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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal period ended September 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 1-14007
SONIC FOUNDRY, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 39-1783372
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
754 Williamson Street, Madison, WI 53703 (608)256-3133
(Address of principal executive offices) (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 whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ------
The aggregate market value of the voting stock held by non-affiliates of the
Issuer's was approximately $38,018,000 based on the last sale price on December
9, 1999.
The number of shares outstanding of the issuer's common equity was 6,785,691 as
of December 9, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 1999 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,
2000.
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 X No
----- -----
1
Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 1999
TABLE OF CONTENTS
PAGE NO.
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PART I
Item 1. Business................................................... 3
Item 2. Properties................................................. 17
Item 3. Legal Proceedings.......................................... 18
Item 4. Submission of Matters to a Vote of Security Holders........ 18
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters........................................ 19
Item 6. Selected Financial Data.................................... 20
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 38
Item 8. Financial Statements and Supplementary Data:
Report of Ernst & Young LLP, Independent Auditors.......... 39
Balance Sheets............................................. 40
Statements of Operations................................... 42
Statements of Stockholders' Equity......................... 43
Statements of Cash Flows................................... 44
Notes to Financial Statements.............................. 46
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................ 55
PART III
Item 10. Directors and Executive Officers of the Registrant......... 56
Item 11. Executive Compensation..................................... 56
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................. 56
Item 13. Certain Relationships and Related Transactions............. 56
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K................................................ 56
Signatures................................................. 59
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PART I
IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K CONTAINS
FORWARD-LOOKING STATEMENTS SUCH AS STATEMENTS OF THE COMPANY'S EXPECTATIONS,
PLANS, OBJECTIVES AND BELIEFS. THESE STATEMENTS USE SUCH WORDS AS "MAY",
"WILL", "EXPECT", "ANTICIPATE", "BELIEVE", "PLAN", AND OTHER SIMILAR
TERMINOLOGY. ACTUAL RESULTS COULD DIFFER MATERIALLY DUE TO CHANGES IN THE
MARKET ACCEPTANCE OF SONIC FOUNDRY'S PRODUCTS, MARKET INTRODUCTION OR PRODUCT
DEVELOPMENT DELAYS, GLOBAL AND LOCAL BUSINESS CONDITIONS, LEGISLATION AND
GOVERNMENTAL REGULATIONS, COMPETITION, THE COMPANY'S ABILITY TO EFFECTIVELY
MAINTAIN AND UPDATE ITS PRODUCT PORTFOLIO, SHIFTS IN TECHNOLOGY, POLITICAL OR
ECONOMIC INSTABILITY IN LOCAL MARKETS, AND CURRENCY AND EXCHANGE RATES.
ITEM 1. BUSINESS
THE COMPANY
We are a leading provider of software products and services that enable our
customers to create and edit digital audio and video content, and deliver this
content by recording or transferring it to digital storage and playback devices,
or by preparing it for digital transmission, including Internet distribution.
Advances in technology such as CDs, DVDs, high definition television and digital
networks, all of which store or transmit digital content, are driving the demand
for software tools and services that help create this content. Media
professionals and home users, including audio and video engineers, musicians,
multimedia developers and website developers, use our products. Our end-user
customers include Capitol Records, CBS News, Disney, Fox News, MSNBC, Universal
Studios and Warner Brothers, and our reseller customers include Guitar Center,
Hewlett Packard and Ingram Micro.
Our current products include:
Creation products - Our ACID product family offers musicians and non-musicians
an easy way to merge short segments of pre-recorded music, or loops, into a
song. We include a basic selection of loops with ACID and sell additional loop
libraries separately. We sell professional and consumer versions of ACID with
various levels of processing features and support for different music genres.
Editing products - Our Sound Forge and Vegas products allow users such as audio
and video engineers, broadcasters, website developers, musicians and consumers
to easily record and modify digital audio and video files. We plan to enhance
Vegas to add additional video editing features.
Delivery products - Our CD Architect and Stream Anywhere products allow users to
record audio or video to a PC hard drive, prepare it for delivery on CD or over
the Internet using various streaming media formats such as RealNetworks G2 or
Microsoft Windows Media Technologies, or convert it into popular audio and video
compression formats such as MP3 and AVI. Our newest consumer product, Siren,
allows users to manage entire music collections for local playback from a PC or
MP3 player, and to record personal music compilations on a CD using
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our proprietary CD recording technology. Since its beta release in August 1999,
we have entered into agreements to include Siren with Hewlett Packard recordable
CD drives.
To satisfy the dramatic increase in demand for digital multimedia content, many
content creators and owners are using our technology to create new digital
content and digitally encode existing content. Many entertainment companies
have vast libraries of older content, such as films and analog audio and video
tapes, that need to be digitized to realize revenue from digital distribution
and archived to prevent deterioration. Furthermore, continuing advances in
digital storage and compression technologies often require these companies to
devote substantial resources to migrate content in current digital formats to
continually evolving new digital formats.
Our new services division uses our existing technology, including unreleased
proprietary automation tools and a wide array of audio and video signal
processing algorithms, to provide format conversion and digital encoding
solutions to content owners. These new services include translating analog or
digital tapes, CDs, films and other audio and video media into various
compression and Internet streaming file formats and cleaning or filtering
recordings for improved quality.
Sonic Foundry was 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 754 Williamson Street, Madison, Wisconsin, 53703 and our
telephone number is (608) 256-3133. Our corporate website is
www.sonicfoundry.com. The information in our website is not a part of this
annual report on Form 10-K.
INDUSTRY BACKGROUND
Communications and Entertainment Industries are Moving to Digital Media and
Content.
We believe that businesses, advertisers and consumers are driving the demand for
digital media and content at an increasing rate. The worldwide communications
industry has been impacted by advances in technology such as CDs, DVDs, high
definition television and streaming media, all of which store or transmit
digitally-encoded content. The advent of broadband cable and telephony and a
whole new range of electronics devices is driving demand for digital media even
further.
We believe there are millions of hours of film and analog audio and video tape
recordings from the entertainment, broadcast, corporate, and educational markets
which still need to be edited and digitized into the specialized formats
required for digital storage and transmission. If not digitized, much of this
content could deteriorate and become unusable.
Content is Moving to Digital Production Processes and Formats.
To overcome the limitations of conventional analog recording and keep pace with
improvements in storage and distribution technologies, many broadcast and
professional audio and video production tool users have adopted digital
technologies. Recently, several technological trends have converged to make
digital audio and video production systems increasingly practical. Powerful,
cost-effective personal computers with graphical user interface based operating
systems, such as Windows and Macintosh, have become widely available. At the
same time,
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high capacity hard disk drives that are capable of storing media
recordings and supporting real-time editing have also become available at
affordable prices. Such advances have created new users of digital media
production tools including businesses, website developers and consumers. We
believe increased demand for editing and formatting digital content for
delivery, commonly called digital post-production, is being driven by these
trends. A 1997 report from Frost and Sullivan predicts the US video and audio
post production hardware and software markets are estimated to reach almost $1.4
billion in 2003.
The Internet is Accelerating the Move to Digital Content.
The effects of the Internet on the communications and entertainment markets are
just beginning to be realized. The growing use of audio and video content to
enhance communication, facilitated by the development of streaming media that
allows this content to be delivered in real-time, has accelerated user demand
for additional content. In our view, the widespread use of the RealNetworks and
Microsoft streaming media players, estimated to include over 80 million users,
is strong evidence of this demand. International Data Corporation estimates
that the number of Internet users worldwide will grow from approximately 97
million users in 1998 to 320 million by the end of 2002. In an effort to
attract these users, website developers are increasingly adding streaming audio
and video to enhance already graphics-intense websites. In addition, several
companies have already built websites enabling large collections of digital
music in the popular MP3 format to be made available on the Internet. Consumers
can search for, sample and download songs according to artist, genre and title,
in some cases for free. Many other types of content owners are already moving
toward an all-digital production and distribution environment for their content.
As a result, we believe the communications and entertainment industries will
increase their spending for digital production software, equipment and services.
Encoding is Emerging as a New Services Market.
While uncompressed digital audio and video files are typically of the highest
quality, they can be extremely large and therefore costly to store or transmit.
In order to efficiently store or transmit these files, they must be translated
or "encoded" into one of several popular storage, compression or streaming
formats. The encoding market is a small subset of the overall digital
production market. Frost and Sullivan predicts that the overall video
compression market worldwide is expected to grow from $177 million in 1998 to
$412 million in 2001, fueled primarily by the growth and expansion of broadband
media. This estimate is independent of content authoring software tools that
incorporate encoding capabilities. Likewise, this market estimate does not
include revenues generated by service companies specializing in encoding.
Numerous formats and standards exist for audio and video compression. MPEG-2
remains the predominant standard for compressed video, having been adopted for
use in DVD technology, while MP3 audio remains the predominant standard for on-
line music, although more compact and robust audio formats are making their way
to market. The MPEG-4 specification promises to offer an even more efficient
audio and video compression technology, which will in turn, drive another
business cycle as archived raw digital footage will require yet another encoding
process. We anticipate continuing improvement in digital storage and
transmission technologies, and therefore an ongoing need for state-of-the-art
encoding services.
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STRATEGY
Our objective is to be the leading provider of products and services that allow
media content owners and creators to deliver the highest quality digital content
in the widest array of formats, including CDs, DVDs and streaming media. To
achieve this objective, our strategy includes the following key elements:
Extend Technology Leadership.
We believe we have established ourselves as a leader in the development of media
editing, production, and encoding software and we intend to build upon our
reputation for quality and innovation by continuing to expand the features and
breadth of our software products and services. We have broadened our in-house
technology by supporting emerging streaming media standards and licensing a tool
for encoding streaming media to Microsoft Corporation. We maintain ownership
rights to the technology licensed to Microsoft and incorporated it into our
Stream Anywhere product, a natural upgrade for website developers desiring a
streaming media tool with enhanced features and RealNetworks G2 encoding
capability. We plan to continue developing Internet media tools with a more
pronounced video editing capability. We have further demonstrated our
commitment to extending our technology leadership by using our digital content
creation technology to develop a jukebox software product, called Siren, which
performs CD recording, transfer support for popular handheld playback devices,
and music database management. Through our rapport with professional users, our
investment in product development, and our hiring of experienced software
engineers, we believe we will stay on the leading edge of development.
Maintain Standards Neutrality.
We believe that maintaining a neutral position on various industry file and
compression formats allows us to offer a key market advantage. By offering the
broadest range of file formats and compression schemes within our product and
service offering, we believe we maintain a marketing advantage over companies
that attempt to impose exclusive use of their format. For example, in the
streaming media marketplace, we believe we have managed to gain broad adoption
and use of our Stream Anywhere, Sound Forge, ACID, and Vegas products. These
products support both RealNetworks G2 and Microsoft WMT formats, offering a true
cross-format advantage to the content developer who now needs to purchase only a
single media authoring package.
Maximize Market Penetration and Brand Recognition.
We believe that our Sonic Foundry brand is one of the most widely recognized
brands in the audio software industry. We pursue our brand development strategy
through various means, such as initially targeting the professional user market
to generate credible product references for expansion into consumer markets.
Our strategy incorporates extensive advertising, consumer rebate programs, in-
store demos, direct mail and Internet campaigns, licensing products for
distribution with third party hardware and software and distribution through
multiple channels. We use major distributors such as Ingram Micro, Tech Data
and Navarre to reach consumer electronics and office superstores, such as Best
Buy and Staples, as well as value added resellers. We also utilize free beta
product downloads and third party distribution through OEM partnerships for the
purpose of distributing our software with partner hardware and software.
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Leverage our Market Position.
We believe that our technology leadership, market position and brand name are
significant assets that we can leverage to maintain and increase our market
share and diversify our revenue base. We intend to build on these assets as
follows:
Grow Digital Media Software Business.
We intend to capitalize on the growth in demand for digital media software tools
by continuing to develop, market and support products for the entire digital
media software market. We also plan to strengthen our marketing, sales and
customer support efforts as the size of our market opportunity and customer base
increases.
Invest in Media Services Division.
We plan to leverage industry relations and proprietary technology by investing
in the media services business. We believe a large percentage of streaming
media developed for Internet distribution is prepared using our products and
that technology not released, in addition to technology being developed, will
give us an advantage in servicing the vast amount of media expected to be
developed for Internet delivery in the future.
Offer Products That Meet The Needs of The Consumer Market.
After establishing brand recognition and meeting the needs of the professional
market, we believe we will be able to define the features and functions that
will appeal to the general consumer. The goal of our consumer effort is to
offer the same functionality offered in the professional product line, but with
a simplified function/feature set.
Expand Internal Operations.
We intend to improve our management information systems, open sales offices in
several locations, integrate sales activities, invest in customer service, and
develop on-line training programs which will help support an outside network of
dealers and distributors.
Expand Internationally.
We intend to expand our international customer base over the next several years
by adapting our products and marketing materials for use internationally,
building our European operations through the hiring of additional employees,
developing international distribution and sales networks, and increasing our
expenditures for marketing.
Strengthen Strategic Relationships.
We have established strategic relationships with a variety of industry
participants, including software and hardware vendors and audio laboratories.
Our relationship with Microsoft, for example, has given us early access to key
technologies and software codes. In addition, we have formed strategic
relationships with other companies. For example, we have licensed the MP3
technology from the Fraunhofer Institute and Thomson Multimedia and have made
MP3 encoding available in our ACID product line. We have pursued strategic
relationships for a variety of purposes, such as maximizing rapid penetration,
validation and adoption of our technologies, and expanding the range of
commercial activities based on our technology and brand name.
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STRATEGIC RELATIONSHIPS
We have relationships with many of the companies developing innovative
technologies involving digital media including the following:
Microsoft.
We license the use of various Microsoft technologies including NetShow, Active
Streaming Format, Windows Media Audio and other various technologies. These
technologies are used in the Sound Forge, ACID, Stream Anywhere, Vegas Pro,
Siren and other products in preparing media for Internet streaming or
compression. We also developed and licensed to Microsoft a tool for encoding
audio and video media, termed Windows Media On-demand producer, which Microsoft
makes available on its website as a free download for website developers and
other users. Users of that program are offered an upgrade to our Stream
Anywhere product which they can purchase directly from us. We also receive
various benefits from our close relationship with Microsoft including early
access to Microsoft product and technology introductions, partner status in the
areas of streaming media authoring tools and Windows Media Audio compression
enabling products, and assistance in marketing programs.
RealNetworks.
We license the G2 streaming technology from RealNetworks in our products which
encode media for use in Internet streaming including Sound Forge, ACID, Vegas
Pro and Stream Anywhere. In addition RealNetworks promotes our Audio Anywhere
product as a music creation and editing tool for use with their RealSlideshow
product.
Fraunhofer Institute and Thomson Multimedia.
We license the use of Fraunhofer and Thomson Multimedia's MP3 audio compression
technology for use with our ACID products. The combined products allow users to
create music and compress it for use with portable players or other uses
requiring smaller audio files.
