10-K 1 a09301910k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal period ended September 30, 2019
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-30407
SONIC FOUNDRY, INC.
(Exact name of registrant as specified in its charter)
MARYLAND
 
39-1783372
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
222 W. Washington Ave, Madison, WI 53703
 
(608) 443-1600
(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 if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.    Yes  ¨    No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ¨    No  ý
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  ý    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a small reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
Accelerated filer
 
¨
 
 
 
 
 
 
 
Non-accelerated filer
 
¨
 
Smaller reporting company
 
x
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
The aggregate market value of the registrant’s common stock held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $3,112,319.
The number of shares outstanding of the registrant’s common equity was 6,736,643 as of December 16, 2019.

1


DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2020 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 for required sections.

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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


TABLE OF CONTENTS
 
 
PAGE NO.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


This annual report on Form 10-K (this "Report") contains statements that are considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and its rules and regulations (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended, and its rules and regulations (the "Exchange Act"). When used in this Report, the words “anticipate”, “expect”, “plan”, “believe”, “seek”, “estimate” and similar expressions are intended to identify such forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements about the features, benefits and performance of our Rich Media products, our ability to introduce new product offerings and increase revenue from existing products, expected expenses including those related to selling and marketing, product development and general and administrative, our beliefs regarding the health and growth of the market for our products, anticipated increase in our customer base, expansion of our products functionalities, expected revenue levels and sources of revenue, expected impact, if any, of legal proceedings, the adequacy of liquidity and capital resources, and expected growth in business. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, market acceptance for our products, our ability to attract and retain customers and distribution partners for existing and new products, our ability to control our expenses, our ability to recruit and retain employees, the ability of distribution partners to successfully sell our products, legislation and government regulation, shifts in technology, global and local business conditions, our ability to effectively maintain and update our products and service portfolio, the strength of competitive offerings, the prices being charged by those competitors, and the risks discussed elsewhere herein. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
PART I
Table of Contents

ITEM 1. BUSINESS

Who We Are

Sonic Foundry (OTC Pink Sheets:SOFO) (the “Company”) is the global leader for video capture, management and streaming solutions. Trusted by more than 4,900 educational institutions, corporations, health organizations and government entities in over 65 countries, its Mediasite Video Platform quickly and cost-effectively automates the capture, management, delivery and search of live and on-demand streaming videos.

Sonic Foundry, Inc. was founded in 1991, incorporated in Wisconsin in March 1994 and merged into a Maryland corporation of the same name in October 1996. Our executive offices are located at 222 West Washington Ave., Madison, Wisconsin 53703 and our telephone number is (608) 443-1600. Our Sonic Foundry International B.V. ("Sonic Foundry International") (formerly Media Mission B.V.) office is located in the Netherlands, and our Mediasite K.K. ("Mediasite KK" or "MSKK") office is located in Japan. Our corporate website is www.sonicfoundry.com. In the “Investors” section of our website we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to reports required to be filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after the filing of such reports with the Securities and Exchange Commission.

Challenges We Address
Every organization faces a fundamental need to share information and communicate efficiently. Universities and colleges connect instructors with students to educate and prepare the next generation. Businesses strive for effective communication and collaboration among employees to provide value to customers. Government agencies must keep partners, stakeholders and constituents informed to operate effectively. And yet, communication and e-learning challenges remain, including how to:

Improve learners’ academic and professional success
Keep geographically-dispersed audiences and mobile teams connected
Boost productivity and overall organizational knowledge
Reduce logistical and financial impacts of day-to-day communications

Sonic Foundry Solutions
Sonic Foundry transforms the way organizations share and use information with these video solutions:

Mediasite Video Platform
Mediasite Video Platform is a scalable on-premises solution to publish, stream, manage, search and analyze all video. With Mediasite Video Platform, enterprises and education institutions:

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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Stream live and on-demand video to any device
Create an enterprise or campus YouTube
Automatically publish video to their learning management system (LMS), content management system (CMS), training portal or any website
Deepen engagement and improve learning with quizzing, annotations, comments, polls, surveys and other interactive tools
Search everything with fully indexed audio, video and slide content
Analyze who is watching what videos when to measure learner engagement and outcomes
Centrally manage and secure any video

Mediasite Video Cloud
Mediasite Video Cloud is a secure, reliable SaaS (Software as a Service) solution offering the same capabilities as Mediasite Video Platform to publish, stream, manage, search and analyze all video. Customers conveniently host and manage all their content with Mediasite Video Cloud, or use it as needed for large events to divert heavy viewing traffic from their on-premises Mediasite Video Platform. Our co-located and high availability data center and experienced team successfully manage customers’ cloud-based video streaming in a secure, fault-tolerant environment.

Mediasite Capture Solutions
Valuable knowledge and expertise is shared every minute, but what’s the best way to capture that knowledge before it evaporates into thin air? Mediasite provides flexible options to record and upload any video-based content from anywhere. More than 2.1 million Mediasite videos are created annually, amassing 7.3 million views per month, and 35 million hours of viewed video each year. This makes Mediasite a critical part of the communication and learning ecosystem.
My Mediasite: My Mediasite makes it a snap for instructors, employees and students to create great looking videos, screencasts and slideshows from their computers or mobile devices. From demos and video training to flipped classes, lectures and assignments, everything to record, upload, manage and publish personal videos is in one simple-to-use tool, requiring no pro video skills.
Mediasite RL Recorders: The RL Series of built-in room appliances uses schedule-based capture and advanced audio/video integration to fully automate video and content recording in lecture halls, training rooms, simulation labs and auditoriums. Instructors and speakers teach and present as they are most comfortable, free from technology worries and confident that everything they say and show is captured.
Mediasite RL Mini: The Mini provides the automation and high-quality capture Mediasite is known for in a compact, affordable device, ensuring even more students never miss a lecture. With the Mini, there’s no need for AV in the room. Instructors simply plug in their laptop and camera and start teaching. The plug-and-play device makes it easy to build or expand an automated lecture capture programs in community colleges, vocational-tech schools, small departments and even K12 classrooms.
Mediasite Catch: Mediasite Catch provides a scalable, economical solution to extend video capture to any classrooms on campus, even if they’re not equipped with extensive audio/video capabilities. Combining the reliability of Mediasite’s recorder-based scheduling automation with the affordability and simplicity of podium-based software, Mediasite Catch provides faculty a worry-free classroom recording experience.
Mediasite ML Recorders: Anyone can be a video producer with the ML Series of portable recording solutions to capture and stream broadcast-quality video. Designed for on-the-go webcasting, hybrid events, guest speakers and conferences, Mediasite ML’s lightweight design moves easily from location to location and can be set up and ready to record in only a few minutes.
Mediasite Join: Real-time video is how today’s best teams, businesses and schools collaborate, exchange ideas and get things done. But too often great ideas, subject matter expertise and important details are forgotten or left behind when a video call ends. Mediasite Join automatically records video and web conferences, transforming them into valuable, searchable video on demand.

Mediasite Events
Mediasite Events is a leading global provider of live and on-demand webcasting services for conferences, hybrid events and high-profile broadcasts, supplying turnkey streaming solutions for hundreds of events each year. Fortune 500 companies, universities, associations, sporting events and charitable organizations use Mediasite Events to produce high-quality online event experiences. With Mediasite Events, customers:
Expand their audience reach by streaming to those that cannot attend in person
Maximize event ROI by generating additional revenue streams from video recordings
Differentiate themselves from competing events
Bolster training and communication effectiveness with interactive video and audience engagement tools

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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Build stronger teams and deepen morale
Save travel time and money
Improve retention and learning outcomes

Mediasite Services
Organizations maximize their return on video with these additional Mediasite Services:
Advanced Integration Services: The value of Mediasite grows when customers’ video assets and streaming workflows seamlessly integrate with the systems that drive their online learning, training or communication strategies. Mediasite Advanced Integration Services provides the resources and expertise to incorporate Mediasite video creation, management and delivery processes into existing or planned application platforms, infrastructures and workflows. Leveraging Mediasite’s open architecture and application programming interfaces (APIs), Sonic Foundry developers collaborate with customers to scope, design and implement a Mediasite solution tailored to their unique requirements.
Installation Services: Sonic Foundry provides on-site consulting and installation services to help customers optimize deployments and efficiently integrate Mediasite within existing AV and IT infrastructures, processes and workflows.
Training Services: Expert Sonic Foundry trainers provide the necessary knowledge transfer so organizations feel confident in using, managing and leveraging Mediasite’s capabilities. On-site training is customized to specific requirements and skill levels, while online training provides convenient anytime access to a web-based catalog of training modules.
Mediasite Monitoring Service: Customers get near real time monitoring of all Mediasite assets, proactive incident notification and Sonic Foundry support response for critical issues, exceptions and anticipated issues that may impact day-to-day Mediasite operations.

Mediasite Customer Care
Standard and Enhanced Customer Care plans give customers peace of mind knowing that they have access to expert technical skills at the level they need.

With a Mediasite Standard Customer Care plan, customers are entitled to:
Software upgrades and updates for Mediasite Video Platform and Mediasite Capture Solutions
Unlimited technical support assistance
Mediasite Recorder hardware warranty extension
Advanced Mediasite Recorder replacement
Authorized access to the Mediasite Customer Care Portal for 24/7 case management, software downloads, documentation, the Mediasite Knowledge Base and other technical resources
Authorized access to the Mediasite Community for online training videos, customer-exclusive webcasts, peer-to-peer best practice sharing and more

Enhanced Customer Care clients receive the most comprehensive access to Sonic Foundry’s world-class technical expertise by selecting the services that are of greatest value to their organization. The Enhanced Plan includes everything in the Standard Plan, plus any combination of these services:
Priority technical support with queue bypass and support case escalation
Proactive Mediasite version administration and management
Mediasite roadmap discussions with Sonic Foundry’s executive team
Exclusive training and an annual call with a Mediasite consultant

Nearly all of our customers purchase a Customer Care plan when they purchase Mediasite Video Platform or Mediasite Capture Solutions.

Annual service contracts for Mediasite Video Cloud include a Standard Customer Care plan.

What Sets Mediasite Apart?
For enterprises to maximize their return on video, it takes more than capturing, storing and streaming content. The true impact and power of video is realized when content is transformed into highly interactive learning experiences rich with searchable metadata and detailed viewing statistics. Mediasite provides:

Complete platform addressing the entire video lifecycle - From content creation and delivery to retention and management. Mediasite’s portfolio of video solutions provides customers maximum flexibility and scalability to develop a comprehensive enterprise video strategy.

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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Interactive, consistent playback experiences across devices - Mediasite involves the viewer in their online video experience with polls, quizzing, chat, bookmarks, sharing, ask-a-question, resource links and more. Plus, Mediasite’s consistent playback experience across all devices significantly reduces learning curves and accelerates adoption and content mastery.
Auto-indexing and powerful video search - As a video search pioneer for over a decade, we have substantial experience in search precision. Mediasite search automatically makes all videos as searchable as text, so keywords can be found anywhere - in audio, slides, handwriting, video or tags.
Deep viewership analytics - Mediasite’s powerful video analytics and built-in reports show exactly who is watching what and when. It’s the deep insight users need to understand viewing behaviors and engagement, to measure video’s impact and value and make informed decisions.
Unmatched support network - Sonic Foundry and the growing Mediasite Community provide a reliable, collaborative support network for all Mediasite customers. Our worldwide network of field-based system engineers and responsive customer care ensure that customers have resources committed to their success. Plus, with nearly 2,000 active customers, the Mediasite Community is one of the most vibrant and growing user communities for video, webcasting, lecture capture and e-learning. Members share ideas and get feedback year-round from community experts through a private online portal, customer-exclusive webcasts and unrivaled networking and learning opportunities at the global Mediasite user conference and other regional customer events.

Sonic Foundry Solutions in Higher Education:
Among post-secondary institutions, Mediasite is used for all academic and campus environments, including:
Lecture capture
Flipped classroom instruction: students view lectures from home and use classroom time for discussion
Blended, hybrid and distance learning
Continuing education
Campus YouTube
Special events: commencement, guest speakers, sporting events, etc.
Faculty training and development
Student video projects
Recruitment and admissions
University business: leadership meetings, alumni relations, outreach

Higher education institutions consistently report that Mediasite:
Improves student learning outcomes
Keeps their institution competitive by supporting higher enrollment and/or tuition without new classrooms
Empowers faculty with technology supporting new teaching pedagogies both in the classroom and online
Boosts campus outreach, recruitment efforts and awareness of campus events
Helps campuses manage, secure and search all campus video

To remain relevant, colleges and universities are striving to differentiate themselves through technical leadership to attract tech-savvy students, while balancing their campus technology improvements with systems that faculty will embrace and adopt. As a result, the education market is restructuring and increasing investments around online learning.

Historically, graduate programs and STEM (science, technology, engineering and math)-oriented degree programs in schools of medicine, nursing, engineering or business have comprised most of our academic customer base. We are now experiencing heightened market demand for academic video within undergraduate and community college programs as well.

The visible integration of video-based learning into core university applications like learning management systems (LMSes) and the success of bundled online learning technology solutions are two healthy indicators for the widespread adoption of campus video. LMSes like Canvas, Brightspace™, Blackboard®, Moodle and Sakai are ubiquitous in education. As the foundation for e-learning, these systems are rapidly evolving to be students’ single-source portal for all course-related materials including recorded lecture and assignment videos. Mediasite’s packaged LMS integrations address the need to make learning content accessible to students when and where they need it. Similarly, video management platforms are emerging as repositories for campus’ media-centric content. These platforms provide additional opportunities through which to make Mediasite content accessible to faculty, staff and students.

Sonic Foundry Solutions in the Enterprise:

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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Executives, event planners and line-of-business managers for human resources, talent development, sales, marketing, and customer service are pushing for more video in their organizations to improve communication, collaboration and results.

