Weis(6) Kenneth A. Minor(7) Robert M. Lipps(8) Frederick H. Kopko, Jr.(9) 29 South LaSalle Street Chicago, IL 60603 David C. Kleinman(10) 1101 East 58th Street Chicago, IL 60637 Paul S. Peercy(11) 1415 Engineering Dr Madison, WI 53706 Brian S. Wiegand 8215 Greenway Blvd., Suite 340 Middleton, WI 53562 Michael H. Janowiak(12) 6688 Joliet Road Countryside, IL 60525 All current Executive Officers and Directors as a Group (9 persons)(13) 247,995 195,000 99,166 68,729 48,905 42,627 34,500 20,040 12,000 4,000 577,962 6.3 5.0 2.5 1.7 1.2 1.1 * * * * 14.1% less than 1% * (1) Sonic believes that the persons named in the table above, based upon information furnished by such persons, except as set forth in notes (3) and (5) where such information is based on a Schedule 13G, have sole voting and dispositive power with respect to the number of shares indicated as beneficially owned by them. (2) Applicable percentages are based on 3,905,514 shares outstanding, adjusted as required by rules promulgated by the Securities and Exchange Commission. 11 (3) Information is based on Schedule 13G filed on January 20, 2012 by Albert C. Matt, President of Wealth Trust Axiom LLC. Based on such information, Wealth Trust Axiom LLC has sole dispositive power but not sole voting power with respect to such shares. (4) Includes 6,000 shares subject to Presently Exercisable Options. (5) Information is based on Schedule 13G filed on February 6, 2012 (6) Includes 39,666 shares subject to Presently Exercisable Options. (7) Consists of 51,580 shares subject to Presently Exercisable Options. (8) Includes 47,830 shares subject to Presently Exercisable Options. (9) Includes 14,000 shares subject to Presently Exercisable Options. (10) Includes 24,500 shares subject to Presently Exercisable Options. (11) Includes 20,000 shares subject to Presently Exercisable Options. (12) Includes 4,000 shares subject to Presently Exercisable Options. (13) Includes an aggregate of 207,576 Presently Exercisable Options. 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 and Executive Vice President of Sales as the ―executive officers.‖ The Executive 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 increasing 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 established performance metrics for each of its Named Executive Officers in fiscal 2012 designed to match Company performance to the amount of incentive compensation paid to such officers following completion of the fiscal year. 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 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. 12 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 approximately $10 million to just over $150 million; market capitalization of $10 million to $400 million and approximately 300 employees or fewer. The following companies comprised the peer group for the study: MakeMusic, Inc., Majesco Entertainment, XATA Corporation, Bsquare Corporation, Versant Corporation, Simulations Plus, Adept Technology, Cinedigm Digital Cinema, SoundBite Communications, Procera Networks, GlobalSCAPE, Broadvision, Evolving Systems and GSE Systems. 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 Towers Watson Data Services dated April 1, 2010 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 are described above. 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. The Committee considered base wage changes for Mssrs. Weis, Minor and Lipps at a meeting of the Committee held on October 17, 2012. Accordingly, base compensation for Mr. Weis was increased from $378,400 to $397,320, base pay for Mr. Minor was increased from $255,646 to $268,428 and base compensation for Mr. Lipps was increased from $196,267 to $206,080. After its review of all sources of market data as described above, the 13 Committee believes that the base salaries and the bonuses described below are within its targeted range for total cash compensation. Annual Performance-Based Variable Compensation The performance-based variable compensation reported for each executive officer represents compensation that was earned based on fiscal 2012 performance. The following describes the methodologies used by the Compensation Committee to determine the final annual performance-based variable compensation earned by each executive officer: Selection of Performance Metrics. For fiscal 2012, the Compensation Committee designed a short-term incentive program (―STIP‖) driven by four performance measures that it determined were appropriate to drive desired business behavior for the Company and would correlate positively with total shareholder return. These measures were the Company’s results with respect to (1) customer billings, (2) pro forma earnings, (3) customer satisfaction, and (4) the officer’s achievement of certain individual goals. Messrs. Weis, Minor and another Non-Executive officer were included in the plan. Mr. Lipps’ short term incentive plan was based solely on the level of customer billings achieved. Establishment of Incentive Goals and Payout Approach. The Compensation Committee designed the relationship between pay and performance to ensure that desired performance would be rewarded with material payouts. Similarly, performance that did not meet the goals would reduce the performance-based variable compensation payout to as low as zero. In setting the performance levels, the Compensation Committee strived to establish challenging but achievable goals. The factors considered by the Compensation Committee in assessing the challenge inherent in the goals included: • Management’s internal operating plan; and • Customer satisfaction. Payout Based on Performance Against Goals. For fiscal 2012 the Company’s performance, as evaluated by the Compensation Committee, lead to the determination that 40% of the STIP performance metrics were achieved and therefore 40% of the target bonus payouts were made under the STIP compensation plan. The STIP earned by Mr. Weis was $75,680 and was $35,784 for Mr. Minor. Mr. Minor earned an additional incentive payout of $15,000 based on achieving certain performance objectives. Total incentive paid to Mr. Lipps during fiscal 2012 was $109,911. 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 those of Sonic’s stockholders. All stock options have been granted under either our 1995 Stock Option Plan, the 1999 Non-Qualified Plan or the 2009 Stock Incentive Plan (―Employee Plans‖). All but the 2009 Stock Incentive Plan are now terminated. 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 or such other future date as the Committee may agree at the time of approval. 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. 14 On October 17, 2012 the Committee awarded Mssrs. Weis, Minor and Lipps option grants to purchase 73,000, 40,000 and 40,000 shares of common stock, respectively, effective October 17, 2012 with the strike price equal to the closing price of Sonic’s stock on that date, which was $7.80. Each grant will vest one third each on the first, second and third anniversaries of the grant. 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 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 provides 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 purchase of substantially all of its assets or securities and following such acquisition, Gary Weis does not remain as Chief Executive Officer 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 his 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. Effective September 30, 2011, the Company entered into an amended and restated employment agreement with Mr. Weis. Pursuant to the terms of the amended and restated employment agreement, Mr. Weis will receive an annual minimum base salary of $378,400 per year subject to increase at the discretion of the Board. Mr. Weis may also receive a performance bonus at the discretion of the Board. Mr. Weis in addition will assume duties as are customarily performed by a Chief Technology Officer. The amended and restated employment agreement will continue in effect until terminated as set forth therein. In the event Mr. Weis’s employment is terminated without cause, as defined in the amended and restated employment agreement, or in the event his employment is constructively terminated, Mr. Weis shall be entitled to receive, in equal bi-weekly installments over a one-year period, compensation equal to one and five hundredths (1.05) multiplied by the highest cash compensation paid to Mr. Weis in any of the last three years immediately prior to his termination. In the event of a Change of Control, as defined in the amended and restated employment agreement, Mr. Weis is entitled to terminate the agreement within one year following such Change of Control, in which event he shall be entitled to receive, in a lump sum payable within thirty days of such termination, compensation equal to two and one-tenth (2.1) multiplied by the highest cash compensation paid to Mr. Weis in any of the last three fiscal years immediately prior to his termination. In any of the above events, (i) all of Mr. Weis’s unvested stock options and stock grants shall vest immediately upon termination, and (ii) Mr. Weis shall receive health insurance continuation as required by COBRA, salary accrued to the date of termination, and any accrued vacation pay. Mr. Weis has further agreed not to disclose the Company’s proprietary information, and, until one year 15 following the termination of his employment agreement, not to compete with the Company or solicit the Company’s employees. Such non-compete clause may not be enforceable, or may be only partially enforceable, in state courts of relevant jurisdiction. For illustrative purposes, if Sonic terminated the employment of Mr. Weis (not for cause) on September 30, 2012, Sonic would be obligated to pay $477,000, representing 1.05 times the cash compensation paid Mr. Weis during fiscal 2012 and $954,000 if Mr. Weis elected to terminate his employment on September 30, 2012, following a change of control as defined in the employment agreement. If Sonic terminated Messrs. Minor and Lipps on September 30, 2012, (not for cause), or if Messrs. Minor and Lipps elected to terminate their employment following a demotion or alteration of duties on September 30, 2012, and a change of control as defined in the employment agreements had occurred, Sonic would be obligated to pay $306,000 and $299,000, respectively. In addition, any non-vested rights of Messrs. Weis, Minor and Lipps under the Employee Plans, would vest as of the date of employment termination. The value of accelerated vesting of the options under these circumstances would be $84,000 for Mr. Weis and $88,000 for both Mssrs. Minor and 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 $1 million paid annually to each of the Chief Executive Officer and each of the other executive officers named in the Summary Compensation Table. There are exemptions from this limit, including compensation that is based on the attainment of performance goals that are established by the Committee and approved by the Company stockholders. No executive officer was affected by this limitation in fiscal 2012. COMPENSATION COMMITTEE REPORT The Compensation Committee of Sonic has reviewed and discussed the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K with management and, based on such review and discussions, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in the Proxy Statement. COMPENSATION COMMITTEE David C. Kleinman, Chair Mark D. Burish Michael H. Janowiak 16 The following table sets forth the compensation of our principal executive officer, our principal financial officer and our other two executive officers for the fiscal year ended September 30, 2012. Summary Compensation Salary ($) (c) Bonus ($) (d) Stock Awards ($) (e) Option Awards ($)(1) (f) Non-Equity Incentive Plan Compensation ($)(2) (g) Change in Pension Value and Non-qualified Deferred Compensation Earnings ($) (h) 378,400 170,000 — 255,123 247,092 241,000 195,811 189,696 185,000 — — — — — — — — — — — — — — — — — — — 191,880 — 75,680 74,923 — 103,400 98,416 18,898 103,400 98,416 18,898 50,784 49,144 — 109,911 101,248 73,834 — — — — — — — — — All Other Compen- sation ($)(3) (i) Total ($) (j) 6,986 — — 461,066 436,803 — 16,809 14,041 7,795 426,116 408,693 270,426 8,787 9,072 1,992 417,909 398,432 279,724 Name and Principal Position (a) Gary R. Weis Chief Executive and Chief Technology Officer Kenneth A. Minor Chief Financial Officer and Secretary Robert M. Lipps Executive Vice President - Sales Year (b) 2012 2011 2010 2012 2011 2010 2012 2011 2010 (1) The option awards in column (f) represent the aggregate grant date fair value computed in accordance with FASB ASC Topic 718 for stock options granted during the fiscal year. The assumptions and methodology used in calculating the 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 value attributed to the awards at the date of grant 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 ASC Topic 718 value. (2) The amounts in column (g) represent cash bonuses which were awarded for performance during the prior fiscal year based on a pre-established formula. (3) The amount shown under column (i) for the fiscal year 2012 includes Sonic’s matching contribution under our 401(k) plan of $6,986, $9,659 and $8,787 for Messrs Weis, Minor and Lipps. Mr. Minor receives $650 per month as a car allowance of which the taxable personal portions were $7,150. Mr. Lipps receives a car allowance of $700 per month of which there was no taxable personal portion. Mr. Weis received car and housing allowances totaling $2,500 per month, of which there was no taxable personal portion. 17 The Following table shows the plan-based awards granted to the Named Executive Officers during fiscal 2012. Grants of Plan-Based Awards Name (a) Grant Date (b) Estimated Future Payouts Under Non-Equity Incentive Plan Awards Target ($) (d) Maximum ($) (e) Threshold ($) (c) Estimated Future Payouts Under Equity Incentive Plan Awards Target ($) (g) Maximum ($) (h) Threshold ($) (f) All other stock awards: Number of Shares of stock or units (#) (i) All other option awards: Number of Securities Underlying Options (#) (j) Exercise or base price of option awards ($/Sh) (1) (k) Grant Date fair Value of Stock and option awards ($) (2) (l) Kenneth A. Minor Robert M. Lipps 10/24/11 — 10/24/11 — — — — — — — — — — — — — 27,500 27,500 9.46 9.46 103,400 103,400 (1) Sonic grants employee stock options with exercise prices equal to the closing stock price on the date of grant. (2) The amount reported in column (l) represents the grant date fair value of the award following the required FASB ASC Topic 718 compensation methodology. Grant date fair value is calculated using the Lattice method. See Note 1, ―Stock Based Compensation‖ in the Notes to the Consolidated Financial Statements in Sonic’s Form 10-K for the fiscal year ended September 30, 2012 for an explanation of the methodology and assumptions used in FASB ASC Topic 718 valuation. With respect to the option grants, there can be no assurance that the options will ever be exercised (in which case no value will be realized by the executive) or that the value on exercise will equal the FASB ASC Topic 718 value. Sonic grants options to its executive officers under our employee stock option plans. As of September 30, 2012, options to purchase a total of 846,280 shares were outstanding under the plans, and options to purchase 601,926 shares remained available for grant thereunder. 18 Outstanding Equity Awards at Fiscal Year-End The following table shows information concerning outstanding equity awards as of September 30, 2012 held by the Named Executive Officers. Option Awards Stock Awards Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($) (j) Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#) (i) Market Value of Shares or Units of Stock That Have Not Vested ($) (h) Number of Shares or Units of Stock That Have Not Vested (#) (g) Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#) (d) None None None Number of Securities Underlying Unexercised Options (#) Exercisable (1)(2) (b) 2,000 2,000 2,000 2,000 2,000 2,000 5,000 2,000 2,000 2,000 0 Number of Securities Underlying Unexercised Options (#) Unexercisable (1)(2) (c) 0 0 0 0 0 0 0 0 0 0 50,000 10,000 5,000 12,000 4,000 4,706 0 2,500 750 1,500 2,500 10,000 6,000 4,000 4,706 0 0 0 0 2,000 9,414 27,500 0 0 0 0 0 0 2,000 9,414 27,500 Option Exercise Price ($) (1)(2) (e) 19.40 13.40 12.30 17.40 37.60 8.00 5.00 5.50 6.90 14.83 8.68 4.20 14.50 15.50 5.26 15.21 9.46 22.60 37.10 15.50 7.50 7.80 5.30 5.26 15.21 9.46 Option Expiration Date (1) (f) 2/9/2014 5/24/2014 5/15/2015 3/15/2016 3/15/2017 3/6/2018 11/3/2018 3/5/2019 3/4/2020 3/3/2021 9/30/2021 05/09/2013 11/26/2014 12/04/2017 12/2/2019 11/24/2020 10/24/2021 04/10/2016 12/07/2016 12/04/2017 03/10/2018 04/16/2018 11/10/2018 12/2/2019 11/24/2020 10/24/2021 Name (a) Gary R. Weis Kenneth A. Minor Robert M. Lipps (1) All options were granted under either our stockholder approved Employee Stock Option Plans 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. (2) All options have been adjusted for the one-for-ten reverse stock split of the Company’s shares completed on November 16, 2009. 19 The following table shows information concerning option exercises in fiscal 2012 by the Named Executive Officers. Option Exercises and Stock Vested Option Awards Stock Awards Number of Shares Acquired on Exercise (#) Value Realized on Exercise ($) Number of Shares Acquired on Vesting (#) Value Realized on Vesting ($) None 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) 741,555 104,725 846,280 (b) 11.37 10.71 11.28 (c) 646,426 - 646,426 (1) Consists of the 2009 Stock Incentive Plan, Employee Incentive Stock Option Plan and the Amended Directors Stock Option Plans. 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. Compensation Committee Interlocks and Insider Participation The members of the Executive Compensation Committee of Sonic's Board of Directors for fiscal 2012 were those named in the Executive Compensation Committee Report. No member of the Committee was at any time during Fiscal 2012 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. 20 PROPOSAL TWO: 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, 2013, 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 at the Annual Meeting. Recommendation of Board of Directors THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR PROPOSAL 2 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 2, the Board has selected GT to serve as our independent auditors for the fiscal year ending September 30, 2012. Audit services performed by GT for Fiscal 2012 and 2011 consisted of the examination of our financial statements, review of fiscal quarter results, and services related to filings with the Securities and Exchange Commission (SEC). 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. 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 2012 and 2011 Audit Firm Fee Summary During fiscal years 2012 and 2011, we retained GT to provide services in the following categories and amounts: Audit Fees Audit Related Tax Fees Years Ended September 30, 2011 2012 $168,200 12,250 27,378 $143,900 11,350 26,081 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. 21 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 2012. Mssrs. Kleinman, Burish and Janowiak 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 August 2009, 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 overall scope and plans of their audit. We met with GT, with and without management present, to discuss results of their examination 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 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. 22 2012, 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, 2012, for filing with the SEC. Respectfully submitted, AUDIT COMMITTEE David C. Kleinman, Chair Mark D. Burish Michael H. Janowiak 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 4,000 shares of Common Stock at exercise prices ranging from $17.40 to $37.60 and was granted options to purchase 10,000 shares of Common Stock at exercise prices ranging from $5.50 to $14.83 pursuant to the 2008 Non-Employee Directors Plan. During fiscal 2012, 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. 