Dolby Laboratories.
We license Dolby's AC3 compression technology for use in our Soft Encode
product. Soft Encode allows users to encode media into the popular DVD format
used in viewing home movies.
Customers.
We license our products to a wide variety of customers in various market
segments. Our customers include Ace Music Center, Guitar Center, Hewlett
Packard, Hook Up, Ingram Micro, Macromedia, Matrox, MusicHall WorldWide,
Pinnacle Systems, Sam Ash Music, Sony and Tech Data Product Marketing. Ingram
Micro accounted for approximately 22% of software license revenues for the year
ended September 30, 1999.
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CURRENT PRODUCTS AND SERVICES
Creation Products
The ACID Family of Products offers both musicians and non-musicians an easy way
to create and play back sound samples via a computer in a multi-track format.
ACID allows users to merge audio "loops" which are audio files of drums, tunes,
cymbals, piano, or any other audio information into another audio file or into
itself on a royalty free basis. ACID also allows the user to change the tempo,
add new rhythms, and add vocals by embedding samples wherever desired, all in
real-time. Musicians who wish to edit and record music loops for output in a
different format use this product on a stand-alone basis or in conjunction with
Sound Forge or CD Architect. We believe ACID will appeal to consumer music
markets such as the rap market and the techno market, and to anyone who wishes
to create quality music quickly and easily. We sell ACID with a library of
audio loops, but sell additional audio loop libraries to be used in conjunction
with our ACID product. In October 1998 we released three consumer versions of
ACID; ACID Rock, ACID Music and ACID DJ. These products include loops
specifically designed to appeal to consumers desiring a certain genre of music
such as rock included with the ACID product. The style versions of ACID also
include simplified user interfaces and features established especially for the
consumer. In September 1999 we released version 2.0 in all ACID pro and style
versions which, depending on the version, include full or limited MP3 support
and the ability to record finished songs on a CD. We expect to continue to
develop additional versions of ACID including additional style versions and
products specifically developed, marketed and co-branded with individual artists
Editing Products
Vegas, Sound Forge 4.5, Sound Forge XP and Related Plug-Ins. Vegas, Sound Forge
and Sound Forge XP are non-linear media editing systems. Vegas and Sound Forge
are generally used by professionals for a variety of digital audio media editing
needs while Sound Forge XP is designed with a simplified user interface and
features for consumer users. Just as a word-processor can store, edit and
transfer textual data more effectively and efficiently than a typewriter, our
editors can store, edit, manipulate, and transfer audio data more effectively
and efficiently than traditional analog editing tools such as a tape recorder.
The advantages of manipulating audio data digitally are as follows:
. digital files can be edited non-linearly, whereas in order to edit an analog
recording, a user would have to rewind the tape to find the spot that needs
editing
. editing on a digital audio file can be non-destructive, whereas audio analog
editing destroys a portion of the tape
. digital audio files do not deteriorate over time, as opposed to the serious
problem of degradation of audio tapes
. digital audio files can be transferred electronically, whereas audio tapes
must be mailed or shipped
. multiple users can work on digital audio files on a shared basis, which is
impossible with analog audio tapes
. digital audio files can be manipulated in ways that analog audio tapes cannot
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We have developed several plug-ins which enhance our products by addressing
various specialized needs. Several of our plug-ins employ "real-time"
capability, i.e. the ability to process and produce special effects to digital
audio at a rate as fast or faster than the actual event. One product, a real-
time noise reduction plug-in, allows users to eliminate background noise from a
prerecorded event. Examples of the many uses of the real-time noise reduction
plug-in include broadcast users eliminating background noise and consumer users
eliminating the hissing and clicking noises produced by vinyl phonograph
records.
We plan to build upon the Vegas product code by adding video editing
capabilities in fiscal year 2000, thereby offering complete media processing
capability.
Delivery Products
CD Architect is a professional level product that addresses the storage and
delivery needs of musicians, audio engineers and home users. This software in
effect converts a computer into a virtual CD recorder by allowing a completed
audio file to be transferred to a CD. With CD Architect, users can create
multiple copies of their completed audio work. A band, for example, can record
its music direct to CD-R (CD Recordable) media without utilizing the services of
traditional studios or production houses. Another use for CD Architect is to
input an existing CD into a computer, where it can be edited, stored and
manipulated using Sound Forge in conjunction with our other plug-ins. Together,
CD Architect and our various plug-ins have enhanced the basic Sound Forge
products and have made them available for a variety of users in markets such as
music, multimedia, digital video, audio/video and broadcast, and the Internet.
Siren, a complete digital music management system, allows PC users to locate and
download digital music from the Internet, record music from their personal CD
collection to their PC hard drive, and manage the music in multiple play-list
arrangements on their PCs. Siren utilizes Microsoft Windows Media Audio digital
compression technology, offering faster compression and requiring less storage
space than alternative technologies. Siren also incorporates the popular MP3
compressed audio file format. Siren uses the code base developed for CD
Architect and features fully integrated audio CD recording, allowing users to
create and record custom compilations of their favorite hits and record them to
CDs from within the jukebox application.
Windows Media On-Demand Producer and Stream Anywhere. Windows Media On-Demand
Producer was developed under contract with Microsoft Corporation. Designed for
both novice and experienced web developers and new entrants to the streaming
media market, WMODP allows Internet and Intranet content developers to transfer
and encode media such as communication, entertainment and training materials
into the Microsoft streaming media format. Microsoft began distributing this
encoding program in February 1999 as a no-charge addition to the Windows Media
tools available on its Windows Media Technologies website. While no revenues
will be realized directly from the agreement with Microsoft, we expect to
generate greater brand recognition and access to Microsoft customers. We
anticipate that certain users of WMODP will require more features than those
found in WMODP. We retained the product rights to WMODP, allowing us to offer
those users Stream Anywhere, a product with the same look and feel as the WMODP
but with the ability to encode multimedia content in either the Microsoft
Windows Media Technologies 4.0 or the RealNetworks RealSystem G2 format in a
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single operation. Media content can either be captured directly from camera or
tape or imported in several popular file formats such as AVI, Apple QuickTime,
MPEG-1, and MP3.
Media Services
We recently began steps to enter the media services business. We believe our
advanced media processing technology, industry relations and secure audio
playback product, Siren, create a unique opportunity for us to become a leader
in this market by offering a complete end-to-end solution.
To begin this effort, we hired a former Microsoft employee responsible for
advancing the use of Microsoft's Windows Media Audio file compression format in
the Internet music download market. We are currently assembling a team of
operations, marketing, sales, and engineering experts tasked with the
responsibility of building this business. We plan to advance our technological
lead in this area by retaining and developing various proprietary technologies
for use in efficiently processing media. This business will require a greater
investment in capital equipment consisting of high capacity server computer
hardware, autoloading equipment, tape playback equipment and computer
workstations. Likewise, higher cost high bandwidth network connections will be
required to efficiently manage and deliver processed media. Process workflow
and efficiencies will be highly dependent on both the labor intensive nature of
entering metadata and the efficiency of our automation processes developed from
the foundation of our software technology. We expect revenues from this
business to be derived from various sources. First, we will be offering a
turnkey service whereby media is directly processed by us. This service will
include encoding, cleaning, and filtering media libraries. After designing and
utilizing the processes developed, we may expand the media services business and
offer a complete system sale including training, upgrades, and customer service
for the clients who desire in house encoding rather than outsourcing this
function. To complete all of these objectives, we may acquire additional
technology or companies and enter into strategic partnerships with other
companies.
Ultimately, our belief is that we are in a unique position to leverage our
brand, our market position, and our industry status to take advantage of a newly
emerging market opportunity. We believe media content owners, especially the
top tier media companies, will seek a trustworthy, efficient, and quality-driven
company to provide these services to them. Our business success in this new
endeavor will hinge on our ability to meet these needs and is the primary goal
of this newly formed business unit.
PRODUCTS AND TECHNOLOGY CURRENTLY IN DEVELOPMENT
The majority of the current software product development effort is focused on
expanding our Vegas technology to include video editing features. We plan to
release a product including various video editing and transition effects as well
as professional level audio processing features during calendar 2000. We expect
our first video focused product to appeal to web developers, broadcasters and
corporations desiring greater flexibility in creating, editing and preparing
video for the Internet. Our engineering efforts have centered on developing
applications designed to run primarily on the Windows/Intel (Wintel) PC
platform. This decision has given us an advantage in offering software
optimization for the Pentium class of PCs. Because of this design
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philosophy, we believe we have developed extremely efficient software designed
to run specifically on the Windows platform, which includes the effort now under
way for the Vegas video product.
Other software development efforts include planned upgrades to Sound Forge and
CD Architect during the calendar year 2000 to add important features such as the
ability to edit and record 24-bit audio data. Our other products including
Siren, Stream Anywhere, and ACID will continue to be improved and updated to
allow for continued revenues in the form of product upgrades. We attempt to
offer significant improvements in the form of upgrades to our products every 1
to 2 years.
Our ACID product line will also continue to expand. Further development of
sound loops will allow us to offer unique libraries of sounds which satisfy the
demands of the media content development community to which the product is sold.
We also expect to continue development of other products and offer unique
solutions in other media tools. Research and development activities are
currently focused on DVD technology, IEEE-1394 digital transfer technology, and
the continual improvements being made in the Internet streaming space. We plan
to expand our product offering by taking advantage of these newly emerging
market developments and any other additional developments.
Our newly established media services division involves an effort to further
develop various proprietary technologies which make the process of encoding
large quantities of digital media more efficient, some of which may be
patentable. We expect the software already developed and future engineering
enhancements will allow us to use standard PC hardware to efficiently and
economically encode large quantities of media without the use of expensive
dedicated hardware, as required in the past. Likewise, our software algorithms
for enhancing and verifying the quality of the video and audio will possibly
address a current concern of media content owners who desire a higher quality
finished product. We feel our expertise in this area offers us a unique
business advantage in gaining a significant portion of the media encoding
business. Finally, we believe our technology will ultimately give us an
advantage over competitors by leveraging the combination of our expertise,
brand, efficiency, quality, and premium level of service as we enter the media
services business.
We devote a substantial portion of our resources to developing new technology
and products, adding product features, enhancing our existing products and
testing and integrating third party hardware and software. A portion of those
technologies will be retained for exclusive use in our media services division.
During the years ended September 30, 1999 and 1998, our disbursements for
product development, including amounts capitalized pursuant to SFAS No. 86, were
$3,415,000 and $1,362,000 or 23% and 18% of revenues. As of September 30, 1999
we had 60 employees, or approximately 38% of our workforce, engaged in product
and technology development activities. The product development group includes
individuals with extensive experience designing Windows software. Areas of
expertise include user interface design, digital signal processing, integration
with third party hardware, and low-level driver work. Our engineers have had
experience developing music software, media and graphics software, games,
multimedia applications and operating system components, as well as hardware. We
intend to
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expand our product development team through internal growth and/or acquisition.
However, competition for highly qualified employees is intense and the process
of locating key technical personnel with the combination of skills and
attributes required to develop new software is extensive. There can be no
assurance that we will be successful in attracting, motivating and retaining
additional software engineers.
OPERATIONS, FULFILLMENT AND CUSTOMER SUPPORT
Our sales department processes phone, fax, and website orders. Generally,
product ships the same day. The production of our software products includes CD
duplication, component purchases (manuals, boxes, and inserts), and final
packaging. Many of the production tasks are provided by a variety of third-party
manufacturers. Third parties produce, assemble, and fulfill most domestic
orders while international orders are fulfilled from our facilities. We believe
there are numerous sources and alternatives to the existing production process.
To date, we have not experienced any material difficulties or delays in the
manufacture and assembly of our products, or material returns due to product
defects. We also provide customer sales and technical support during business
hours and maintain a user group forum on our website.
We have recently assembled a team and acquired additional servers and storage
capacity necessary to enter the media services business. The network of
hardware is scalable, allowing us to offer automated high capacity encoding
services and to match our resources with the growth.
SALES
We currently sell and distribute our products through professional dealers, a
direct sales force, PC product distributors, music distributors, OEMs, and the
Internet. We also sell a large portion of our products internationally through
a worldwide distribution network. As of September 30, 1999, we had 49
employees, or approximately 31% of our workforce, engaged in sales, marketing
and business development activities. Sales to a single customer amounted to 22%
of revenue in the year ended September 30, 1999. A different customer accounted
for 10% and 14% during the year ended September 30, 1998 and the nine-months
ended September 30, 1997. International revenues accounted for 20%, 17% and 27%
of total revenues for years ended September 30, 1999 and 1998 and the nine
months ended September 30, 1997.
Professional. Our dealers in the music and professional audio industries
provide a demonstration site for our family of products. When dealing with the
professional consumer, we utilize extensive sales experience and training by
using our network of representatives, and provide a large degree of marketing
and promotion support. Training is an integral aspect of the entire sales and
marketing process and is expected to become more important as the product line
broadens.
Direct Sales. Our direct sales force markets our products to customers who will
sometimes purchase more than ten units of software for an entire media
production activity. These customers may also request on-site or remote
training for their employees. Additionally, we maintain an "800" number--800-
57-SONIC--and accept orders via our website for individuals that wish to
purchase products directly from us.
13
Distributors. We have entered into agreements with Ingram Micro, Tech Data,
Navarre Corporation, Bayside and others to handle sales and distribution of our
consumer products to various computer resellers, value added resellers, catalog
distributors and smaller retail outlets. Under the distribution agreements, we
have granted some distributors the right to return unsold inventories of
outdated products in exchange for credit against open invoices. Likewise, price
protection support is offered in certain circumstances, whereby the distributor
is protected from price reductions. Monthly sales and inventory reports are
provided directly by the major distributors and retailers.
Original Equipment Manufacturers ("OEMs"). We have entered into various
distribution relationships with third parties pursuant to which our products are
incorporated into, or bundled with, the third party's products for delivery by
the third party to end users. These third parties include Microsoft, Creative
Labs, Hewlett Packard, Sony, Pinnacle, Smart and Friendly, MusicHall Worldwide,
Digital Processing Systems, Macromedia, Matrox and Event Electronics.
Electronic Commerce. We have developed the capacity to handle on-line sales via
the Internet, including the ability to directly download our Vegas Pro, Sound
Forge XP, Stream Anywhere and other products following processing of an approved
credit card. Likewise, we have granted third parties licenses for the sale and
distribution of both electronic and fulfillment based orders on their sites.
International. We opened an office in Delft, Netherlands in August 1998 which
oversees the sales and marketing efforts of a network of over 30 European music
and professional audio distributors. Our European distributors also provide
product support to customers, local marketing efforts, and local language
translation services for product literature and manuals. We provide our
distributors with services similar to those we provide to our North American
dealer network.
MARKETING
We participate in trade shows, advertising, press tours, public relations,
dealer events, and Internet advertising. We engage in direct mail efforts by
sending newsletters, new product announcements, and special promotions to
existing and prospective customers. Our Internet website also is expected to be
a critical marketing component as the Internet matures as a viable marketing
medium.