Mediasite has numerous applications within medium to large corporate, healthcare and government enterprises:

In corporate enterprises it is used for:
Executive communications: town hall meetings, all-hands meetings
Unified communications and meetings
Workforce development: onboarding and training, HR communications, policy documentation
Secure corporate YouTube
Sales, marketing and customer support
Investor relations: earnings calls, analyst briefings, annual reports
Conferences and events: user group, sales and annual meetings

In health-related enterprises it is used for:
Continuing medical education, medical conferences and seminars
Grand rounds, simulations and procedural training
Pharmaceutical and new product education
Caregiver and patient education
Emergency response coordination and public health announcements
Research and collaboration

In government agencies it is used for:
Training and compliance
Inter- and intra-agency communications
Legislative proceedings
Constituent outreach, committee meetings, public safety announcements
Relief work, military coordination, emergency preparedness

Through interviews across these verticals, enterprise customers report that Mediasite:
Expands training and communications opportunities
Cuts travel and meeting expenses
Boosts efficiency by allowing participants to watch when it’s convenient to avoid interruptions and increase retention
Helps build stronger teams through direct management and employee communications

Future Direction
Video management, webcasting and lecture capture are becoming an everyday part of the way people work and learn. We strive to shorten the time it takes to not only capture and distribute information but to also transform video into more interactive, discoverable content with rich management, search and analytics capabilities. As a company, we are helping create and manage the video libraries of tomorrow. Our ongoing innovations focus on supporting this vision by:
Advancing enterprise video content management to accommodate organizations’ existing digital video assets, content generated from third-party video sources and the corresponding metadata associated with those video assets.
Introducing new applications to easily publish, search and retrieve videos from a video library as well as expanding and automating Mediasite’s powerful multi-modal search capabilities.
Offering the industry’s widest variety of content capture solutions capable of scaling economically across entire organizations and allowing anyone, on any device, to capture and share their knowledge or expertise.
Delivering content capture solutions that test the limits of recording, synchronizing and playing back multiple high definition video sources.
Supporting consistent, interactive content playback experiences across all viewing devices.
Deepening integration with core enterprise platforms including collaborative platforms like video and web conferencing, learning and course management systems (LMS/CMS), content management systems and student information systems (SIS).
Introducing market-driven innovations to our Mediasite Video Cloud offering.

Segment Information


8

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


We have determined that in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280-10, Segment Reporting, we operate in three operating segments, however these segments meet the criteria for aggregation for reporting purposes as one reporting segment as of September 30, 2019.

Billings and Distribution

Our services are typically billed and collected in advance of providing the service. Billings, which are a non-GAAP measure, are a better indicator of customer activity and cash flow than revenue is, in management’s opinion, and is therefore used by management as a key operational indicator. Billings are computed by combining revenue with the change in unearned revenue.

Our largest individual customers are typically value added resellers (“VARs”) and prior to mid fiscal 2019, distributors, since the majority of our end users require additional complementary products and services which we do not provide. In January 2019 we began reducing our reliance on domestic distributors by shipping direct to VARs when possible. Accordingly, in fiscal 2019 and 2018 one master distributor, Synnex Corporation (“Synnex”), contributed less than 1% and 6%, respectively, of total world-wide billings. A second master distributor, Starin Marketing, Inc. (“Starin”), contributed less than 1% and 11% of total world-wide billings in fiscal 2019 and 2018, respectively. As master distributors, Synnex and Starin fulfill transactions to VARs, end users and other distributors. No other customer represented over 10% of billings in 2019 or 2018.

Sales

We sell and market our offerings through a sales force that manages a channel of value-added resellers, system integrators, consultants and distributors. These third-party representatives specialize in understanding both audio/video systems and IT networking. In fiscal 2018, we utilized two master distributors in the U.S. and reduced our reliance on them in fiscal 2019. We also sold to approximately 300 resellers, and over 1,150 total end users. Our focus has been primarily to customers we have identified as having the greatest potential for high use; that is, organizations with presenters, trainers, lecturers, marketers, event planners and leaders who have a routine need to communicate to many people in higher education, government, health and certain corporate markets. Reseller, customer interest and sales outside the United States has grown and accordingly, we made two international acquisitions in fiscal 2014 in the Netherlands and Japan, significantly increasing our international headcount in sales, operations, technical and administrative positions. To date, we have sold our products to customers in over 65 countries outside the United States. Total billings for Mediasite product and support outside the United States totaled 36% in both fiscal 2019 and 2018.

Market expansion: Over two-thirds of our revenue is realized from the education market. Recent trends are driving more students, particularly adult learners, to seek online education options. Similarly, demand for lecture capture within undergraduate, community college and blended learning programs is demonstrating growth. This development represents an emerging trend beyond the traditional academic customer base for the company, which has primarily consisted of post-graduate, distance learning and technical degree programs.

For our higher education as well as corporate, government and association clients, we anticipate economic conditions will expand market demand for more outsourced services versus licensed sales. Over the last two years, the company has made extensive capital and technology investments to advance its services model with turnkey event webcasting, a comprehensive cloud-based Software as a Service (SaaS) datacenter, and e-commerce capabilities that position us well to deliver more diversified business services.

With Mediasite Events, we continue to see growing demand for conference webcasting and streaming. These event-based communication, education and training applications, combined with outsourced webcasting services, are expected to drive the company’s corporate sales activities going forward.

Repeat orders: Many customers initially purchase a small number of Mediasite Recorders to test or pilot in a department, school or business unit. A successful pilot project and the associated increase in webcasting demand from other departments or schools leads to follow up, multiple Recorder orders, as well as increased Mediasite Video Platform or Mediasite Video Cloud capacity. In fiscal 2019, 93% of billings were to preexisting customers compared to 91% of billings in fiscal 2018.

Renewals: As is typical in the industry, we offer annual support and maintenance service contract extensions for a fee to our customer base. Nearly all customers purchase a Customer Care plan with their initial Mediasite Recorders and Mediasite Video Platform, and the majority renew their contracts annually.

9

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019



Marketing

In the enterprise, our marketing strategy is based on a cross-industry approach with programs targeting a blend of IT and line of business decision makers responsible for video initiatives in corporate communications, training and development, live webcasting and/or corporate events. The addition of Mediasite Join to our family of enterprise video solutions boosts demand generation marketing to specifically target use cases for streaming and managing the rapidly growing amount of unified communication and collaboration (UCC)-generated video. The medical/healthcare, pharmaceutical and technology segments are particularly strong enterprise markets for us.

Across higher education institutions, Mediasite maintains its market leadership position for scalable and affordable lecture capture and video management. Our marketing focuses on professional schools of business, academic health, law and engineering. Mediasite Join provides new demand generation opportunities as UCC technologies are the basis of many distance learning programs.

Spanning both education and enterprise are marketing programs targeting continuing education. Across these two macro markets we maintain a balanced blend of new demand generation and customer nurturing, to drive Mediasite expansion and add-on business in existing accounts.

Our integrated marketing strategy leverages:
Customer success stories regularly shared through our best practices webinar series, speaking placements at industry events, email marketing, industry guest columns and blog
Thought leadership content created and curated from customer successes, Sonic Foundry subject matter experts (SMEs) and industry experts in the form of ebooks, whitepapers, videos, best practice toolkits and more
The Mediasite Community, a vibrant online community of 2000+ users and its companion community events including the global Mediasite User Conference, Unleash; Mediasite Summits in Europe and Australia/New Zealand; and year-round regional chapter meetings

Sonic Foundry also has field sales/support personnel in Europe, Japan and China to deliver its marketing message and execute region-specific marketing programs.

Operations

We contract with a third party to build the hardware for our Mediasite Recorders and purchase quantities sufficient to fill specific customer orders, including purchases of inventory by resellers. Quantities are maintained in inventory by the third-party provider and shipped directly to the end customer or reseller. The hardware manufacturer provides a limited one-year warranty on the hardware, which we pass on to our customers who purchase a Mediasite Customer Care support and maintenance plan. We believe there are alternative sources of manufacturing for our recorders and believe there are numerous additional sources and alternatives to the existing production process. We have experienced delays in production of our products and component parts used in our products in the past and have maintained excess quantities of inventory to mitigate the risk of such delays. In order to improve liquidity, we have reduced the balance of inventory we maintain and are therefore more likely to experience a short-term outage of inventory. To date, we have not experienced any material returns due to product defects.

OTHER INFORMATION

Competition

Various vendors provide lecture capture, enterprise webcasting or video content management capabilities, but few offer an end-to-end solution that addresses all phases of the video content lifecycle (capture, delivery, transformation and management) in a single platform like Mediasite.

Lecture capture solutions designed specifically for higher education differ in their technology approach.
Appliance- or room-based lecture capture provides a fully integrated system with complete recording automation for live or on-demand content. The automated, pre-scheduled workflow results in the greatest faculty and staff adoption and largest volumes of recorded content in the shortest amount of time.
Software-based lecture capture that resides on a podium or computer in the classroom also captures and publishes rich media content, but relies on campus- or user-supplied hardware.

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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Desktop capture tools reside on individual users’ laptops or computers allowing them to record user-generated content.

Few lecture capture vendors offer a mix of all lecture capture approaches to best suit customers’ needs. Most vendors, including Crestron and Panopto support only one approach to lecture capture. Likewise, a very small number of vendors provide an integrated platform like Mediasite to archive and manage video and rich media recorded with their solution. Most rely on a third-party platform, typically the institution’s learning or course management system, to publish, search and secure content.

Enterprise video management solutions serve as centralized media repositories that facilitate the delivery, publishing and management of on-demand video. Unlike Mediasite, most platforms do not include a video capture, webcasting or live streaming component, but instead ingest or import video-based content captured by other third-party devices or solutions. Also, most other platforms focus on ingesting video-only content rather than rich video which combines multiple synchronous video and/or slide streams into an interactive media experience.

Some current and potential customers develop their own home-grown lecture capture, webcasting or video content solutions which may also compete with Mediasite. However, we often find many of these organizations are now looking for a commercial solution that offers comprehensive management capabilities, requires fewer resources and internal maintenance and delivers a less cumbersome workflow.

Intellectual Property

The status of United States patent protection in the internet industry is not well defined and will evolve as the U.S. Patent and Trademark Office grants additional patents. Currently three U.S. patents have been issued to us and we may seek additional patents in the future. We do not know if any future patent application will result in any patents being issued with the scope of the claims we seek, if such patents are issued at all. We do not know whether our patents which have been issued or any patents we may receive in the future will be challenged, invalidated or be of any value. It is difficult to monitor unauthorized use of technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States, and our competitors may independently develop technology similar to ours. We will continue to seek patent and other intellectual property protections, when appropriate, for those aspects of our technology that we believe constitute innovations providing significant competitive advantages. Any future patent applications may not result in the issuance of valid patents.

Our success depends in part upon our rights to proprietary technology. We rely on a combination of copyright, trade secret, trademark and contractual protection to establish and protect our proprietary rights. We have registered three U.S. and four foreign country trademarks. We require our employees to enter into confidentiality and nondisclosure agreements upon commencement of employment. Before we will disclose any confidential aspects of our services, technology or business plans to customers, potential business distribution partners and other non-employees, we routinely require such persons to enter into confidentiality and nondisclosure agreements. In addition, we require all employees, and those consultants involved in the deployment of our services, to agree to assign to us any proprietary information, inventions or other intellectual property they generate, or come to possess, while employed by us. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our services or technology. These precautions may not prevent misappropriation or infringement of our intellectual property.

Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights. In addition, we may be subject to claims of alleged infringement of patents and other intellectual property rights of third parties or may be required to defend against alleged infringement claims filed against our customers due to indemnification agreements. We may be unaware of filed patent applications which have not yet been made public and which relate to our services.

Intellectual property claims may be asserted against us in the future. Intellectual property litigation is expensive and time-consuming and could divert management’s attention away from running our business. Intellectual property litigation could also require us to develop non-infringing technology or enter into royalty or license agreements. These royalty or license agreements, if required, may not be available on acceptable terms, if at all. Our failure or inability to develop non-infringing technology or license the proprietary rights on a timely basis would harm our business.

Research and Development

We believe that our future success will depend in part on our ability to continue to develop new business, and to enhance our existing business. Accordingly, we invest a significant amount of our resources in research and development activities. During the

11

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


fiscal years ended September 30, 2019 and 2018, we spent $7.4 million and $7.1 million, respectively, on internal research and development activities in our business. These amounts represent 21% of total revenue in each of those years.

Global Expansion

We acquired Sonic Foundry International in the Netherlands and Mediasite KK in Japan in fiscal 2014. With these acquisitions, we significantly expanded our global market reach in the Asia-Pacific Region and Europe, and accelerated our commitment to enterprise video communication world-wide.

Employees

At September 30, 2019 and 2018, we had 183 and 198 full-time employees, respectively. Our employees are not represented by a labor union, nor are they subject to a collective bargaining agreement. We have never experienced a work stoppage and believe that our employee relations are satisfactory.

ITEM 1A. RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT PRESENTLY AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OR ALL OF THESE RISKS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE SIGNIFICANTLY DUE TO ANY OF THESE RISKS, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. IN ASSESSING THESE RISKS, YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES.
We may need to raise additional capital.
At September 30, 2019, we had cash of $4.3 million, $1.3 million of which was in our foreign operations compared to total cash of $1.2 million and foreign operations cash of $1.1 million at September 30, 2018. We no longer have a revolving credit facility available for any financing needs beyond our available cash and cash generated from operations. Our former revolving credit facility was replaced with term notes at higher interest rates that expose us to greater debt service and interest costs. Failure to meet any debt service payments will create an event of default with our lenders who may accelerate the maturity of the notes, charge fees to regain compliance or take other action. The Company may not be able to replace such term debt on acceptable terms, if at all. The Company has a history of losses and has historically financed its operations primarily through cash from sales of equity or debt securities, and to a limited extent, cash from operations and through credit facilities. The Company has a goal to increase revenue in fiscal 2020 and reduce operating expense, in an effort to reach a positive adjusted EBITDA. We cannot ensure that revenue will grow as anticipated nor that we will be successful reducing operating expenses. If revenue is determined to be growing at a rate less than anticipated and expenses are not sufficiently reduced, our cash resources may not be sufficient to support working capital needs, and we may have to attempt to borrow additional funds from other debt providers or attempt to raise equity capital. In addition, our financial condition may, in the future, cause us to be in non-compliance with certain provisions of our debt facilities.
In the event we need to borrow additional money or raise additional equity capital, we may not be able to do so on acceptable terms and conditions. In that event, we may seek to raise money from entities that are affiliated with the Company, as we have done in the past. However, most investors will require that their investment be in the form of convertible preferred stock or convertible debt, which will dilute the interests of our existing stockholders. It is also likely that access to capital will be limited due to the time constraints associated with the need for capital, and the Company may need to rely on its Chairman, Mark Burish, ("Mr. Burish") to provide additional capital on terms reasonable and acceptable to the independent members of the Board of Directors. There is no assurance that Mr. Burish, or any other affiliated party, will be willing to provide additional capital, in which case the Company may have to cease operations.
As a result of the non-cash goodwill and other intangible assets impairment charges recorded in fiscal 2018, the Company was no longer able to satisfy the NASDAQ requirement to maintain $2.5 million of stockholders' equity. On December 18, 2018, the Board of Directors approved the voluntary transfer of its common stock from the NASDAQ Stock Exchange to the OTCQB Market ("the "QTCQB"). The OTCQB Market is operated by OTC Markets Group, a centralized electronic quotation service for over-the-counter-securities. The Company ceased trading on NASDAQ at the close of business on December 28, 2018 and began trading