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 who 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. STOCKHOLDER PROPOSALS FOR 2014 ANNUAL MEETING OF STOCKHOLDERS Requirements for Stockholder Proposals to be Considered for Inclusion in Sonic's Proxy Materials. Stockholders of Sonic may submit proposals on matters appropriate for stockholder action at meetings of Sonic's stockholders in 23 accordance with Rule 14a-8 promulgated under the Securities Exchange Act of 1934. For such proposals to be included in Sonic's proxy materials relating to its 2014 Annual Meeting of Stockholders, all applicable requirements of Rule 14a-8 must be satisfied and such proposals must be received by Sonic no later than the anniversary date of 120 days prior to the date of this proxy statement (September 30, 2013). Such proposals should be delivered to Corporate Secretary, Sonic Foundry, Inc., 222 West Washington Avenue, Madison, Wisconsin 53703. Requirements for Stockholders Proposals to be Brought Before the Annual Meeting. Sonic's bylaws provide that, except in the case of proposals made in accordance with Rule 14a-8, for stockholder nominations to the Board of Directors or other proposals to be considered at an annual meeting of stockholders, the stockholder must have given timely notice thereof in writing to the Secretary not less than ninety nor more than one hundred twenty calendar days prior to the anniversary of the date on which Sonic held its immediately preceding annual meeting of stockholders. To be timely for the 2014 Annual Meeting of Stockholders, a stockholder's notice must be delivered or mailed to and received by Sonic's Secretary at the principal executive offices of Sonic between November 7, 2013 and December 7, 2013. However, in the event that the annual meeting is advanced by more than 30 days or delayed by more than 60 days from March 7, 2014, to be timely, notice by the stockholders must be so received not earlier than the close of business on the 120th day prior to such annual meeting and not later than the close of business on the later of the 90th day prior to such annual meeting or the tenth calendar day following the date on which public announcement of the date of the annual meeting is first made. In no event will the public announcement of an adjournment of an annual meeting of stockholders commence a new time period for the giving of a stockholder's notice as provided above. A stockholder's notice to Sonic's Secretary must set forth the information required by Sonic's bylaws with respect to each matter the stockholder proposes to bring before the annual meeting. In addition, the proxy solicited by the Board of Directors for the 2014 Annual Meeting of Stockholders will confer discretionary authority to vote on (i) any proposal presented by a stockholder at that meeting for which Sonic has not been provided with notice on or prior to the anniversary date of 45 days prior to the date of this proxy statement (December 14, 2013) and (ii) any other proposal, if the 2014 proxy statement briefly describes the matter and how management's proxy holders intend to vote on it, and if the stockholder does not comply with the requirements of Rule 14a-4(c)(2) under the Securities Exchange Act of 1934. Notwithstanding the above, all stockholder proposals must comply with the provisions of Sonic’s bylaws. 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, 2012 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. 24 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, 2012, 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 25, 2013 Kenneth A. Minor, Secretary 25 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) FORM 10-K   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal period ended September 30, 2012 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 000-30407 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. Yes No  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  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  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 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  No 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  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No  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 $29,987,000. The number of shares outstanding of the registrant's common equity was 3,900,024 as of December 6, 2012. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the 2012 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, 2013.  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 .................................................................................................................. Mine Safety Disclosures ........................................................................................................ 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 Accounting Fees and Services ................................................................................ 4 16 28 28 28 28 29 32 33 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, 2012 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 our 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. (NASDAQ: SOFO) is the trusted market leader for enterprise webcasting solutions, providing video content management and distribution for education, business and government. Powered by the patented Mediasite webcasting platform, Sonic Foundry empowers people to share knowledge online, use webcasts to bridge time and distance, enhance learning outcomes and improve performance. Sonic Foundry solutions include: • Mediasite Recorders for capturing video and rich media presentations • Mediasite EX for video content management and distribution • Mediasite Events for turnkey meeting, conference and event webcasting services based on the Mediasite platform • Mediasite Services for hosting, installation, training and integration • Mediasite Customer Assurance for annual hardware and software maintenance and technical support Today, over 2,500 customers using more than 6,500 Mediasite Recorders in presentation environments around the world are capturing hundreds of thousands of multimedia presentations with millions of viewers. Sonic Foundry, Inc. 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 is www.sonicfoundry.com. In the “Investors” section of our website we make available, free of charge, 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 soon as reasonably practicable after the filing of such reports with the Securities and Exchange Commission. is (608) 443-1600. Our corporate website telephone number Challenges We Address Every organization faces a fundamental need to communicate information efficiently to individuals who need it. Universities and colleges need to connect instructors with students for advanced learning. Corporations strive for 4 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 successful communication and collaboration among colleagues to provide value to customers. Government agencies must keep partners, stakeholders and constituents informed to operate effectively. And yet, communication and e- learning challenges remain, including: Ensuring learners’ academic and professional success • Enabling learners to review course material to improve retention and positively impact learning outcomes and grades • Providing distance learners with the same quality education as on-campus students • Helping students balance education, career and family commitments • • Capturing complex graphics where visual clarity is essential for learning Increasing enrollment without the expense of new classrooms and facilities Connecting with a geographically-dispersed audience • Simultaneously addressing people in multiple locations • Holding meetings, conferences and events when it is not feasible for everyone to attend in person • Transmitting timely information that is crucial for all to receive • Requiring employees, regardless of time zone or schedule, to attend training Increasing retention by avoiding distractions, interruptions or absence Improving productivity and overall organizational knowledge • Avoiding the need for participants to leave their desks to attend a conference, meeting or training • Reducing time to train new hires • • Keeping everyone on the same page to prevent false starts and forgotten directives • Documenting meeting content for later review • Extending the life and value of conferences, meetings and events • Maintaining an online library of organizational knowledge • Documenting and preserving expertise from a retiring workforce Reducing logistical and financial impacts • Cutting travel expenses and carbon footprints • Eliminating repetition of the same information to different audiences • Reducing repeated costs for printing, mailing and meeting expenses • Enabling individuals to attend professional development in light of budget cuts Avoiding cumbersome and restrictive technologies • Maintaining the way presenters present without requiring 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 significant time and specialized expertise to manage presentation systems Sonic Foundry Solutions Sonic Foundry is changing the way organizations share and use information. Our solutions include: Mediasite Recorders Designed with instructors and speakers in mind, Mediasite Recorders automatically capture their video and any presentation materials in high resolution and webcasts them live or on-demand – without changing how they present. The result is a high quality, interactive streaming experience to a broad range of devices from laptops and computers to all of the most popular mobile devices. Mediasite Recorders eliminate time-consuming authoring, slide uploads and post-production work. Plus, seamless integration with existing audio/video and educational technology means organizations can confidently scale webcasting throughout their academic or corporate enterprise. 5 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 We offer Mediasite Recorders for the following environments: • A room-based Mediasite Recorder (RL Series) for presentation facilities like conference and training rooms, lecture halls, auditoriums and classrooms • A mobile Mediasite Recorder (ML Series) for portability to off-site events, conferences, trade shows or multiple venues throughout an organization Mediasite EX Mediasite EX, a powerful video content management platform for distributing and archiving live and on-demand content, provides a single system to catalog, customize, search, secure, analyze and edit video-based content. Mobile-ready and unconstrained by traditional webcast layouts, watching live or on-demand Mediasite presentations is like being in the room with the presenter, but with flexible playback options and interactive tools to enhance learning and improve retention. We understand the value in quickly publishing, retrieving and measuring the impact of video content. Mediasite automatically publishes content to searchable online catalogs or embeds content directly in learning or course management systems – no web development or integration skills are required. Powerful analytics show who is watching what and when, providing valuable data for viewing patterns that we believe correlate to improved learning outcomes, increased performance and program effectiveness. Built to leverage existing IT and AV infrastructures, Mediasite EX reduces the resources and effort to manage multimedia content. Its built-in scheduler saves time by recording and publishing recurring presentations in a fully automated operation. Integration with leading enterprise directories guarantees that content and intellectual property remain secure. Best of all, Mediasite EX scales to meet any webcasting needs, whether departmentally with a couple of rooms or implemented campus- or company-wide. Customers also have the flexibility to deploy Mediasite on- premises, hosted within Sonic Foundry’s SaaS datacenter or through a combination of both models. Mediasite Events Mediasite Events equips customers with a team of trained technicians who work on-site to webcast conferences and events. • Enhances attendee experience with online presentation catalogs • Reaches a wider audience, making webcasts available to those not able to attend • Brands webcasts using organization logos, colors and messages • Provides a real-time record of what took place • Links handout materials with the full presentation, including audio, video and graphics • Offers sample content to entice new attendees to participate Mediasite Services Organizations can quickly and easily take advantage of the Mediasite platform, without wading through IT or network complexities associated with their infrastructure, with these Mediasite Services: • Cloud Services / Software as a Service (SaaS): Our cloud services offering provides content hosting, delivery and management of Mediasite content using Sonic Foundry’s data center and infrastructure. These managed services allow organizations of all sizes to jump start their webcasting and video content management initiatives quickly and simply. They provide a low-risk way to implement Mediasite before adopting an on-premises implementation and for some organizations, provide a hassle-free long-term solution. Installation: Sonic Foundry provides onsite consulting and installation services to help customers optimize on- premises deployments and efficiently integrate Mediasite within existing AV and IT infrastructures, processes and workflows. • • 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. 6 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 • Advanced Integration Services: Sonic Foundry streamlines how Mediasite interfaces with a customer’s specific technologies, internal policies, workflow or content delivery systems through project-based development. Mediasite Customer Assurance Sonic Foundry’s annually renewable maintenance and support plans provide customers access to technical expertise and Mediasite software updates. With a Mediasite Customer Assurance contract, customers are entitled to: • Software upgrades and updates for Mediasite Recorders and Mediasite EX • Unlimited technical support assistance • Extension of their recorder hardware warranty • Advanced recorder hardware replacement • Authorized access to the Mediasite Customer Assurance Portal where they can access software downloads, documentation, knowledge base articles, tutorials, online training and technical resources at any time. Nearly all our customers purchase a Customer Assurance plan when they purchase Mediasite Recorders or Mediasite EX. What Sets Mediasite Apart? • Comprehensive video content management and delivery – Sonic Foundry believes a complete solution focuses on all phases of the academic and business video lifecycle – from content creation to delivery to retention and management. Mediasite automatically creates searchable online catalogs of Mediasite-recorded as well as uploaded content from other sources – whether live or on-demand. With integration support for leading enterprise directories, all content can be secured to manage access to specific groups or individuals based on roles and permissions. Powerful analytics allow organizations to track and report on exactly who is watching what, when and how long. • • Powerful video search – We understand the need to bring order to growing video libraries so content can be found, used and re-purposed to derive maximum value. Mediasite’s powerful search capabilities leverage indexed slide text, audio transcripts, presentation metadata and tags to find where keywords are spoken or shown during a webcast and display a playlist of these instances for the user. Interactive playback on any device – Mediasite provides an interactive experience that engages the viewer via different modalities – auditory, visual and kinesthetic – to increase content comprehension and retention. Unconstrained by viewing device or traditional webcast layouts, watching a live or archived Mediasite presentation is like being in the room with the presenter, but with greater playback control and time-saving conveniences. Mediasite’s interactivity incorporates polls, ask-a-question capabilities and links to other related reference materials. Support for video closed captioning enhances the playback experience for learners of all abilities. The interactive Mediasite experience is available on Windows PC, Mac, iPad, iPhone, iPod, Android and BlackBerry. • Flexible deployment options – Sonic Foundry offers customers the option to implement Mediasite video content management on-premises, in the cloud or as any combination of the two. Customers find the convenience of being able to mix and match deployment models, depending on the unique requirements of their business, to be an attractive option that provides Mediasite a competitive advantage over SaaS- or on-premises- only offerings. • Customer support – Sonic Foundry and the growing Mediasite community provide a reliable, collaborative support network for all Mediasite customers. Our breadth of field-based system engineers and responsive customer care ensure that customers have readily available resources committed to their success. With over 1000 active customer members, the Mediasite User Group (MUG) is one of the most vibrant and expanding user communities for lecture capture, online training and e-learning. MUG members share ideas and get feedback year-round from community experts through online forum discussions, live quarterly meetings and unrivaled networking and learning opportunities at UNLEASH, the annual Mediasite User Conference. • Market Leadership – Industry analyst firm, Frost & Sullivan, has consistently recognized Mediasite as the worldwide market leader for lecture capture, naming Sonic Foundry the Global Market Share Leader in Lecture Capture Solutions for six consecutive years, from 2007 – 2012. The Frost & Sullivan Award for Market Share 7 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 Leadership is presented to the company that demonstrates excellence in capturing the highest market share within its industry. According to Mukul Krishna, Frost & Sullivan Global Director, “Sonic Foundry’s world- class reputation, legacy of innovation and rich features, including live HD streaming, ubiquitous mobile playback and a robust video content management system, set the company apart and establish it as the uncontested leader for lecture capture. Sonic Foundry’s outstanding performance inspires participants in the lecture capture solutions market to strive for new levels of success. The company’s unique competitive perspective provides its worldwide customer base with technologies that dramatically enhance on-campus, blended and distance learning initiatives.” Mediasite has also been voted best in class in five consecutive Streaming Media Readers’ Choice Awards and named 2011 Best Video Capture, Production and Publishing Solution by eLearning! Magazine. Sonic Foundry solutions in higher education: Among post-secondary institutions, Mediasite is used for: • Online lectures (blended/hybrid learning): students review content outside of in-class instruction • Flipped classroom instruction: students view lectures from home and use classroom time for discussion • Distance learning: off-campus students learn remotely online • Continuing education: professionals learn online or supplement classroom experiences • Special events: commencement, guest speakers, sporting events • Faculty training and development • Recruitment and orientation: campus tours, financial aid instructions • University business: leadership meetings, alumni relations, outreach Through interviews, many higher education institutions report that Mediasite: • • Enables their institution to remain competitive by supporting higher enrollment and/or tuition without new Improves student learning outcomes classrooms • Empowers faculty with technology supporting new teaching pedagogies both in the classroom and online • Boosts campus outreach, recruitment efforts and awareness of campus events Given the technology pedigree of today’s college students, this move to online learning makes perfect sense as these students have never known a world without computers, mobile devices and the web. The delivery options for a modern education are akin to the electronic delivery of music that emerged several years ago. Students demand immediate access to their coursework regardless of time or place. Recent trends impacting the economy and lingering high fuel prices continue to drive more students, particularly adult learners, to online education – through enrollment in blended or hybrid courses with a traditional on-campus component or through fully online distance learning programs. Historically, graduate programs and STEM (science, technology, engineering and math)-oriented degree programs in schools of medicine, nursing, engineering or business have comprised the majority of our academic customer base. We are now experiencing heightened market demand for lecture capture within undergraduate and community college programs as well. According to the Sloan Consortium report, Going the Distance: Online Education in the United States, 2011, online enrollments the past several years have been growing considerably. The 10 percent growth rate for online enrollments far exceeds the less than one percent growth of the overall higher education student population. The survey of more than 2,500 colleges and universities nationwide finds more than 6.1 million students were enrolled in at least one online course in the fall 2010 term, 560,000 more than in the fall 2009 term. Sixty-seven percent of academic leaders report that online learning is as good as or better than face-to-face instruction. Three-quarters of institutions also report that the economic downturn has increased demand for existing online courses and programs. Sixty-five percent of all reporting institutions now say that online learning is a critical part of their long term strategy, with 31 percent of all higher education students now taking at least one course online. Community colleges, specifically, have significantly increased their number of blended or hybrid and web-enhanced courses. The Instructional Technology Council’s “2011 Distance Education Survey Results: Trends in eLearning: Tracking the Impact of eLearning at Community Colleges (April 2012)” reported an 8.2 percent increase in distance 8 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 education enrollments, higher than the less than one percent increase in overall higher education campus enrollment. Twenty-seven percent of community colleges offer blended/hybrid courses, and fifty-five percent continue to increase the number of blended/hybrid courses each term. Factors cited for contributing to the increase in elearning enrollments include downturn in the economy (22 percent), typical growth for distance education classes (28 percent) and new enrollment initiatives (14 percent). The study also showed that overall, 68 percent of community colleges offer audio/video streaming, and another 12 percent plan to offer audio/video streaming in the next year. According to The Campus Computing Project’s Campus Computing2011: The National Survey of Computing and Information Technology in American Higher Education, 66 percent of all universities indicated that they already have or are currently preparing a strategic plan for lecture capture In their 2011 21st Century Campus Report (July 2011), CDW-G reports that 72 percent of faculty and 66 percent of students believe digital content is considered essential to a 21st century classroom. Of IT professionals surveyed, 68 percent of institutions currently offer virtual learning opportunities. Analysts predict the lecture capture market will more than triple over the next six years. Frost & Sullivan analysts estimate lecture capture revenues will reach over $192 million by 2016, exhibiting a nearly 22 percent compound annual growth rate (CAGR) for the six-year period (World Lecture Capture Solutions Markets report, 2010). Wainhouse Research predicts in “Market Sizing & Forecast 2011-2016: Lecture Capture & Streaming for Education & Training” (December 2011), “Lecture capture and streaming tools are now reaching a stage of maturity and usability that presages mainstream adoption. In fact, lecture capture – by the end of the forecast period in this report, 2016 – is likely to be as pervasive as email on college campuses.” Several universities have conducted their own independent studies to assess the impact of Mediasite on student performance. Last year, the University of Maryland-Baltimore Dental School announced new independent survey results demonstrating the positive impact of Mediasite on student outcomes. A Mediasite campus since 2006, the school compiled several years of student surveys after amassing five-thousand captures with half a million views. The latest results come from feedback by 118 graduating seniors and are available in the webinar, “Evaluating Lecture Capture's Impact on Student Outcomes” which can be viewed at http://sofo.com/ada52. A survey of dental students results reveal: • • • • • • • 97% felt Mediasite made it easier to learn 73% used a combination of in-class lectures and Mediasite to enhance their studies 98% indicated they watched most or all of the lectures online 40% said Mediasite helped them prepare for the boards 50% agreed or strongly agreed that lecture capture attracted them to the dental school 74% would recommend the dental school to potential students because of Mediasite 95% expressed satisfaction with Mediasite This finding and additional findings from independent research projects at other universities and colleges are published in the ebook, “Evaluating the Impact of Mediasite Lecture Capture on Retention, Recruitment and Student Satisfaction” which can be downloaded at http://bit.ly/PlZjyJ. 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 multimedia 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 large lecture halls, auditoriums 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®, Moodle, Instructure, Desire2Learn®, Angel, or Sakai 9 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 students’ single-source portal for all course-related materials including recorded multimedia content like online lectures. Mediasite’s packaged integrations for Blackboard and Moodle and its support for the Basic Learning Tools Interoperability (LTI) standard, address the need to make learning content accessible to students when and where they need it. Similarly, video content management platforms are starting to emerge as repositories for campus’ media-centric content. These platforms provide additional opportunities through which to make Mediasite content accessible to faculty, staff and students. Sonic Foundry Solutions in the Enterprise: Within medium to large corporate, healthcare and government enterprises, Mediasite has numerous applications. In corporate enterprises it is used for: • Executive communications: state of the enterprise speeches, all-hands meetings • Workforce development: training, HR briefings, policy documentation • Sales and marketing: demonstrations, product announcements, webinars, channel relations • • Customer support: product tutorials, self-guided troubleshooting • Investor relations: earnings calls, analyst briefings, annual reports • Conferences and events: user group, sales and annual meetings Internal knowledge repositories: technical training, research collaboration, user-generated content In health-related enterprises it is used for: • Education: continuing medical education, grand rounds, seminars, student/patient simulations, surgical training • On-demand medical information • Caregiver training • Emergency response coordination • Public health announcements • Research and collaboration • Conferences and events In government agencies it is used for: • Program management: relief work, military coordination, emergency preparedness • Community outreach: committee meetings, public safety announcements • Training, workshops and events • Executive and legislative communications: constituent relations, public speeches, debates Through interviews across these verticals, enterprise customers report that Mediasite: • Expands training and communications opportunities o Enables them to offer training to more and larger audiences o Captures knowledge from a retiring workforce o Supports the creation and sharing of user-generated content o Aides in building a knowledge library o Extends the life of conferences and events • Cuts travel and meeting expenses • Boosts efficiency by allowing participants to watch when it’s convenient to avoid interruptions and increase retention • Helps build stronger teams through direct management/employee communications Less than a decade ago, the only people in the enterprise talking openly about online multimedia were audiovisual specialists in information technology or media services units, and even these people were skeptical about what benefits streaming would hold for the enterprise. Now, executives, event planners and people in training, sales, human resources and research and development are pushing for online multimedia and webcasting as part of their e- learning initiatives. They need to be seen and heard by their colleagues, and the return on investment (ROI) for multimedia online learning is real and measurable. 10 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 Matt Brown, senior analyst for Forrester Research wrote in the April 11, 2011 report, Market Overview: Video Platforms For The Enterprise, “[Content and collaboration] pros planning video initiatives should look beyond just videoconferencing when they consider the benefits of video. Streaming video, for example, is less taxing on the network — particularly for ad hoc, on-demand use — and is more scalable to a large audience of employees, customers, and partners.” He further reported that “video platforms are designed for a broad set of enterprise uses. Among others, common capabilities include: • Capture live or ingest pre-recorded video • Manage workflow and content rules deliver live or on-demand video to three screens • Engage with video content during and after viewing • Report on video performance and viewership” In its 2011 report, World Enterprise Video Webcasting Solutions Market, industry analyst Frost & Sullivan cites several drivers contributing to the growth of the worldwide enterprise video webcasting market: • Video webcasting allows enterprises to reduce costs and enhance communication • Video webcasting is increasingly cheaper to deploy • Video webcasting integrated into the enterprise portal helps enhance shelf life of video content • Maturing capabilities of enterprise IT departments help drive buy-in for video webcasting deployments • Interactive functionality including tools for reporting and analytics enhance the value proposition of enterprise video webcasting The technology market for enterprise webcasting solutions that support many e-learning and business communications initiatives is growing as well. In Wainhouse Research’s, 2012 Enterprise Streaming Solutions Market Sizing & 5-Year Forecast (August 2012), senior analyst and partner Ira Weinstein and Steve Vonder Haar, senior analyst, estimate the enterprise streaming solutions market (which includes content capture and management solutions and related services for installation, training and support) totaled $470 million in 2011. According to the report, this market will expand to more than $1 billion by 2016 with Weinstein projecting a CAGR for the period around 19 percent; a growth rate that will see the absolute size of the market nearly double. In the 2012 Enterprise Webcasting Services Market Size & 5-Year Forecast, also by Wainhouse Research, Weinstein and Vonder Haar reported the actual spending on the webcasting services market for hosted streaming application platforms supporting live virtual events (specifically excluding web conferencing offerings and consumer-focused video streaming services) exceeded $350 million in 2011. By 2016, Weinstein and Vonder Haar predict the market will expand to $920 million. Future Directions Because webcasting, lecture capture and video are becoming an everyday part of the way people work and learn, we are driven to shorten the time it takes people to not only capture and share their information but to also quickly find and effectively manage it. As a company, we are helping create and manage the video libraries of tomorrow. Supporting this vision, our ongoing innovations center on: • Advancing enterprise video content management to accommodate organizations’ existing digital video assets, content generated from third-party solutions and the corresponding metadata associated with those video assets. • Offering expanded content capture solutions that test the limits of capturing multiple high definition video sources. • Continuing to introduce the industry’s widest assortment of content capture solutions that scale even more economically across entire organizations, allowing anyone to record and share their knowledge or expertise from their desktop. • Expanding and automating Mediasite’s powerful multi-modal search capabilities. • Supporting ubiquitous and interactive content playback on all popular mobile devices. • Deepening integration with core enterprise platforms including learning and course management systems (LMS/CMS), content management repositories, online learning portals and student information systems (SIS). 11 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 • Continuing to introduce innovations to our cloud-based or Software as a Service (SaaS) offering for Mediasite – an increasingly attractive alternative to on-premises deployments that seek to minimize IT challenges and risk while affordably extending high performance, fault tolerant webcasting services. Segment Information We have determined that in accordance with FASB ASC 280-10, 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. We have included the cash effect of billings not recorded as revenue, which are deferred for GAAP purposes, in arriving at non-GAAP net income or loss. Our services are typically billed and collected in advance of providing the service which requires minimal cost to perform in the future. Billings are a better indicator of customer activity and cash flow than revenue is, in management’s opinion, and is therefore used by management as a key operational indicator. Billings is computed by combining revenue with the change in unearned revenue. Total billings for Mediasite product and support outside the United States totaled 27 percent and 25 percent in fiscal 2012 and 2011, respectively. Our largest individual customers are typically value added resellers (“VARs”) and distributors since the majority of our end users require additional complementary products and services which we do not provide. Accordingly, in fiscal 2012 and 2011 one master distributor, Synnex Corporation (“Synnex”), contributed 18 percent and 24 percent, respectively, of total world-wide billings. A second master distributor, Starin Marketing, Inc. (“Starin”), contributed 25 percent and 26 percent of total world-wide billings in fiscal 2012 and 2011, respectively. As master distributors, Synnex and Starin fulfill transactions to VARs, end users and other distributors. No other customer represented over 10 percent of billings in 2012 or 2011. Sales We sell and market our offerings through a sales force that manages a 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 2012, we utilized two master distributors in the U.S. and approximately 130 resellers, and sold our products to over 1,100 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, event planners and leaders who have a routine need to communicate to many people in higher education, government, health and certain corporate markets. Despite our primary attention on the United States market, reseller and customer interest outside the United States has grown and accordingly, we allocate five sales professionals to address international demand. To date, we have sold our products to customers in over 50 countries outside the United States. Total billings for Mediasite product and support outside the United States totaled 27 percent and 25 percent in fiscal 2012 and 2011, respectively. Vertical market expansion: Over half our revenue is realized from the education market. Recent trends such as 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 demonstrating 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 our higher education as well as corporate, government and association clients, we anticipate weak 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 turnkey event webcasting, comprehensive hosting/Software as a Service (SaaS), and e-commerce capabilities that position us well to deliver more diversified business services. 12 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 With our Mediasite Events group, we continue to see growing demand for conference webcasting and hybrid events (conferences which combine both face-to-face meeting and viewing over the web). 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 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 2012, 81 percent of billings were to preexisting customers compared to 67 percent in fiscal 2011. Renewals: As is typical in the industry, we offer annual support and maintenance service contract extensions for a fee to our customer base. Nearly all customers purchase a Customer Assurance plan with their initial Mediasite Recorders and Servers, and the majority renew their contracts annually. Marketing Marketing efforts span the spectrum of thought leadership and best practices webinars, tradeshows, product demonstrations, websites, public relations, social media, direct mail, e-mail campaigns, newsletters, print and online advertising, sponsorships, Mediasite User Group community building, annual user conference, brochures, white papers and analyst relations. We often request and receive press release quotes and written or multimedia testimonials from satisfied, high-profile reference customers, particularly those that demonstrate innovative and valuable uses of the Mediasite platform and Mediasite Events. 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 for our Mediasite Recorders and purchase quantities sufficient to fill specific customer orders, including purchases of inventory by resellers. Quantities are maintained in inventory by the 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 believe there are alternative sources of manufacturing for our recorders and believe there are numerous additional sources and alternatives to the existing production process. We have experienced delays in production of our products and component parts used in our products in the past and expect to maintain greater quantities of inventory in the future to mitigate the risk of such delays. To date, we have not experienced any material returns due to product defects. OTHER INFORMATION Competition Various vendors provide lecture capture, enterprise webcasting or video content management capabilities, but few offer an end-to-end solution that addresses all phases of the video content lifecycle (capture, delivery and management) in a single platform like Mediasite. Lecture capture solutions designed specifically for higher education differ in their technology approach. • Appliance- or room-based lecture capture provides a fully integrated system with complete recording automation for live or on-demand content. The automated, pre-scheduled workflow results in the greatest faculty and staff adoption and largest volumes of recorded content in the shortest amount of time. • Software-based lecture capture that resides on a podium or computer in the classroom also captures and publishes rich media content, but relies on campus- or user-supplied hardware. 13 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 • Desktop capture tools reside on individual users’ laptops or computers allowing them to record user-generated content. Few lecture capture vendors, like Sonic Foundry and Echo360, offer a mix of lecture capture approaches to best suit customers’ needs. Most vendors, including Crestron, Panopto, TechSmith and Tegrity, support only one approach to lecture capture. Likewise, a very small number of vendors provide an integrated platform to archive and manage video and rich media recorded with their solution. Most rely on a third-party platform, typically the institution’s learning or course management system, to publish and secure content. Enterprise video management solutions (e.g. Brightcove, Kaltura) serve as centralized media repositories that facilitate the delivery, publishing and management of on-demand video. Unlike Mediasite, most platforms do not include a video capture, webcasting or live streaming component, but instead ingest or import video-based content captured by other third-party devices or solutions. Some current and potential customers develop their own home-grown lecture capture, webcasting or video content solutions which may also compete with Mediasite. However, we often find many of these organizations are now looking for a commercial solution offering comprehensive management capabilities, less internal maintenance and resources, and a less cumbersome workflow. Solutions that are designed primarily to address other online communication needs sometimes compete with Mediasite. Often these solutions are complementary to Mediasite and are integrated with the Mediasite solution as follows: • Web conferencing (e.g. Adobe, Cisco WebEx and Citrix). These solutions are designed primarily for one-to-few or group collaboration online versus one-to-many communications like Mediasite. Many organizations acknowledge that they need both technologies to appropriately address their different communication requirements. In a growing number of instances, customers are ingesting their recorded web conferencing content into the Mediasite EX platform. • Video conferencing (e.g. Polycom and Cisco TANDBERG). Similar to web conferencing, these solutions are designed primarily for one-to-few or group communications with high levels of interactivity and collaboration. Similarly, many organizations integrate their video conferencing endpoints with Mediasite to record and manage interactive meetings, discussions and distance learning courses alongside their Mediasite content. • Authoring tools (e.g. TechSmith). Unlike webcasting, web conferencing or video conferencing, which capture and stream content as it occurs in real-time, these tools are used to produce and edit on-demand multimedia content. Content authors integrate audio, video, images, branding and other visual elements into a presentation which can then be published for distribution. The authoring process can require a significant amount of production effort and user expertise. Mediasite is capable of ingesting content produced by popular authoring tools like TechSmith’s Camtasia Relay – allowing the content to be delivered, managed and secured alongside all other Mediasite content. • Virtual meeting platforms (e.g. INXPO, ON24, InterCall Unisfair). These companies offer cloud-based virtual event solutions for online conferences, tradeshows and meetings. The platforms often include the ability to embed or link to streaming video or webcasts within the interactive environment, however they do not provide the streaming video directly. 