Our customers vary from high-end professionals to general consumers. Because of
this, different marketing methods are being developed, tested and used to reach
each respective audience. For the professional audience, who tend to be early
adopters, we rely on press announcements, product reviews and advertising in
publications such as Digital Content Creation, Keyboard, Electronic Musician, DV
(Digital Video), Mix, EQ, and Pro Audio Review to help spread product awareness.
We also use "Not For Resale" copies of our software installed on computers
within dealer stores as a promotional means of educating potential customers.
On-site dealer training and clinics are also used to help market and promote the
advantages of our product line.
14
Computer industry customers are reached through the Internet, advertising in
publications such as New Media, Music and Computers, Interactivity, and by
direct mail. We inform distributors and end users about the benefits of our
products through informative dealer kits and product brochures. Our direct mail
process involves maintaining a database of over 50,000 dealers, distributors,
opinion leaders, and customers who are sent information on new products, product
enhancements, and trade show schedules.
Various OEM relationships with hardware and software vendors help spread broad-
based brand awareness to the consumer channel. We require the proper placement
and use of our logos and trademarks on third party products and literature.
Continued expansion of our OEM presence is expected to assist in establishing
greater brand identity and generate awareness that our various products conform
to industry specifications and are designed to operate with a variety of third
party hardware.
Marketing related functions such as graphic design, literature preparation,
product launch planning, advertising preparation, placement and news media
relations are all provided for by our marketing staff. We believe that
maintaining an internal creative department allows us to respond quickly and
efficiently to the ever-changing technology industry.
CUSTOMER SUPPORT
We provide free customer support for a 90-day period following product purchase.
After the initial 90-day term, customers are able to receive technical
information through our website, newsletters, and third party articles and
technical notes. We currently do not offer extended maintenance contracts to
our customers, nor 900 number support but may do so in the future.
We offer a 30-day money-back guarantee on all of our software products. We also
provide a 90-day replacement warranty covering product defects, shipping damage,
or missing materials. Under these circumstances, dealers, distributors, and
customers may return their software directly to us for free replacement.
In the case of upgrades we attempt to offer incentives to sell existing
inventory. We replace existing inventory with new inventory after a product is
upgraded. As a result of the signing of distribution agreements with Ingram
Micro, Tech Data and Navarre and the release of more consumer oriented products,
we expect greater sales to occur in the computer retail channel, and as a
result, we will allocate a greater allowance for product returns. There can be
no assurance that the level of returns will not exceed the budgeted allowance.
COMPETITION
The markets for our products are intensely competitive. Pricing pressure, rapid
development, feature upgrades, and undefined new technologies characterize the
industry. Numerous companies including Adaptec, Adobe, Avid Technology,
Cakewalk Company, CreamWare, Euphonix, Media 100, MusicMatch, RealNetworks,
Sonic Solutions, Syntrillium Software Corporation and Steinberg Soft-Und
Hardware offer products which compete directly or indirectly with one or more of
our products, although none of these companies can independently
15
offer a matching product line which competes one for one with our product line.
Most of our competitors or potential competitors have significantly greater
financial, management, technical and marketing resources than we do. We could
also face future competition from Autodesk, Macromedia, Microsoft, or Oracle.
Each of these potential competitors has substantially greater resources than we
do and could become a significant competitor. The primary factors on which we
compete are quality, pricing, product features, cross-platform file support,
brand marketing, and customer support. The relative importance of each factor is
dependent on the market and customer group targeted. We believe we compete
favorably with respect to these factors, but there can be no assurance that we
will continue to do so.
In addition, our Internet media creation products and services may compete with
companies such as Adobe, Encoding.com, Liquid Audio, Macromedia, Microsoft,
RealNetworks, and STV Communications. These companies are currently providing
low cost website creation tools and/or services that offer some features that
satisfy the media creation requirements of professionals, corporate users, and
serious hobbyists. Although we have chosen to carve out distinct product and
service niches, there can be no assurance that these companies will not
introduce products that are more directly competitive or undercut the price of
our products. Moreover, many of our competitors and potential competitors offer
software products for the Macintosh operating system, which many musicians have
traditionally utilized. There can be no assurance that such potential customers
will accept our Windows based software products. Likewise, there can be no
assurance that market sentiment for Macintosh or other competing operating
systems, such as Java or Linux, will not overtake the current dominant market
position of Windows based systems, upon which our products are based. In
addition, due to the low barriers to entry in the computer software market,
there can be no assurance that a new company will not be able to effectively
compete with us.
Our competitors may be able to develop products and technology comparable or
superior to those offered by us or adapt more quickly than we do to new
technologies or evolving customer requirements. Accordingly, there can be no
assurance that we will be able to compete effectively in our target markets,
that competition will not intensify or that future competition will not have a
material adverse effect on us.
INTELLECTUAL PROPERTY
Our success depends in part on our ability to protect our proprietary software.
We rely on a combination of trade secret, contract, copyright and trademark law
to establish and protect our proprietary rights in our products and technology.
We do not currently have any patent protection for our products. Our software
products are sold under "shrink wrap" licenses which set forth the terms and
conditions under which the purchaser can use the product and which bind the
purchaser by its acceptance and purchase of the products to such terms and
conditions. Such shrink-wrap licenses are not signed by licensees and may be
unenforceable under the laws of certain jurisdictions. We also license certain
of our proprietary rights to third parties.
Although we rely to a great extent on trade secret protection for much of our
technology and have obtained confidentiality agreements from most of our key
employees, there can be no assurance that third parties will not independently
develop the same or similar technology, obtain
16
unauthorized access to our proprietary technology or misuse technology to which
we have granted access. We believe that the rapid pace of innovation in the
industry renders the innovation, skill and creativity of our development staff
more influential to our competitive success than the various legal protections
of our technology.
We attempt to avoid infringing known proprietary rights of third parties in our
product development efforts. However, we have not conducted and do not conduct
comprehensive patent or trademark searches to determine whether we infringe
patents or proprietary rights held by third parties. In addition, it is
difficult to proceed with certainty in a rapidly evolving technological
environment in which there may be numerous patent applications pending, many of
which are confidential when filed, with regard to similar technologies. If we
were to discover that our products violate third-party proprietary rights, there
can be no assurance that we would be able to obtain licenses to continue
offering such products without substantial reengineering or that any effort to
undertake such reengineering would be successful, that any such licenses would
be available on commercially reasonable terms, if at all, or that litigation
regarding alleged infringement could be avoided or settled without substantial
expense and damage awards.
We also rely on certain technology that we license from third parties, including
software that is integrated with our internally developed software and used in
our products, to perform key functions. There can be no assurance that such
third-party technology licenses will continue to be available to us on
commercially reasonable terms. The loss of any of these technologies could have
a material adverse effect on us. In addition, we have agreed to indemnify
certain distributors and OEMs from claims that our technology infringes the
proprietary rights of others. There can be no assurance that infringement or
invalidity claims arising from the incorporation of third-party technology, and
claims for indemnification from distributors and OEMs resulting from such
claims, will not be asserted or prosecuted against us.
EMPLOYEES
As of September 30, 1999 and 1998, we had 160 and 83 full-time employees,
respectively. Our employees are not represented by a labor union, nor are they
subject to a collective bargaining agreement. We have never experienced a work
stoppage and believe that our employee relations are satisfactory.
ITEM 2. PROPERTIES
We own one property and have leases on several others in downtown Madison,
Wisconsin. We own a 10,000 square foot building that we use as our sales and
marketing office. The balance on the mortgage of this property is approximately
$625,000 at September 30, 1999. We lease an 11,000 square foot facility that we
use as an administration and engineering office. Its lease term is through
April 30, 2003. We lease a 9,000 square foot facility that we use as an
engineering office. Its lease term is through June 30, 2002. We lease a 6,000
square foot facility that we use as a shipping, assembly and warehouse facility.
Its lease term is through May 31, 2000. We entered into a lease on October 1,
1999 for a 45,000 square foot facility. The term of that lease is through May
31, 2010.
17
Our office in Delft, Netherlands is 600 square feet and is leased on a month to
month basis.
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no stockholder actions during the fourth-quarter ended September 30,
1999.
18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock and common stock purchase warrants have been traded
on the American Stock Exchange under the symbols "SFO" and "SFOW" since the
Company's initial public offering in April of 1998.
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 American Stock Exchange.
High Low
----------- -----------
Year Ended September 30, 1998
Third Quarter (commencing April 22, 1998)............. $10.13 $ 6.13
Fourth Quarter........................................ 8.94 5.75
Year Ended September 30, 1999
First Quarter......................................... 14.88 5.38
Second Quarter........................................ 10.88 6.69
Third Quarter......................................... 20.75 10.13
Fourth Quarter........................................ 12.25 7.88
The Company has not paid any cash dividends and does not intend to pay any cash
dividends in the foreseeable future.
At December 9, 1999 there were 133 common stockholders of record. Many shares
are held by brokers and other institutions on behalf of shareholders.
RECENT SALES OF UNREGISTERED SECURITIES
Between July 1, 1999 and September 30, 1999, the Company issued unregistered
securities as follows:
(1) The conversion of Series B Preferred Stock of the Registrant into 91,596
shares of common stock on August 30, 1999 by Frederick H. Kopko Jr., and into an
aggregate of 3,739,643 shares of common stock on September 13, 1999 by Rimas
Buinevicius, Monty Schmidt and Curtis Palmer. These issuances of common stock
were made in reliance upon the exemption from registration set forth in Section
4(2) of the Securities Act, relating to sales by an issuer not involving a
public offering. Individuals acquiring the common stock were all accredited and
sophisticated investors. By virtue of their relation to the Registrant, these
individuals all had access to information on the Registrant necessary to make an
informed investment decision. Consideration received by the Registrant consisted
of shares of Series B Preferred stock.
(2) The issuance by the Company of $5,000,000 of 7.5% Convertible Subordinated
Redeemable Debentures due September 2002. The debentures are convertible into
common stock at a rate of $10.28 per share, subject to certain adjustments.
Concurrent with the issuance of the debentures, the Company issued the investors
97,276 warrants expiring September 2004.
19
The warrants are initially exercisable at any time at a price of $10.28 per
share of common stock. In addition, the Company issued 30,000 warrants to
investment advisors and consultants expiring September 2004 exercisable at price
of $11.68 per common share. These issuances of debentures and warrants were made
in reliance upon the exemption from registration set forth in Section 4(2) of
the Securities Act, relating to sales by an issuer not involving public
offering. Based on a discussion with such investors, the Registrant reasonably
believes that such investors were accredited and sophisticated investors. By
virtue of their relation to the Registrant, these investors had access to
information on the Registrant necessary to make an informed investment decision.
Consideration received by the Registrant consisted of a loan in the amount of
$5,000,000.
(3) The issuance of warrants to Frederick H. Kopko, Jr. and Edward M. Kopko in
August 1999 to purchase a total of 30,000 shares of common stock. These
issuances of options were made in reliance upon the exemption from registration
set forth in Section 4(2) of the Securities Act, relating to sales by an issuer
not involving a public offering. Based on a discussion with such investors, the
Registrant reasonably believes that such investors were accredited and
sophisticated investors. By virtue of their relation to the Registrant, these
investors had access to information on the Registrant necessary to make an
informed investment decision. No underwriters were engaged in connection with
these issuances. Consideration received by the Registrant consisted of a stand-
by loan commitment in the amount of $2,000,000.
(4) The issuance of 74,000 options granted to employees. These issuances of
options were made in reliance upon the exemption from registration set forth in
Section 4(2) of the Securities Act, relating to sales by an issuer not involving
public offering. Based on a close working relationship with such optionees,
along with various discussions with such optionees, the Registrant reasonably
believes that such optionees were accredited and/or sophisticated investors. By
virtue of their relation to the Registrant, these employees had access to
information on the Registrant necessary to make an informed decision.
USE OF PROCEEDS
The company's registration statement under the Securities Act for its initial
public offering became effective on April 22, 1998 (Registration No. 333-46005).
Offering proceeds, net of aggregate expenses of approximately $2.6 million, were
approximately $13.6 million. The company has used nearly all of the net offering
proceeds. Of the net offering proceeds, $8.2 million was used for product
development, selling and marketing, expansion of internal operations, working
capital and general corporate purposes. In addition, the company repaid debt of
$1.7 million with a portion of the proceeds and invested $2.7 million in
facilities and other capital equipment. None of the net offering proceeds were
paid directly or indirectly to directors or officers of the company, persons
owning 10% or more of the company's securities, or affiliates of the company.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial and operating data as of and for the years ended
September 30, 1999 and 1998 and the nine months ended September 30, 1997 were
derived from our financial statements that have been audited by Ernst & Young
LLP, independent auditors. The selected financial and
20
operating data as of and for the years ended December 31, 1996 and 1995 were
derived from our financial statements that have been audited by Williams, Young
& Associates LLC, independent auditors. 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.