12

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


on the OTCQB on December 31, 2018 under its current trading symbol "SOFO". The Company ceased trading on the OTCQB at the close of business on February 15, 2019 and began trading on the OTC Pink Sheets on February 18, 2019 under its current trading symbol "SOFO". The Company has remained a reporting company under the Securities Exchange Act of 1934, as amended, notwithstanding its voluntary withdrawal from the NASDAQ. As a result of the Company's inability to satisfy the NASDAQ requirements, its ability to raise equity capital may be adversely affected.
In the event we are able to borrow money, we may incur significant interest charges, which could harm our profitability. Holders of debt would also have rights, preferences or privileges senior to those of existing holders of our common stock. In the event we are able to raise additional equity, the terms of such financing may dilute the ownership interests of current investors and cause our stock price to fall significantly. In the event additional capital is provided by executive officers or directors, then, due to the low price levels of our common stock, control by such executive officers or directors may substantially increase.
We may not be able to secure debt or equity financing upon acceptable terms, if at all. If we cannot raise funds on acceptable terms, our business, operating results, and financial condition could be negatively impacted. The Company believes its cash position is adequate to accomplish its business plan through at least the next twelve months.
If the funds held by our foreign subsidiaries are needed for our operations in the United States, the repatriation of some of these funds to the United States could require payment of additional U.S. taxes.
Provisions of our charter documents and Maryland law could also discourage an acquisition of our company that would benefit our stockholders and, due to our insiders control of a substantial percentage of our stock, our officers, directors, and major stockholders will have a substantial amount of control over whether to approve or disapprove of a transaction.
Provisions of our articles of incorporation and by-laws may make it more difficult for a third party to acquire control of our company, even if a change in control would benefit our stockholders. Our articles of incorporation authorize our board of directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Furthermore, our articles of incorporation provide for a classified board of directors, which means that our stockholders may vote upon the retention of only one or two of our five directors each year. Moreover, Maryland corporate law restricts certain business combination transactions with “interested stockholders” and limits voting rights upon certain acquisitions of “control shares.” In addition, even when there are no interested stockholders involved in a transaction, Maryland law requires that a transaction involving a merger, consolidation, transfer of assets, or share exchange, must be approved by the affirmative vote of at least two-thirds of the Company’s stockholders.
Our executive officers and directors together beneficially own, on an “as converted basis”, over 42% of our outstanding common stock, and Mr. Burish, individually, owns nearly 33% on an as converted basis. As a result, these stockholders, if they act together or in a block, or individually in the case of Mr. Burish, could have significant influence over most matters that require approval by our stockholders, including the approval of significant corporate transactions, even if other stockholders oppose them. In addition, under federal law, in many circumstances a company such as Sonic Foundry is not required to disclose that negotiations relating to a merger or to a sale of its stock or assets are occurring until a material definitive agreement has been reached. Concentration of ownership as described here might also have the effect of delaying or preventing a change of control of our Company that other stockholders may view as beneficial.
Our common stock is subject to low trading volume and broad price swings.
Our common stock is quoted on the OTC Market (“OTC Pink Sheets”) administered by the Financial Industry Regulatory Authority under the symbol “SOFO” since February 18, 2019. Prior to that, our common stock was traded on the OTCQB since December 31, 2018 and before that, the NASDAQ exchange under the same symbol. Trading of our stock on the OTC Pink Sheets has often been subject to very low volumes, broad price swings and often with no company news.
We have a history of losses.
Our operations have generated losses in most years. Despite our plans to grow revenue and reduce expenses in fiscal 2020, we may not realize sufficient revenues to reach or sustain profitability on a quarterly or annual basis. To achieve profitability, we may need to change our operating infrastructure or manage our operations more efficiently. We initiated a plan for reducing costs in fiscal 2019 that began with eliminating certain headcount and functions, including a reduction in senior executive positions. These or additional changes, could be difficult to realize anticipated benefits, may negatively impact morale or may carry greater risk to the Company or jeopardize our plans to increase revenue. For the year ended September 30, 2019, we had a gross margin of $25.5 million on revenue of $34.8 million with which to cover selling, marketing, product development and general and administrative costs. Our selling, marketing, product development and general and administrative costs have historically been a significant percentage of our revenue, due partly to the expense of developing leads, the relatively long period required to convert leads into sales associated with selling products that are not yet considered “mainstream” technology investments, and the cost of developing

13

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


and maintaining those products. Fluctuations in profitability or failure to maintain profitability have and will likely impact the valuation of the Company and the price of our stock in the future.
Multiple unit deals are needed for continued success.
We need to sell multiple units to educational, corporate and government institutions in order to sell most efficiently and become profitable. In fiscal 2019 and fiscal 2018, 93% and 91% of billings, respectively, were generated by sales to existing customers. In particular, sales of multiple units to corporate customers have lagged behind results achieved in the higher education market; consequently, we have allocated more resources to the higher education market. While we have addressed a strategy to leverage existing customers, better address the needs of potential new customers, and close multiple unit transactions, a customer may choose not to make expected purchases of our products. Despite our strategy to focus on a customer base with a recurring need to purchase our products and services, we need to identify and sell more products and services to new customers, enter new markets and reduce the rate of attrition from certain existing customers, typically those with smaller deployments. The failure to develop effective strategies to enter new markets, and increase sales will adversely impact the valuation of the Company and the price of our stock, and will harm our business.
If a sufficient number of customers do not accept our products, our business may not succeed.
Part of our strategic challenge is to convince enterprise customers of the productivity, improved communications, cost savings, suitability and other benefits of our products. In higher education the decision to include lecture capture technology in the classroom is often influenced by the professor teaching the class, who sometimes views lecture capture technology as a threat to their job. The market for content delivery solutions is very complex, includes many products and solutions that address various aspects of customer needs and as a result it is often difficult for customers and channel partners to understand how our products and services compare. Further, corporate customers may use video as a tool, but may choose to rely upon their own IT infrastructure and resources to manage their video content. Because many companies generally are predisposed to maintaining control of their IT systems and infrastructure, there may be resistance to using software as a service provided by a third party. Our future revenue and revenue growth rates will depend in large part on our success in delivering these products effectively, creating market acceptance for these products in existing markets that we sell into and in new markets, and meeting customer’s needs for new or enhanced products. If we fail to do so, our products will not achieve widespread market acceptance, and we may not generate sufficient revenue to offset our product development and selling and marketing costs, which will adversely impact the valuation of the Company and the price of our stock, and will harm our business.
Manufacturing disruption or capacity constraints would harm our business.
We subcontract the manufacturing of our recorders to a third-party contract manufacturer. Although we believe there are multiple sources of supply from other contract manufacturers, as well as, multiple suppliers of component parts required by our contract manufacturer, a disruption of supply of component parts or completed products, even if short term, would have a material negative impact on our revenues. Likewise, we are susceptible to any material change in terms; such as pricing, level of services performed or changes to payment terms by our contract manufacturer. In particular, the cost of our products increased this year as a result of tariffs imposed by us. Many component parts currently have long delivery lead times or cease production of certain components with limited notice in which to evaluate or obtain alternate supply, requiring conservative estimation of production requirements. Lengthening lead times, product design changes and other third-party manufacturing disruptions have caused delays in delivery in the past. In order to compensate for supply delays, we have sourced components from off-shore locations, used cross component parts, paid significantly higher prices or premium fees to expedite delivery for short supply components and converted inventory from one version to another. We have typically maintained greater amounts of inventory as insurance against delays but currently hold substantially lower quantities of inventory in order to improve liquidity. Many of these strategies have increased our costs or require substantial resources to maintain and may not be sufficient to ensure against a product shortage. We depend on our subcontract manufacturer to produce our products efficiently while maintaining high levels of quality despite frequent changes in configuration and scheduling imposed by us. Any manufacturing or component defects, delay in production or changes in product features will likely cause customer dissatisfaction and may harm our reputation. Moreover, any incapacitation of the manufacturing site due to destruction, natural disaster or similar events could result in a loss of product inventory. As a result of any of the foregoing, we may not be able to meet demand for our products, which could negatively affect revenues in the quarter of the disruption or longer depending upon the magnitude of the event, and could harm our reputation.
We may not be able to innovate to meet the needs of our target market.
Our future success will continue to depend upon our ability to create an effective development product strategy, to develop new products, product enhancements and service offerings that address future needs of our target markets and to respond to these changing standards and practices on a timely basis. The success of new strategies, products, product enhancements and service offerings depends on several factors, including the timely completion, quality and market acceptance of the product, enhancement

14

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


or service. Our fiscal 2020 business plan includes an expectation for revenue contribution from both new and existing customers associated with the introduction of lower priced hardware and software recorders in locations that can’t support our more comprehensive solutions. There can be no assurance that we will be successful in achieving our revenue expectations from these new products or that we are able to retain existing customers with our more comprehensive solutions. Our revenue could be adversely impacted if we do not capitalize on opportunities to develop innovative new products, product enhancements and service offerings that will increase the likelihood that our products and services will be accepted in preference to the products and services of our current and future competitors. Some of our prospective customers may delay the purchase of our products or services until certain features are completed, may require custom development of certain features as part of the purchase decision, or may condition additional payments tied to completion of such features. Prioritizing such custom features can be difficult to adapt to other customers and distracts our engineering team from implementing features required by other customers.
If our marketing and lead generation efforts are not successful, our business will be harmed.
We believe that continued marketing efforts will be critical to achieve widespread acceptance of our products. Our marketing strategies and campaigns may not be successful, and we may not be able to generate sufficient cash flow from operations to cover the expenses required to implement effective strategies and campaigns. For example, failure to adequately generate and develop qualified sales leads could cause our future revenue to decrease. In addition, our inability to generate and cultivate qualified sales leads into large organizations, where there is the potential for significant use of our products, could have a material adverse effect on our business. We may not be able to identify and secure the number of strategic qualified sales leads necessary to help generate marketplace acceptance of our products. If our marketing or lead-generation efforts are not successful, our business and operating results will be harmed.
There is a great deal of competition in the market for our products, which could lower the demand for our products and have a negative impact on our operations.
The market for our products and services is intensely competitive, dynamic and subject to rapid technological change. The intensity of the competition and the pace of change are expected to increase in the future, and likely will require the Company to compete on price more than in the past, which could adversely affect our business and operating results. Increased competition has reduced gross margins, has resulted in new customer losses and may result in loss of market share, any one of which could seriously harm our business. Competitors vary in size and in the scope and breadth of the products and services offered, many of which have greater financial resources, greater name recognition, more employees and greater financial, technical, marketing, public relations and distribution resources than we have. In addition, new competitors with greater financial resources may arise through partnerships, distribution agreements, mergers, acquisitions or other types of transactions at any time. In particular, large companies have begun to make investments in and/or partner with smaller companies to enter the lecture capture and video management markets.
Various vendors provide lecture capture, enterprise webcasting or video content management capabilities, but few offer an end-to-end solution that addresses all phases of the video content lifecycle (capture, delivery, transformation and management) in a single platform like Mediasite.

Lecture capture solutions designed specifically for higher education differ in their technology approach.
Appliance- or room-based lecture capture provides a fully integrated system with complete recording automation for live or on-demand content. The automated, pre-scheduled workflow results in the greatest faculty and staff adoption and largest volumes of recorded content in the shortest amount of time.
Software-based lecture capture that resides on a podium or computer in the classroom also captures and publishes rich media content, but relies on campus- or user-supplied hardware.
Desktop capture tools reside on individual users’ laptops or computers allowing them to record user-generated content.

Few lecture capture vendors offer a mix of all lecture capture approaches to best suit customers’ needs. Most vendors, including Extron and Panopto, support only one approach to lecture capture. Likewise, a very small number of vendors provide an integrated platform like Mediasite to archive and manage video and rich media recorded with their solution. Most rely on a third-party platform, typically the institution’s learning or course management system, to publish, search and secure content.

Enterprise video management solutions serve as centralized media repositories that facilitate the delivery, publishing and management of on-demand video. Unlike Mediasite, most platforms do not include a video capture, webcasting or live streaming component, but instead ingest or import video-based content captured by other third-party devices or solutions. Also, most other platforms focus on ingesting video-only content rather than rich video which combines multiple synchronous video and/or slide streams into an interactive media experience.


15

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Some current and potential customers develop their own home-grown lecture capture, webcasting or video content solutions which may also compete with Mediasite. However, we often find many of these organizations are now looking for a commercial solution that offers comprehensive management capabilities, requires fewer resources and internal maintenance and delivers a less cumbersome workflow.
The competitive environment has required us to make changes in our products, pricing, licensing, services, or marketing to maintain and extend our current technology. Price concessions or the emergence of other pricing, licensing, and distribution strategies or technology solutions of competitors has impacted revenue growth and may in the future further reduce our revenue, margins or market share. Other changes we have to make in response to competition could cause us to expend significant financial and other resources, disrupt our operations, strain relationships with partners, release products and enhancements before they are thoroughly tested or result in customer dissatisfaction, any of which could harm our operating results and stock price.
Because most of our service contracts are renewable on an annual basis, a reduction in our service renewal rate could significantly reduce our revenues.
Our clients have no obligation to renew their content hosting agreements, customer support contracts or other annual service contracts after the expiration of the initial period, which is typically one year, and some clients have elected not to do so. A decline in renewal rates could cause our revenues to decline. Recurring revenue related to customer support contracts, software licenses and hosting accounted for 53% and 51% of total revenue in fiscal 2019 and 2018, respectively. Our renewal rates may decline or fluctuate as a result of a number of factors, including client dissatisfaction with our products and services, our slow response to customer technical inquiries, our failure to update our products to maintain their attractiveness in the market, deteriorating economic conditions or budgetary constraints or changes in budget priorities faced by our clients. If our retention rates decrease, we may need to provide more incentives, reduce pricing or increase marketing costs to improve lead generation through marketing in order to increase revenues, all of which could reduce profitability.
Our business is susceptible to risks associated with international operations.
International product and service billings were 36% of our total billings in each of the past two years and are expected to continue to account for a significant portion of our business in the future. International sales are subject to a variety of risks, including:
Difficulties in establishing and managing international subsidiaries, distribution channels and operations;
Difficulties in selling, servicing and supporting overseas products, translating products into foreign languages and compliance with local hardware requirements;
Difficulties in managing the demands of large international deployments, many of which distract key sales personnel from opportunities in other parts of the world;
Challenges associated with management transition;
Challenges related to language or cultural differences;
The uncertainty of laws and enforcement in certain countries, such as China, relating to the protection of intellectual property or requirements for product certification, protection of personal data or other restrictions;
Competitive pressure impacting other parts of the world;
Multiple and possibly overlapping tax structures;
Currency and exchange rate fluctuations and imposition of tariffs or quotas;
Difficulties in collecting accounts receivable in foreign countries, including complexities in documenting letters of credit;
Economic or political changes in international markets;
Restrictions on access to the Internet; and
Difficulty in complying with international employment related requirements
Changes in U.S. trade policy, including the imposition of tariffs and the resulting consequences, may have a material adverse impact on our business, operating results and financial condition.
The U.S. government has indicated its intent to adopt a new approach to trade policy and in some cases to renegotiate, or potentially terminate, certain existing bilateral or multi-lateral trade agreements. It has also initiated tariffs on certain foreign goods and has raised the possibility of imposing significant, additional tariff increases or expanding the tariffs to capture other types of goods. In response, certain foreign governments have imposed retaliatory tariffs on goods that their countries import from the U.S. Changes in U.S. trade policy have resulted in one or more foreign governments, including China, adopting responsive trade policies that make it more difficult or costly for us to do business in or import our products from those countries. As a result of tariffs in China, the cost of our products has increased. Additional trade restrictions may lead to increased prices to our customers, which may reduce demand, or, if we are unable to achieve increased prices, result in lowering our margin on products sold.
We cannot predict the extent to which the U.S. or other countries will impose quotas, duties, tariffs, taxes or other similar restrictions upon the import or export of our products in the future, nor can we predict future trade policy or the terms of any renegotiated