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. Currently four U.S patents have been issued to us and we may seek additional patents in the future. We do not know if 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 our patents which have been issued 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, 14 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 when appropriate, for those aspects of our technology that we believe constitute innovations providing significant competitive advantages. 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 four 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 or may be required to defend against alleged infringement claims filed against our customers due to indemnification agreements. 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. 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 each of the fiscal years ended September 30, 2012 and 2011, we spent $4.1 million and $3.5 million, respectively, on internal research and development activities in our business. These amounts represent 16% and 14%, respectively, of total revenue in each of those years. The increase reflects our decision to accelerate development on identified new products as well as enhancements to existing products. Employees At September 30, 2012 and 2011, we had 109 and 94 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. 15 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 global economic crisis experienced since 2008 and any continuing unfavorable economic conditions have negatively affected, and could continue to negatively affect, our business, operating results or financial condition, which could in turn affect our stock price. Weak economic conditions and the resulting impact on the availability of public funds along with the possibility of state and local budget cuts and reduced university enrollment could lead to a reduction in demand for our products and services. In addition, a prolonged economic downturn could cause insolvency of key suppliers resulting in product delays, inability of customers to obtain credit to finance purchases of the Company’s products and inability or delay of our channel partners and other customers to pay accounts receivable owed to us. Economic conditions may have a disproportionate effect 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 cost of 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 institutions due to budgetary constraints may have a disproportionate impact on the Company and result in a material adverse impact on our financial condition. Multiple unit deals are needed for continued success. We need to sell multiple units to educational, corporate and government institutions in order to sell most efficiently and remain profitable. In fiscal 2012, 81% of revenue was to existing customers compared to 67% in fiscal 2011. In particular, sales of multiple units to corporate customers have lagged behind 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. Manufacturing disruption or capacity constraints would harm our business. We subcontract the manufacture of our recorders to one third-party contract manufacturer. Although we believe there are multiple sources of supply from other contract manufacturers as well as multiple suppliers of component parts required by our contract manufacturer, a disruption of supply of component parts or completed products, even if short term, would have a material negative impact on our revenues. Many component parts currently have long delivery lead times and some suppliers cease production of certain components with limited notice in which to evaluate or obtain alternate supply, both require careful estimation of production requirements. Lengthening lead times, product design changes and other third party manufacturing disruptions have caused delays in delivery. In order to compensate for supply delays, we have sourced components from off-shore sources, used cross component 16 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 parts, paid for expediting and currently hold substantially larger quantities of inventory than in the past. Many of these strategies have increased our costs and may not be sufficient to ensure against production delays. We depend on our subcontract manufacturers to produce our products efficiently while maintaining high levels of quality. Any manufacturing defects, delay in production or changes in product features will likely cause customer dissatisfaction and may harm our reputation. 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. We may need to raise additional capital. At September 30, 2012 we had cash of $4.5 million and availability under our line of credit facility with Silicon Valley Bank of $2.8 million. The Company has historically financed its operations primarily through cash from sales of equity securities, and to a limited extent, cash from operations and, through bank credit facilities. The Company has a history of operating losses and historically used cash in operations prior to fiscal 2010. The Company improved both metrics with a combination of increased revenue and expense reductions over the last several fiscal years and while we expect to continue to increase revenue in fiscal 2013 and manage our expense growth to a level less than anticipated growth in revenues, we cannot ensure that revenue will grow as anticipated and if revenue is determined to be growing at a rate less than anticipated, it may be too late to reduce expenses for fiscal 2013. The Company believes its cash position and available credit is adequate to accomplish its business plan through at least the next twelve months. We may evaluate further operating or capital lease opportunities or incur additional term debt to finance equipment purchases in the future and may utilize the Company’s revolving line of credit to support working capital needs. While the Company anticipates that it will be in compliance with all provisions of our debt facilities, there can be no assurance that the existing debt facilities will be available to the Company or 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 only recently achieved profitability. While we reached profitability in fiscal 2012 and generated cash from operations of $350 thousand, we may not realize sufficient revenues to sustain profitability on a quarterly or annual basis. For the year ended September 30, 2012, we had a gross margin of $18.8 million on revenue of $26.1 million with which to cover selling, marketing, product development and general and administrative costs. Our selling, marketing, product development and general and administrative 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. Fluctuations in profitability or failure to maintain profitability will likely impact the price of our stock. 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 17 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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. The severe economic downturn experienced in the U.S. and globally has caused many of our clients to experience severe budgetary pressures, which has and will likely continue to have a negative impact on sales of our products. Continuing unfavorable economic conditions may result in further budget cuts and lead to lower overall spending, including information technology spending, by our current and potential clients, which may cause our revenues to decrease. 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 sufficient 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, product enhancements or service offerings that address future needs of our target markets and to respond to these changing standards and practices. The success of new products, product enhancements or service offerings depend on several factors, including the timely completion, quality and market acceptance of the product, enhancement or service. Our revenue could be reduced if we do not capitalize on our current market leadership by timely developing innovative new products, product enhancements or service offerings that will increase the likelihood that our products and services will be accepted in preference to the products and services of our current and future competitors. 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 campaigns 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 cycles are 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. Our largest potential sources of revenue are 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. In addition, educational institutions that started with small pilots are committing to more complex installations. Further, our educational market is expanding to include undergraduate classrooms, which, due to the increased size of these types of transactions, typically require a longer sales cycle. Also, our enterprise 18 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 accounts are less motivated by seasonal sales and promotions, and therefore are frequently difficult to finalize. As a result of these factors, our sales and deployment cycles are unpredictable. Our sales and deployment cycles is also 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, particularly with customers or potential customers that rely on government funding. Our products are aimed toward a broadened user base within our key markets and these products are relatively early in their product life cycles. 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. As such, we believe that quarter-to-quarter comparisons of our revenues, operating results and cash flows may not be meaningful and should not be relied upon as an indication of future performance. 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 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, our event business is particularly unpredictable and subject to variation due to the short time-frame between when we learn of an opportunity and when the event occurs. Further, the majority of our product orders are received in the last month of a quarter; thus, the unpredictability of the receipt of these orders could negatively impact our future results. We historically have received all or nearly all our channel partner orders in the last month of a quarter and often in the last few days of the quarter. Accordingly, any significant shortfall in demand for our products or services in relation to our expectations, even if the result was a short term delay in orders, 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 software 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 more recurring revenue. We subcontract for some services required by our events customers, such as close captioning, and charge for such services at a lower margin than other services. The percentage of billings represented by services, provided either directly or indirectly, is also likely to fluctuate from quarter to quarter due to seasonality of event services and other factors. Since hosting and support 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 increase in the percentage of our billings for deferred services. 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 distributors such as Synnex Corporation and Starin Marketing, Inc., as well as 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 long- term continuation or increase, in global economic uncertainty and downturn in technology spending, the volume of 19 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 two 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 these two 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, we would not be able to recognize revenue until these two distributors sell the inventory to the final end user which would have a material adverse effect on revenues in the period covered by that change. We depend in part on the success of our relationships with third-party resellers and integrators. Our success depends on various third-party relationships, particularly in our non-higher education business and with our international and events services operations. The relationships include third party resellers as well as system integrators that assist with implementations of our products and sourcing of our products and services. Identifying partners, negotiating and documenting relationships with them and maintaining their relationships require significant time and resources from us. In addition, our agreements with our resellers and integrators are typically non- exclusive and do not prohibit them from working with our competitors or from offering competing products or services. We have limited control, if any, as to whether these strategic partners devote adequate resources to promoting, selling and implementing our products as compared to our competitor’s products. Our competitors may be effective in providing incentives to third parties to favor their products or services. If we are unsuccessful in establishing or maintaining our relationships with these third parties, our ability to compete in the marketplace or to maintain or grow our revenue could be impaired and our operating results would suffer. 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, 43% of our billings in 2012 were to Synnex Corporation and Starin Marketing Inc., two master distributors who fulfill demand from other distributors, VARs 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, Starin, or other large distributors or VARs, could have a material impact on the collections of our receivables during a particular quarter. We offer credit terms to some of our international customers; however, payments tend to go beyond terms in certain countries and advances allowable on accounts receivable from international customers under our revolving line of credit are calculated using a lower advance rate than domestic receivables and are limited to $500 thousand. Therefore, as Europe, Asia and other international regions grow, accounts receivable balances will likely increase as compared to previous years and our ability to finance the increase will be limited. 20 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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, some of which are new, as well as varied interpretations and implementation practices for such rules. These rules require us to apply judgment in determining revenue recognition in certain situations. Factors that are considered in revenue recognition include those such as vendor specific objective evidence (VSOE), best estimate of selling price and the inclusion of other services and contingencies to payment terms. We expect that we will continue to defer portions of our service billings because of these factors, and to the extent that management’s judgment is incorrect it could result in an increase in the amount of revenue deferred in any one period. The amounts deferred may also be significant and may vary from quarter to quarter depending on the mix of products sold or contractual 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, deteriorating economic conditions 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 have ranged from less than one month to 48 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 and have a negative impact on our operations. The market for our products and services is intensely competitive, dynamic and subject to rapid technological change. The intensity of the competition and the pace of change are expected to increase in the future. Increased competition is likely to result in price reductions, reduced gross margins and loss of market share, any one of which could seriously harm our business. Competitors vary in size and in the scope and breadth of the products and services offered, many of which have greater financial resources, longer operating histories, greater name recognition, more employees and greater financial, technical, marketing, public relations and distribution resources than we have. In addition, new competitors with greater financial resources may arise through partnerships, distribution agreements, mergers, acquisitions or other types of transactions at any time. In particular, large companies have begun to make investments in and/or partner with smaller companies to enter the lecture capture market. We encounter competition with respect to different aspects of our solution from a variety of sources including: 21 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 • Web conferencing solutions (e.g. 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. • Video conferencing solutions (e.g. Polycom, TANDBERG (now Cisco) and Sony). These solutions are designed primarily for one-to-one or group-to-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. • Authoring tools solutions (e.g. Polycom Accordent PresenterPLUS and TechSmith Camtasia ). 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. Mediasite is capable of ingesting content produced by popular desktop tools like TechSmith’s Camtasia Relay or in video formats like Windows Media or H.264, allowing the content to be delivered, managed and secured alongside all other Mediasite content. • Online video services and virtual meeting platforms (e.g.INXPO, Livestream, ON24, Onstream Media, InterCall, Thomson Reuters, Unisfair and Wall Street Webcasting). These companies offer services or SaaS-based platforms that either allow audio and video to be captured from a presenter’s computer (often with supporting materials uploaded in advance), produced streaming video services or 2D/3D virtual environments that may or may not include rich media webcasts. Other vendors such as Echo360, Tegrity, Panopto, TechSmith, Crestron and Accordent Technologies (now Polycom), provide lecture capture or webcasting capabilities, but differ in their technology approach, particularly in the lecture capture arena. Mediasite is an appliance- or room-based platform for lecture capture. It provides a fully integrated system designed around an automated purpose-built recording appliance to capture, publish and manage rich media content. This transparent recording automation means no presenter intervention which leads to the broadest end-user adoption across campuses. Room-based appliances are capable of streaming live or on-demand and can leverage the full breadth of in-room audio/visual technology. A room-based platform like Mediasite also includes complete content management for captured multimedia presentations. Other lecture capture solutions are implemented as software applications designed to capture and publish rich media content, but dependent upon a third-party content management platform, typically the institution’s course management system. Software applications for lecture capture support on-demand streaming only and require in-room PC integration with varying levels of presenter intervention and recording knowledge which may lead to lower adoption rates throughout a given campus. Lastly, laptop-resident desktop tools capture and publish non-rich media (limited video and presentation graphics) and like software applications support only on-demand streaming and require a third-party content management platform. Desktop tools require the greatest degree of presenter intervention, technical confidence and support. While desktop tools are prevalent on many campuses, these three factors limit its practicality for campus-wide adoption. The competitive environment may require us to make changes in our products, pricing, licensing, services, or marketing to maintain and extend our current technology. Price concessions or the emergence of other pricing, licensing, and distribution strategies or technology solutions of competitors may reduce our revenue, margins or market share. Other changes we have to make in response to competition could cause us to expend significant financial and other resources, disrupt our operations, strain relationships with partners, release products and enhancements before they are thoroughly tested or result in customer dissatisfaction, any of which could harm our operating results and stock price. 