Twelve Months Nine Months
(In thousands except per share Year Year Ended Ended Year ended
and share data) Ended Sept. 30, Ended Sept. 30, Sept. 30, Sept. 30, December 31,
1999 1998 1997 1997 1996 1995
---------- ---------- -------- -------- ---------- --------
(Unaudited)
Statement of Operations Data:
Revenues $ 14,830 $ 7,470 $ 3,061 $ 2,242 $ 2,442 $ 758
Cost of revenues 3,390 2,028 580 407 372 82
---------- ---------- -------- -------- ---------- --------
11,440 5,442 2,481 1,835 2,070 676
Selling and marketing expenses 10,484 3,231 1,772 1,445 954 235
General and administrative expenses 4,253 1,878 1,084 835 718 256
Product development expenses 2,875 1,046 461 374 184 151
---------- ---------- -------- -------- ---------- --------
17,612 6,155 3,317 2,654 1,856 642
---------- ---------- -------- -------- ---------- --------
Income (loss) from operations (6,172) (713) (836) (819) 214 34
Other income (expense) 175 130 (45) (40) (15) (1)
---------- ---------- -------- -------- ---------- --------
Income (loss) before income
taxes and extraordinary item (5,997) (583) (881) (859) 199 33
Income tax expense (benefit) -- -- -- (20) 20 --
---------- ---------- -------- -------- ---------- --------
Income (loss) before extraordinary item (5,997) (583) (881) (839) 179 33
Extraordinary item - early
extinguishment of debt -- (49) -- -- -- --
---------- ---------- -------- -------- ---------- --------
Net Income (loss) $ (5,997) $ (632) $ (881) $ (839) $ 179 $ 33
========== ========== ======== ======== ========== ========
Pro forma net Income (loss) per
common share:
Basic $ (2.11) $ (.43) $ (6.13) $ (5.15) $ 5.82 $ 25.65
---------- ---------- -------- -------- ---------- --------
Diluted $ (2.11) $ (.43) $ (6.13) $ (5.15) $ .09 $ .23
========== ========== ======== ======== ========== ========
Weighted average common shares 2,843,648 1,356,478 143,811 163,231 22,178 1,026
---------- ---------- -------- -------- ---------- --------
Weighted average adjusted common shares 2,843,648 1,356,478 143,811 163,231 1,432,909 112,356
---------- ---------- -------- -------- ---------- --------
September 30, December 31,
------------------------------ -----------------
1999 1998 1997 1996 1995
------- ------- ------ ------ ------
Balance Sheet Data:
Cash and Cash Equivalents $ 5,889 $ 9,940 $ 115 $ 454 $ 23
Working capital 8,843 11,156 (265) 516 53
Total assets 16,709 15,950 2,333 1,627 238
Total indebtedness 5,283 714 993 200 -
Stockholders' equity 8,747 14,091 684 1,077 175
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Background
We began shipment of Sound Forge, a Windows based audio editing software program
developed by one of our founders, in 1993. By 1996, we had released Sound Forge
versions 3.0 and 4.0, which significantly expanded the effects and processes
available in our audio editor, thereby meeting the needs of professional
musicians and audio engineers. At that time, we expanded the product line to
include Sound Forge XP, a scaled down version of Sound Forge, as
21
well as various plug-in products whose functions include noise reduction,
spectrum analysis and batch conversion. In June 1997, we released CD Architect,
an audio mastering software product and in May 1998, we released a music
creation software product called ACID. ACID allows musicians, media
professionals, Internet developers and others to compose royalty free, loop
based music. Additionally, in October 1998, we introduced consumer versions of
ACID for home entertainment use. Both ACID products are supported by loop
library CD's which offer professionals and consumers a variety of music genres
to choose from when composing music. In May 1999 we introduced our first product
targeted to an office environment, Audio Anywhere, which combines existing
products, ACID and Sound Forge XP, to produce multimedia content for use with
Microsoft Office 2000. We released Vegas Pro in July 1999 as a multi-track
digital audio editor developed for professional audio and video users. In
September 1999, we released Stream Anywhere, a software tool that allows website
developers to translate or encode audio and video media in either the Microsoft
Windows Media Technologies or RealNetworks' RealSystem G2 streaming format. We
also released Siren in a beta form in September 1999 and began licensing for
versions of it to hardware manufacturers such as Hewlett Packard for CD
recordable drives. Siren is a comprehensive digital music management system that
allows PC users to locate and download digital music from the Internet, record
music from their personal CD collection to their PC hard drive, and manage the
music in multiple play list arrangements on their PC. In addition, Siren
provides seamless transfer to portable digital players and traditional CD
players. In October 1999, we announced the formation of and significant
investment in a media services division - a new business unit designed
specifically to offer complete encoding services to the music, film, broadcast,
and corporate markets.
Revenues
Revenues consist of fees charged for the licensing of Windows based software
products. Prior to June 1997 we generated revenues primarily from sales of our
Sound Forge family of products. Since June 1997, we have generated revenues
from sales of our expanded product line that includes Sound Forge, Sound Forge
XP, CD Architect, Acoustic Mirror, Soft Encode, ACID, Stream Anywhere, Audio
Anywhere, Vegas, Siren and various plug-in products and music libraries. To
date, we have not recorded any revenues from our media services.
We recognize revenues upon delivery, net of allowances for estimated returns,
provided that we have no significant obligations remaining and collection of the
resulting receivable is deemed probable. We recognize revenues from software
license agreements with OEMs when the following conditions are met: the
software product has been delivered to the OEM, our fee is fixed and/or
determinable, and collectibility is probable. Additionally, revenues include
fees recorded pursuant to long-term contracts, using the percentage of
completion method of accounting, when significant customization or modification
is required. Efforts to develop further OEM transactions and enter new markets
and distribution channels have resulted in and are expected to continue to
result in significant quarter to quarter variability in revenues.
22
Cost of Revenues
Cost of revenues include product material costs, contracted and internal
assembly labor, freight, royalties on third party technology or intellectual
content and amortization of previously capitalized product development costs.
We have experienced wide fluctuations in costs of revenues as a percentage of
revenues due to variations in product mix. We have sold our software products
bundled with purchased third party hardware, which results in higher costs as a
percentage of revenue. We incur no costs of revenues in connection with OEM
sales where our customers bundle our software products with their hardware.
Selling and Marketing Expenses
Selling and marketing expenses include wages and commissions for sales,
marketing and technical support personnel, as well as advertising, direct mail,
trade show and various promotional expenses and product rebates. Timing of
these costs vary greatly depending on introduction of new products or entrance
into new markets. For example, during the quarter ended December 31, 1998, we
initiated a marketing campaign for our consumer products, ACID Music, ACID DJ
and ACID Rock. Additionally, in June 1999, we took part in a series of
promotional programs, including rebates, store demos, fliers, and end-cap
displays to promote our Audio Anywhere product in conjunction with the
introduction of Microsoft Office 2000. We believe that our success depends
largely on developing brand recognition early in a product's life cycle.
Accordingly, we expect selling and marketing costs to increase in the near
future, especially in periods of new product or market introductions.
General and Administrative Expenses
General and administrative expenses consist of costs associated with facilities,
finance, legal, management information systems and various employee benefits not
fully allocated to functional areas.
Product Development Expenses
Product development expenses include salaries and wages of the software research
and development staff and an allocation of benefits, facility and administrative
expenses, net of product development expenses capitalized pursuant to SFAS No.
86, "Accounting for the Cost of Computer Software to be Sold, Leased, or
Otherwise Marketed." We believe that continued investment in research and
development is critical to attaining our strategic objectives and, as a result,
we expect research and development expenses to increase significantly.
Results of Operations
The following table sets forth certain items from our statement of operations as
a percentage of net revenues for the periods indicated as if the nine month
fiscal year ended September 30, 1997 included the three-month period ended
December 31, 1996 and as compared to the years ended September 30, 1998 and
1999.
23
Twelve Months
Year Ended Year Ended Ended
September 30, 1999 September 30, 1998 September 30, 1997
------------------- ------------------ -------------------
(Unaudited)
Revenues 100.0% 100.0% 100.0%
Cost of revenues 22.9 27.1 18.9
-------- -------- -------
77.1 72.9 81.1
Selling and marketing expenses 70.6 43.3 57.9
General and administrative expenses 28.7 25.1 35.4
Product development expenses 19.4 14.0 15.1
-------- -------- -------
118.7 82.4 108.4
-------- -------- -------
Loss from operations (41.6) (9.5) (27.3)
Interest expense (0.3) (1.5) (1.7)
Interest and other income 1.5 3.2 0.2
-------- -------- -------
1.2 1.7 (1.5)
-------- -------- -------
Loss before income taxes and
extraordinary item (40.4) (7.8) (28.8)
Income tax expense 0.0 0.0 0.0
-------- -------- -------
Loss before extraordinary item (40.4) (7.8) (28.8)
Extraordinary item - early
extinguishment of debt 0.0 (0.7) 0.0
-------- -------- -------
Net loss (0.4)% (8.5)% (28.8)%
======== ======== =======
Years Ended September 30, 1999 and 1998
Revenues increased by $7,360,000, or 99%, to $14,830,000 for the year ended
September 30, 1999 from $7,470,000 for the year ended September 30, 1998. The
increase resulted primarily from retail sales of the ACID consumer products
released in October 1998, the introduction of Audio Anywhere into the office
superstore market in May 1999, and OEM agreements for Siren in June and
September of 1999.
Revenues to customers outside of North America accounted for 17% and 14% of
revenues for the years ended September 30, 1999 and 1998.
Cost of revenues increased by $1,362,000, or 67%, to $3,390,000 for the year
ended September 30, 1999 from $2,028,000 for the year ended September 30, 1998
and were 22.9% and 27.1% of 1999 and 1998 revenues. The majority of the
decrease as a percentage of net revenues resulted primarily from a shift in mix
toward higher margin stand-alone software sales versus products bundled with
purchased third party CD recordable disk drives. Initial order quantities of
Audio Anywhere exceeded our available assembly capacity and necessitated outside
fulfillment. Such costs partially offset reduced material costs both in
absolute dollars and as a percentage of revenues. The remainder of the increase
in absolute dollars related to the increased volume of software products sold
during the period.
Selling and marketing expenses increased by $7,253,000, or 224%, to $10,484,000
for the year ended September 30, 1999 from $3,231,000 for the year ended
September 30, 1998 and were 70.6% and 43.3% of 1999 and 1998 revenues. The
increase in selling and marketing costs in absolute dollars, and as a percentage
of revenues, resulted from marketing and promotional expenses incurred to
introduce our ACID products to the consumer markets and Audio Anywhere product
to the electronics and office retail markets. We began investing heavily in
promoting our ACID consumer products upon introduction in October 1998,
including trade
24
shows, print and radio advertisements, concert promotions, store demos and other
marketing related activities. In June 1999, we took part in the promotional
campaign introducing Microsoft's Office 2000 product. During the promotion, we
offered rebates applied against the purchase price of Audio Anywhere to office
superstore customers that bought Office 2000. In return, we received favorable
shelf placement, in-store displays, inclusion in fliers and performed in-store
demonstrations of the product. European trade show and other marketing costs
incurred by our sales and marketing office in Delft, Netherlands impacted both
absolute dollars and costs as a percentage of revenues. The remaining increase
related to personnel costs to support the growth in revenues from existing
products and for future product releases.
General and administrative expenses increased by $2,375,000, or 126%, to
$4,253,000 for the year ended September 30, 1999 from $1,878,000 for the year
ended September 30, 1998, and were 28.7% and 25.1% of 1999 and 1998 revenues.
The increase in absolute dollars related to wages and related recruitment and
benefit costs, professional fees, facility costs, and other expenses. These
costs were required to build an infrastructure to support existing and future
products and to satisfy reporting and other requirements of a public company.
General and administrative costs in 1999 also include a charge of $625,000 to
record an allowance against a receivable recorded from a customer that announced
a restructuring in November 1999. The allowance was recorded due to uncertainty
regarding collection of the amount due. However, we believe the customer is
contractually obligated to pay the royalty commitment regardless of future
business plans and we plan to aggressively pursue payment if necessary.
Product development expenses increased by $1,829,000, or 175%, to $2,875,000 for
the year ended September 30, 1999 from $1,046,000 for the year ended September
30, 1998, and were 19.4% and 14.0% of 1999 and 1998 revenues. In accordance with
SFAS Number 86, we capitalize the cost of development of software products that
have reached the level of technological feasibility. Our ACID product fell into
this category during 1998, resulting in capitalization of $316,000 of
development costs. Development of our Vegas product reached the beta stage in
March 1999 resulting in capitalization of $540,000 in 1999. The addition of
software engineers to accelerate development of our expanding line of software
products caused the remaining increase in product development costs between the
two years.
Year Ended September 30, 1998 and Twelve Months Ended September 30, 1997
Revenues increased by $4,409,000, or 144%, to $7,470,000 during the year ended
September 30, 1998 from $3,061,000 for the twelve-month period ended September
30, 1997. The increase in revenues were attributable to the nearly equal impact
of: 1) new software products released in late 1997 or 1998; 2) the distribution
of product bundles consisting of our software products and purchased third party
components; and 3) increases in revenues from various hardware and software OEM
customers. The primary new software product contributors were the ACID family of
products first released in May 1998 and the Sound Forge 4.5 upgrade released in
July 1998. We released product bundles in 1998 including CD Factory, consisting
of our CD Architect product and third party recordable disc drives and Pro Remix
Factory, a bundle consisting of CD Architect, ACID and third party recordable
disc drives. Revenues associated with new OEM arrangements were primarily
attributable to sales of our ACID, CD Architect and Sound Forge XP products with
manufacturers of recordable disc drives, sound cards and video capture boards.
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Revenues to international customers accounted for 17% and 25% of revenues for
the year ended September 30, 1998 and the twelve-month period ended September
30, 1997. The percentage decrease was attributable to the growth in domestic
sales associated with the expanded U.S. music dealer network and new
arrangements with domestic OEM customers.
Cost of revenues increased by $1,448,000, or 250%, to $2,028,000 during the year
ended September 30, 1998 from $580,000 for the twelve-month period ended
September 30, 1997 and were 27.1% and 18.9% of 1998 and 1997 revenues. The
increase in both absolute dollars and as a percentage of net revenues resulted
primarily from the sales of lower margin Professional CD Factory and Pro Remix
bundles consisting of our CD Architect and ACID software products with third
party recordable compact disc drives. The remainder of the dollar increase in
costs of revenues was associated with the increase in software license revenues.
Selling and marketing expenses increased by $1,459,000, or 82%, to $3,231,000
during the year ended September 30, 1998 from $1,772,000 during the twelve month
period ended September 30, 1997 and were 43.3% and 57.9% of 1998 and 1997
revenues. The increase in absolute dollars was primarily related to increased
personnel related costs incurred to support the increase in revenues as well as
for products expected to be released in the near future. The lower level of
selling and marketing expenses as a percentage of revenues was due to operating
efficiencies obtained as the level of revenues increased.
General and administrative expenses increased by $794,000, or 73%, to $1,878,000
for the year ended September 30, 1998 from $1,084,000 during the twelve month
period ended September 30, 1997 and were 25.1% and 35.4% of 1998 and 1997
revenues. The increase in absolute dollars was primarily attributable to
increases in wages and related recruitment and benefit costs, professional fees,
depreciation and other expenses required to build an infrastructure to support
recently released products as well as products currently under development. The
decrease in general and administrative expenses as a percentage of revenues was
primarily due to achieving greater personnel and related efficiencies as the
volume of revenues increased.
Product development expenses increased by $585,000, or 127%, to $1,046,000
during the year ended September 30, 1998 from $461,000 during the twelve month
period ended September 30, 1997 and were 14.0% and 15.1% 1998 and 1997 revenues.
In accordance with SFAS Number 86, we capitalize the cost of development of
software products that have reached the level of technological feasibility. We
capitalized $212,000 relating primarily to our CD Architect and Acoustic Mirror
products during the twelve months ended September 30, 1997 and $316,000 relating
primarily to our ACID product during the year ended September 30, 1998. The
combined increase in product development costs incurred during the 1998 period
over the comparable 1997 period was due to an increase in the number of software
engineers needed to accelerate development of our expanding line of software
products.
Liquidity and Capital Resources
Cash was used in operating activities of $6,054,000 and $2,072,000 for the years
September 30, 1999 and 1998. A $5,997,000 net loss driven by new product and
market introductions was the
26
primary use of operating funds in 1999. A loss of $632,000 contributed to the
use of cash during 1998. Additional increases in working capital of $1,158,000
and $1,941,000 also impacted cash used in operations for the two years. The
impact of non-cash charges such as depreciation, amortization and issuance of
common stock warrants and options for the years totaled $1,096,000 and $452,000.