16

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


trade agreements and their impact on our business. The adoption and expansion of trade restrictions, the occurrence of a trade war, or other governmental action related to tariffs or trade agreements or policies has the potential to adversely impact demand for our products, our costs, our customers, our suppliers, and the U.S. economy, which in turn could have a material adverse effect on our business, operating results and financial condition.
The length of our sales and deployment cycles are uncertain, which may cause our revenue and operating results to vary significantly from quarter to quarter and year to year.
During our sales cycle, we spend considerable time and expense providing information to prospective customers about the use and benefits of our products without generating corresponding revenue. Our expense levels are relatively fixed in the short-term and based in part on our expectations of future revenue. Therefore, any delay in our sales cycle could cause significant variations in our operating results, particularly because a relatively small number of customer orders represent a large portion of our revenue.
Our largest potential sources of revenue are educational institutions, large corporations and government entities that often require long testing and approval processes before making a decision to purchase our products, particularly when evaluating our products for inclusion in new buildings under construction, high dollar transactions or competitive bids. In general, the process of selling our products to a potential customer may involve lengthy negotiations, collaborations with consultants, designers and architects, time consuming installation processes and changes in network infrastructure in excess of what we or our VARs are able to provide. In addition, educational institutions that started with small pilots are committing to more complex installations and expanding to include undergraduate classrooms, which, due to the increased size of these types of transactions, typically require a longer sales cycle. Also, our enterprise accounts are less motivated by seasonal sales and promotions, and therefore are frequently difficult to finalize. As a result of these factors, our sales and deployment cycles are unpredictable. Our sales and deployment cycles are also subject to delays as a result of customer-specific factors over which we have little or no control, including budgetary constraints, existing infrastructure technical issues and internal approval procedures, particularly with customers or potential customers that rely on government funding.
Our products are aimed toward a broadened user base within our key markets and these products are relatively early in their product life cycles. We cannot predict how the market for our products will develop, and part of our strategic challenge will be to convince targeted users of the productivity, improved communications and test scores, cost savings and other benefits. Accordingly, it is likely that delays in our sales cycles with these products will occur and this could cause significant variations in our operating results.
Sales of some of our products have experienced seasonal fluctuations which have affected sequential growth rates for these products, particularly in our first fiscal quarter. For example, there is generally a slowdown for sales of our products in the higher education and corporate markets in the first fiscal quarter of each year. Seasonal fluctuations could negatively affect our business, which could cause our operating results to fall short of anticipated results for such quarters. As such, we believe that quarter-to-quarter comparisons of our revenues, operating results and cash flows may not be meaningful and should not be relied upon as an indication of future performance.
Supporting our existing and growing customer base and implementing large customer deployments could strain our personnel resources and infrastructure, and if we are unable to scale our operations and increase productivity, customer satisfaction and our business will be harmed.
Frequent enhancements to our software puts pressure on our customers to install, maintain and train their personnel on its use. Further, frequent releases of the software can lead to less product stability. As a result, our customer care and engineering resources have come under, and are expected in the future to come under significant pressure in providing the high-quality of technical support our customers expect during periods of high demand. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for support services. Increased customer demand for these services, without corresponding revenues, could increase costs and adversely affect our operating results. In addition, our sales process is highly dependent on our applications and business reputation and on positive recommendations from our existing customers. Any failure to maintain high-quality technical support, or a market perception that we do not maintain high-quality support, could adversely affect our reputation, our ability to sell our products and services to existing and prospective customers, and our business, operating results and financial position.
As we target more of our sales efforts at larger initial transactions, we face increasingly complex deployments requiring substantial technical and management resources, including in some cases significant product customization and integration with other applications or hardware. Customers making large expenditures for our products and services typically have higher expectations of product and service operability and response time if issues arise. Some of these customers have asked us to host their content

17

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


and have significant amounts of legacy content to transfer to our datacenter. Such increased activity and storage demand on our data centers put additional strain on our personnel and hosting infrastructure. Our hosting customers typically require a high level of access, data security and need to capture and store multiple high definition streams. Such requirements require costly enhancements to our infrastructure. If we do not accurately plan for our infrastructure capacity requirements and we experience significant strains on our data center capacity, our customers could experience performance degradation or service outages that may subject us to financial penalties, result in customer losses and harm our business. As we add or change data centers or capacity, we may move or transfer our data and our customers’ data. Despite precautions taken during this process, any unsuccessful data transfers may impair the delivery of our services, which may damage our business. High demand on technical and management resources to manage large transactions distract personnel from existing customers, development of new products and other important activities which could lead to potential customer dissatisfaction, product development delays or other issues associated with the distraction.
If a customer is not satisfied with the quality of work performed by us or a third party or with the type of services or solutions delivered, then we could incur additional costs to address the situation and delay recognition of revenue, the profitability of that work might be impaired, and the customer’s dissatisfaction with our services could damage our ability to obtain additional work from that customer. In addition, negative publicity related to our customer relationships, regardless of its accuracy, may further damage our business by affecting our ability to compete for new business with current and prospective customers.
Our operating results are hard to predict as a significant amount of our sales typically occur at the end of a quarter and the mix of product and service orders may vary significantly.
Revenue for any particular quarter is extremely difficult to predict with any degree of certainty. We typically ship products within a short time after we receive an order and therefore, we do not have an order backlog with which to estimate future revenue. Any decline or uncertainty in end-user demand could negatively impact end-user orders. Accordingly, our expectations for both short and long-term future revenue is based almost exclusively on our own estimate of future demand based on history and the pipeline of sales opportunities we manage, rather than on firm orders. The mix of product demand varies significantly from quarter to quarter, further complicating our estimated product needs. Our expense and inventory levels are based largely on these estimates. In addition, our events business is particularly unpredictable and subject to variation due to the short time-frame between when we learn of an opportunity and when the event occurs. Further, the majority of our product orders are received in the last month of a quarter; thus, the unpredictability of the receipt of these orders could negatively impact our future results. Accordingly, any significant shortfall in demand for our products or services in relation to our expectations, even if the result was a short-term delay in orders, would have an adverse impact on our operating results.
We have experienced growing demand for our hosting and event services as well as a growing preference from our customers in purchasing our annually licensed software. As a result, we have seen an increase in service billings and recurring revenue as a percentage of total billings. We expect this trend to continue, which we expect to help improve predictability of revenue and gross margins but will delay the impact on revenue of any increase or decrease in billings during any particular quarter. We subcontract for some services required by our events customers, such as onsite management labor and closed captioning. We typically charge for such services at a lower margin than other services. The percentage of billings represented by services, provided either directly or indirectly, is also likely to fluctuate from quarter to quarter due to seasonality of event services and other factors. Since content hosting and support services are typically billed in advance of providing the service, revenue is initially deferred, leading to reduced current period revenue with a corresponding negative impact to profits or losses in periods of significant increase in the percentage of our billings for deferred services.
Economic conditions could materially adversely affect the Company.
Weakness in domestic markets and global uncertainties exist in many areas of focus for us including the United Kingdom, Japan and the Middle East. Many of our customers rely on local, state or Federal government funding, both domestic and international. The Japanese government provides subsidies to support higher education from time to time but has not been consistent. Any future delay or elimination of government programs will have a negative impact on our operations in Japan. Any continuing unfavorable economic conditions could continue to negatively affect our business operating results or financial condition, which could in turn affect our stock price. Weak economic conditions and the resulting impact on the availability of public funds along with the possibility of state and local budget cuts and reduced university enrollment could lead to a reduction in demand for our products and services. In addition, a prolonged economic downturn could cause insolvency of key suppliers resulting in product delays, inability of customers to obtain credit to finance purchases of the Company’s products and inability or delay of our channel partners and other customers to pay accounts receivable owed to us.
Economic conditions may have a disproportionate effect on the sale of our products.

18

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Many of our customers will look at the total A/V equipment and labor cost to outfit a typical conference room or lecture hall as one amount for budgetary purposes. Consequently, although our products represent only a portion of the total cost, the cost of the entire project of outfitting a room or conference hall may be considered excessive and may not survive budgetary constraints. Alternatively, our resellers may modify their quotes to end customers by eliminating our products or substituting less expensive products supplied by our competitors in order to win opportunities within budget constraints. Event service partners may similarly suggest that customers eliminate recording and webcasting as a means of reducing event cost. Consequently, declines in spending by government, educational or corporate institutions due to budgetary constraints may have a disproportionate impact on the Company and result in a material adverse impact on our financial condition.
Privacy concerns and laws, evolving regulation of cloud computing, cross-border data transfer restrictions and other domestic or foreign regulations may limit the use and adoption of our solutions and adversely affect our business.
Regulation related to the provision of services on the Internet is increasing, as federal, state and foreign governments continue to adopt new laws and regulations addressing data privacy and the collection, processing, storage and use of personal information, including health data. In some cases, foreign data privacy laws and regulations, such as the European Union’s General Data Protection Regulation that was enacted in May 2018, and an amended Act on the Protection of Personal Information in Japan, impose new obligations directly on us both as a data controller and a data processor, as well as on many of our customers. These new laws may require us to make changes to our services and/or our customers to meet the new legal requirements, and may also increase our potential liability exposure through higher potential penalties for non-compliance. Further, laws such as the European Union’s proposed e-Privacy Regulation are increasingly aimed at the use of personal information for marketing purposes, and the tracking of individuals’ online activities. These new or proposed laws and regulations are subject to differing interpretations and may be inconsistent among jurisdictions. These and other requirements could reduce demand for our services, require us to take on more onerous obligations in our contracts, restrict our ability to store, transfer and process data or, in some cases, impact our ability to offer our services in certain locations or our customers' ability to deploy our solutions globally. For example, ongoing legal challenges in Europe to the mechanisms allowing companies to transfer personal data from the European Economic Area to the United States could result in further limitations on the ability to transfer data across borders, particularly if governments are unable or unwilling to reach new or maintain existing agreements that support cross-border data transfers, such as the EU-U.S. and Swiss-U.S. Privacy Shield framework. Additionally, certain countries have passed or are considering passing laws requiring local data residency. In addition, domestic data privacy laws, such as the California Consumer Privacy Act (“CCPA”) which will take effect in January 2020, continue to evolve and could expose us to further regulatory burdens. Further, laws such as the European Union’s proposed e-Privacy Regulation are increasingly aimed at the use of personal information for marketing purposes, and the tracking of individuals’ online activities. The costs of compliance with, and other burdens imposed by, privacy laws, regulations and standards may limit the use and adoption of our services, reduce overall demand for our services, make it more difficult to meet expectations from or commitments to customers, lead to significant fines, penalties or liabilities for noncompliance, or slow the pace at which we close sales transactions, any of which could harm our business.
We likely will need to acquire software and hardware in order to enhance our ability to defend and to detect intrusions to our network infrastructure. These enhancements will be expensive and require significant staff time to deploy and develop. These risks are mitigated, to the extent possible, by our ability to maintain and improve business and data governance policies, enhanced processes and internal security controls, including our ability to escalate and respond to known and potential risks. Our executive management are regularly briefed on our cyber-security policies and practices and ongoing efforts to improve security, as well as periodic updates on cyber-security events. In addition, we update our Audit Committee at least annually regarding our processes for evaluating and mitigating risks including cyber related risks. Although we have developed systems and processes designed to protect our customers’ and our customers’ customers’ proprietary and other sensitive data, we can provide no assurances that such measures will be effective.
In addition to government activity, privacy advocacy and other industry groups have established, or may establish, new self-regulatory standards that may place additional burdens on us. Many of our customers in the European Union face increasingly complex procurement requirements that have delayed some projects and caused us not to be successful in winning other opportunities. If we are unable to maintain these certifications or meet these standards, it could adversely affect our ability to provide our solutions to certain customers and could harm our business.
Our customers and potential customers do business in a variety of industries, including financial services, the public sector, healthcare and telecommunications. Regulators in certain industries have adopted and may in the future adopt regulations or interpretive positions regarding the use of cloud computing and other outsourced services. The costs of compliance with, and other burdens imposed by, industry-specific laws, regulations and interpretive positions may limit customers’ use and adoption of our services and reduce overall demand for our services.