22 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 If potential customers or competitors use open source software to develop products that are competitive with our products and services, we may face decreased demand and pressure to reduce the prices for our products. The growing acceptance and prevalence of open source software may make it easier for competitors or potential competitors to develop software applications that compete with our products, or for customers and potential customers to internally develop software applications that they would otherwise have licensed from us. One of the aspects of open source software is that it can be modified or used to develop new software that competes with proprietary software applications, such as ours. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. As open source offerings become more prevalent, customers may defer or forego purchases of our products, which could reduce our sales and lengthen the sales cycle for our products or result in the loss of current customers to open source solutions. If we are unable to differentiate our products from competitive products based on open source software, demand for our products and services may decline, and we may face pressure to reduce the prices of our products, which would hurt our profitability. If our use of open-source is challenged and construes unfavorably, our operating results could be adversely impacted. We use open source software in our application suite. Although we monitor our use of open source software closely, the terms of many open source licenses have not been interpreted by United States courts, and there is risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to re-engineer our technology or to discontinue offering all or a portion of our products in the event re-engineering cannot be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition. 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 and services to share confidential and sensitive information, the security of which is critical to their business. Third parties may attempt to breach our security for customer hosted content or the networks of our customers. Customers may take inadequate security precautions with their sensitive information and may inadvertently make that information public. 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, cause us to lose clients and sales to potential clients and 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 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. We have recently acquired additional hardware and systems and outsourced most aspects of our network infrastructure to two providers. As a result, we are reliant on third parties for network availability so outages may be outside our control and we may need to acquire additional hardware in order to provide an appropriate level of redundancy required by our customers. We license technology from third parties. If we are unable to maintain these licenses, our operations and financial condition may be negatively impacted. We license technology from third parties. The loss of, our inability to maintain, or changes in material terms of these licenses could result in increased cost or delayed sales of our software and services, or may cause us to remove features from our products or services. We anticipate that we will continue to license technology from third parties in the future. This technology may not continue to be available on commercially reasonable terms, if at all. Although 23 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 we do not believe that we are substantially dependent on any individual licensed technology, some of the component technologies that we license from third parties could be difficult for us to replace. The impairment of these third- party relationships, especially if this impairment were to occur in unison, could result in delays in the delivery of our software and services until equivalent technology, if available, is identified, licensed and integrated. This delay could adversely affect our operating results and financial condition. 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 have, and will in the future, 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:  Damage our reputation  Cause our customers to initiate product liability suits against us   Cause customers to cancel orders or potential customers to purchase competitive products or services  Delay release or market acceptance of our products, or otherwise adversely impact our relationships with Increase our product development resources our customers  Cause us to allocate valuable engineering resources to fix our existing products, which may cause us to allocate fewer resources toward developing new products, or toward adding features to our existing products 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. We have developed a lower cost desktop software product to better address that market segment. Our desktop software product has more limited features compared to our existing products. While we believe we can preserve the market for our full-featured products, release of our desktop software product could reduce demand for products sold at higher prices. 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 valuable 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 four U.S. patents that have been issued to us. We may seek additional patents in the future. However, it is possible that:  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  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 24 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012  We may not have the resources to enforce our patents or may determine the potential benefits are not worth the cost and risk of ultimately being unsuccessful We also rely upon trademark, copyright and trade secret laws, 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 four 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, it is possible that:  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  Contractual agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information  Other companies may claim common law trademark rights based upon state or foreign laws that precede the federal registration of our marks  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. 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, 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, particularly our Chief Executive Officer. Most of our officers and 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. As we seek to replace such departures, or expand our business, the hiring of qualified sales, technical and support personnel has been difficult due to the limited number of qualified professionals. 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 addition, we do not have life insurance policies on any of our key employees. If we lose the services of any of our key employees, the integration of replacement personnel could be time consuming, may cause disruptions to our operations and may be unsuccessful. 25 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 billings ranged from 25% to 27% of our total billings in each of the past two years and 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:    difficulties in establishing and managing international distribution channels or operations; difficulties in selling, servicing and supporting overseas products, translating products into foreign languages and compliance with local hardware requirements; the uncertainty of laws and enforcement in certain countries relating to the protection of intellectual property or requirements for product certification or other restrictions;  multiple and possibly overlapping tax structures;   currency and exchange rate fluctuations; difficulties in collecting accounts receivable in foreign countries, including complexities in documenting letters of credit; and economic or political changes in international markets. difficulty in complying with international employment related requirements   Our operating results may fluctuate due to our investment in Mediasite KK. We currently own approximately 23% of the common stock of Mediasite KK, our Japanese affiliate. Because our ownership interest exceeds 20%, our investment is accounted for under the equity method of accounting. This method requires us to record 23% of Mediasite KK's income or loss each quarter. However, due to our less-than- majority interest, we do not exercise control over Mediasite KK's operations. Therefore, a substantial portion of our overall profits and losses have been and will continue to be subject to events over which we have little control. If equity income had not been recorded, we would have incurred a loss of $263 thousand, rather than a profit of $157 thousand. 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 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 more strict 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, 2012, we had less than 1 thousand of outstanding warrants and 846 thousand of outstanding stock options granted under our stock option plans, 555 thousand of which are immediately exercisable. 26 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 or overseas 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. An acquisition could expose us to unexpected liabilities, regulations or costs, including tax or other regulatory items impacting repatriation of profits. 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 ability to utilize our net operating loss carryforwards may be limited. The use of our net operating loss carryforwards may have limitations resulting from certain future ownership changes or other factors under Section 382 of the Internal Revenue Code. If our net operating loss carryforwards are limited, and we have taxable income which exceeds the available net operating loss carryforwards for that period, we would incur an income tax liability even though net operating loss carryforwards may be available in future years prior to their expiration. Any such income tax liability may adversely affect our future cash flow, financial position and financial results. Our business is subject to changing regulations regarding corporate governance and public disclosure that will increase both our costs and the risk of noncompliance. 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, 2012 and we were therefore not required to have an auditor attestation on our internal controls over financial reporting for fiscal 2012, SEC rules may in the future require us to have such an attestation if our non-affiliate market capitalization exceeds a certain threshold. We cannot assure that in the future our management or our auditors, will not find a material weakness in connection with our internal control over financial reporting 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 27 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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, our stock price may 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.” 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 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 more strict 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. ITEM 1B. UNRESOLVED STAFF COMMENTS None ITEM 2. PROPERTIES Our principal office is located in Madison, Wisconsin in a leased facility of approximately 26,000 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 December 31, 2018. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. MINE SAFETY DISCLOSURES Not applicable 28 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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, 2009, 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, 2013: First Quarter (through December 6, 2012) Year Ended September 30, 2012: First Quarter Second Quarter Third Quarter Fourth Quarter Year Ended September 30, 2011: First Quarter Second Quarter Third Quarter Fourth Quarter High Low $ 8.18 $ 6.81 10.46 8.98 9.09 8.50 15.94 15.90 15.39 13.47 7.00 7.05 6.70 6.85 10.10 13.45 12.38 8.68 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 agreement with Silicon Valley Bank. At December 6, 2012 there were 383 common stockholders of record and approximately 6,000 total shareholders. Many shares are held by brokers and other institutions on behalf of shareholders. 29 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 Equity Compensation Plan Information Plan category Equity compensation plans approved by security holders (1) Equity compensation plans not approved by security holders (2) 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) 741,555 $ 11.37 646,426 104,725 10.71 - Total 846,280 $ 11.28 646,426 (1) Consists of the 2009 Stock Incentive Plan, Employee Incentive Stock Option Plan and the Directors Stock Option Plans. 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. The graph below compares the cumulative total stockholder return on our common stock from September 30, 2007 through and including September 30, 2012 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, 2007 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. 30 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN* Among Sonic Foundry, Inc., the NASDAQ Composite Index, and the RDG Technology Composite Index $140 $120 $100 $80 $60 $40 $20 $0 9/07 9/08 9/09 9/10 9/11 9/12 Sonic Foundry, Inc. NASDAQ Composite RDG Technology Composite *$100 invested on 9/30/07 in stock or 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 31 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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). All share and per share data have been adjusted for the one-for-ten reverse stock split which was effective on November 16, 2009. Statement of Operations Data: Revenue Cost of revenue Gross margin Operating expenses Income (loss) from operations Other income (expense), net Provision for income taxes Net income (loss) Basic net income (loss) per common share Diluted net income (loss) per common share 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 Years Ended September 30, 2012 2011 2010 2009 2008 $ 26,090 7,246 18,844 18,735 109 288 (240) $ 157 $ 25,222 7,311 17,911 17,633 278 (310) (211) $ (243) $ 20,476 5,065 15,411 15,138 273 (170) (225) $ (122) $ 18,577 4,331 14,246 16,724 (2,478) (25) (142) $ (2,645) $ 15,601 4,205 11,396 19,279 (7,883) 10 (256) $ (8,129) $ 0.04 $ (0.06) $ (0.03) $ (0.74) $ (2.28) $ 0.04 $ (0.06) $ (0.03) $ (0.74) $ (2.28) 3,857,161 3,907,888 3,748,840 3,748,840 3,617,423 3,617,423 3,598,040 3,598,040 3,557,966 3,557,966 2012 2011 2010 2009 2008 $ 4,478 3,332 22,821 3,748 10,539 $ 5,515 3,083 21,840 3,072 9,261 $ 3,358 1,442 18,267 3,202 7,137 $ 2,598 (344) 16,173 1,977 6,601 $ 3,560 774 17,474 1,610 8,455 32 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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: Impairment of long-lived assets;  Revenue recognition, allowance for doubtful accounts, and reserves;   Valuation allowance for net deferred tax assets; and  Accounting for stock-based compensation. 33 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 collectability 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 recorders and Mediasite related products such as server software revenue. Services The Company sells support and content hosting contracts to our customers, typically one year in length, and records 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 distribution partners, 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 manufacturers we contract with to build the units provide a limited one-year warranty on the hardware. 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. 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 The Company has historically applied the software revenue recognition rules as prescribed by Accounting Standards Codification (ASC) Subtopic 985-605. In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2009-14, “Certain Revenue Arrangements That Include Software Elements,” which amended ASC Subtopic 985-605. This ASU removes tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of the software revenue recognition rules. In the case of the Company’s hardware products with embedded software, the Company has determined that the hardware and software components function together to deliver the product’s essential functionality, and therefore, the revenue from the sale of these products no longer falls within the scope of the software revenue recognition rules. Revenue from the sale of software-only products remains within the scope of the software revenue recognition rules. Installation, training, and post customer support no longer fall within the scope of the software revenue recognition rules, except when they are sold with and relate to a software- only product. Revenue recognition for products that no longer fall under the scope of the software revenue recognition rules is similar to that for other tangible products. ASU Number 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amended ASC Topic 605 and was also issued in October 2009, is applicable for multiple-deliverable revenue arrangements. ASU 2009-13 allows companies to allocate revenue in a multiple- deliverable arrangement in a manner that better reflects the transaction’s economics. ASU 2009-13 and 2009-14 were adopted and are effective for revenue arrangements entered into or materially modified beginning in the Company’s fiscal year 2011. Under the software revenue recognition rules, the fee from a multiple-deliverable arrangement is allocated to each of the undelivered elements based upon vendor-specific objective evidence (VSOE), which is limited to the price 34 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 charged when the same deliverable is sold separately, with the residual value from the arrangement allocated to the delivered element. The portion of the fee that is allocated to each deliverable is then recognized as revenue when the criteria for revenue recognition are met with respect to that deliverable. If VSOE does not exist for all of the undelivered elements, then all revenue from the arrangement is typically deferred until all elements have been delivered to the customer. All revenue arrangements, with the exception of hosting contracts, entered into prior to October 1, 2010 and the sale of all software-only products and associated services have been accounted for under this guidance. Under the revenue recognition rules for tangible products as amended by ASU 2009-13, the fee from a multiple- deliverable arrangement is allocated to each of the deliverables based upon their relative selling prices as determined by a selling-price hierarchy. A deliverable in an arrangement qualifies as a separate unit of accounting if the delivered item has value to the customer on a stand-alone basis. A delivered item that does not qualify as a separate unit of accounting is combined with the other undelivered items in the arrangement and revenue is recognized for those combined deliverables as a single unit of accounting. The selling price used for each deliverable is based upon VSOE if available, third-party evidence (TPE) if VSOE is not available, and best estimate of selling price (ESP) if neither VSOE nor TPE are available. TPE is the price of the Company’s or any competitor’s largely interchangeable products or services in stand-alone sales to similarly situated customers. ESP is the price at which the Company would sell the deliverable if it were sold regularly on a stand-alone basis, considering market conditions and entity- specific factors. All revenue arrangements negotiated after September 30, 2010, excluding the sale of all software- only products and associated services, have been accounted for under this guidance. The selling prices used in the relative selling price allocation method are as follows: (1) the Company’s products and services are based upon VSOE and (2) hardware products with embedded software, for which VSOE does not exist are based upon ESP. The Company does not believe TPE exists for any of these products and services because they are differentiated from competing products and services in terms of functionality and performance and there are no competing products or services that are largely interchangeable. Management establishes ESP for hardware products with embedded software using a cost plus margin approach with consideration for market conditions, such as the impact of competition and geographic considerations, and entity-specific factors, such as the cost of the product and the Company’s profit objectives. Management believes that ESP is reflective of reasonable pricing of that deliverable as if priced on a stand-alone basis. When a sales transaction includes deliverables that are divided between ASC Topic 605 and ASC Subtopic 985-605, the Company allocates the selling price using the relative selling price method whereas value is allocated using an ESP for software developed using a percent of list price approach. The other deliverables are valued using ESP or VSOE as previously discussed. While the pricing model, currently in use, captures all critical variables, unforeseen changes due to external market forces may result in a revision of the inputs. These modifications may result in the consideration allocation differing from the one presently in use. Absent a significant change in the pricing inputs or the way in which the industry structures its deals, future changes in the pricing model are not expected to materially affect our allocation of arrangement consideration. Management has established VSOE for hosting services. Billings for hosting are spread ratably over the term of the hosting agreement, with the typical hosting agreement having a term of 12 months, with renewal on an annual basis. The Company sells most hosting contracts without the inclusion of products. When the hosting arrangement is sold in conjunction with product, the product revenue is recognized immediately while the remaining hosting revenue is spread ratably over the term of the hosting agreement. The selling price is allocated between these elements using the relative selling price method. The Company uses ESP for development of the selling price for hardware products with embedded software. 