Cash provided by (used in) investing activities of $589,000 and ($4,781,000) for
the years ended September 30, 1999 and 1998 included net purchases of fixed
assets of $1,362,000 and $1,465,000. Leasehold expenditures for our
administrative and engineering offices in 1998 and purchases of computers,
furniture and other assets were the primary fixed asset additions. Investing
activities also included capitalized software development efforts of $540,000
and $316,000 in 1999 and 1998 and a 1999 $514,000 investment in common stock of
a company that develops high speed networking products for broadband access to
and delivery of on-line media. The primary generator of cash provided by
investing activities for 1999 were $3,000,000 in proceeds from the sale of
marketable securities.
Cash provided by financing activities of $4,415,000 and $13,677,000 for the
years ended September 30, 1999 and 1998, were impacted by net proceeds from debt
of $5,257,000 and $1,022,000 and by payments on debt of $643,000 and $1,262,000.
Debt proceeds in 1999 included $4,625,000, net of commissions and other expenses
from the issuance of redeemable convertible subordinated debentures. Financing
proceeds in 1998 included the combined issuance of $13,918,000 of common stock
from the June 1998 initial public offering and from the earlier private
placement.
We received the proceeds of a $40,000 unsecured note in August 1997 from
relatives of one of our officers. The note paid interest monthly at 15% per
annum and was convertible into common stock at $5.00 per share at our election.
We exercised our right and converted the note into 8,000 shares of common stock
in October 1997.
In June 1998, we completed an initial public offering, including over allotment
shares, of 2,097,775 shares of common stock at a price of $7.50 per share and
1,145,387 common stock purchase warrants at a price of $0.10 each. The net
proceeds from the offering, after deduction of underwriting discounts and other
expenses relating to the offering, were approximately $13,258,359. We have used
the net proceeds for development of new products, capital expenditures, sales
and marketing, expansion of internal operations, acquisition activities and/or
joint venture activities and working capital and general corporate purposes.
In March 1999, we completed the refinancing of a mortgage with a bank on our
sales and marketing facility of $632,000. The agreement provides for monthly
payments of interest and principal of $5,050 based on an interest rate of 7.375%
percent per annum.
We entered into an agreement with Oracle in September 1999 for license of and
implementation of an enterprise resource planning system. The first phase of
the system is expected to be operational by January 1, 2000. We entered into a
lease on October 1, 1999 for a 45,000 square foot facility. The lease provides
for future expansion opportunities over the course of the ten-year commitment
and, once ready for occupancy, is expected to be sufficient for our needs for
27
the near future. We anticipate there will be additional needs for increased
capital expenditures and lease commitments in the next 12 months consistent with
our anticipated growth in operations and infrastructure.
We expect to experience significant growth in operating expenses, particularly
research and development and sales and marketing expenses, for the foreseeable
future in order to execute our business plan. As a result, we anticipate that
such operating expenses, as well as planned capital expenditures, will
constitute a material use of our cash resources. In addition, we may utilize
cash resources to fund acquisitions or investments in complementary businesses,
technologies or product lines. Although we believe our current cash, cash
equivalents, and capital commitments are sufficient to fund current operating
levels and obligations for the near future, it will be necessary to supplement
these resources with additional capital in order to fund our significant growth
initiatives. Therefore, we may seek to raise additional funds through public
or private equity financing, or through other sources such as credit or lease
facilities. There can be no assurance that we will obtain additional debt or
equity on satisfactory terms.
New Accounting Standards
In December 1998, the American Institute of Certified Public Accounts (AICPA)
issued Statement of Position 98-9, "Modification of SOP 97-2, Software Revenue
Recognition, with Respect to Certain Transactions" (SOP 98-9), which amends
certain elements of SOP 97-2, "Software Revenue Recognition" and is effective
for fiscal years beginning after March 15, 1999. The Company believes that the
adoption of SOP 98-9 will not have a material effect on its results of
operations or financial position.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133). SFAS 133 establishes a new model for
accounting for derivatives and hedging activities and supersedes and amends
existing accounting standards and is effective for fiscal years beginning after
June 15, 2000. SFAS 133 requires that all derivatives be recognized in the
balance sheet at their fair market value, and the corresponding derivative gains
or losses be either reported in the statement of operations or as a component of
other comprehensive income depending on the type of hedge relationship that
exists with respect to such derivative. The Company does not expect the adoption
of SFAS 133 to have a material impact on its consolidated financial statements.
Year 2000 Impact
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Computer programs that
have time-sensitive software may recognize a date using "00" as the year 1900
rather than the year 2000. The Year 2000 issue creates risk for us from
unforeseen problems in our own computer systems and from third parties,
including customers, vendors, and manufacturers, with whom we deal. Failure of
our and/or third parties' computer systems could have a material impact on our
ability to conduct our business.
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We believe our software products are year 2000 compliant. Our products obtain
date information, such as creation dates and modification dates, directly from
the computer's operating system. Microsoft Corporation has stated that their
operating systems will continue to operate into the twenty-first century.
With regard to our internal processing and operational systems, we implemented a
Year 2000 readiness plan including the following steps: (i) conducting an
inventory of our internal systems, including information technology systems and
non-information technology and the systems acquired or to be acquired by us from
third parties; (ii) assessing and prioritizing any required remediation; (iii)
remediating any problems by repairing or, if appropriate, replacing the non-
compliant systems; (iv) testing of all remediated systems for Year 2000
compliance; and (v) developing contingency plans that may be employed in the
event that any system used by us is unexpectedly affected by an unanticipated
Year 2000 problem. We have not discovered any material operational issues or
costs associated with preparing internal systems for the Year 2000 however,
there can be no assurance that we will not experience material adverse effects
from undetected errors or the failure of such systems to be Year 2000 compliant.
Any such failures could have a material adverse effect on our business,
financial condition and results of operations.
In addition to assessing our own systems, we have reviewed our dependence on
vendors, service providers and third party business partners. We believe there
are numerous sources and alternatives to vendors for which we rely on for
products or services. Despite our lack of dependence, there can be no guarantee
that we will not be adversely impacted by non-compliance of one or more vendors,
service providers or customers. The actual impact on us resulting from non-
compliance of these entities cannot be determined at this time.
To date, we have expended an immaterial amount in conjunction with our Year 2000
readiness plan. We further expect that the cost of completing the Year 2000
readiness plan, including replacement of any necessary computer systems, will
not be material.
Factors that may affect Sonic Foundry's Business, Future Operating results and
Financial Condition
In addition to the other information in this Annual Report on Form 10-K, the
following factors should be considered in evaluating our business and prospects.
Operating History Risks
We have a limited operating history upon which you can evaluate our business and
our future prospects and our operating results will likely fluctuate
significantly.
We were incorporated in March 1994 and we have a limited operating history and
limited financial results upon which you can assess our future success. We have
no history of digital media services operations upon which you can evaluate our
digital media services business model and the prospects for that
29
business. As a result of our limited operating history and the rapidly changing
nature of the markets in which we compete, our quarterly and annual revenues and
operating results are difficult to predict and may fluctuate significantly from
quarter to quarter and from year to year. You should therefore not rely upon our
revenues and our operating results for any one quarter or year as an indication
of our future revenues or operating results. Fluctuations in our revenues and
our operating results will likely increase the volatility of our stock price,
and if our revenues or results of operations fall below the expectations of
investors or public market analysts, the price of our common stock could fall
substantially. You should evaluate our chances of financial and operational
success in light of the risks, uncertainties, expenses and difficulties
frequently encountered by growing companies in new and rapidly evolving markets.
We have a history of losses and we may never attain profitability.
We have incurred significant losses since our inception and we may never become
profitable. For the years ended September 30, 1999 and 1998 and the twelve
months ended September 30, 1997, we incurred net losses of $5,997,000, $632,000,
and $881,000 and as of September 30, 1999, we had an accumulated deficit of
$7,466,000. We cannot assure you that we will achieve or maintain profitability
in the future.
Industry Risks
The market for our products and services is relatively new, and we cannot assure
you that the market will develop as we expect.
Because the market for our products and services is relatively new and rapidly
changing, it is difficult to predict future financial results. Our research and
development and sales and marketing efforts, and business expenditures are
partially based on predictions regarding certain developments for software
products and media services. To the extent that these predictions prove
inaccurate, we may not achieve the level of revenues and operating expenses that
we expect at the time that we expect them and our revenues and operating
expenses may fluctuate.
Our markets are highly competitive, and we may not be able to compete
effectively in our business.
Competition in the markets for digital media software, products and services is
intense. We compete with several companies engaged in the software and digital
media businesses and we expect competition to increase as new companies enter
the market and our current competitors expand their products and services. This
could mean lower prices or reduced demand for our products. Many of our current
and potential competitors have longer operating histories, greater name
recognition, more employees and significantly greater financial, technical,
marketing, public relations and distribution resources than we do, and we may
not be able to successfully compete with them. Any of these developments would
have an adverse effect on our operating results.
30
Lack of commercial acceptance of, or decreased demand for, complementary
products and technologies developed by third parties may lead to a decreased
demand for our digital media software products and services.
The success of some of our digital media software products and planned digital
media services depends, in part, upon the commercial acceptance of products and
technologies developed by other companies that our digital media software
products and services may complement, including compact disc recorders, Digital
Versatile Disc players and MP3 technology. These complementary products help
drive the demand for digital media and if businesses and consumers do not accept
these products, the demand for our products and services may decrease or fail to
grow and our business may suffer.
The success of our business depends, in part, upon strategic relationships that
we have with other companies.
Our business depends, in part, upon relationships that we have with strategic
partners such as Microsoft, RealNetworks and Fraunhofer Institute. We rely, in
part, on strategic relationships to help us:
. maximize the acceptance of our products by customers through distribution
arrangements;
. increase the amount and availability of compelling media content on the
Internet to help boost demand for our products and services;
. increase awareness of our Sonic Foundry brand; and
. increase the performance and utility of our products and services.
We would be unable to realize many of these goals without the cooperation of
these partners. We anticipate that the efforts of our strategic partners will
become more important as the availability and use of multimedia content on the
Internet increases. For example, we may become more reliant on strategic
partners to provide multimedia content, provide more secure and easy-to-use
electronic commerce solutions and build out the necessary infrastructure for
media delivery. The loss of these strategic relationships, the inability to find
other strategic partners or the failure of our existing relationships to achieve
meaningful positive results could harm our business.
We rely upon a number of distributors to increase our market penetration
domestically and internationally.
We rely upon 60 distributors in 52 countries to sell and market our digital
media software products internationally. We generally do not have contracts with
these distributors. If these distributors were to cease selling and marketing
our products, the international sales of our products may decrease.
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We have a distribution contract with Ingram Micro, Inc., which distributes our
software products to various computer resellers, value-added resellers, catalog
distributors and smaller retail outlets. Our contract with Ingram Micro requires
us to accept the return of any of our products that Ingram Micro does not sell
and to credit Ingram Micro for the value of these products. Our contract with
Ingram Micro also protects Ingram Micro for the value of its inventory in the
event that we lower our prices. If Ingram Micro fails to continue to carry our
products, returns a large quantity of our products to us, or competitive
pressures require us to lower the prices of the products that we supply to
Ingram Micro, our business will suffer.
The growth of our business depends upon the increased use of the Internet for
communications, commerce and advertising.
The growth of our business depends upon the continued growth of the Internet as
a medium for communications. The Internet may not be accepted as a viable
commercial medium for broadcasting digital and multimedia content or digital
media delivery for a number of reasons, including:
. potentially inadequate development of the necessary infrastructure to
accommodate growth in the number of users and Internet traffic;
. unavailability of compelling multimedia content; and
. delays in the development or adoption of new technological standards and
protocols or increased governmental regulations, which could inhibit the
growth and use of the Internet.
In addition, we believe that other Internet-related issues, including security
of transactions, reliability of data transmission, cost and ease of use, are not
fully resolved and may affect the amount of business that is conducted over the
Internet.
If Internet usage grows, its infrastructure may not be able to support the
demands placed on it by this growth, in particular growing demands for
delivering high-quality media content. As a result, its performance and
reliability may decline. In addition, websites have experienced interruptions in
service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently in
the future, Internet usage, as well as the use of our products and services,
could grow more slowly or decline.
Technology Risks
We depend upon access to Microsoft software codes to develop our digital media
software products.
Quick access to Microsoft's software codes enables us to develop Microsoft
Windows-based software products in a timely manner. Although, in the past,
Microsoft consistently has given us quick access to its software codes,
Microsoft is under no obligation to do so and may refuse us this access in the
future at its discretion. If we do not continue to receive quick access to
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Microsoft's software codes, the development of our software products will be
delayed and our business may suffer.
We may not be successful in our attempts to keep pace with rapid technological
change and evolving industry standards.
The markets for digital media products and digital media services are
characterized by rapidly changing customer requirements, evolving technologies
and industry standards, and frequent new product and service introductions. Our
future success will depend, in part, upon our ability to:
. use leading technologies effectively;
. enhance our current software products and services;
. identify, develop, and market new software products and service
opportunities; and
. influence and respond to emerging industry standards and other
technological changes.
We must accomplish these objectives in a timely and cost-effective manner. We
have experienced development delays and cost overruns in our development efforts
in the past and we may encounter such problems in the future. Delays and cost
overruns could affect our ability to respond to technological changes, evolving
industry standards, competitive developments or customer requirements. Our
products also may contain undetected errors that could cause increased
development costs, loss of revenues, adverse publicity, reduced market
acceptance of those products or lawsuits by customers. If we fail to develop
products that achieve widespread market acceptance or that fail to generate
significant revenues to offset development costs, our business and operating
results would suffer. We may not timely and successfully identify, develop and
market new product and service opportunities. If we introduce new products and
services, they may not attain broad market acceptance or contribute meaningfully
to our revenues or profitability. Any of these developments would have an
adverse effect on our operating results.
Demand for our digital media software products might decrease or fail to grow if
commercial acceptance of the Microsoft Windows computer operating system
declines.
Our digital media software products work exclusively on the Microsoft Windows
computer operating system. Some of our competitors offer products for the Apple
Macintosh and other computer operating systems. If the Macintosh computer
operating system, which is popular with many musicians, or other competing
operating systems, including Linux and Java, were to become dominant in the
marketplace at the expense of the Microsoft Windows computer operating system,
demand for our digital media software products may decrease or fail to grow.
Moreover, if we were unable to adapt our current digital media software products
or develop new digital media software products in a timely and cost-effective
manner to work on these different operating systems, our business might suffer.
33
Development of new standards for the electronic delivery of digital media,
particularly music, could significantly affect our growth and the way we do
business.
The onset of competing industry standards for the electronic delivery of music
could slow the growth of our business or force us to adjust the way in which we
do business. Some of the major recording studios have recently announced a plan
to develop a universal standard for the electronic delivery of music, called
Secured Digital Music Initiative, or SDMI, and have announced their intention to
make this delivery method available by the end of 1999. In addition, major
corporations have launched efforts to establish their own proprietary audio
formats. The lack of defined, generally accepted standards for delivery formats
could slow the widespread commercial acceptance of this media delivery
technology and our products. If standard delivery technology does not achieve
widespread commercial acceptance and we are unable to adapt our digital media
software products accordingly in a timely and cost-effective manner, our
business may suffer.