19

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


The costs of compliance with, and other burdens imposed by laws, regulations and standards, may limit the use and adoption of our service and reduce overall demand for it, or lead to significant fines, penalties or liabilities for any noncompliance.
Furthermore, concerns regarding data privacy may cause the users of our customers’ data to resist providing the data necessary to allow our customers to use our service effectively. Even the perception that the privacy of personal information is not satisfactorily protected or does not meet regulatory requirements could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions.
Operational failures in our network infrastructure could disrupt our remote hosting services, cause us to lose clients and sales to potential clients and result in increased expenses and reduced revenues.
Unanticipated problems affecting our network systems could cause interruptions or delays in the delivery of the hosting services we provide to some of our clients. We are not equipped to provide full disaster recovery to all of our hosted clients. If there are operational failures in our network infrastructure that cause interruptions, slower response times, loss of data or extended loss of service for our remotely hosted clients, we may be required to issue credits or pay penalties, current clients may terminate their contracts or elect not to renew them and we may lose sales to potential clients. We have recently acquired additional hardware and systems, expect to make more significant investments in hardware and outsourced most aspects of our network infrastructure to multiple providers. We also rely on Internet systems and infrastructure to operate our business and provide our services. As a result, we are reliant on third parties for network availability, so outages may be outside our control and we may need to acquire additional hardware in order to provide an appropriate level of redundancy required by our customers. These hardware, data, and cloud computing platforms may not be available at reasonable terms or prices.
We license technology from third parties. If we are unable to maintain these licenses, our operations and financial condition may be negatively impacted.
We license technology from third parties. The loss of, our inability to maintain, or changes in material terms of these licenses could result in increased cost or delayed sales of our software, and services, or may cause us to remove features from our products or services. We anticipate that we will continue to license technology from third parties in the future. This technology may not continue to be available on commercially reasonable terms, if at all. Although we do not believe that we are substantially dependent on any individual licensed technology, some of the component technologies that we license from third parties could be difficult for us to replace. The impairment of these third-party relationships, especially if this impairment were to occur in unison, could result in delays in the delivery of our software and services until equivalent technology, if available, is identified, licensed and integrated. This delay could adversely affect our operating results and financial condition.
The technology underlying our products and services is complex and may contain unknown defects that could harm our reputation, result in product liability or decrease market acceptance of our products.
The technology underlying our products is complex and includes software that is internally developed, software licensed from third parties and hardware purchased from third parties. These products have, and will in the future, contain errors or defects, particularly when first introduced or when new versions or enhancements are released. We may not discover defects that affect our current or new applications or enhancements until after they are sold, and our insurance coverage may not be sufficient to cover our exposure. Further, there are third-party applications our products and services are dependent on, or integrate with, such as operating systems and learning management systems. These integrations require specialized knowledge that is difficult and expensive to maintain. Failure to maintain compatibility with such applications or identification of defects in our products and services could:
Damage our reputation;
Cause our customers to initiate product liability suits against us;
Increase our product development resources;
Cause customers to cancel orders, ask for partial refunds or potential customers to purchase competitive products or services;
Delay release or market acceptance of our products, or otherwise adversely impact our relationships with our customers; and/or
Cause us to allocate valuable engineering resources to fix our existing products, which may cause us to allocate fewer resources toward developing new products, or toward adding features to our existing products.
We depend in part on the success of our relationships with third-party resellers and integrators.
Our success depends on various third-party relationships, particularly in our non-higher education business, with certain international geographies and our events services operations. The relationships include third party resellers, as well as, system integrators that assist with implementations of our products and sourcing of our products and services. Identifying partners, negotiating and documenting relationships with them and maintaining their relationships require significant time and resources

20

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


from us. In addition, our agreements with our resellers and integrators are typically non-exclusive and do not prohibit them from working with our competitors or from offering competing products or services. We have limited control, if any, as to whether these strategic partners devote adequate resources to promoting, selling and implementing our products as compared to our competitor’s products. Our competitors may be effective in providing incentives to third parties to favor their products or services. If we are unsuccessful in establishing or maintaining our relationships with these third parties, our ability to compete in the marketplace or to maintain or grow our revenue could be impaired and our operating results would suffer.
Our cash flow could fluctuate due to the potential difficulty of collecting our receivables.
A significant portion of our sales are fulfilled by VARs or regional distributors. Our distributor in China has been unsuccessful in building a team to address demand in China, is under-funded and, significantly behind in their payments to us causing us to record approximately $3 thousand and $326 thousand of bad debt in fiscal 2019 and 2018, respectively. Any delay from large distributors or VARs, could have a material impact on the collections of our receivables during a particular quarter.
The market price of our common stock may be subject to volatility.
In the past and through 2019, the trading prices of the securities of technology companies have been more volatile than the broader market. Factors affecting the market price of our common stock include:
Variations in our operating results, earnings per share, cash flows from operating activities, deferred revenue and other financial metrics and non-financial metrics, and how those results compare to investor expectations;
Our announcement of actual results for a fiscal period that are higher or lower than expected results;
Changes in the estimates of our operating results or changes in recommendations by securities analysts that elect to follow our common stock;
Announcements of technological innovations, new services or service enhancements, strategic alliances or significant agreements by us or by our competitors;
Announcements by us or by our competitors of mergers or other strategic acquisitions, or rumors of such transactions involving us or our competitors;
Announcements of customer additions and customer cancellations or delays in customer purchases;
Recruitment or departure of key personnel;
Disruptions in our service due to computer hardware, software, network or data center problems;
The economy as a whole, market conditions in our industry and the industries of our customers;
The issuance of shares of common stock and preferred stock by us, whether in connection with an acquisition or a capital raising transaction;
Low trading volumes of our shares and inconsistent trading activity;
Issuance of debt, changes to, defaults or non-renewal of debt facilities and other convertible securities;
Failure to meet OTC market requirements; and
Any other factors discussed herein.
In addition, if the market for technology stocks or the stock market in general experiences uneven investor confidence, the market price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The market price of our common stock might also decline in reaction to events that affect other companies within, or outside, our industry even if these events do not directly affect us.
Accounting regulations and related interpretations and policies, particularly those related to revenue recognition, cause us to defer revenue recognition into future periods for all or portions of our products and services.
Revenue recognition for our products and services is complex and subject to multiple sources of authoritative guidance, some of which are new, as well as, varied interpretations and implementation practices for such rules. These rules require us to apply judgment in determining revenue recognition. In certain situations, we may have to defer the entire amount of revenue from a transaction, even when the product has already shipped. This may occur when the customer has delayed payment on the transaction, or in certain other circumstances, such as when we agree to extend payment terms on other invoices from such customer. In addition, we always defer revenue when services are included in a transaction, and not performed. Other factors that are considered in revenue recognition include those such as standalone selling price (SSP), best estimate of selling price and the inclusion of other services and contingencies to payment terms. We expect that we will continue to defer portions or, in certain circumstances with respect to a particular customer, all of our product or service billings because of these factors, and to the extent that management’s judgment is incorrect it could result in an increase in the amount of revenue deferred in any one period. The amounts deferred may be significant and may vary from quarter to quarter depending on, among other factors, compliance with payment terms, the mix of products sold, combination of products and services sold together or contractual terms.


21

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Additional changes in authoritative guidance, including the interpretation of "Revenue from Contracts with Customers (Topic 606)", or changes in practice in applying such rules could also cause us to defer the recognition of revenue to future periods or recognize lower revenue. See Note 1 - Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.
We could lose revenues if there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools and other education providers.
Most of our customers and potential customers are public colleges, universities, schools and other education providers who depend substantially on government funding. Accordingly, any general decrease, delay or change in federal, state or local funding for colleges, universities, schools and other education providers could cause our current and potential customers to reduce or delay their purchases of our products and services, or to decide not to renew service contracts, either of which could cause us to lose revenues. In addition, a specific reduction in governmental funding support for products such as ours would also cause us to lose revenues. Unfavorable economic conditions may result in further budget cuts and lead to lower overall spending, including information technology spending, by our current and potential clients, which may cause our revenues to decrease.
If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired.
Our future success depends upon the continued service of our key management, technical, sales and other critical personnel, including our Chief Executive Officer. Most of our officers and other key personnel are employees-at-will, and we cannot assure that we will be able to retain them. Key personnel have left our Company in the past, sometimes to accept employment with companies that sell similar products or services to existing or potential customers of ours. The technology industry is subject to substantial and continuous competition for engineers with high levels of experience in designing, developing and managing software and Internet-related services, as well as competition for sales and operations personnel. There will likely be additional departures of key personnel from time to time in the future and such departures could result in additional competition, loss of customers or confusion in the marketplace. As we seek to replace such departures, or expand our business, the hiring of qualified sales, technical and support personnel is difficult due to the limited number of qualified professionals. Training of new sales, technical and support personnel can take six months or longer before they become productive. Sales and technical strategies have changed and will likely change further in the future and require different skills to sell to different customer types and develop new and changing products. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of company initiatives and the results of our operations. In addition, we do not have life insurance policies on any of our key employees. If we lose the services of any of our key employees, the integration of replacement personnel could be time consuming, may cause disruptions to our operations and may be unsuccessful.
Because we generally recognize revenues ratably over the term of our service contracts, decrease or increase in service transactions will not be fully reflected in our operating results until future periods.
We recognize most of our revenues from service contracts monthly over the terms of their agreements, which are typically 12 months, although terms have ranged from less than one month to 48 months. As a result, much of the service revenue we report in each quarter is attributable to agreements entered into during previous quarters. Consequently, a decline in sales, client renewals or market acceptance of our products in any one quarter will not necessarily be fully reflected in the revenues in that quarter and will negatively affect our revenues and profitability in future quarters. This ratable revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as revenues from new clients must be recognized over the applicable agreement term.
Currency exchange rate fluctuations could result in higher costs and decreased margins and earnings.
The functional currency of our foreign subsidiaries in the Netherlands is the Euro and in Japan is the Japanese Yen. They are subject to foreign currency exchange rate risk. The conversion rate of the Yen to the US Dollar varied from about 105 to approximately 114 during fiscal 2019. Similarly, the Euro varied from about 0.86 to approximately 0.92 to the US Dollar during fiscal 2019. The strength of the dollar impacts our ability to export profitably to other countries, and will likely continue to fluctuate. Any increase in the exchange rate of the US Dollar compared to the Euro or the Japanese Yen will impact our future operating results and financial position.
If potential customers or competitors use open source software to develop products that are competitive with our products and services, we may face decreased demand and pressure to reduce the prices for our products.
The growing acceptance and prevalence of open source software may make it easier for competitors or potential competitors to develop software applications that compete with our products, or for customers and potential customers to internally develop software applications that they would otherwise have licensed from us. One of the aspects of open source software is that it can

22

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


be modified or used to develop new software that competes with proprietary software applications, such as ours. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. As open source offerings become more prevalent, customers may defer or forego purchases of our products, which could reduce our sales and lengthen the sales cycle for our products or result in the loss of current customers to open source solutions. If we are unable to differentiate our products from competitive products based on open source software, demand for our products and services may decline, and we may face pressure to reduce the prices of our products, which would hurt our profitability. If our use of open-source is challenged and construes unfavorably, our operating results could be adversely impacted.
We use open source software in our application suite. Although we monitor our use of open source software closely, the terms of many open source licenses have not been interpreted by United States courts, and there is risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to re-engineer our technology or to discontinue offering all or a portion of our products in the event re-engineering cannot be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.
Our customers may use our products to share confidential and sensitive information, and if our system security is breached, our reputation could be harmed and we may lose customers.
Our customers may use our products and services to share confidential and sensitive information, the security of which is critical to their business. Third parties may attempt to breach our security for customer hosted content or the networks of our customers. Malicious third-parties may also conduct attacks designed to temporarily deny customers access to our services. Customers may take inadequate security precautions with their sensitive information and may inadvertently make that information public. We may be liable to our customers or subject to fines for a breach in security, and any breach could harm our reputation and cause us to lose customers. In addition, customers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources to further protect against security breaches or to resolve problems caused by any breach, including litigation-related expenses if we are sued.
If we are viewed only as a commodity supplier, our margins and valuations will shrink.
We need to provide value-added services in order to avoid being viewed as a commodity supplier, which could adversely impact the valuation of the Company, and the price of our stock. This entails building long-term customer relationships and developing features that will distinguish our products. Our technology is complex and is often confused with other products and technologies in the market place, including video conferencing, streaming and collaboration.
We have developed lower cost hardware, software products and cloud solutions to better address the more cost-conscious customers. Such products have more limited features compared to our existing products. While we believe we can preserve the market for our full-featured products due to differentiation between the two and migration to full featured products, release of lower cost products has and could continue to reduce gross margins and demand for products sold at higher prices, which could adversely affect our business and operating results. Potential large-scale deployments of our products often include the lower cost products we sell, putting greater pressure on gross margin due to expectations for greater volume discounts.
If we fail to build long-term customer relationships, develop features that distinguish our products in the market place and address the market for lower function and cost solutions, our margins will shrink, and our stock may be adversely impacted.
Our success depends upon the proprietary aspects of our technology.
Our success and ability to compete depend to a significant degree upon the protection of our proprietary technology. We currently have three U.S. patents that have been issued to us. We may seek additional patents in the future. However, it is possible that:
Any patents acquired by or issued to us may not be broad enough to protect us.
Any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents.
Current and future competitors may independently develop similar technology, duplicate our services or design around any of our patents.
Effective patent protection, including effective legal-enforcement mechanisms against those who violate our patent-related assets, may not be available in every country in which we do or plan to do business.
We may not have the resources to enforce our patents or may determine the potential benefits are not worth the cost and risk of ultimately being unsuccessful.
We also rely upon trademark, copyright and trade secret laws, which may not be sufficient to protect our intellectual property.

23

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


We also rely on a combination of laws, such as copyright, trademark and trade secret laws and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our technology. We have registered three U.S. and four foreign country trademarks. These forms of intellectual property protection are critically important to our ability to establish and maintain our competitive position. However, it is possible that:
Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights.
Laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or to deter others from developing similar technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully or as readily as Unites States laws. Our recent growth in activities in China will likely increase this risk.
There have been attacks on certain patent systems, increasing the likelihood of changes to established laws, including in the United States. We cannot predict the long-term effects of any potential changes, which could be detrimental to our licensing program.
Effective trademark, copyright and trade secret protection, including effective legal-enforcement mechanisms against those who violate our trademark, copyright or trade secret assets, may be cost prohibitive or unavailable or limited in foreign countries.
Contractual agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.
Other companies may claim common law trademark rights based upon state or foreign laws that precede the federal registration of our marks.
Policing unauthorized use of our services and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use.
Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business.
If other parties bring infringement or other claims against us, we may incur significant costs or lose customers.
Other companies may obtain patents or other proprietary rights that would limit our ability to conduct our business and could assert that our technologies infringe their proprietary rights. We have incurred substantial costs to defend against such claims in the past and could incur legal costs in the future, even if without merit, and intellectual property litigation could force us to cease using key technology, obtain a license or redesign our products. In the course of our business, we may sell certain systems to our customers, and in connection with such sale, we may agree to indemnify these customers from claims made against them by third parties for patent infringement related to these systems, which could harm our business.
We may need to make acquisitions or form strategic alliances or partnerships in order to remain competitive in our market, and recent acquisitions, strategic alliances or partnerships, including the acquisition of Mediasite KK and Sonic Foundry International, could be difficult to integrate, disrupt our business and dilute stockholder value.
We completed the acquisitions of Mediasite KK in Japan and MediaMission (now Sonic Foundry International) in the Netherlands in fiscal 2014. As a result of these acquisitions, we are integrating products, services, dispersed operations, management systems and very different cultures. In the future, we may acquire or form strategic alliances or partnerships with other businesses in order to remain competitive or to acquire new technologies. Acquisitions and investments involve numerous risks, including:
The potential failure to achieve the expected benefits of the combination or acquisition;
Difficulties in and the cost of integrating operations, technologies, services and personnel;
Diversion of financial and managerial resources from existing operations;
Risk of entering new markets in which we have little or no experience or where competitors may have stronger market positions;
Potential write-offs of acquired assets or investments, and potential financial and credit risks associated with acquired customers;
Potential loss of key employees;
Inability to generate sufficient revenue to offset acquisition or investment costs;
The inability to maintain relationships with customers and partners of the acquired business;
The difficulty of transitioning the acquired technology onto our existing platforms and maintaining the security standards consistent with our other services for such technology;
Potential unknown liabilities associated with the acquired businesses;
Unanticipated expenses related to acquired technology and its integration into existing technology;