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 35 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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. Credit Evaluation and Allowance for Doubtful Accounts We assess the realization of our receivables by performing ongoing credit evaluations of our customers’ financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. Our reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. Our reserves are also based on amounts determined by using percentages applied to certain aged receivable categories. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. Allowance for doubtful accounts for accounts receivable was $85,000 at September 30, 2012 and $90,000 at September 30, 2011. Impairment of long-lived assets We assess the impairment of goodwill 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 FASB ASC 360-10. 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. 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 uses a lattice valuation model to account for all stock options granted. The lattice valuation model provides a 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 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. Forfeitures are based on actual behavior patterns. Recent Accounting Pronouncements In December 2010, FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts by requiring an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This update became 36 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 effective for fiscal years beginning after December 15, 2010. The Company’s adoption of ASU 2010-28 did not have a material impact on its consolidated financial statements. In May 2011, the FASB issued ASU 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRS”, which amends ASC 820. This update clarifies the existing guidance and amends the wording used to describe many of the requirements in US GAAP for measuring fair value and for disclosing information about fair value measurements. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with prospective application required. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements. In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in ASC 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The early adoption of this guidance during fiscal 2012 did not have a material impact on the Company’s consolidated financial statements. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company's financial statements upon adoption. 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 includes the sale of Mediasite recorders and server software products and related services contracts, such as customer support, installation, training, content hosting and event services. 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 fiscal 2012 totaled $26.1 million, compared to $25.2 million in fiscal 2011, an increase of 3%. Revenue consisted of the following: • Product revenue from the sale of Mediasite recorder units and server software decreased from $12.8 million in fiscal 2011 to $12.4 million in fiscal 2012. The product revenue decrease relates to an increase in discounted upgrade recorders sold to customers whose product had reached the end of hardware warranty eligibility (“refresh units”). Units sold Rack to mobile ratio Average sales price, excluding support (000’s) Refresh Units 2012 1,280 2.4 to 1 $9.4 434 2011 1,250 2.3 to 1 $9.6 327  Services revenue represents the portion of fees charged for Mediasite customer support contracts amortized 37 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 over the length of the contract, typically 12 months, as well as training, installation, event and content hosting services. Services revenue increased from $12.2 million in fiscal 2011 to $13.4 million in fiscal 2012 due primarily to an increase in event services as well as an increase in customer support contracts on Mediasite recorder units. At September 30, 2012 $5.6 million of revenue was deferred, of which we expect to recognize $5.3 million in the next twelve months, including approximately $2.2 million in the quarter ending December 31, 2012. At September 30, 2011, $6.0 million of revenue was deferred.  Other revenue relates to freight charges billed separately to our customers. Gross Margin Total gross margin in fiscal 2012 was $18.8 million or 72% compared to $17.9 million or 71% in fiscal 2011. Gross margin increased due to operational efficiencies in recorder and services costs and a decrease in direct and outsourced event labor costs with lower markups for services which the Company does not provide, such as closed captioning. These improvements were partially offset by a greater volume of discounted upgrade units for customers whose product had reached end of hardware warranty eligibility and by an increase in high definition material cost. The significant components of cost of revenue include:  Material and freight costs for the Mediasite recorders. Costs for fiscal 2012 Mediasite recorder hardware and other costs totaled $4.7 million compared to $4.8 million in fiscal 2011. Freight costs were $369 thousand and labor and allocated costs were $863 thousand in fiscal 2012 compared to $369 thousand and $813 thousand, respectively, in fiscal 2011.  Services costs. Staff wages and other costs allocated to cost of service revenues were $1.4 million in both fiscal 2012 and fiscal 2011, resulting in gross margin on services of 90% in fiscal 2012 and 89% in fiscal 2011. The Company expects the gross margin percentage to remain consistent or higher in fiscal 2013 as total revenue increases and as the Company benefits from manufacturing efficiencies anticipated in fiscal 2013. Operating Expenses Selling and Marketing Expenses Selling and marketing expenses include wages and commissions for sales, marketing, business development 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 or entrance into new markets, or participation in major tradeshows. Selling and marketing expense increased $1.1 million, or 10% from $10.76 million in fiscal 2011 to $11.84 million in fiscal 2012. Increases in the major categories include:  Salaries, incentive compensation, and benefits increased $246 thousand over the prior year due to slightly higher staff levels in fiscal 2012 compared to fiscal 2011.  Costs also increased by $144 thousand as a result of higher stock compensation expense and depreciation expense.  Tradeshow, market research and travel expense increased by $772 thousand due to an increase in the number of tradeshows and market research agreements. At September 30, 2012 we had 70 employees, excluding interns, in Selling and Marketing, an increase from 64 employees at September 30, 2011. We anticipate modest growth in Selling and Marketing headcount in fiscal 2013 to support future revenue growth. 38 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 General and Administrative Expenses General and administrative (“G&A”) expenses consist of personnel and related costs associated with the facilities, finance, legal, human resources and information technology departments, as well as other expenses not fully allocated to functional areas. G&A expenses increased slightly from $2.81 million in fiscal 2011 to $2.82 million in fiscal 2012. Professional services increased by $72 thousand, mainly due to an increase in investor relations services. This was partially offset by a decrease in compensation and benefits of $41 thousand. At September 30, 2012 and September 30, 2011 we had 6 full-time employees in G&A. We do not anticipate growth in G&A headcount in fiscal 2013. 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. R&D expenses increased $541 thousand, or 15%, from $3.54 million in fiscal 2011 to $4.08 million in fiscal 2012. Some significant differences include:  Increase in compensation and benefits of $540 thousand related to an increase in headcount and performance related incentive compensation.  Professional services decrease of $111 thousand, primarily related to payments made pursuant to a consulting agreement with our former chief technology officer during the second half of fiscal 2011.  Costs also increased by $122 thousand as a result of higher stock compensation expense and depreciation expense. At September 30, 2012 we had 33 employees, excluding interns, in Product Development compared to 24 employees at September 30, 2011. The increase in fiscal year 2012 headcount will result in an additional increase in R&D compensation cost in fiscal 2013 as the full year effect of the current level of headcount is realized. We anticipate a slight increase in R&D headcount in fiscal 2013. No fiscal 2012 or 2011 software development efforts qualified for capitalization. Severance Costs On September 30, 2011, Rimas Buinevicius resigned his position as Chief Strategy Officer, Executive Chairman of the Board, and Director. The Company agreed to pay Mr. Buinevicius, in equal bi-weekly installments over a one- year period, an amount equal to one and five hundredths (1.05) multiplied by the highest cash compensation paid to Mr. Buinevicius in any of the last three fiscal years immediately prior to his termination. Mr. Buinevicius’ unvested stock options also immediately vested on September 30, 2011 upon termination. The consulting agreement with Monty Schmidt, former Chief Technology Officer and Director, was also terminated in September 2011. The remaining six months of Mr. Schmidt’s consulting agreement along with Mr. Buinevicius’ one year severance agreement and immediately vested stock options total $528 thousand of expense and were fully recognized in fiscal 2011. These severance amounts were paid in full by September 30. 2012. Other Income (Expense), Net Under the equity method of accounting, we record our proportional share of earnings in Mediasite KK. We currently own approximately 23% of their common stock. We recorded $420 thousand of net equity in earnings during fiscal 2012. Other income included primarily interest income from investments in overnight investment vehicles. Lower interest rates led to a decrease in interest income from $6 thousand in fiscal 2011 to $2 thousand in fiscal 2012. Other expense primarily consists of interest costs related to outstanding debt and amortization of a debt discount. The refinancing of our debt obligations in the second half of fiscal 2011 was a driver of decreased interest expense 39 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 from $316 thousand in fiscal 2011 to $152 thousand in fiscal 2012. The primary driver of the decrease in interest expense was non-cash interest associated with the amortization of debt discount relating to the issuance of warrants of $142 thousand in fiscal 2011 and $32 thousand in fiscal 2012. The Company paid the balance of the note payable to Partners for Growth in October 2011. Provisions Related to Income Taxes The Company records a non-cash deferred tax liability related to goodwill acquired in 2001. The related income tax expense was $240 thousand for both fiscal 2012 and fiscal 2011. The Company netted an income tax credit of $29 thousand against this amount for fiscal 2011. LIQUIDITY AND CAPITAL RESOURCES We funded our operations primarily with cash generated from operations in fiscal 2012. On September 30, 2012 and 2011, we had cash and cash equivalents of $4.5 million and $5.5 million, respectively. Cash provided by operating activities totaled $350 thousand in fiscal 2012 and $1.4 million in fiscal 2011, a decrease of $1.1 million. Cash provided in fiscal 2012 was impacted by working capital changes including the negative effects of an increase in inventory of $517 thousand, a decrease in unearned revenue of $385 thousand and an increase of equity in earnings from investment in Mediasite KK of $420 thousand. These were offset by the positive effects of increases in accounts payable, accrued liabilities and other long-term liabilities of $601 thousand and a decrease in accounts receivable of $226 thousand. Cash provided in fiscal 2011 was impacted by working capital changes including the negative effects of a $746 thousand increase in accounts receivable and an increase in prepaid expenses and other assets of $307 thousand. These were offset by the positive effects of increases in accounts payable, accrued liabilities and other long-term liabilities of $999 thousand. Cash used in investing activities totaled $1.5 million in fiscal 2012 compared to cash used in investing activities of $739 thousand in fiscal 2011. Investing activities for each of these two years were due to purchases of property and equipment. Cash provided by financing activities in fiscal 2012 totaled $69 thousand compared to $1.5 million in fiscal 2011. Cash provided in fiscal 2012 was due primarily to proceeds from exercise of common stock options and issuance of common stock of $379 thousand and $1.2 million of proceeds from notes payable. This was mostly offset by $1.5 million of cash used for payments on notes payable and capital leases. Cash provided in fiscal 2011 was due primarily to proceeds from exercise of common stock options of $1.7 million and $800 thousand of proceeds from notes payable. This was partially offset by $985 thousand of cash used for payments on notes payable. The Company believes its cash position is adequate to accomplish its business plan through at least the next twelve months. We will likely evaluate operating or capital lease opportunities to finance equipment purchases in the future and anticipate utilizing the Company’s revolving line of credit to support working capital needs. We may also seek additional equity financing, or issue additional shares previously registered in our available shelf registration, although we currently have no plans to do so. On June 27, 2011, Sonic Foundry and its wholly-owned subsidiary (the “Companies”) entered into the Second Amended and Restated Loan and Security Agreement with Silicon Valley Bank (the “Second Amended Agreement”). Under the Second Amended Agreement, the revolving line of credit has a maximum principal amount of $3,000,000. Interest accrues on the revolving line of credit at the per annum rate of one percent (1.0%) above the Prime Rate (as defined), provided that Sonic Foundry maintains an Adjusted Quick Ratio (as defined) of greater than 2.0 to 1.0, or one-and-one half percent (1.5%) above the Prime Rate, if Sonic Foundry does not maintain an Adjusted Quick Ratio of greater than 2.0 to 1.0. The Second Amended Agreement does not provide for a minimum interest rate on the revolving loan. The Second Amended Agreement also provides for an increase in the advance rate on domestic receivables from 75% to 80%, and extends the facility maturity date to October 1, 2013. Under the Second Amended Agreement, the existing term loan continues to accrue interest at a per annum rate equal to the greater of (i) one percentage point (1.0%) above Silicon Valley Bank’s prime rate; or (ii) eight and three quarters percent (8.75%). In addition, a new term loan can be issued in multiple draws provided that the total term loan from 40 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 Silicon Valley Bank shall not exceed $2,000,000 and provided further that total term debt shall not exceed $2,400,000. Under the Second Amended Agreement, any new draws on the term loan will accrue interest at a per annum rate equal to the Prime Rate plus three and three quarters percent (3.75%). The Second Amended Agreement does not provide for a minimum interest rate on the new term loan. Each draw on the new term loan will be amortized over a 36-month period. All draws on the term loan were required to have been made within ten (10) months of June 27, 2011. The Second Amended Agreement also requires Sonic Foundry to continue to comply with certain financial covenants, including the maintenance of an Adjusted Quick Ratio (as defined) of at least 1.75 to 1.00 and of a Debt Service Coverage Ratio of at least 1.25 to 1.00, the latter of which will be waived if certain funds are reserved. The Company maintains the revolving line of credit with Silicon Valley Bank and has $2.8 million available for borrowing at September 30, 2012. Contractual Obligations The following summarizes our contractual obligations at September 30, 2012 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in thousands): Total Less than Years 2-3 Years 4-5 Contractual Obligations: Product purchase commitments Operating lease obligations Capital lease obligations (a) Notes payable (a) $ 1,317 3,981 274 1,541 1 Year $ 1,317 602 138 743 $ ─ 1,239 136 798 $ ─ 1,298 ─ ─ Over 5 years $ ─ 842 ─ ─ (a) Includes fixed and determinable interest payments 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 FASB ASC-815-10. 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 not significant due to the short-term nature of these investments. At September 30, 2012, all of our $1.4 million of debt outstanding is variable rate. We do not expect that an increase in the level of interest rates would have a material impact on our Consolidated Financial Statements. We monitor our positions with, and the credit quality of, the financial institutions that are party to any of our financial transactions. 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, 2012 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm 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, 2012 and 2011, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years then ended. Our audits of the basic consolidated financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). 