Our business will suffer if our systems fail or become unavailable.
A reduction in the performance, reliability and availability of our website and
network infrastructure will harm our ability to distribute our products and
services to our users, as well as our reputation and ability to attract and
retain users, customers, advertisers and content providers. Our systems and
operations could be damaged or interrupted by fire, flood, power loss,
telecommunications failure, Internet breakdown, earthquake and similar events.
Our systems are also subject to break-ins, sabotage, intentional acts of
vandalism and similar misconduct. Our computer and communications infrastructure
is located at a single facility in Madison, Wisconsin. We do not have fully
redundant systems or a formal disaster recovery plan, and we do not carry
adequate business interruption insurance to compensate us for losses that may
occur from a system outage.
Our electronic commerce and digital distribution activities are managed by
sophisticated software and computer systems. We are in the process of adopting a
new enterprise resource planning system, which handles all of our accounting,
operations, sales and information systems. We may encounter delays in adopting
this or other systems that we use. Furthermore, these systems may contain
undetected errors that could cause the systems to fail. Any system error or
failure that causes interruption in availability of products or content or an
increase in response time could result in a loss of potential or existing
business services customers. If we suffer sustained or repeated interruptions,
our products, services and website could be less attractive and our business may
suffer.
A sudden and significant increase in traffic on our website could strain the
capacity of the software, hardware and telecommunications systems that we deploy
or use. This could lead to slower response times or system failures. We depend
on Web browsers, ISPs and online service providers to provide Internet users
access to our website. Many of these providers have experienced significant
outages in the past, and could experience outages, delays and other difficulties
due to system failures unrelated to our systems.
34
Intellectual Property Risks
We may not be successful in protecting our intellectual property and proprietary
rights.
Our inability to protect our proprietary rights, and the costs of doing so,
could harm our business. Our success and ability to compete partly depends on
the superiority, uniqueness or value of our technology, including both
internally developed technology and technology licensed from third parties. To
protect our proprietary rights, we rely on a combination of trademark, copyright
and trade secret laws, confidentiality agreements with our employees and third
parties and "shrink wrap" licenses. Despite our efforts to protect our
proprietary rights, unauthorized parties may copy or infringe aspects of our
technology, products, services or trademarks, or obtain and use information we
regard as proprietary. In addition, others may independently develop
technologies that are similar or superior to ours, which could reduce the value
of our intellectual property.
Companies in the computer industry have frequently resorted to litigation
regarding intellectual property rights. We may have to litigate to enforce our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of other parties' proprietary rights. From time to time,
other parties' proprietary rights, including patent rights, have come to our
attention and on several occasions we have received notice of claims of
infringement of other parties' proprietary rights, and we may receive such
notices in the future.
Our intellectual property may infringe the rights of others.
Because we protect our proprietary rights with a combination of trademark,
copyright and trade secret laws, confidentiality agreements with our employees
and third parties and "shrink wrap" licenses rather than with patents, our
intellectual property may unintentionally infringe upon the proprietary rights
of others. If a third party's claim of intellectual property right infringement
were to prevail, we could be forced to pay damages, comply with injunctions, or
halt distribution of our products while we re-engineer them or seek licenses to
necessary technology, which might not be available on reasonable terms. We
could also be subject to claims for indemnification resulting from infringement
claims made against our customers and strategic partners, which could increase
our defense costs and potential damages. In addition, we have agreed to
indemnify certain distributors and original equipment manufacturers, or OEMs,
for infringement claims of other parties. If these other parties sue the
distributors or OEMs, we may be responsible for defending the lawsuit and for
paying any judgment that may result. Any of these events could harm our
business.
We may be unable to retain technology licensed or obtained from third parties
and strategic partners.
We rely upon licenses from third parties and strategic partners for some of our
technologies. These companies that license the technologies to us may decide to
discontinue the licenses at any time. If they do so, our business may suffer.
35
Further, the Internet and software industries have experienced substantial
consolidation and a proliferation of strategic transactions. We expect this
consolidation and strategic partnering to continue. Acquisitions or strategic
relationships could harm us in a number of ways. For example:
. our competitors could acquire or form partnerships with companies with which
we have strategic relationships and discontinue our relationship, resulting
in the loss of distribution opportunities for our products and services or
the loss of certain enhancements or value-added features to our products and
services; or
. a party with significant resources and experience could acquire a competitor
of ours, increasing the ability of the competitor to compete with our
products and services.
Management Risks
Our business could suffer if we lose the services of, or fail to attract, key
personnel.
Our success depends in significant part upon a number of key management and
technical employees. The loss of the services of one or more key employees,
particularly Rimas Buinevicius, our Chairman of the Board and Chief Executive
Officer, Monty R. Schmidt, our President, and Curtis Palmer, our Chief
Technology Officer, could seriously impede our success. Although we have
employment agreements with each of these individuals, a state court may
determine not to enforce, or to only partially enforce, these agreements. We do
not have employment agreements with any other of our key employees. We maintain
$1 million "key-man" insurance policies on the lives of Mr. Buinevicius, Mr.
Schmidt, and Mr. Palmer, but do not maintain any "key-man" insurance policies on
any other employees. Our success also depends upon our ability to attract and
retain highly skilled technical, managerial, marketing, and customer service
personnel. Competition for highly-skilled personnel is intense. In particular,
we have experienced difficulty in hiring software engineers and other technical
employees necessary to further our research and development efforts. Our
failure to attract or retain these personnel could adversely affect our
business.
We may not successfully manage our growth.
We cannot successfully implement our business model if we fail to manage our
growth. We have rapidly and significantly expanded our operations domestically
and internationally and anticipate further expansion to take advantage of market
opportunities. We have increased the number of our full-time employees from 43
on January 1, 1998 to 160 on September 30, 1999. Managing this substantial
expansion has placed a significant strain on our management, operational and
financial resources. If our growth continues, we will need to continue to
improve our financial and managerial control and reporting systems and
procedures.
We may pursue acquisitions and investments that could adversely affect our
business.
We may make acquisitions of, or investments in, businesses, products and
technologies that could complement or expand our business in the future. We
currently have no commitments or
36
agreements with respect to any business acquisitions or investments. If we
identify an acquisition candidate, we may not be able to successfully negotiate
or finance the acquisition or integrate the acquired businesses, products or
technologies into our existing business and products. Future acquisitions could
result in potentially dilutive issuances of equity securities, the incurrence of
debt and contingent liabilities, amortization expenses or write-downs of
acquired assets.
Our international operations involve risks.
We have an office in the Netherlands, and we use over 60 distributors to market
and sell our products in 52 countries. For the year ended September 30, 1999,
17% of our revenues were from outside North America. We are subject to the
normal risks of doing business internationally. These risks include:
. unexpected changes in regulatory requirements;
. export and import restrictions;
. tariffs and trade barriers and limitations on fund transfers;
. longer payment cycles and problems in collecting accounts receivable;
. potential adverse tax consequences;
. exchange rate fluctuations; and
. increased risk of piracy and limits on our ability to enforce our
intellectual property rights.
Any of these factors could harm our business. We do not currently hedge our
foreign currency exposure.
We may be subject to assessment of sales and other taxes for the sale of our
products, license of technology or provision of services.
We may have to pay past sales or other taxes that we have not collected from our
customers. We do not currently collect sales or other taxes on the sale of our
products, license of technology or provision of services in states and countries
other than Wisconsin. The federal Internet Tax Freedom Act, passed in 1998,
imposes a three-year moratorium on discriminatory sales taxes on electronic
commerce. We cannot assure you that this moratorium will be extended. Further,
foreign countries or, following the moratorium, one or more states, may seek to
impose sales or other tax obligations on companies that engage in such
activities within their jurisdictions. Our business would suffer if one or more
states or any foreign country were able to require us to collect sales or other
taxes from current or past sales of products, licenses of technology or
provision of services, particularly because we would be unable to go back to
customers to collect sales taxes for past sales and may have to pay such taxes
out of our own funds.
37
Corporate Governance Risks
Stockholders may be unable to exercise control because our management controls a
large percentage of our stock.
Our directors, officers and affiliated persons own approximately 40% of our
common stock and have significant influence over stockholder voting matters. If
our directors, officers and affiliated persons act together, they will be able
to influence the composition of our board of directors, and will continue to
have significant influence over our affairs in general.
Provisions of our charter documents and Maryland law could 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 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 classified voting, which means that
our stockholders may vote upon the retention of only one of our five directors
each year. Moreover, Maryland corporate law restricts certain business
combination transactions with "interested stockholders."
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Because our cash equivalents consist of overnight investments in money market
funds, we will not experience decreases in principal value associated with a
decline in interest rates. Although we license our software to customers
overseas in U.S. dollars, we have exposure to foreign currency fluctuations
associated with liabilities, bank accounts and other assets maintained by our
office in the Netherlands. We currently do not hedge our exposure to foreign
currency fluctuations, which have historically been immaterial.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
38
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sonic Foundry, Inc.
We have audited the accompanying balance sheets of Sonic Foundry, Inc. (the
Company) as of September 30, 1999 and 1998, and the related statements of
operations, stockholders' equity and cash flows for the years ended September
30, 1999 and 1998, and the nine months ended September 30, 1997. Our audits also
included the financial statement schedule listed in the index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
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 financial statements referred to above present fairly, in
all material respects, the financial position of the Company at September 30,
1999 and 1998 and the results of its operations and its cash flows for the years
ended September 30, 1999 and 1998 and the nine months ended September 30, 1997,
in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
ERNST & YOUNG LLP
Milwaukee, Wisconsin
November 5, 1999
39
Sonic Foundry, Inc.
Balance Sheets
September 30,
1999 1998
-------------------------------
Assets
Current assets:
Cash and cash equivalents $ 5,889,107 $ 6,939,533
Marketable securities - 3,000,000
Trade accounts receivable, net of allowances of $1,314,750 and
$73,344 3,760,720 1,690,175
Revenues in excess of billings for software license fees - 705,263
Inventories 1,040,927 316,140
Prepaid expenses and other current assets 880,123 285,703
-------------------------------
Total current assets 11,570,877 12,936,814
Property and equipment:
Land 190,000 190,000
Buildings and improvements 1,737,962 1,491,228
Equipment 2,218,113 1,186,818
Furniture and fixtures 202,187 132,802
-------------------------------
4,348,262 3,000,848
Less accumulated depreciation 923,051 389,863
-------------------------------
Net property and equipment 3,425,211 2,610,985
Capitalized software development costs, net 643,220 401,629
Long term investment 513,787 -
Other assets 556,165 261
-------------------------------
Total assets $16,709,260 $15,949,689
===============================
See accompanying notes.
40
Sonic Foundry, Inc.
Balance Sheets
September 30,
1999 1998
-------------------------------
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 1,866,821 $ 828,086
Accrued liabilities 812,401 316,677
Current portion of long-term debt 48,569 636,081
-------------------------------
Total current liabilities 2,727,791 1,780,844
Long-term debt 5,234,525 77,472
Stockholders' equity:
Preferred stock, $.01 par value, authorized 5,000,000 shares; none
issued and outstanding - -
5% preferred stock, Series B, voting, cumulative, convertible,
$.01 par value (liquidation preference at par), authorized
10,000,000 shares, 7,223,719 shares issued and outstanding in 1998 - 72,237
Common stock, $.01 par value, authorized 20,000,000 shares;
6,497,249 and 2,665,935 shares issued and outstanding 64,973 26,660
Common stock warrants and options 1,011,375 159,500
Additional paid-in capital 15,336,252 15,297,096
Accumulated deficit (7,465,656) (1,464,120)
Unearned compensation (200,000) -
-------------------------------
Total stockholders' equity 8,746,944 14,091,373
-------------------------------
Total liabilities and stockholders' equity $16,709,260 $15,949,689
===============================
See accompanying notes.
41
Sonic Foundry, Inc.
Statements of Operations
Nine Months
Year Ended Year Ended Ended
September 30, September 30, September 30,
1999 1998 1997
-------------------------------------------------
Revenues $14,829,639 $7,469,658 $2,242,512
Cost of revenues 3,389,403 2,027,918 407,099
-------------------------------------------------
11,440,236 5,441,740 1,835,413
Selling and marketing expenses 10,484,036 3,230,448 1,445,302
General and administrative expenses 4,253,403 1,878,377 834,934
Product development expenses 2,875,174 1,046,055 374,128
-------------------------------------------------
17,612,613 6,154,880 2,654,364
-------------------------------------------------
Loss from operations (6,172,377) (713,140) (818,951)
Interest expense (53,980) (111,239) (42,771)
Interest and other income 229,209 241,030 2,631
-------------------------------------------------
175,229 129,791 (40,140)
-------------------------------------------------
Loss before income taxes and extraordinary
item (5,997,148) (583,349) (859,091)
Income tax benefit - - (20,000)
-------------------------------------------------
Loss before extraordinary item (5,997,148) (583,349) (839,091)
Extraordinary item - early extinguishment
of debt - (48,750) -
-------------------------------------------------
Net loss $(5,997,148) $ (632,099) $ (839,091)
=================================================
Per common share:
Loss before extraordinary item $ (2.11) $ (.43) $ (5.15)
Extraordinary item - early extinguishment
of debt - (.04) -
-------------------------------------------------
Net loss per common share - basic and
diluted $ (2.11) $ (.47) $ (5.15)
=================================================
See accompanying notes.
42
Sonic Foundry, Inc.
Statements of Stockholders' Equity
Years Ended September 30, 1999 and 1998
and Nine Months Ended September 30, 1997
Preferred Stock
--------------- Common
Series B Common Stock Stock Additional Retained
-------- ------------ Warrants and Unearned Paid-in- Earnings
Shares Dollars Shares Dollars Options Compensation Capital (Deficit) Total
------ ------- ------ ------- ------------ ------------ --------- ----------- -----
Balance,
December 31, 1996 6,680,000 $ 66,800 127,800 $ 1,278 $ 78,000 $ - $ 735,439 $ 195,188 $ 1,076,705
Issuance of common
stock, net - - 101,960 1,020 - - 508,780 - 509,800
Subchapter S
distributions - - - - - - - (63,000) (63,000)
Preferred stock
dividend 199,732 1,997 - - - - - (1,997) -
Undistributed
Subchapter S
Earnings - - - - - - 119,681 (119,681) -
Net loss - - - - - - - (839,091) (839,091)
-------------------------------------------------------------------------------------------------------------
Balance,
September 30, 1997 6,879,732 68,797 229,760 2,298 78,000 - 1,363,900 (828,581) 684,414
Issuance of common
stock, net - - 2,228,175 22,282 - - 13,888,076 - 13,910,358
Conversion of
convertible debt
to common stock 8,000 80 39,920 40,000
Exercise of common
stock options - - 200,000 2,000 - - 5,200 - 7,200
Issuance of common
stock warrants - - - - 81,500 - - - 81,500
Preferred stock
dividend 343,987 3,440 - - - - - (3,440) -
Net loss - - - - - - - (632,099) (632,099)
-------------------------------------------------------------------------------------------------------------
Balance,
September 30, 1998 7,223,719 72,237 2,665,935 26,660 159,500 - 15,297,096 (1,464,120) 14,091,373
Exercise of common
stock warrants - - 75 1 - - 843 - 844
Issuance of common
stock warrants and
options - - - - 851,875 - - - 851,875
Preferred stock
dividend 438,764 4,388 - - - - - (4,388) -
Conversion of
preferred stock to
common stock (7,662,483) (76,625) 3,831,239 38,312 - - 38,313 - -
Purchase and
subsequent
issuance of stock
under restricted
stock awards - - - - - (200,000) - - (200,000)
Net loss - - - - - - - (5,997,148) (5,997,148)
-------------------------------------------------------------------------------------------------------------
Balance,
September 30, 1999 - $ - 6,497,249 $64,973 $1,011,375 $(200,000) $15,336,252 $(7,465,656) $ 8,746,944
===================================================================================================================================
See accompanying notes.