24

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Negative impact to our results of operations because of the depreciation and amortization of amounts related to acquired intangible assets, fixed assets and deferred compensation, and the loss of acquired deferred revenue and unbilled deferred revenue;
Delays in customer purchases due to uncertainty related to any acquisition;
The need to implement controls, procedures and policies at the acquired company;
Challenges caused by distance, language and cultural differences;
In the case of foreign acquisitions, the challenges associated with integrating operations across different cultures and languages and currency, technological, employee and other regulatory risks and uncertainties in the economic, social and political conditions associated with specific countries; and
The tax effects of any such acquisitions.
Our failure to successfully manage the acquisitions of Mediasite KK and Sonic Foundry International, or other future acquisitions, strategic alliances or partnerships could seriously harm our operating results. In addition, our stockholders would be diluted if we finance the future acquisitions, strategic alliances or partnerships by incurring convertible debt or issuing equity securities.
We face risks associated with government regulation of the internet and related legal uncertainties.
Currently, few existing laws or regulations specifically apply to the Internet, other than laws generally applicable to businesses. Many Internet-related laws and regulations, however, are pending and may be adopted in the United States, in individual states and local jurisdictions and in other countries. These laws may relate to many areas that impact our business, including encryption, network and information security, and the convergence of traditional communication services, such as telephone services, with Internet communications, taxes and wireless networks. These types of regulations could differ between countries and other political and geographic divisions both inside and outside the United States. Non-U.S. countries and political organizations may impose, or favor, more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. Certain countries have implemented, or may implement, legislative and technological actions that either do or can effectively regulate access to the Internet, including the ability of Internet Service Providers to limit access to specific websites or content. In addition, state and local governments within the United States may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for, and the costs associated with, our products and services. The adoption of such laws and regulations may harm our business.
Exercise of outstanding options and warrants will result in further dilution.
The issuance of shares of common stock upon the exercise of our outstanding options and warrants will result in dilution to the interests of our stockholders, and may reduce the trading price of our common stock.
At September 30, 2019, we had 383 thousand outstanding warrants and 1.7 million of outstanding stock options granted under our stock option plans, 1.7 million of which are immediately exercisable.
While nearly all outstanding warrants and options are currently priced above the market price of our common stock, dilution to the interests of our stockholders will likely occur if or when they are exercised. Additional options and warrants may be issued in the future at prices not less than 85% of the fair market value of the underlying security on the date of grant. Exercises of these options, or even the potential of their exercise may have an adverse effect on the trading price of our common stock. The holders of our options are likely to exercise them at times when the market price of the common stock exceeds the exercise price of the securities. Accordingly, the issuance of shares of common stock upon exercise of the options will likely result in dilution of the equity represented by the then outstanding shares of common stock held by other stockholders. Holders of our options can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms, which are more favorable to us than the exercise terms provided, by these options.
Our ability to utilize our net operating loss carryforwards may be limited.
The use of our net operating loss carryforwards may have limitations resulting from certain future ownership changes or other factors under the Internal Revenue Code and other taxing authorities. The Tax Cuts and Jobs Act of 2017 changed both the federal deferred tax value of the net operating loss carryforwards and the rules of utilization of federal net operating loss carryforwards. The Tax Cuts and Jobs Act of 2017 lowered the corporate tax rate from 35% to 21% effective for our 2018 fiscal year. For net operating loss carryforwards generated in years prior to 2018, there is no annual limitation on the utilization and the carryforward period remains at 20 years. There could be a limitation if a change in ownership occurs. However, net operating loss carryforwards generated in years after 2017 will only be available to offset 80% of future taxable income in any single year, but will not expire.

25

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


If our net operating loss carryforwards are limited, and we have taxable income which exceeds the available net operating loss carryforwards for that period, we would incur an income tax liability even though net operating loss carryforwards may be available in future years prior to their expiration. Any such income tax liability may adversely affect our future cash flow, financial position and financial results.
Our business is subject to changing regulations regarding corporate governance and public disclosure that will increase both our costs and the risk of noncompliance.
As a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices and continue to update the program in response to newly implemented regulatory requirements and guidance, we cannot assure that we are or will be in compliance with all potentially applicable regulations.

Although our non-affiliate market capitalization was less than $75 million at March 31, 2019 and we were therefore not required to have an auditor attestation on our internal controls over financial reporting for fiscal 2019, SEC rules may in the future require us to have such an attestation if our non-affiliate market capitalization exceeds a certain threshold. We have found material weaknesses in our internal control over financial reporting in the past and cannot assure that in the future our management or our auditors, will not find additional material weaknesses in connection with our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot assure that we could correct all such weaknesses to allow our management to attest that we have maintained effective internal controls over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in our Annual Report on Form 10-K to be filed with the Securities and Exchange Commission or attest that we have maintained effective internal control over financial reporting as of the end of our fiscal year. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines, or other sanctions or litigation. In addition, the disclosure of any material weakness in our internal control over financial reporting could have a negative impact on our stock price.

On June 28, 2018, the SEC adopted amendments that raise the thresholds in the smaller reporting company ("SRC") definition, thereby expanding the number of smaller reporting companies eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. On May 9, 2019, the SEC proposed an amendment that would provide for a new subset of firms with annual revenues of less than $100 million and a public float of $250 million or more, but less than $700 million, or public float of $75 million or more, but less than $250 million, regardless of annual revenues, that also qualify as smaller reporting companies to be exempt from the requirement to have an auditor attestation on its internal controls over financial reporting. The amended definition of a smaller reporting company, and the proposal to create a new subset of firms that are exempt from the auditor attestation requirement, reduces the likelihood that the Company would be required to have auditor attestation on our internal controls over financial reporting in future periods.

ITEM 1B. UNRESOLVED STAFF COMMENTS
None.

ITEM 2. PROPERTIES
Our principal office is located in Madison, Wisconsin in a leased facility of approximately 26,000 square feet. The building serves as our corporate headquarters, accommodating our general and administrative, product development and selling and marketing departments. We believe this facility is adequate for our needs. The current lease term for this office expires on December 31, 2021. The rent for the remainder of the lease period is approximately $60 thousand per month.
Our operations in Japan are managed in Tokyo, Japan in a leased facility of approximately 9,874 square feet with a term expiring on December 31, 2020. The facility includes sales, technical and administrative functions. The rent for the remainder of the lease period is approximately $41 thousand per month.
Our European operations are managed in Utrecht, Netherlands in a leased facility of approximately 3,886 square feet with a term expiring on January 31, 2022. The facility includes sales, technical and administrative functions. The rent for the remainder of the lease period is approximately $5 thousand per month.

ITEM 3. LEGAL PROCEEDINGS

26

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


None.

ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.


27

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range of Common Stock
Our common stock was initially traded on the American Stock Exchange under the symbol “SFO,” beginning with our initial public offering in April of 1998. On April 24, 2000, our common stock began trading on the NASDAQ Global Market under the symbol “SOFO.” Effective September 16, 2009, we transferred the listing of our common stock to the NASDAQ Capital Market. Effective December 31, 2018, we transferred the listing of our common stock to the OTCQB Market under the symbol "SOFO". Effective February 18, 2019, we transferred the listing of our common stock to the OTC Pink Sheets under the symbol "SOFO". The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported on the NASDAQ Capital Market, the OTCQB Market, and the OTC Pink Sheets.
 
High
 
Low
Year Ended September 30, 2020:
 
 
 
First Quarter (through November 26, 2019)
1.22

 
0.92

Year Ended September 30, 2019:
 
 
 
First Quarter
1.71

 
0.60

Second Quarter
1.77

 
0.62

Third Quarter
1.17

 
0.72

Fourth Quarter
1.44

 
0.86

Year Ended September 30, 2018:
 
 
 
First Quarter
3.87

 
2.05

Second Quarter
3.18

 
2.20

Third Quarter
2.91

 
2.01

Fourth Quarter
2.32

 
1.51

Dividends
The Company has not paid any cash dividends and does not intend to pay any cash dividends in the foreseeable future. The Company is prohibited from paying any cash dividends pursuant to the terms of the loan and security agreement with Partners for Growth.
Unregistered Sale of Equity Securities and Use of Proceeds

On November 15, 2018, 718 shares of Preferred Stock, Series A, held by Mr. Burish, were automatically converted by the Company into 169,741 shares of common stock. The amount of shares converted represents all preferred shares issued on November 9, 2017.
On January 4, 2019, Sonic Foundry, Inc. and Mark Burish entered into a Promissory Note (the "Promissory Note") pursuant to which Mr. Burish purchased a 9.25% Unsecured Promissory Note for $1,000,000 in cash. The Promissory Note was later included in the Note Purchase Agreement, dated February 28, 2019, as detailed below.
On January 31, 2019, Sonic Foundry, Inc. and Mr. Burish entered into a Promissory Note (the "January 31, 2019 Promissory Note") pursuant to which the Mr. Burish purchased a 9.25% Unsecured Promissory Note for $1,000,000 in cash. The January 31, 2019 Promissory Note was later included in the Note Purchase Agreement, dated February 28, 2019, as detailed below.
On February 14, 2019, Sonic Foundry, Inc. and Mr. Burish entered into a Promissory Note (the "February 14, 2019 Promissory Note") pursuant to which Mr. Burish purchased a 9.25% Unsecured Promissory Note for $1,000,000 in cash.The February 14, 2019 Promissory Note was later included in the Note Purchase Agreement, dated February 28, 2019, as detailed below.
On February 28, 2019, Sonic Foundry, Inc. entered into a Note Purchase Agreement (the "Note Purchase Agreement") with Mr. Burish. The Note Purchase Agreement provided for subordinated secured promissory notes (the "Subordinated Promissory Notes") in an aggregate original principal amount of up to $5,000,000. Mr. Burish acquired from the Company (a) on the initial closing dates, the notes in an aggregate principal amount of $3,000,000 (the "Initial Notes") and (b) on March 31, 2019 and April 30, 2019, two additional tranches, each in the amount of $1,000,000.

28

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Coincident with execution of the Note Purchase Agreement, the Company entered into a Warrant Agreement ("Warrant") with Mr. Burish. Pursuant to the terms of the Warrant, the Company issued to Mr. Burish a warrant to purchase up to 728,155 shares of common stock of the Company at an exercise price of $1.18 per share, subject to certain adjustments. On April 25, 2019, Mr. Burish exercised the Warrant.
A special committee of disinterested and independent directors approved the issuance of the above Promissory Notes and the Warrant.

On April 25, 2019, Mr. Burish exercised his warrant to purchase 728,155 shares of common stock of the Company at an exercise price of $1.18 per share, which was entered into coincident with the execution of the Note Purchase Agreement on February 28, 2019.

On May 17, 2019, 2,080 shares of Preferred Stock Series A, held by Mr. Burish, were automatically converted by the Company into 491,753 shares on common stock. The amount of shares converted represents all preferred shares issued on May 17, 2018, including related dividends.

The Company relied on Section 4(a)(2) of the Securities Act of 1933, as amended, to issue the Promissory Notes and stock, inasmuch as the director and the affiliated party both received from the Company information that registration would provide and neither the Company nor any person acting on its behalf offered or sold the Notes or stock by any form of general solicitation or general advertising.
Holders
At December 16, 2019, there were 209 common stockholders of record and approximately 3,000 total shareholders. Many shares are held by brokers and other institutions on behalf of shareholders.
Equity Compensation Plan Information
Plan category
Number of securities
to be issued upon
exercise of
outstanding options
 
Weighted average
exercise price of
outstanding
options
 
Number of
securities
remaining
available for
future issuance
 
(a)
 
(b)
 
(c)
Equity compensation plans approved by security holders (1)
1,654,429

 
$
5.62

 
1,058,201

Equity compensation plans not approved by security holders (2)

 

 

Total
1,654,429

 
$
5.62

 
1,058,201

(1)
Consists of the 2009 Stock Incentive Plan, Employee Incentive Stock Option Plan and the Directors Stock Option Plans. For further information regarding these plans, reference is made to Note 5 of the financial statements.
(2)
Consists of the Non-Qualified Stock Option Plan. For further information regarding this plan, reference is made to Note 5 of the financial statements.
The graph below compares the cumulative total stockholder return on our common stock from September 30, 2014 through and including September 30, 2019 with the cumulative total return on The NASDAQ Stock Market (US only) and the RDG Technology Composite. The graph assumes that $100 was invested in our common stock on September 30, 2014 for each of the indexes and that all dividends were reinvested. Unless otherwise specified, all dates refer to the last day of each month presented. The comparisons in the graph below are based on historical data, with our common stock prices based on the closing price on the dates indicated, and are not intended to forecast the possible future performance of our common stock.


29

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
chart-dac01b2d43ff5605b43.jpg
*$100 invested on 9/30/14 in stock or index, including reinvestment of dividends fiscal year ending September 30.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial and operating data were derived from our consolidated financial statements. The selected financial data set forth below is qualified in its entirety by, and should be read in conjunction with, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto appearing elsewhere in this annual report on Form 10-K (in thousands except per share data).