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 and financial statement schedule 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. and subsidiary as of September 30, 2012 and 2011, and the results of their operations and their cash flows for each of the years then ended, 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 consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ GRANT THORNTON LLP Milwaukee, Wisconsin December 12, 2012 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 $85 and $90 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: Goodwill Investment in Mediasite KK Other intangibles, net of amortization of $180 and $137 Total assets Liabilities and stockholders' equity Current liabilities: Revolving line of credit Accounts payable Accrued liabilities Accrued severance Unearned revenue Current portion of capital lease obligations Current portion of notes payable Total current liabilities Long-term portion of unearned revenue Long-term portion of capital lease obligations Long-term portion of notes payable Other liabilities Deferred tax liability Total liabilities Commitments and contingencies Stockholders' equity: Preferred stock, $.01 par value, authorized 500,000 shares; none issued 5% Preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 1,000,000 shares, none issued Common stock, $.01 par value, authorized 10,000,000 shares; 3,909,040 and 3,845,531 shares issued and 3,896,324 and 3,832,815 shares outstanding Additional paid-in capital Accumulated deficit Receivable for common stock issued Treasury stock, at cost, 12,716 shares Total stockholders' equity Total liabilities and stockholders' equity See accompanying notes 43 September 30, 2012 2011 $ 4,478 5,578 1,053 757 11,866 $ 5,515 5,799 536 740 12,590 852 3,851 865 5,568 2,624 2,944 980 3,586 461 5,027 3,391 1,636 7,576 420 15 $ 22,821 7,576 - 38 $ 21,840 $ - 1,604 850 - 5,284 129 667 8,534 349 131 766 532 1,970 12,282 ─ ─ $ - 1,373 1,073 528 5,547 89 897 9,507 471 177 694 - 1,730 12,579 ─ ─ 39 189,459 (178,764) (26) (169) 10,539 $ 22,821 38 188,339 (178,921) (26) (169) 9,261 $ 21,840 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 Severance costs Product development Total operating expenses Income from operations Equity in earnings from investment in Mediasite KK Interest expense Other income, net Total other income (expense), net Income (loss) before income taxes Provision for income taxes Years Ended September 30, 2012 2011 $ 12,385 13,409 296 26,090 $ 12,784 12,187 251 25,222 5,883 1,363 7,246 18,844 11,841 2,815 - 4,079 18,735 109 420 (152) 20 288 397 (240) 5,957 1,354 7,311 17,911 10,755 2,811 528 3,539 17,633 278 - (316) 6 (310) (32) (211) Net income (loss) $ 157 $ (243) Income (loss) per common share: Basic net income (loss) per common share Diluted net income (loss) per common share Weighted average common shares – Basic – Diluted See accompanying notes $ 0.04 $ 0.04 $ (0.06) $ (0.06) 3,857,161 3,907,888 3,748,840 3,748,840 44 Sonic Foundry, Inc. Consolidated Statements of Stockholders' Equity For the Year Ended September 30, 2012 and 2011 (in thousands) Common stock Additional paid-in capital Accumulated Deficit Receivable for common stock issued Treasury stock Total $ 37 $185,973 $ (178,678) $ (26) $ (169) $ 7,137 ─ ─ 1 ─ 664 32 1,670 ─ ─ ─ ─ (243) ─ ─ ─ ─ ─ ─ ─ ─ 664 32 1,671 (243) 38 188,339 (178,921) (26) (169) 9,261 ─ ─ 1 ─ 742 134 244 ─ ─ ─ ─ 157 ─ ─ ─ ─ ─ ─ ─ ─ 742 134 245 157 $ 39 $189,459 $ (178,764) $ (26) $ (169) $ 10,539 Balance, September 30, 2010 Stock compensation and other Issuance of common stock Exercise of common stock warrants and options Net loss Balance, September 30, 2011 Stock compensation and other Issuance of common stock Exercise of common stock options Net income Balance, September 30, 2012 See accompanying notes 45 Sonic Foundry, Inc. Consolidated Statements of Cash Flows (in thousands) Operating activities Net income (loss) Adjustments to reconcile net income (loss) to net cash provided by operating activities: $ 157 $ (243) Years Ended September 30, 2012 2011 Equity in earnings from investment in Mediasite KK Amortization of other intangibles Depreciation and amortization of property and equipment Provision for doubtful accounts Deferred taxes Stock-based compensation expense related to stock options 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 provided by operating activities Investing activities Purchases of property and equipment Net cash used in investing activities Financing activities Net proceeds from (payments on) revolving line of credit Proceeds from notes payable Payments on notes payable Payments of loan fees Proceeds from issuance of common stock Proceeds from exercise of common stock warrants and options Payments on capital leases Net cash provided by financing activities Net increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Supplemental cash flow information: Interest paid Non-cash transactions: Property and equipment financed by accounts payable, accrued liabilities or capital lease See accompanying notes (420) 75 855 (5) 240 742 226 (517) (17) (601) (385) 350 (1,456) (1,456) — 1,200 (1,390) (20) 134 245 (100) 69 — 208 704 (15) 240 707 (746) (78) (307) 999 (55) 1,414 (739) (739) — 800 (985) (21) 32 1,671 (15) 1,482 (1,037) 5,515 $ 4,478 2,157 3,358 $ 5,515 120 752 174 330 46 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 wholly-owned subsidiary, Sonic Foundry Media Systems, Inc. All significant intercompany transactions and balances have been eliminated. In 2012 and 2011, net income (loss) equaled comprehensive income (loss) as there were no items of comprehensive income. Under the equity method of accounting, the Company’s investment in unconsolidated affiliates are initially recorded as an investment in the stock of an investee at cost and are adjusted on a quarterly basis for the carrying amount of the investment to recognize the investor’s share of the earnings or losses of the investee after the date of the initial investment. 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 collectability 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 and sale occurs. 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 our server software. Services The Company sells support and content hosting contracts to our customers, typically one year in length, and records 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 manufacturers the Company contracts with to build the units provide a limited one-year warranty on 47 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 the hardware. The Company also sells 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. 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 The Company has historically applied the software revenue recognition rules as prescribed by Accounting Standards Codification (ASC) Subtopic 985-605. In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2009-14, “Certain Revenue Arrangements That Include Software Elements,” which amended ASC Subtopic 985-605. This ASU removes tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of the software revenue recognition rules. In the case of the Company’s hardware products with embedded software, the Company has determined that the hardware and software components function together to deliver the product’s essential functionality, and therefore, the revenue from the sale of these products no longer falls within the scope of the software revenue recognition rules. Revenue from the sale of software-only products remains within the scope of the software revenue recognition rules. Installation, training, and post customer support no longer fall within the scope of the software revenue recognition rules, except when they are sold with and relate to a software- only product. Revenue recognition for products that no longer fall under the scope of the software revenue recognition rules is similar to that for other tangible products. ASU Number 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amended ASC Topic 605 and was also issued in October 2009, is applicable for multiple-deliverable revenue arrangements. ASU 2009-13 allows companies to allocate revenue in a multiple- deliverable arrangement in a manner that better reflects the transaction’s economics. ASU 2009-13 and 2009-14 were adopted and are effective for revenue arrangements entered into or materially modified beginning in the Company’s fiscal year 2011. Under the software revenue recognition rules, the fee from a multiple-deliverable arrangement is allocated to each of the undelivered elements based upon vendor-specific objective evidence (VSOE), which is limited to the price charged when the same deliverable is sold separately, with the residual value from the arrangement allocated to the delivered element. The portion of the fee that is allocated to each deliverable is then recognized as revenue when the criteria for revenue recognition are met with respect to that deliverable. If VSOE does not exist for all of the undelivered elements, then all revenue from the arrangement is typically deferred until all elements have been delivered to the customer. All revenue arrangements, with the exception of hosting contracts, entered into prior to October 1, 2010 and the sale of all software-only products and associated services have been accounted for under this guidance. Under the revenue recognition rules for tangible products as amended by ASU 2009-13, the fee from a multiple- deliverable arrangement is allocated to each of the deliverables based upon their relative selling prices as determined by a selling-price hierarchy. A deliverable in an arrangement qualifies as a separate unit of accounting if the delivered item has value to the customer on a stand-alone basis. A delivered item that does not qualify as a separate unit of accounting is combined with the other undelivered items in the arrangement and revenue is recognized for those combined deliverables as a single unit of accounting. The selling price used for each deliverable is based upon VSOE if available, third-party evidence (TPE) if VSOE is not available, and best estimate of selling price (ESP) if neither VSOE nor TPE are available. TPE is the price of the Company’s or any competitor’s largely interchangeable products or services in stand-alone sales to similarly situated customers. ESP is the price at which the Company would sell the deliverable if it were sold regularly on a stand-alone basis, considering market conditions and entity- specific factors. All revenue arrangements negotiated after September 30, 2010, excluding the sale of all software- only products and associated services, have been accounted for under this guidance. The selling prices used in the relative selling price allocation method are as follows: (1) the Company’s products and services are based upon VSOE and (2) hardware products with embedded software, for which VSOE does not exist, are based upon ESP. The Company does not believe TPE exists for any of these products and services because they are differentiated from competing products and services in terms of functionality and performance and there are no competing products or services that are largely interchangeable. Management establishes ESP for hardware products 48 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 with embedded software using a cost plus margin approach with consideration for market conditions, such as the impact of competition and geographic considerations, and entity-specific factors, such as the cost of the product and the Company’s profit objectives. Management believes that ESP is reflective of reasonable pricing of that deliverable as if priced on a stand-alone basis. When a sales transaction includes deliverables that are divided between ASC Topic 605 and ASC Subtopic 985-605, the Company allocates the selling price using the relative selling price method whereas value is allocated using an ESP for software developed using a percent of list price approach. The other deliverables are valued using ESP or VSOE as previously discussed. While the pricing model, currently in use, captures all critical variables, unforeseen changes due to external market forces may result in a revision of the inputs. These modifications may result in the consideration allocation differing from the one presently in use. Absent a significant change in the pricing inputs or the way in which the industry structures its deals, future changes in the pricing model are not expected to materially affect our allocation of arrangement consideration. Management has established VSOE for hosting services. Billings for hosting are spread ratably over the term of the hosting agreement, with the typical hosting agreement having a term of 12 months, with renewal on an annual basis. The Company sells most hosting contracts without the inclusion of products. When the hosting arrangement is sold in conjunction with product, the product revenue is recognized immediately while the remaining hosting revenue is spread ratably over the term of the hosting agreement. The selling price is allocated between these elements using the relative selling price method. The Company uses ESP for development of the selling price for hardware products with embedded software. The Company also offers hosting services bundled with events services. The Company uses VSOE to establish relative selling prices for its events services. The Company recognizes events revenue when the event takes place and recognizes the hosting revenue over the term of the hosting agreement. The total amount of the arrangement is allocated to each element based on the relative selling price method. Reserves The Company records reserves for stock balancing return rights, price adjustments, rebates, and sales incentives to reduce revenue and accounts receivable for these and other credits granted to two of our distributors. 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 the Company determines that it can no longer accurately estimate amounts for stock rotations and sales incentives, the Company 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 assess the realization of our receivables by performing ongoing credit evaluations of our customers’ financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. Our reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. Our reserves are also based on amounts determined by using percentages applied to certain aged 49 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 receivable categories. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. Allowance for doubtful accounts for accounts receivable was $85,000 at September 30, 2012 and $90,000 at September 30, 2011. We had billings for Mediasite product and support services as a percentage of total billings to one distributor of approximately 18% in 2012 and 24% in 2011 and to a second distributor of approximately 25% in 2012 and 26% in 2011. At September 30, 2012 and 2011, these two distributors represented 56% and 68%, respectively of total accounts receivable. Currently all of our product inventory purchases are from one third-party contract manufacturer. Although we believe there are multiple sources of supply from other contract manufacturers as well as multiple suppliers of component parts required by the contract manufacturers, a disruption of supply of component parts or completed products, even if short term, would have a material negative impact on our revenues. At September 30, 2012 and 2011, this supplier represented 60% and 21%, respectively, of total accounts payable. 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. 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 typically 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, 2012 2011 $ 216 837 $ 1,053 $ 232 304 $ 536 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, typically occurs when the beta testing commences, and the general availability of such software has been short and software development costs 50 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 qualifying for capitalization have been insignificant. Accordingly, the Company has not capitalized any internal software development costs. 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 5 to 7 years We assess the impairment of goodwill 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. Effective for fiscal 2012 with the adoption of ASU 2011-08, “Testing Goodwill for Impairment”, we first assessed qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Using the qualitative assessment, we determined that the fair value of goodwill is more likely than not greater than its carrying amount thus step two was not deemed necessary to perform. The Company has recognized no such losses as of September 30, 2012 and 2011. If we had determined 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. 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. For the years ended September 30, 2012 and 2011, no events or changes in circumstances occurred that required this analysis. Advertising Expense Advertising costs included in selling and marketing, are expensed when the advertising first takes place. Advertising expense was $261 and $169 thousand for years ended September 30, 2012 and 2011, 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. The Company also accounts for the uncertainty in income taxes related to the recognition and measurement of a tax position and measurement of a tax position taken or expected to be taken in an income tax return. The Company follows the applicable accounting guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure related to the uncertainty in income tax positions. 51 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 The Company uses a lattice valuation model to account for all employee stock options granted. The lattice valuation model provides a 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 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. Forfeitures are based on actual behavior patterns. The fair value of each option grant is estimated using the assumptions in the following table: Expected life Risk-free interest rate Expected volatility Expected forfeiture rate Expected exercise factor Expected dividend yield Years Ending September 30, 2011 2012 4.7 – 4.8 years 0.4% 51.4% - 64.0% 12.0%-13.1% 1.34 – 1.36 0% 4.4 – 4.8 years 0.4% - 1.4% 68.2% - 83.0% 12.8%-17.7% 1.15 – 1.32 0% 52 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 Per Share Computation Basic and diluted net income (loss) per share information for all periods is presented under the requirements of FASB ASC-260-10. 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. In periods where the Company reports net income, diluted net income per share is 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: Denominator for basic earnings per share - weighted average common shares Years Ending September 30, 2012 2011 3,857,161 3,748,840 Effect of dilutive options and warrants (treasury method) 50,727 ─ Denominator for diluted earnings per share - adjusted weighted average common shares 3,907,888 3,748,840 Options and warrants outstanding during each year, but not included in the computation of diluted earnings per share because they are antidilutive ─ 787,347 Recent Accounting Pronouncements In December 2010, FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts by requiring an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This update was effective for fiscal years beginning after December 15, 2010, the Company’s adoption of ASU 2010-28 did not have a material impact on its consolidated financial statements. In May 2011, the FASB issued ASU 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRS”, which amends ASC 820. This update clarifies the existing guidance and amends the wording used to describe many of the requirements in US GAAP for measuring fair value and for disclosing information about fair value measurements. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with prospective application required. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements. In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in ASC 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The early adoption of this guidance during fiscal 2012 did not have a material impact on the Company’s consolidated financial statements. 53 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company's financial statements upon adoption. 2. Commitments The Company leases certain equipment under capital lease agreements expiring through March 2015. Such leases are included in fixed assets with a cost of $375 thousand and accumulated depreciation of $76 thousand at September 30, 2012. Minimum lease payments, including principal and interest, are summarized in the table below. Fiscal Year (in thousands) 2013 2014 2015 Total payments Less interest Total Capital $ 138 119 17 274 (14) $ 260 The Company leases certain facilities and equipment under operating lease agreements expiring at various times through December 31, 2018. Total rent expense on all operating leases was approximately $526 thousand and $522 thousand for the years ended September 30, 2012 and 2011, respectively. In November 2011, the Company occupied office space related to a lease agreement entered into on June 28, 2011. The lease term is from November 2011 through December 2018. The lease includes a tenant improvement allowance of $613 thousand that was recorded as a leasehold improvement liability and is being amortized as a credit to rent expense on a straight-line basis over the lease term. At September 30, 2012, the unamortized balance is $532 thousand. The following is a schedule by year of future minimum lease payments under operating leases: Fiscal Year (in thousands) 2013 2014 2015 2016 2017 Thereafter Total Operating $ 602 614 625 641 657 842 $ 3,981 The Company enters into unconditional purchase commitments on a regular basis for the supply of Mediasite product. The Company has an obligation to purchase $1.3 million at September 30, 2012, which is not recorded on the Company's Consolidated Balance Sheet. 