43
Sonic Foundry, Inc.
Statements of Cash Flows
Year Ended Year Ended Nine Months Ended
September 30, September 30, September 30,
---------------------------------------------------------------
1999 1998 1997
---------------------------------------------------------------
Operating activities
Net loss $(5,997,148) $ (632,099) $ (839,091)
Adjustments to reconcile net loss to net cash
Used in operating activities:
Depreciation and amortization 545,907 205,469 98,630
Amortization of capitalized software development 298,178 214,087 85,718
costs
Amortization of debt discount and debt issuance 12,600 16,250 -
costs
Extraordinary item - 48,750 -
Deferred income taxes - - (20,000)
Loss on disposal of property plant and equipment 5,170 - -
Charge for common stock warrants and options 238,836 16,500 -
Changes in operating assets and liabilities:
Accounts receivable (1,365,282) (1,966,954) 41,541
Inventories (724,787) (259,478) (11,435)
Prepaid expenses and other assets (601,933) (204,333) (4,394)
Accounts payable and accrued liabilities 1,534,459 489,831 324,515
---------------------------------------------------------------
Total adjustments (56,852) (1,439,878) 514,575
---------------------------------------------------------------
Net cash used in operating activities (6,054,000) (2,071,977) (324,516)
Investing activities
Proceeds from (purchases of) marketable 3,000,000 (3,000,000) -
securities
Purchases of property and equipment (1,361,573) (1,465,083) (1,042,665)
Proceeds from disposals of property and equipment 4,043 - -
Capitalized software development costs (539,769) (315,638) (212,073)
Purchases of long-term investments (513,787) - -
---------------------------------------------------------------
Net cash provided by (used in) investing activities 588,914 (4,780,721) (1,254,738)
See accompanying notes.
44
Sonic Foundry, Inc.
Statements of Cash Flows
Year Ended Year Ended Nine Months Ended
September 30, September 30, September 30,
-------------------------------------------------------------------------
1999 1998 1997
-------------------------------------------------------------------------
Financing activities
Proceeds from issuance of common stock, net of
issuance costs 844 13,917,558 509,800
Proceeds from debt issuance 5,257,000 1,022,200 747,800
Payments on long-term debt (643,184) (1,042,264) (14,183)
Purchase of common stock for restricted stock
awards (200,000) - -
Borrowings (payments) on line of credit, net - (220,000) 120,000
Payments on note payable to related party - - (60,000)
Subchapter S distributions - - (63,000)
-------------------------------------------------------------------------
Net cash provided by financing activities 4,414,660 13,677,494 1,240,417
-------------------------------------------------------------------------
Net increase (decrease) in cash (1,050,426) 6,824,796 (338,837)
Cash and cash equivalents at beginning of period 6,939,533 114,737 453,574
-------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 5,889,107 $ 6,939,533 $ 114,737
=========================================================================
Supplemental cash flow information:
Interest paid $ 32,855 $ 113,459 $ 41,451
Noncash transactions:
Preferred stock dividend 4,388 3,440 1,997
Issuance of warrants 285,000 - -
Issuance of restricted stock 200,000 - -
Conversion of notes payable into common stock - 40,000 -
45
See accompanying notes.
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
1. Basis of Presentation and Significant Accounting Policies
Business and Concentration of Credit Risk
Sonic Foundry, Inc. (the Company) develops and licenses the use of digital-based
media software. It sells to both retail and wholesale markets, primarily in
North America, Asia and Europe. All domestic and international sales are
denominated in U.S. dollars. The Company performs periodic credit evaluations of
its customers' financial condition and generally does not require collateral.
Change in Year End
On September 30, 1997, the Company changed its fiscal year so as to end on
September 30 of each year. As a result, the Company's fiscal year ended on
September 30, 1997 was nine months in length and previous fiscal years ended on
December 31 of their respective years.
Cash and Cash Equivalents
For purposes of the statement of cash flows, the Company considers all highly
liquid investments purchased with a maturity of three months or less to be cash
equivalents.
Marketable Securities
Marketable securities consisted of bank certificates of deposit. The marketable
securities are considered by management to be available-for-sale, thus requiring
the Company to carry them at fair value, with unrealized gains and losses, net
of tax, reported as a separate component of stockholders' equity. At September
30, 1998, the amortized cost of marketable securities approximated fair value,
and no adjustment to stockholders' equity for unrealized gains and losses was
required. The marketable securities matured on February 13, 1999 and bore
interest at 5.35% per annum.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Revenue Recognition
Revenues consist of fees charged for licensing of windows based software
products. The Company adopted Statement of Position (SOP) 97-2, "Software
Revenue Recognition", effective for arrangements entered into during its fiscal
year beginning October 1, 1997. In accordance with SOP 97-2, the Company
recognizes revenue from product sales upon delivery of the software product to
the end-user, unless the fee is not fixed or determinable or collectibility is
not probable. The Company has established programs, which under specified
conditions, provide price protection and/or product return rights to its
customers. Current period sales and cost of sales are reduced by the estimated
effect of these programs.
The Company has entered into agreements whereby it licenses products to Original
Equipment Manufacturers or provides customers the right to multiple copies.
These agreements generally provide for nonrefundable fixed fees, which are
recognized at delivery of the product master or
46
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
the first copy, provided that the fee is fixed and determinable and
collectibility is probable. For arrangements that include significant
customization or modification of the software, revenue is recognized using
contract accounting. Revenue from those arrangements is recognized on a
percentage-of-completion method with progress-to-completion measured based upon
labor hours incurred.
Inventory Valuation
Inventories are carried at the lower of cost or market with cost determined on a
first-in, first-out (FIFO) basis.
Software Development Costs
The Company capitalizes internal costs in developing software products upon
determination that technological feasibility has been established for the
product. Costs incurred prior to the establishment of technological feasibility
are charged to product development expense. When the product is available for
general release to customers, capitalization ceases and such costs are amortized
on a product-by-product basis computed as the greater of (a) the ratio that
current gross revenues for the product bear to the total of current and
anticipated future gross revenues or (b) the straight-line amortization over the
remaining estimated economic useful life of the product. Capitalized software
development costs are reported at the lower of unamortized cost or net
realizable value.
Capitalized software development costs at September 30, 1999 and 1998 are net of
accumulated amortization of $650,000 and $352,000.
Advertising Costs
Advertising costs are expensed at the time the advertising takes place.
Advertising costs were $1,039,000, $720,000, and $521,000 for the years ended
September 30, 1999 and 1998 and the nine months ended September 30, 1997.
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:
Years
---------------
Building and improvements 5 to 40 years
Equipment 3 to 5 years
Furniture and fixtures 7 years
Debt Issuance Costs
Deferred loan costs associated with various debt issues are amortized over the
terms of the related debt using the straight-line method. The amortization
costs do not materially differ from those obtained using the effective interest
method.
47
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
Income Taxes
Deferred income taxes are provided for temporary differences between financial
reporting and income tax bases 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.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, trade receivables, trade payables and debt instruments. The book
values of cash and cash equivalents, trade receivables, and trade payables are
considered to be representative of their respective fair values. None of the
Company's debt instruments that are outstanding at September 30, 1999, have
readily ascertainable market values; however, the carrying values are considered
to approximate their respective fair values. See Note 4 for the terms and
carrying values of the Company's various debt instruments.
Per Share Computation
The following table sets forth the computation of basic and diluted loss per
share:
Nine Months
Year Ended Year Ended Ended
September 30, September 30, September 30,
1999 1998 1997
--------------------------------------------------------------------
Numerator
Net loss $(5,997,148) $ (632,099) $ (839,091)
Preferred stock dividends declared (4,388) (3,440) (1,997)
--------------------------------------------------------------------
Net loss used in computing basic loss per (841,088)
share (6,001,536) (635,539)
Interest on convertible debt - 279 718
--------------------------------------------------------------------
Adjusted net loss used in computing diluted
loss per share $(6,001,536) $ (635,260) $ (840,370)
====================================================================
Denominator
Denominator for basic and dilutive loss per
share -- weighted average common shares 2,843,648 1,356,478 163,231
====================================================================
Securities that could potentially dilute
earnings per share in the future that are
not included in the computation of diluted
loss per share as their impact is
antidilutive (treasury stock method)
Options and warrants 522,547 266,636 348,962
Convertible debt 486,381 - 8,000
Convertible Series B Preferred Stock - 3,611,859 3,439,866
48
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
2. Inventories
Inventory consists of the following:
September 30,
-----------------------
1999 1998
-----------------------
Raw materials and supplies $ 437,223 $174,787
Work-in-process 577,651 49,299
Finished goods 26,053 92,054
-----------------------
$1,040,927 $316,140
=======================
3. Long-Term Investment
During 1999, the Company guaranteed the operating lease of a company (the
entity) that develops high speed networking products for broadband access to and
delivery of on-line media. The Company received common stock of the lessee in
exchange for the guarantee and also invested $513,787 in common stock of the
entity. The operating lease has a five-year term with aggregate base lease
payments of approximately $500,000. The Company owns less than 20% of the
entity; accordingly, the investment is accounted for using the cost method.
Certain officers and directors of the Company have personal investments in and
serve on the board of directors of the entity.
4. Long-Term Debt and Notes Payable
Long-term obligations consist of the following:
September 30,
---------------------------
1999 1998
---------------------------
Redeemable convertible subordinated debentures due $ -
September 2002, with stated interest of 7.5% per
annum, net of unamortized discount of $419,275 $4,580,725
Mortgage note payable to a bank, with interest at 7.71%
per annum, paid in October 1998 - 605,006
Mortgage note payable to a bank, due March 2002, -
monthly payments of $5,050 including interest at
7.375% per annum, secured by building and land 624,897
Note payable to the Madison Development Corporation,
due February 2002, monthly payments of $3,196
including interest at 7.70% per annum, secured by
substantially all assets 77,472 108,547
---------------------------
Total 5,283,094 713,553
Less amounts due within one year 48,569 636,081
---------------------------
Long-term debt $5,234,525 $ 77,472
===========================
The redeemable convertible subordinated debentures, issued in September 1999,
and accrued interest thereon are convertible into common stock at a rate of
$10.28 per share, subject to
49
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
certain adjustments. Concurrent with the issuance of the debentures, the Company
issued the investors 97,276 common stock purchase warrants expiring September
2004. Each of the warrants are exercisable for one share of common stock at a
price of $10.28 per share of common stock. The warrants were valued at $425,000,
which reduced the carrying amount of the debt.
In February 1998, the Company issued unsecured notes payable in the aggregate
amount of $1,000,000. The notes were to mature in February 1999 and bore
interest at a rate of 12% per annum. In connection with the issuance of the
notes, the Company issued a total of 50,000 common stock purchase warrants, each
exercisable for one share of common stock at an exercise price of $5.00 per
share (see Note 7). The warrants were valued at $65,000, which reduced the
carrying amount of the debt. In May 1998, the Company paid the face amount of
the notes and recorded an extraordinary loss equal to the remaining unamortized
debt discount of $49,000.
Maturities of long-term debt, at September 30, 1999 are as follows:
Fiscal
- - ------
2000 $ 48,569
2001 52,391
2002 5,601,409
----------
5,702,369
Debt Discount (419,275)
----------
Total $5,283,094
==========
5. Lease Commitments
The Company leases certain facilities and equipment under operating lease
agreements expiring through August 2003. Total rent expense on all operating
leases was approximately $390,000, $84,000, and $30,000 for the years ended
September 30, 1999 and 1998 and the nine months ended September 30, 1997. At
September 30, 1999, future minimum lease commitments under such lease agreements
are as follows:
Fiscal
- - ------
2000 $ 469,000
2001 438,000
2002 350,000
2003 190,000
2004 2,000
----------
Total $1,449,000
==========
The Company entered into a lease on October 1, 1999 on a 45,000 square foot
facility. The term of the lease is through May 31, 2010. Annual payments, which
are not reflected in the schedule above, commence at $460,000 and increase
yearly.
50
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
6. Preferred Stock
The Series B preferred stock accrues cumulative dividends at a 5% rate per annum
(using a liquidation value of $.01 per share), and all dividends in arrears must
be paid prior to any payment of dividends on common stock. Dividends, if
declared by the board of directors, may be paid in cash or with additional
shares of preferred stock at the holder's option. The Company declared a
dividend on June 30, 1999, 1998, and 1997 of 361,185, 343,987, and 199,732
shares of preferred stock.
In September 1999, all previously outstanding preferred stock, plus an
additional 77,579 shares for dividends in arrears, was converted into common
stock at the rate of one common share for two preferred shares.
7. Common Stock Warrants
The Company has issued restricted common stock purchase warrants to various
consultants, underwriters, and debtors. The Company also issued public common
stock purchase warrants as part of the initial public offering in April of 1998.
Each warrant represents the right to purchase one share of common stock. All
warrants are currently exercisable.
Warrants Outstanding at Expiration Date
Exercise Prices September 30, 1999
- - ------------------- ----------------------- ---------------
Restricted
$5.00 180,000 2001 to 2003
8.00 to 12.00 157,276 2004
12.00 to 19.00 300,000 2003
Public
$11.25 1,145,387 2003
-----------------------
1,782,663
=======================
8. Stock Options
The Company maintains an employee stock option plan under which the Company may
grant options to acquire up to 1,000,000 shares of common stock. The Company
also has a directors' stock option plan under which the Company may grant
options to acquire up to 90,000 shares of common stock to independent directors.
Each independent director who is re-elected or who is continuing as a member of
the board of directors on the 1999 annual meeting date and on each subsequent
meeting of stockholders is granted options to purchase 10,000 shares of common
stock. Each option entitles the holder to purchase one share of common stock at
the specified option price. The exercise price of each option granted under
either plan was set at the market price of the Company's common stock at the
respective grant date. Options vest at various intervals, as determined by the
Board of Directors at the date of grant, and expire at 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.
51
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
The number of shares available for grant under these plans at September 30, 1999
is as follows:
Employee Director
stock option stock option
plan plan
------------------ ------------------
Shares available for grant at
September 30, 1998 296,300 60,000
Shares granted in fiscal 1999 (210,025) (30,000)
Shares forfeited in fiscal 1999 5,500 -
--------- --------
Shares available for grant at
September 30, 1999 91,775 30,000
========= ========
The following table summarizes information with respect to the stock option
plans.