30

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


 
Years Ended September 30,
 
2019
 
2018
 
2017
 
2016
 
2015
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Revenue
$
34,781

 
$
34,544

 
$
36,000

 
$
37,975

 
$
36,459

Cost of revenue
9,280

 
9,656

 
9,867

 
9,985

 
10,635

Gross margin
25,501

 
24,888

 
26,133

 
27,990

 
25,824

Operating expenses
28,009

 
29,118

 
30,091

 
30,266

 
29,916

Impairment of goodwill & intangible assets

 
11,809

 
600

 

 

Loss from operations
(2,508
)
 
(16,039
)
 
(4,558
)
 
(2,276
)
 
(4,092
)
Other income (expense), net
(117
)
 
142

 
(65
)
 
(178
)
 
46

Interest expense, net
(897
)
 
(601
)
 
(495
)
 
(594
)
 
(372
)
Benefit (provision) for income taxes
(90
)
 
4,332

 
79

 
(269
)
 
(107
)
Net loss
$
(3,612
)
 
$
(12,166
)
 
$
(5,039
)
 
$
(3,317
)
 
$
(4,525
)
Dividends on preferred stock
$
(122
)
 
$
(257
)
 
$
(169
)
 
$

 
$

Net loss attributable to common shareholders
$
(3,734
)
 
$
(12,423
)
 
$
(5,208
)
 
$
(3,317
)
 
$
(4,525
)
Basic net loss per common share
$
(0.64
)
 
$
(2.67
)
 
$
(1.17
)
 
$
(0.76
)
 
$
(1.04
)
Diluted net loss per common share
$
(0.64
)
 
$
(2.67
)
 
$
(1.17
)
 
$
(0.76
)
 
$
(1.04
)
Weighted average common shares:
     – Basic
5,833,301

 
4,655,520

 
4,436,333

 
4,389,421

 
4,332,576

– Diluted
5,833,301

 
4,655,520

 
4,436,333

 
4,389,421

 
4,332,576

Balance Sheet Data at September 30:
2019
 
2018
 
2017
 
2016
 
2015
Cash and cash equivalents
$
4,295

 
$
1,189

 
$
1,211

 
$
1,794

 
$
1,976

Working capital (deficit)
(847
)
 
(5,765
)
 
(4,833
)
 
(3,720
)
 
(618
)
Total assets
15,180

 
13,583

 
28,356

 
33,082

 
34,803

Long-term liabilities
7,602

 
3,451

 
8,147

 
7,249

 
8,435

Stockholders’ equity (deficit)
(6,253
)
 
(6,458
)
 
3,118

 
6,516

 
7,803


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The financial and business analysis below provides information that Sonic Foundry, Inc. (the “Company”) believes is relevant to an assessment and understanding of the Company’s consolidated financial position and results of operations. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes.
This report includes estimates, projections, statements relating to our business plans, objectives, and expected operating results that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including the following sections: “Management’s Discussion and Analysis,” and “Risk Factors.” These forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially. We describe risks and uncertainties that could cause actual results and events to differ materially in “Risk Factors” (Part 1, Item 1A of this Form 10-K), “Quantitative and Qualitative Disclosures about Market Risk” (Part II, Item 7A of this Form 10-K), and in this Item 7. We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.
Overview


31

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Sonic Foundry, Inc. is the trusted global leader for video capture, management and streaming solutions. Trusted by educational institutions, corporations and government entities, Mediasite Video Platform quickly and cost-effectively automates the capture, management, delivery and search of live and on-demand streaming video and rich media. Mediasite transforms communications, training, education and events for our customers.
Critical Accounting Policies
We have identified the following as critical accounting policies to our Company and have discussed the development, selection of estimates and the disclosure regarding them with the audit committee of the board of directors:

Revenue recognition, allowance for doubtful accounts and reserves;
Impairment of long-lived assets;
Asset retirement obligations;
Valuation allowance for net deferred tax assets; and
Accounting for stock-based compensation.
Revenue Recognition, Allowance for Doubtful Accounts and Reserves
Revenue recognition
We recognize revenues in accordance with Financial Accounting Standards Board ("FASB"), Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers ("ASC 606"). Recording revenues requires judgment, including determining whether an arrangement includes multiple performance obligations, whether any of those obligations are distinct and cannot be combined and allocation of the transaction price to each performance obligation based on the relative standalone selling prices ("SSP"). Customers receive certain contract elements over time. Changes to the elements in an arrangement or, in our determination, to the relative SSP for these elements, could materially affect the amount of earned and unearned revenues reflected in our consolidated financial statements.
The primary judgments relating to our revenue recognition include determining whether (i) the contract with a customer exists; (ii) performance obligations are identified; (iii) the transaction price is determined; (iv) the transaction price is allocated to performance obligations; and (v) the distinct performance obligations are satisfied by transferring control of the product or service to the client. Transfer of control is typically evaluated from the customer's perspective.
At contract inception, we determine whether we satisfy the performance obligation over time or at a point in time. Revenues from software and hosting solutions are primarily recognized ratably over time or as fee-bearing usages occur. Certain software licenses are sold either on-premises or through term-based hosting agreements. These hosting arrangements provide customers with the same product functionality and differ mainly in the duration over which the customer benefits from the software. We deliver our software licenses electronically. Electronic delivery occurs when we provide the customer with access to the software and license key via a secure portal. Revenue from on-premises software licenses is generally recognized upfront at the point in time when the software is made available to the customer.
Our contracts with customers for on-premises software licenses include maintenance services and may also include training and/or professional services. Maintenance services agreements consist of fees for providing software updates on an if and when available basis and for providing technical support for software products for a specified term. We believe that our software updates and technical support each have the same pattern of transfer to the customer and are substantially the same. Therefore, we consider these updates and technical support to be a single distinct performance obligation. Revenues allocated to maintenance services are recognized ratably as the maintenance services are provided. Revenues related to training services are billed on a fixed fee basis and are recognized as the services are delivered. Payments received in advance of services performed are deferred and recognized when the related services are performed. Revenues related to professional services are billed on a time and materials basis and are recognized as the services are performed.
We also provide cloud-based subscriptions, which allow customers to access our software during a contractual period without taking possession of the software. We recognize revenue related to these cloud-based subscriptions ratably over the life of the subscription agreement beginning when the customer first has access to the software.
We are often party to multiple concurrent contracts or contracts pursuant to which a client may purchase a combination of goods and services. These situations require judgment to determine whether multiple contracts should be combined and accounted for as a single arrangement. In making this determination, we consider whether the economics of the individual contracts cannot be understood without reference to the whole and multiple promises represent one single performance obligation.

32

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Due to the large number, broad nature and average size of individual contracts we are a party to, the effect of judgments and assumptions we apply in recognizing revenues for any single contract is not likely to have a material effect on our consolidated operations. However, the broader accounting policy assumptions that we apply across similar arrangements or classes of clients could significantly influence the timing and amount of revenues recognized in our results of operations.
Reserves
The Company reserves for stock rotations, price adjustments, rebates, and sales incentives to reduce revenue and accounts receivable for these and other credits granted to customers. Such reserves are recorded at the time of sale and are calculated based on historical information (such as rates of product stock rotations) and the specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, it may compromise our ability to recognize revenue to these distributors at the time of shipment. Also, if the Company determines that it can no longer accurately estimate amounts for stock rotations and sales incentives, the Company would not be able to recognize revenue until resellers sell the inventory to the final end user.
Credit Evaluation and Allowance for Doubtful Accounts
We assess the realization of our receivables by performing ongoing credit evaluations of our customers’ financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. Our reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. Our reserves are also based on amounts determined by using percentages applied to certain aged receivable categories. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. Allowance for doubtful accounts for accounts receivable and financing receivables was $661 thousand at September 30, 2019 and $1.0 million at September 30, 2018.
Impairment of long-lived assets
Goodwill had an indefinite useful life and was recorded at cost and not amortized but, instead, tested at least annually for impairment. We assessed the impairment of goodwill on an annual basis or whenever events or changes in circumstances indicated that the fair value of these assets is less than the carrying value. If a qualitative assessment was used and the Company determined that the fair value of goodwill was more likely than not (i.e., a likelihood of more than 50%) less than its carrying amount, a quantitative impairment test would be performed. If goodwill was quantitatively assessed for impairment, the Company compared the estimated fair value of the reporting unit to which goodwill is allocated to its carrying value. The amount of impairment, if any, is equal to the amount by which the carrying value of the reporting unit exceeds its fair value.
For purposes of the fiscal 2018 test, goodwill balances were evaluated within three separate reporting units and we performed a quantitative analysis and determined that the fair value of all three of the Company's reporting units is less than its carrying value. The Company recognized an impairment charge of $10.4 million, the remaining balance of goodwill, as of September 30, 2018.
Long-lived assets and intangible assets other than goodwill are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. For the year ended September 30, 2018, it was determined that changes in circumstances were present, primarily the decline in the Company's market capitalization during the fiscal year and past performance. For the year ended September 30, 2018, the Company determined that intangible assets, consisting of customer relationships and product rights, were impaired and recognized an impairment charge of $1.4 million. Key assumptions utilized in the analysis of undiscounted cash flows for each asset or asset group being tested included 1) whether cash flows were attributable solely to the asset or group, or to an entire reporting unit; and 2) the useful lives of the asset or asset group. Forecasts used in the analysis were also consistent with those used in determining fair value of reporting units during goodwill impairment testing. For the year ended September 30, 2019, no events or changes in circumstances occurred that required this analysis.
Asset retirement obligation
An asset retirement obligation (“ARO”) represents a legal obligation associated with the retirement of a tangible long-lived asset that is incurred upon the acquisition, construction, development, or normal operation of that long-lived asset. The Company’s ARO is associated with MSKK leasehold improvements that we are contractually obligated to remove at the end of a lease to comply with the lease agreement. We recognize asset retirement obligations upon construction of leasehold improvements with such conditions if a reasonable estimate of fair value can be made. The ARO is recorded in other noncurrent liabilities in the Consolidated Balance Sheets. The associated estimated ARO is capitalized as part of the carrying amount of the long-lived asset and depreciated over its useful life.

33

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019



Valuation allowance for net deferred tax assets
Deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. We do not provide for U.S. income taxes on the undistributed earnings of our foreign subsidiaries, which we consider to be permanently invested outside of the U.S.
We make judgments regarding the realizability of our deferred tax assets. The balance sheet carrying value of our net deferred tax assets is based on whether we believe that it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets after consideration of all available evidence. We regularly review our deferred tax assets for recoverability considering historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. Generally, cumulative losses in recent years is a significant piece of negative evidence that is difficult to overcome in determining that a valuation allowance is not needed.
As of September 30, 2019 and 2018, valuation allowances have been established for all U.S. and for certain foreign deferred tax assets which we believe do not meet the “more likely than not” criteria for recognition. If we are subsequently able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been established, then we will be required to recognize these deferred tax assets through the reduction of the valuation allowance, which could result in a material benefit to our results of operations in the period in which the benefit is determined.
Accounting for stock-based compensation
The Company uses a lattice valuation model to account for all employee stock options granted. The lattice valuation model is a more flexible analysis to value options because of its ability to incorporate inputs that change over time, such as actual exercise behavior of option holders. The Company uses historical data to estimate the option exercise and employee departure behavior in the lattice valuation model. Expected volatility is based on historical volatility of the Company’s stock. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogenous groups for valuation. The expected term of options granted is derived from the output of the option pricing model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods the options are expected to be outstanding is based on the U.S. Treasury yields in effect at the time of grant. Forfeitures are based on actual behavior patterns.
All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measured.
RESULTS OF OPERATIONS
You should read the following discussion of our results of operations and financial condition in conjunction with our consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K.
ASC 606
On October 1, 2018, we adopted ASC Topic 606, Revenue from Contracts with Customers ("ASC 606"), using the modified retrospective method. Under this method, we recognized the cumulative effect of applying the new revenue recognition standard to existing revenue contracts that were active as of the adoption date as an adjustment to the opening balance of accumulated deficit. The reported results for the twelve months ended September 30, 2019 reflect the adoption of ASC 606, while the comparative information has not been restated and continues to be reported under the related accounting standards in effect for those periods. Refer to Note 9 to the Notes to the Consolidated Financial Statements for additional information related to the effect of the adoption of ASC 606.
Revenue

34

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Revenue from our business includes the sale of Mediasite recorders and server software products and related services contracts, such as customer support, installation, customization services, training, content hosting and event services. We market our products to educational institutions, corporations and government agencies that need to deploy, manage, index and distribute video content on Internet-based networks. We reach both our domestic and international markets through reseller networks, a direct sales effort and partnerships with system integrators.

Revenue in fiscal 2019 totaled $34.8 million, compared to $34.5 million in fiscal 2018, an increase of 1%. Revenue consisted of the following:

Product and other revenue from the sale of Mediasite recorder units and server software decreased from $12.3 million in fiscal 2018 to $11.6 million in fiscal 2019. Mediasite recorder revenue was negatively impacted in fiscal 2019 by approximately $1.3 million due to the decision to eliminate the stocking of recorder units at distributors. Distributors held 238 recorder units in inventory at September 30, 2018 while no recorders were held in inventory at September 30, 2019. The average sales price per unit decreased in fiscal 2019 primarily due to an increase in sales of refresh units as compared to the prior year. Refresh units are sold at a discounted price to existing customers.
 
2019
 
2018
Units sold
1,269
 
1,507
Rack to mobile ratio
8.2 to 1
 
13.9 to 1
Average sales price, excluding support (000’s)
$5.3
 
$5.9
Refresh Units
547
 
421

Services revenue represents the portion of fees charged for Mediasite customer support contracts amortized over the length of the contract, typically 12 months, as well as training, installation, event and content hosting services. Services revenue increased from $22.2 million in fiscal 2018 to $23.2 million in fiscal 2019 primarily due to increases in hosting and customer support contract revenues as compared to fiscal 2018.
At September 30, 2019, $11.5 million of revenue was deferred, of which we expect to recognize $9.6 million in the next twelve months, including approximately $4.0 million in the quarter ending December 31, 2019. At September 30, 2018, $13.3 million of revenue was deferred. The decrease in deferred revenue is largely a result of the ASC 606 adjustment upon adoption. See Note 9 - Revenue for further details.

Other revenue relates to freight charges billed separately to our customers.
Gross Margin
Total gross margin in fiscal 2019 was $25.5 million or 73% compared to $24.9 million or 72% in fiscal 2018. The significant components of cost of revenue include:

Material and freight costs for Mediasite recorders. Costs for fiscal 2019 Mediasite recorder hardware and other costs totaled $2.5 million compared to $3.2 million in fiscal 2018 as result of the decrease in unit sales year over year. Freight costs were $244 thousand, and labor and allocated costs were $1.6 million in fiscal 2019 compared to $262 thousand and $1.5 million, respectively, in fiscal 2018. The remaining $34 thousand in fiscal 2019 and $217 thousand in fiscal 2018 relate to material and freight costs for Sonic Foundry International and MSKK. The decrease in material and freight costs for Sonic Foundry International and MSKK is a result of a shift in mix toward greater services revenue resulting in a $885 thousand increase in services revenues for the subsidiaries year over year.
Services costs. Staff wages and other costs allocated to cost of service revenues were $2.0 million in fiscal 2019 and $1.9 million in fiscal 2018, resulting in gross margin on services of 79% in fiscal 2019 and 80% in fiscal 2018. The remaining $2.9 million in fiscal 2019 and $2.5 million in fiscal 2018 relate to costs of providing content hosting, events and technical support services at Sonic Foundry International and MSKK. The increase in services costs for Sonic Foundry International and MSKK is a result of a $885 thousand increase in services revenues for the subsidiaries year over year.
The Company expects the gross margin percentage to be reduced slightly in fiscal 2020 primarily as a result of an expectation to allocate a greater amount of cost currently in operating expense, which is expected to be partially offset by an improvement to gross margins as a result of an expected increase in high gross margin software and services revenue.
Operating Expenses

35

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Selling and Marketing Expenses
Selling and marketing expenses include wages and commissions for sales, marketing and business development personnel, print and digital advertising, tradeshows and various promotional expenses for our products. Timing of these costs may vary greatly depending on introduction of new products and services or entrance into new markets, or participation in major tradeshows.
Selling and marketing expense decreased $895 thousand, or 6%, from $15.6 million in fiscal 2018 to $14.7 million in fiscal 2019. Fluctuations in the major categories include:

Public relations expense decreased by $23 thousand.
Salary, commissions and benefits expenses decreased by $648 thousand as a result of reduced headcount compared to fiscal 2018.
Expenses related to business meetings increased by $34 thousand.
Selling and marketing expenses for Sonic Foundry International and MSKK accounted for $563 thousand and $2.7 million, respectively in fiscal 2019, an aggregate increase of $314 thousand from the prior year, primarily as a result of an increase in revenue.
At September 30, 2019, we had 117 employees in selling and marketing, a decrease from 122 employees at September 30, 2018. Of the 117 employees in selling and marketing at September 30, 2019, 56 are employed by our foreign subsidiaries. We do not anticipate an increase in selling and marketing headcount in fiscal 2020.
General and Administrative Expenses
General and administrative (“G&A”) expenses consist of personnel and related costs associated with the facilities, finance, legal, human resources and information technology departments, as well as other expenses not fully allocated to functional areas.
G&A expenses decreased by $425 thousand, or 7%, to $5.9 million in fiscal 2019 from $6.4 million in fiscal 2018. Fluctuations in major categories include:

Increase in compensation and benefits of $188 thousand due to severance expense for certain executives, partially offset by a reduction in base wages prior to their separation.
Severance expense for two executives of $560 thousand recorded in fiscal 2019.
Decrease of $48 thousand related to travel and entertainment.
Bad debt expense decreased by $370 thousand due to certain large accounts that were fully written off in fiscal 2018.
Depreciation decreased $304 thousand compared to fiscal 2018.
G&A expenses for Sonic Foundry International and MSKK accounted for $288 thousand and $1.1 million, respectively in fiscal 2019, an aggregate increase of $291 thousand from the prior year.
At September 30, 2019, we had 23 full-time employees in G&A, a decrease from 27 full-time employees at September 30, 2018. Of the 23 employees in G&A at September 30, 2019, 10 are employed by our foreign subsidiaries. We do not anticipate an increase in G&A headcount in fiscal 2020.
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.
Product development expenses increased $211 thousand, or 3%, from $7.1 million in fiscal 2018 to $7.4 million in fiscal 2019. Fluctuations include:

Increase in compensation and benefits of $472 thousand related primarily to severance expense for certain senior managers.
Severance expense for two senior level managers of $346 thousand recorded in fiscal 2019.
Professional services decreased by $198 thousand due to decreased use of outsourced development.
Product development expenses for Sonic Foundry International and MSKK accounted for $482 thousand and $288 thousand, respectively, for fiscal 2019, an aggregate increase of $60 thousand from the prior year related to the subsidiaries.