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. 54 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 3. Credit Arrangements On June 27, 2011, the Companies executed the Second Amended and Restated Loan and Security Agreement with Silicon Valley Bank (the “Second Amended Agreement”). Under the Second Amended Agreement, the revolving line of credit will continue to have a maximum principal amount of $3,000,000. Interest will accrue on the revolving line of credit at the per annum rate of one percent (1.0%) above the Prime Rate (as defined), provided that Sonic Foundry maintains an Adjusted Quick Ratio (as defined) of greater than 2.0 to 1.0, or one-and-one half percent (1.5%) above the Prime Rate, if Sonic Foundry does not maintain an Adjusted Quick Ratio of greater than 2.0 to 1.0. The Second Amended Agreement does not provide for a minimum interest rate on the revolving loan. The Second Amended Agreement also provides for an increase in the advance rate on domestic receivables from 75% to 80%, and extends the facility maturity date to October 1, 2013. Under the Second Amended Agreement, the existing 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 Bank’s prime rate; or (ii) eight and three quarters percent (8.75%). In addition, a new term loan can be issued in multiple draws provided that the total term loan from Silicon Valley Bank shall not exceed $2,000,000 and provided further that total term debt shall not exceed $2,400,000. Under the Second Amended Agreement, any new draws on the term loan will accrue interest at a per annum rate equal to the Prime Rate plus three and three quarters percent (3.75%). The Second Amended Agreement does not provide for a minimum interest rate on the new term loan. Each draw on the new term loan will be amortized over a 36-month period. All draws on the term loan must be made within ten (10) months of June 27, 2011. The Second Amended Agreement also requires Sonic Foundry to continue to comply with certain financial covenants, including covenants to maintain an Adjusted Quick Ratio (as defined) of at least 1.75 to 1.00 and Debt Service Coverage Ratio of at least 1.25 to 1.00, the latter of which will be waived if certain funds are reserved. At September 30, 2012, a balance of $1.4 million was outstanding on the term loans with Silicon Valley Bank and no balance was outstanding on the revolving line of credit. At September 30, 2012, there was $2.8 million available under this credit facility for advances. At September 30, 2012, the Company was in compliance with all covenants in the Second Amended Agreement. The Second Amended 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 Second Amended Agreement. Pursuant to the Second Amended Agreement, the Companies pledged as collateral to Silicon Valley Bank substantially all non-intellectual property business assets. The Companies also entered into an Intellectual Property Security Agreement with respect to intellectual property assets. Partners for Growth On March 5, 2010, the Companies executed a $1,250,000 Loan and Security Agreement (the “Term Loan”) and a $750,000 Revolving Loan and Security Agreement (the “Revolving Loan”) with Partners for Growth II, L.P. (“PFG”), (collectively the “Agreements”). On June 28, 2011, the Companies entered into a Consent and Modification No. 1 to Loan and Security Agreement (“Consent and Modification Agreement”) with PFG. Under the Consent and Modification Agreement, PFG consented to the Companies incurring additional indebtedness to Silicon Valley Bank, provided that total outstanding term indebtedness owed to PFG and Silicon Valley Bank does not exceed $1,900,000. The Term Loan accrued interest at 11.75% per annum with principal due in 36 equal monthly payments of $34,722 beginning April 1, 2011 and continuing through March 1, 2014. At September 30, 2011, a balance of $642 thousand was outstanding on the Term Loan. In October 2011, the Company paid the remaining balance of the Term Loan. 55 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 The annual principal payments on the term loans were as follows: Fiscal Year (in thousands) 2013 2014 2015 Total 4. Common Stock Warrants $ 667 633 133 $ 1,433 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 did not grant any warrants in fiscal 2012 or fiscal 2011. All such warrants are either valued and expensed in full at the date of grant or valued at the date of grant and deferred over the term of the relevant contract for services. Exercise Prices September 30, 2012 Expiration Date Warrants Outstanding at $ 23.50 750 Fiscal 2013 5. Stock Options and Employee Stock Purchase Plan On March 5, 2009, Stockholders approved adoption of the 2009 Stock Incentive Plan (the “2009 Plan”). The 2009 Plan, beginning October 1, 2009, replaced two former employee stock option plans that terminated coincident with the effectiveness of the 2009 Plan. On March 7, 2012, Stockholders approved an amendment to increase the number of shares of common stock subject to this plan by 600,000 and to increase the number of shares for the directors’ stock option plan by 50,000 shares. The Company maintains a directors' stock option plan under which options may be issued to purchase up to an aggregate of 100,000 shares of common stock. Each non-employee director, who is re-elected or who continues as a member of the board of directors on each annual meeting date and on each subsequent meeting of Stockholders, will be granted options to purchase 2,000 shares of common stock under the directors’ plan, or at other times or amounts at the discretion of the Board of Directors. 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 fair market value of the Company's common stock at 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. Compensation cost for options will be recognized in earnings, net of estimated forfeitures, on a straight-line basis over the requisite service period. 56 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 The number of shares available for grant under these plans at September 30 is as follows: Shares available for grant at September 30, 2010 Options granted Options forfeited Shares available for grant at September 30, 2011 Stockholder approval to increase shares Options granted Options forfeited Shares available for grant at September 30, 2012 Qualified Employee Stock Option Plans Director Stock Option Plans 327,300 (189,051) 13,634 151,883 600,000 (180,350) 30,393 601,926 19,500 (12,500) – 7,000 50,000 (12,500) – 44,500 The following table summarizes information with respect to outstanding stock options. Years Ended September 30, 2012 2011 Weighted Average Exercise Price $ 11.52 9.03 5.75 11.12 $ 11.28 Weighted Average Exercise Price $ 10.98 12.64 10.08 11.69 $ 11.52 Options 764,718 201,551 (138,496) (42,226) 785,547 535,668 Options 785,547 192,850 (42,499) (89,618) 846,280 555,135 Outstanding at beginning of year Granted Exercised Forfeited Outstanding at end of year Exercisable at end of year Weighted average fair value of options granted during the year $ 3.45 $ 5.39 The options outstanding at September 30, 2012 have been segregated into four ranges for additional disclosure as follows: Options Outstanding Options Exercisable Options Outstanding at September 30, 2012 478,370 200,801 121,801 45,308 846,280 Weighted Average Remaining Contractual Life 7.5 5.5 5.6 4.2 Weighted Average Exercise Price $ 7.53 13.04 15.89 33.63 Options Exercisable at September 30, 2012 263,179 146,533 100,115 45,308 555,135 Weighted Average Exercise Price $ 6.41 12.92 16.04 33.63 Exercise Prices $ 4.20 to $9.90 10.10 to 14.83 15.00 to 19.40 21.40 to 46.90 At September 30, 2012, there was $687 thousand of total unrecognized compensation cost related to non-vested stock-based compensation, including $91 thousand of estimated forfeitures. The cost is expected to be recognized over a weighted-average life of 1.8 years. 57 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 A summary of the status of the Company’s non-vested shares at September 30, 2012 and for the year then ended is presented below: Non-vested shares at October 1, 2011 Granted Vested Forfeited Non-vested shares at September 30, 2012 Weighted Average Grant Date Fair Value $ 5.05 3.45 4.31 4.27 $ 4.40 Shares 249,879 192,850 (123,531) (28,053) 291,145 Stock-based compensation recorded in the year ended September 30, 2012 of $742 thousand was allocated $485 thousand to selling and marketing expenses, $43 thousand to general and administrative expenses and $214 thousand to product development expenses. Stock-based compensation recorded in the year ended September 30, 2011 of $707 thousand was allocated $482 thousand to selling and marketing expenses, $49 thousand to general and administrative expenses and $176 thousand to product development expenses. Cash received from exercises under all stock option plans and warrants for the years ended September 30, 2012 and 2011 was $245 thousand and $1.7 million, respectively. There were no tax benefits realized for tax deductions from option exercises for the years ended September 30, 2012 and 2011. The Company currently expects to satisfy stock-based awards with registered shares available to be issued. The Company also has an Employee Stock Purchase Plan (Purchase Plan) under which an aggregate of 100,000 common shares may be issued. The Shareholders approved an amendment to increase the number of shares of common stock subject to the plan from 50,000 to 100,000 at the Company’s annual meeting in March 2011. All employees who have completed 90 days of employment with the Company on the first day of each offering period and customarily work twenty hours per week or more are eligible to participate in the Purchase Plan. An employee who, after the grant of an option to purchase, would hold common stock and/or hold outstanding options to purchase stock possessing 5% or more of the total combined voting power or value of the Company will not be eligible to participate. Eligible employees may make contributions through payroll deductions of up to 10% of their compensation. No participant in the Purchase Plan is permitted to purchase common stock under the Purchase Plan if such option would permit his or her rights to purchase stock under the Purchase Plan to accrue at a rate that exceeds $25,000 of the fair market value of such shares, or that exceeds 1,000 shares, for each calendar year. The Company makes a bi-annual offering to eligible employees of options to purchase shares of common stock under the Purchase Plan on the first trading day of January and July. Each offering period is for a period of six months from the date of the offering, and each eligible employee as of the date of offering is entitled to purchase shares of common stock at a purchase price equal to the lower of 85% of the fair market value of common stock on the first or last trading day of the offering period. A total of 29,408 shares are available to be issued under the plan. There were 21,010 and 5,405 shares purchased by employees during fiscal 2012 and 2011, respectively. The Company recorded stock compensation expense under this plan of $26 and $16 thousand during fiscal 2012 and 2011, respectively. Cash received from issuance of stock under this plan was $134 and $32 thousand during fiscal 2012 and 2011, respectively. 6. Income Taxes The provision for income taxes consists of the following (in thousands): Current tax benefit Deferred income tax expense Provision for income taxes 58 Years Ended September 30, 2012 2011 $ - 240 $ 240 $ (29) 240 $ 211 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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): Income tax expense (benefit) at U.S. statutory rate of 34% Federal income tax refundable research credit State income tax expense (benefit) Permanent differences, net Adjustment of temporary differences to income tax returns Change in valuation allowance Income tax expense Years Ended September 30, 2012 2011 $ 135 - 105 93 264 (357) $ 240 $ (11) (29) (2) 158 212 (117) $ 211 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 Valuation allowance Goodwill amortization Deferred tax liability for goodwill amortization September 30, 2012 2011 $ 34,352 519 33 175 35,079 (35,079) (1,970) $ (1,970) $ 34,444 460 35 249 35,188 (35,188) (1,730) $ (1,730) At September 30, 2012, the Company had net operating loss carryforwards of approximately $88 million for U.S. Federal and $51 million for state tax purposes. For Federal tax purposes, the carryforwards expire in varying amounts between 2019 and 2032. For state tax purposes, the carryforwards expire in varying amounts between 2013 and 2031. 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 $500 thousand, which expire in varying amounts between 2017 and 2020. 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, as a result of the Company’s past history of losses. Beginning with an acquisition in fiscal year 2002, the Company has amortized Goodwill for tax purposes over a 15 year life. Goodwill is not amortized for book purposes. Annual impairment tests are performed for book purposes and the balance of goodwill is to be written down if impairment occurs. The impairment tests have not indicated any goodwill impairment. The difference between the book and tax balance of Goodwill creates a Deferred Tax Liability and an annual tax expense. Because of the long term nature of the goodwill timing difference, tax planning strategies cannot be applied related to the Deferred Tax Liability. The balance of the Deferred Tax Liability at September 30, 2012 was $1.97 million and $1.73 million at September 30, 2011. 59 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 In accordance with accounting guidance for uncertainty in income taxes, the Company has concluded that a reserve for income tax contingencies is not necessary. 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 consolidated balance sheets at September 30, 2012 and 2011, and has not recognized any interest or penalties in the consolidated statement of operations for the years ended September 30, 2012 or 2011. The Company’s tax rate differs from the expected tax rate each reporting period as a result of the aforementioned items. 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. 7. 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 matching contributions of $316 and $229 thousand during the years ended September 30, 2012 and 2011, respectively. The Company made no additional discretionary contributions during 2012 and 2011. 8. Related-Party Transactions The Company incurred fees of $186 and $220 thousand during the years ended September 30, 2012 and 2011, respectively, to a law firm whose partner is a director and stockholder of the Company. The Company had accrued liabilities for unbilled services to the same law firm of $30 and $50 thousand at September 30, 2012 and 2011, respectively. The Company recorded Mediasite product and customer support billings of $1.1 million and $861 thousand during the years ended September 30, 2012 and 2011, respectively, to Mediasite KK, a Japanese reseller in which the Company has an equity interest. Mediasite KK owed the Company $240 and $241 thousand on such billings at September 30, 2012 and 2011, respectively. The Company accounts for its investment in Mediasite KK under the equity method. The recorded value is $420 thousand and $0 at September 30, 2012 and 2011, respectively. During the years ended September 30, 2012 and 2011, the Company had a loan outstanding to an executive totaling $26 thousand. The loan is collateralized by Company stock. 9. Goodwill and Other Intangible Assets Goodwill and intangible assets that have indefinite useful lives are not amortized but, instead, tested at least annually for impairment. The Company assesses the impairment of goodwill 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 the Company determines that the fair value of goodwill is less than its carrying value, based upon the annual test or the existence of impairment, the Company 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, an impairment charge for the difference would be recorded. The Company performed its annual goodwill impairment test as of July 1, 2012 and tested goodwill recognized in connection with the acquisition of Mediasite and determined it was not impaired. 60 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 The following tables present details of the Company’s total intangible assets at September 30, 2012 and 2011: Life (years) Gross Accumulated Amortization at September 30, 2012 Balance at September 30, 2012 (in thousands) Amortizable: Loan origination fees Non-amortizable goodwill Total 7,576 $ 7,771 - $ 180 3 $ 195 195 $ 180 180 $ 15 15 7,576 $ 7,591 Life (years) Gross Accumulated Amortization at September 30, 2011 Balance at September 30, 2011 3 $ 175 175 $ 137 137 7,576 $ 7,751 - $ 137 $ 38 38 7,576 $ 7,614 (in thousands) Amortizable: Loan origination fees Non-amortizable goodwill Total 10. Segment Information The Company has determined that it operates in only one segment 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. The following summarizes revenue by geographic region (in thousands): United States Europe and Middle East Asia Other Total 11. Customer Concentration Years Ended September 30, 2012 2011 $ 20,014 3,189 1,740 1,147 $ 26,090 $ 19,231 3,311 1,161 1,519 $ 25,222 In the fiscal year ended September 30, 2012 and 2011, two distributors represented 43% and 50% of total revenue. At September 30, 2012 and 2011, these two distributors represented 56% and 68%, respectively, of total accounts receivable. 61 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 12. Quarterly Financial Data (unaudited) The following table sets forth selected quarterly financial information for the years ended September 30, 2012 and 2011. The operating results are not necessarily indicative of results for any future period. (in thousands except per share data) Revenue Gross margin Income (loss) from operations Net income (loss) Basic and diluted net income (loss) per share Quarterly Financial Data Q4-’12 Q3-’12 Q2-’12 Q1-’12 Q4-’11* Q3-’11 Q2-’11 Q1-’11 $ 6,219 4,497 $ 7,757 $ 5,928 $ 6,185 4,507 4,284 5,555 $ 6,677 4,852 $ 7,090 4,928 $ 5,525 3,870 $ 5,930 4,261 (186) (103) 399 559 (32) (115) (72) (184) (277) (406) 361 212 (152) (272) 346 223 $ (0.03) $ 0.14 $ (0.03) $ (0.05) $ (0.11) $ 0.06 $ (0.07) $ 0.06 * During Q4-‘11, the Company recognized $528 thousand of expense due to executive severance compensation triggered by the resignations of Rimas Buinevicius, former Executive Chairman of the Board, and Monty Schmidt, former Chief Technology Officer. 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 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). 62 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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, 2012, 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 2012 Annual Meeting of Stockholders, which will be filed no later than January 28, 2013 (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 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. 63 Sonic Foundry, Inc. Annual Report on Form 10-K For the Year Ended September 30, 2012 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 plans 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 ACCOUNTING 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 2011 and 2012 Audit Fee Summary” in the Proxy Statement. 64 (This page intentionally left blank) (This page intentionally left blank) (This page intentionally left blank) ©2013 Sonic Foundry, Inc. All rights reserved. Sonic Foundry and the Sonic Foundry logo are registered trademarks of Sonic Foundry, Inc. Mediasite and the Mediasite logo are registered trademarks of Sonic Foundry, Inc. All other trademarks are the property of their respective owners. sonic foundry annual report 2012

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