Year ended Year ended Nine Months ended
September 30, 1999 September 30, 1998 September 30, 1997
------------------------------ ------------------------------ ------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------------------------ ------------------------------ ------------------------------
Outstanding at beginning of
period 533,700 $1.48 627,550 $0.58 560,000 $0.05
Granted 240,025 7.62 111,000 5.08 67,550 5.00
Exercised - - (200,000) 0.04 - -
Forfeited (5,500) 2.19 (4,850) 5.00 - -
------------------------------ ------------------------------ ------------------------------
Outstanding at end of period 768,225 $3.37 533,700 $1.48 627,550 $0.58
============================== ============================== ==============================
Exercisable at end of period 508,167 260,000 320,000
=========== ============ ===========
Weighted average fair value of
options granted during period $3.77 $1.29 $1.30
=========== ============ ===========
The options outstanding at September 30, 1999 have been segregated into four
ranges for additional disclosure as follows:
Options Outstanding Options Exercisable
----------------------------------------------------- ------------------------------------------
Weighted
Options Average Weighted Options
Outstanding at Remaining Average Exercisable at Weighted
Exercise September 30, Contractual Exercise September 30, Average
Prices 1999 Life Price 1999 Exercise Price
- - ---------- ------------------ --------------- ------------ ------------------- -------------------
$0.06 360,000 6.4 $0.06 360,000 $0.06
5.00 162,700 6.2 5.00 127,667 5.00
5.50-7.00 108,525 9.0 6.25 15,500 6.25
7.50-11.00 137,000 7.2 8.68 5,000 9.00
In August 1999, the Company entered into a separation agreement with a former
employee. The agreement called for a change in certain vesting and termination
provisions on previously
52
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
granted employee stock options. Accordingly, the Company recorded $142,000 of
compensation expense associated with changes in the measurement dates of these
options.
As permitted by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS No. 123), the Company follows
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," in accounting for its stock option plans. Had the Company accounted
for its stock option plans based upon the fair value at the grant date for
options granted under the plan, based on the provisions of SFAS 123, the
Company's pro forma net loss and pro forma net loss per share would have been as
follows (for purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period):
Year ended Year ended Nine months ended
September 30, September 30, September 30,
1999 1998 1997
------------------ ------------------ -------------------
Pro forma net loss $(6,850,745) $(678,142) $(845,370)
Pro forma net loss per share (2.10) (.50) (1.11)
Pro forma information regarding net loss and net loss per share is required by
SFAS No. 123, and has been determined as if the Company had accounted for its
employee stock options under the minimum value method of that Statement for
option grants made prior to the Company's initial public offering and the Black-
Scholes method for grants made subsequent to such offering. With the exception
of volatility (which is ignored in the case of the minimum value method), the
following weighted-average assumptions were used for all periods presented:
risk-free interest rates of 5%, dividend yields of 0%; expected common stock
market price volatility factors ranging from .5 to .661 and a weighted-average
expected life of the option of five years.
9. Income Taxes
Income tax benefit in the statement of operations consists of the following:
Year ended Year ended Nine months ended
September 30, September 30, September 30,
1999 1998 1997
---------------- ---------------- --------------------
Deferred income tax benefit $(2,448,000) $(260,000) $(337,000)
Change in valuation allowance 2,448,000 260,000 317,000
---------------- ---------------- --------------------
$ - $ - $ (20,000)
================ ================ ====================
The reconciliation of income tax expense computed at the U.S. federal statutory
rate to income tax expense is:
Year ended Year ended Nine months ended
September 30, September 30, September 30,
1999 1998 1997
---------------- ----------------- --------------------
Tax (tax benefit) at U.S. $(2,039,000) $(215,000) $(292,000)
statutory rate of 34%
State income taxes (benefit),
net of federal benefit (308,000) (32,000) (67,000)
Permanent differences, net 25,000 (13,000) 2,000
General business credits (126,000) - -
Change in valuation allowance 2,448,000 260,000 337,000
---------------- ----------------- --------------------
$ - $ - $ (20,000)
================ ================= ====================
53
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
The significant components of the deferred tax accounts recognized for financial
reporting purposes were as follows:
September 30,
--------------------------------------------------------
1999 1998
-------------------------- ------------------------
Deferred tax liabilities:
Capitalized computer software costs $ (256,000) $(141,000)
Depreciation (153,000) (72,000)
-------------------------- ------------------------
Total deferred tax liabilities (409,000) (213,000)
Deferred tax assets:
Net operating loss and other carryforwards $ 2,601,000 $ 679,000
Common stock warrants 155,000 62,000
Accruals 185,000 40,000
Allowance for doubtful accounts 513,000 29,000
-------------------------- ------------------------
Total deferred tax assets 3,454,000 810,000
-------------------------- ------------------------
3,045,000 597,000
Valuation allowance (3,045,000) (597,000)
-------------------------- ========================
Net deferred tax assets $ - $ -
========================== ========================
At September 30, 1999, the Company had federal and state net operating loss
carryforwards of approximately $6,100,000 and $4,800,000, respectively,
available to offset future federal taxable income, expiring beginning in 2012.
In addition, the Company has research and development credits totaling
approximately $274,000 which can reduce taxable income, but expire beginning in
2012.
10. Savings Plan
The Company's defined contribution 401(k) savings plan covers substantially all
employees meeting certain minimum eligibility requirements. Participating
employees can elect to defer a portion of their compensation and contribute it
to the plan on a pretax basis. The Company may also match certain amounts and/or
provide additional discretionary contributions, as defined. The Company made
discretionary contributions of $88,000 and $29,000 during the years ended
September 30, 1999 and 1998 (none during fiscal 1997).
11. Related-Party Transactions
The Company incurred $39,000 and $55,000 in consulting fees to a company whose
principal stockholder is a common stockholder of the Company, during the year
ended September 30, 1998 and the nine months ended September 30, 1997.
The Company paid fees of $135,000, $196,000, and $10,000 during the years ended
September 30, 1999 and 1998 and the nine months ended September 30, 1997 to a
law firm whose partner is a director and stockholder of the Company.
In June 1998 the Board of Directors approved the issuance of guarantees of
certain obligations of certain officers of the Company. The guarantees were
executed in June and July of 1998 to a bank in order to facilitate the issuance
of loans to the officers. The guarantees carry an aggregate maximum amount of
approximately $375,000.
54
SONIC FOUNDRY, INC.
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
In August of 1999, a partnership, of which a director is a 50% principal, was
granted warrants to purchase 30,000 shares of common stock at an exercise price
of $8.00 per share, in exchange for a stand by capital commitment of $2,000,000.
12. Segment Disclosure and Major Customers
The Company operates in one industry segment. For the year ended September 30,
1999 sales to one customer totaled 22% of total revenues while sales to another
customer amounted to 10% and 14% of total revenues during the year and nine
months ended September 30, 1998 and 1997, respectively.
Percentage of revenues by continent were as follows:
Year ended Year ended Nine months ended
September 30, 1999 September 30, 1998 September 30, 1997
---------------------- ---------------------- ----------------------
North America 83% 86% 77%
Europe 10 7 16
Asia 5 5 7
Other 2 2 0
---------------------- ---------------------- ----------------------
Total 100% 100% 100%
====================== ====================== ======================
Long-lived assets in foreign countries are insignificant.
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
Not applicable.
55
PART III
A definitive proxy statement pursuant to Regulation 14A will be filed with the
Commission not later than January 28, 2000, which is 120 days after the close of
the Registrant's fiscal year. The proxy statement will be incorporated by
reference into Part III (Items 10 through 13) of Form 10-K.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following financial statements are filed as part of this report:
1. Financial Statements and Supplementary Data Listed in the Table of
Contents provided in response to Item 8 hereof.
2. Financial Statement Schedules. Financial Statement Schedule II of
the Company is included in the Report. All other Financial
Statement Schedules have been omitted since they are either not
required, not applicable, or the information is otherwise
included.
3. Exhibits.
NUMBER DESCRIPTION
- - ------ ----------------------------------------------------------------------------
3.1 Amended and Restated Articles of Incorporation of the Registrant, filed as
Exhibit No. 3.1 to the Registration Statement, and hereby incorporated by
reference.
3.2 Amended and Restated By-Laws of the Registrant, filed as Exhibit No. 3.2 to
the Registration Statement, and hereby incorporated by reference.
4.1 Specimen Common Stock Certificate, filed as Exhibit No. 4.1 to the
Registration Statement, and hereby incorporated by reference.
4.2 Form of Warrant Agreement, including Warrant Certificate, filed as Exhibit
No. 4.2 to the Registration Statement, and hereby incorporated by reference.
4.3 Form of Representatives' Warrant Agreement, including Specimen
Representatives' Warrant Certificate, filed as Exhibit No. 4.3 to the
Registration Statement, and hereby incorporated by reference.
10.1 Registrant's 1995 Stock Option Plan, filed as Exhibit No. 10.1 to the
Registration Statement, and hereby incorporated by reference.
10.2 Registrant's Non-Employee Directors' Stock Option Plan, filed as Exhibit
No. 10.2 to the Registration Statement, and hereby incorporated by
reference.
10.3 Commercial Lease between Registrant and The Williamson Center, LLC
regarding 740 and 744 Williamson Street, Madison, Wisconsin dated January
20, 1998, filed as Exhibit No. 10.3 to the Registration Statement, and
hereby incorporated by reference.
10.4 Employment Agreement between Registrant and Rimas Buinevicius dated as of
November 30, 1997 and effective as of January 1, 1997, filed as Exhibit No.
10.4 to the Registration Statement, and hereby incorporated by reference.
10.5 Employment Agreement between Registrant and Monty R. Schmidt dated as of
November 30, 1997 and effective as of January 1, 1997, filed as Exhibit
56
No. 10.5 to the Registration Statement, and hereby incorporated by reference.
10.6 Employment Agreement between Registrant and Curtis J. Palmer dated as of
November 30, 1997 and effective as of January 1, 1997, filed as Exhibit No.
10.6 to the Registration Statement, and hereby incorporated by reference.
10.7 Digital Audio System License Agreement between Registrant and Dolby
Laboratories Licensing Corporation dated July 28, 1997, filed as Exhibit
No. 10.7 to the Registration Statement, and hereby incorporated by
reference.
10.8 Digital Audio System License Agreement between Registrant and Dolby
Laboratories Licensing Corporation dated July 28, 1997, filed as Exhibit
No. 10.8 to the Registration Statement, and hereby incorporated by
reference.
10.9 Start-up Agreement between Registrant and Ingram Micro Inc. dated October
16, 1997, filed as Exhibit No. 10.9 to the Registration Statement, and
hereby incorporated by reference.
10.10 Form of Lock-up Agreement between Registrant and all directors, officers,
and non-selling stockholders, filed as Exhibit No. 10.10 to the
Registration Statement, and hereby incorporated by reference.
10.11 Form of Lock-up Agreement between Registrant and all selling stockholders,
filed as Exhibit No. 10.11 to the Registration Statement, and hereby
incorporated by reference.
10.12 Software License Agreement, effective as of September 29, 1998, between
Registrant and Hewlett-Packard Company - CONFIDENTIAL MATERIAL FILED
SEPARATELY.
10.13 Commercial Lease between Registrant and Seven J's, Inc. regarding 627
Williamson Street, Madison, Wisconsin dated March 26, 1999, filed as
Exhibit No. 10.13 to the Quarterly Report on form 10-QSB for the period
ended March 31, 1999, and hereby incorporated by reference.
10.14 Loan Agreement, dated March 3, 1999 between Registrant and Associated Bank
South Central, filed as Exhibit No. 10.14 to the Quarterly Report on form
10-QSB for the period ended March 31, 1999, and hereby incorporated by
reference.
10.15 Business Note Agreement, dated March 3, 1999 between Registrant and
Associated Bank South Central, filed as Exhibit No. 10.15 to the Quarterly
Report on form 10-QSB for the period ended March 31, 1999, and hereby
incorporated by reference.
10.16 Termination Statement between Registrant and Associated Bank South
57
Central, effective June 30, 1999, filed as Exhibit No. 10.16 to the Quarterly
Report on form 10-QSB for the period ended June 30, 1999, and hereby
incorporated by reference.
10.17 Convertible Debenture Purchase Agreement dated September 13, 1999 between
Purchasers and the Registrant filed as Exhibit No. 10.17 to the Current
Report on form 8-K filed on September 24, 1999.
10.18 Commercial Lease between Registrant and Tenney Place Development, LLC
regarding 1617 Sherman Ave., Madison, Wisconsin dated October 1, 1999.
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
On September 13, 1999 the Company filed a current report on Form 8-K. The
report provided certain information in Item 5 regarding the issuance of
$5,000,000 7.5% redeemable convertible subordinated debentures and the
conversion of all outstanding shares of 5% Series B Preferred Stock into common
stock.
58
SIGNATURES
Pursuant to the requirement of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized in the City of Madison,
State of Wisconsin, on December 14, 1999.
Sonic Foundry, Inc.
-------------------
(Registrant)
By: /s/ Rimas P. Buinevicius
------------------------------------
Rimas P. Buinevicius
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons in the capacities and on the dates
indicated.
Signature Title Date
- - --------- ----- -----------------
/s/ Rimas P. Buinevicius Chief Executive Officer and Chairman December 14, 1999
- - ---------------------------
/s/ Monty R. Schmidt President and Director December 14, 1999
- - ---------------------------
/s/ Curtis J. Palmer Chief Technology Officer and Director December 14, 1999
- - ---------------------------
/s/ Kenneth A. Minor Chief Financial Officer December 14, 1999
- - ---------------------------
/s/ Frederick H. Kopko, Jr. Secretary and Director December 14, 1999
- - ---------------------------
/s/ Arnold Pollard Director December 14, 1999
- - ---------------------------
/s/ David C. Kleinman Director December 14, 1999
- - ---------------------------
59
Schedule II
Sonic Foundry, Inc.
Valuation and Qualifying Accounts
Nine months ended September 30, 1997 and Years ended September 30, 1998 and 1999
Additions
----------------------------------
Beginning Charged to Charged to Ending
Description balance expenses revenues Deductions balance
- - --------------------- ------------- -------------- ---------------- ---------------- --------------
Allowances deducted from accounts
receivable:
Nine months ended
September 30, 1997 $ - $ 26,550 $ 654 $ 7,114(a) $ 20,090
============= ============== ================ ================ ==============
Year ended
September 30, 1998 $20,090 $ 28,605 $ 54,343 $ 29,694(a) $ 73,344
============= ============== ================ ================ ==============
Year ended
September 30, 1999 $73,344 $1,568,821 $525,351 $852,766(a) $1,314,750
============= ============== ================ ================ ==============
(a) Product returns, claimed rebates, and uncollectible accounts written off,
net of recoveries
60