At September 30, 2019, we had 43 full-time employees in product development compared to 49 employees at September 30, 2018. Of the 43 employees in product development at September 30, 2019, 10 are employed by our foreign subsidiaries. There were no

36

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


software development efforts in fiscal 2019 or 2018 that qualified for capitalization. We do not anticipate an increase in product development headcount in fiscal 2020.
Impairment of Goodwill & Intangible Assets
The Company recorded an impairment loss of $10.4 million for goodwill related to all three reporting units during the fiscal year ended September 30, 2018. This non-cash loss was primarily due to the fall in the Company's stock price and resulting decrease of our market capitalization as well as past performance. As a consequence, management forecasts were revised and additional risk factors were applied. The Company also recorded an impairment loss of $1.4 million for intangible assets, consisting of customer relationships and product rights, during the fiscal year ended September 30, 2018. As goodwill and intangible assets were fully written off in fiscal 2018, no impairment test was performed in fiscal 2019 and no additional impairment expense was recorded.
Other Income and Expense, Net
Interest expense for fiscal 2019 increased $296 thousand compared to fiscal 2018, mainly as a result of interest on the Subordinated Promissory Notes with Mr. Burish, the first tranche of which was disbursed on January 4, 2019, as well as the disbursement of the second and final tranche of the PFG debt in November 2018. Interest payments on the Burish notes are currently being deferred. See Note 3 - Credit Arrangements for further details on the deferred interest. The Company also recorded $74 thousand of interest expense during fiscal 2019 related to the accretion of discounts on the PFG Loan and Warrant Debt compared to $6 thousand in the same period last year. The Company also recorded amortization expense related to the back-end fee on the PFG loan of $50 thousand during fiscal 2019 compared to $19 thousand during fiscal 2018. The Company also recorded $79 thousand of interest expense during fiscal 2019 related to the accretion of discounts on the Burish notes payable, which was first disbursed in the quarter ended March 31, 2019.
Warrants were also issued in connection with the Burish note. For further details, see Note 3 - Credit Arrangements and Note 10 - Related Party Transactions.
During fiscal 2019, a change in fair value of $5 thousand was recorded related to the fair value remeasurement on the derivative liability associated with the PFG V Loan and Warrant Debt compared to a change in fair value of $14 thousand during fiscal 2018.
No foreign currency exchange gain or loss was recorded related to re-measurement of the subordinated notes payable related to the Company's foreign subsidiaries in either fiscal 2019 or 2018.
Provisions Related to Income Taxes
Historically, the Company recorded a non-cash deferred tax liability related to tax amortization of goodwill acquired in 2001. The income tax benefit related to this amortization was $8 thousand in fiscal 2018. The remaining balance of the deferred tax liability related to tax amortization of goodwill was fully written off as of September 30, 2018 as a result of the impairment.
The Company believes the valuation allowance for its deferred tax assets is appropriate. See Note 6 - Income Taxes for further details.

On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which significantly changed existing U.S. tax law and includes provisions that affect our business. The TCJA reduced the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. The TCJA was effective in the second quarter of fiscal year 2018 and the effective tax rate for the quarter ended December 31, 2017 is a blended rate reflecting the anticipated benefit of the three quarters of federal tax rate reductions for fiscal 2018. During fiscal 2018, we recorded an income tax benefit of $4.3 million, with $1.5 million resulting from the application of TCJA to existing deferred tax balances based on reasonable estimates for those tax effects and $3.0 million resulting from the write-off of the deferred tax liability associated with goodwill and customer relationships as a result of the full impairment. The repatriation of undistributed foreign earnings is not expected to result in a material change to our financial results.

Foreign Currency Translation Adjustment
The Company’s wholly-owned subsidiaries operate in Japan and the Netherlands, and utilize the Japanese Yen and Euro, respectively, as their functional currency. Assets and liabilities of the Company’s foreign operations are translated into US dollars

37

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


at period end exchange rates whiles revenues and expenses are translated using average rates for the period. Gains and losses from the translation are deferred and included in accumulated other comprehensive loss on the consolidated statements of operations.
For the year ended September 30, 2019, the Company’s foreign currency translation adjustment was a gain of $130 thousand compared to a loss of $81 thousand in the year ended September 30, 2018. The gain in fiscal 2019 is attributable to the strengthening in the Japanese Yen and the Euro compared to the U.S. dollar during the period as compared to fiscal 2018.
During fiscal 2019, the Company recorded an aggregate transaction loss of $157 thousand compared to an aggregate gain of $6 thousand during fiscal 2018. The aggregate transaction gain or loss is included in the other expense line of the consolidated statements of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company’s primary sources of liquidity are its cash and debt and equity financing. During fiscal 2019, the Company used $736 thousand of cash in operating activities compared with $638 thousand of cash used in operating activities in fiscal 2018. The Company had a decrease in net loss in fiscal 2019 as compared to fiscal 2018 of $8.6 million, mainly due to the full impairment of goodwill and intangible assets of $11.8 million recorded in Q4-2018.
Capital expenditures for property and equipment were $433 thousand in fiscal 2019 compared to $840 thousand in fiscal 2018.
The Company generated $4.3 million of cash from financing activities during fiscal 2019, primarily due to proceeds from the issuance of term debt of $500 thousand with PFG V and $5.0 million with Mr. Burish. The Company also received $873 thousand from the issuance of common stock and 728,155 warrants during Q3-2019. These transactions were partially offset by debt and capital lease payments of $1.1 million. For the same period in fiscal 2018, the Company generated $1.5 million of cash from financing activities, mainly due to proceeds from the issuance of term debt of $2.0 million with PFG V.
At September 30, 2018, the Company had a $4.0 million revolving line of credit with Silicon Valley Bank. The line of credit bore interest at prime rate plus 2.00%. Collections from accounts receivable were directly applied to the outstanding obligations under the revolving line of credit. The revolving line of credit with Silicon Valley Bank matured on January 31, 2019 and was fully paid off in fiscal 2019. The highest balance on the line of credit during the year was $1.7 million.
At September 30, 2019, there was no balance outstanding on the line of credit with Mitsui Sumitomo Bank. At September 30, 2018, a balance of $264 thousand was outstanding on the line of credit. The credit facility relates to Mediasite K.K., and accrues interest at an annual rate of approximately one-and-one half percent (1.5%).
At September 30, 2019, the Company had $6.4 million outstanding, net of warrant debt and debt discounts, related to notes payable with PFG V and Mr. Burish. The Company received proceeds of $5.5 million from loan agreements with Mr. Burish and PFG V, and made payments of $833 thousand on term debt related to PFG V, resulting in net proceeds of $4.7 million from notes during the fiscal 2019 compared to net proceeds of $2.2 million on notes in the fiscal 2018. During fiscal 2018, the Company also fully converted $1.0 million of subordinated debt due to Mr. Burish into preferred stock shares, which did not and will not require cash settlement.
At September 30, 2019 approximately $1.3 million of cash and cash equivalents was held by the Company’s foreign subsidiaries.
The Company believes its cash position plus available resources is adequate to accomplish its business plan through at least the next twelve months. We will likely evaluate operating and capital leases opportunities to finance equipment purchases in the future and anticipate utilizing proceeds from the recently issued promissory notes to support working capital needs. We may also seek additional equity financing, or issue additional shares previously registered in our available shelf registration and there are no assurances that these will be on terms acceptable to the Company.
Contractual Obligations
The following summarizes our contractual obligations at September 30, 2019 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in thousands):

38

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Contractual Obligations:
Total
 
Less than
1 Year
 
Years
2-3
 
Years
4-5
 
Over
5 years
Product purchase commitments
$
464

 
$
464

 
$

 
$

 
$

Operating lease obligations
2,437

 
1,289

 
1,148

 

 

Capital lease obligations (a)
401

 
210

 
179

 
12

 

Notes payable (a)
8,444

 
1,801

 
3,775

 
2,868

 

(a)
Includes fixed and determinable interest payments


ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivative Financial Instruments
Pursuant to Item 305 of Regulation S-K, the Company, as a smaller reporting company, is not required to provide the information required by this item.
Interest Rate Risk
Our cash equivalents, which consist of overnight money market funds, are subject to interest rate fluctuations, however, we believe this risk is minimal due to the short-term nature of these investments.
At September 30, 2019, $4.6 million of the Company’s $6.4 million in outstanding debt is variable rate. We do not expect that an increase in the level of interest rates would have a material impact on our Consolidated Financial Statements. We monitor our positions with, and the credit quality of, the financial institutions that are party to any of our financial transactions.
Foreign Currency Exchange Rate Risk
The functional currency of our foreign subsidiaries in the Netherlands is the Euro and in Japan is the Japanese Yen. They are subject to foreign currency exchange rate risk. Any increase or decrease in the exchange rate of the U.S. Dollar compared to the Euro or Japanese Yen will impact our future operating results and financial position.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders, Audit Committee and Board of Directors
Sonic Foundry, Inc. and Subsidiaries
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Sonic Foundry, Inc. and Subsidiaries (the "Company") as of September 30, 2019, and the related consolidated statement of operations, comprehensive loss, stockholders' equity (deficit), and cash flows for the year ended September 30, 2019, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2019, and the results of its operations and its cash flows for the year ended September 30, 2019, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to

39

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.




/s/ WIPFLI, LLP

We have served as the Company's auditor since 2019.
Milwaukee, Wisconsin
December 19, 2019


40

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders, Audit Committee and Board of Directors
Sonic Foundry, Inc. and Subsidiaries
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Sonic Foundry, Inc. and Subsidiaries (the "Company") as of September 30, 2018, the related consolidated statements of operations, comprehensive loss, stockholders' deficit, and cash flows for the year ended September 30, 2018, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2018, and the results of its operations and its cash flows for the year ended September 30, 2018, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion

These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.




/s/ BAKER TILLY VIRCHOW KRAUSE, LLP


We served as the Company's auditor from 2014 to 2018.


Madison, Wisconsin
March 15, 2019


41

Sonic Foundry, Inc.
Consolidated Balance Sheets
(in thousands, except for share and per share data)



 
September 30,
 
2019
 
2018
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
4,295

 
$
1,189

Accounts receivable, net of allowances of $135 and $524
6,532

 
7,418

Financing receivables, current, net of allowances of $526

 
100

Inventories
558

 
1,027

Investment in sales-type lease, current
163

 
150

Capitalized commissions, current
464

 

Prepaid expenses and other current assets
972

 
941

Total current assets
12,984

 
10,825

Property and equipment:
 
 
 
Leasehold improvements
1,121

 
1,105

Computer equipment
5,610

 
5,718

Furniture and fixtures
1,233

 
1,099

Total property and equipment
7,964

 
7,922

Less accumulated depreciation and amortization
6,396

 
6,009

Property and equipment, net
1,568

 
1,913

Other assets:
 
 
 
Financing receivables, long-term

 
181

Investment in sales-type lease, long-term
134

 
249

Capitalized commissions, long-term
106

 

Other long-term assets
388

 
415

Total assets
$
15,180

 
$
13,583

Liabilities and stockholders’ equity (deficit)
 
 
 
Current liabilities:
 
 
 
Revolving lines of credit
$

 
$
885

Accounts payable
843

 
1,610

Accrued liabilities
2,216

 
1,609

Unearned revenue
9,610

 
11,645

Current portion of capital lease and financing arrangements
194

 
248

Current portion of notes payable and warrant debt, net of discounts
968

 
593

Total current liabilities
13,831


16,590

Long-term portion of unearned revenue
1,842

 
1,691

Long-term portion of capital lease and financing arrangements
179

 
187

Long-term portion of notes payable and warrant debt, net of discounts
5,429

 
1,357

Derivative liability, at fair value
9

 
14

Other liabilities
143

 
202

Total liabilities
21,433

 
20,041

Commitments and contingencies

 

Stockholders’ equity (deficit):
 
 
 
Preferred stock, $.01 par value, authorized 500,000 shares; none issued

 

9% Preferred stock, Series A, voting, cumulative, convertible, $.01 par value (liquidation preference of $1,000 per share), authorized 4,500 shares; zero and 2,678 shares issued and outstanding, respectively, at amounts paid in

 
1,651

5% Preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 1,000,000 shares, none issued

 

Common stock, $.01 par value, authorized 10,000,000 shares; 6,749,359 and 5,113,400 shares issued and 6,736,643 and 5,100,684 shares outstanding
67

 
51

Additional paid-in capital
203,735

 
200,130

Accumulated deficit
(209,340
)
 
(207,419
)
Accumulated other comprehensive loss
(546
)
 
(676
)

42

Sonic Foundry, Inc.
Consolidated Balance Sheets
(in thousands, except for share and per share data)



Receivable for common stock issued

 
(26
)
Treasury stock, at cost, 12,716 shares
(169
)
 
(169
)
Total stockholders’ equity (deficit)
(6,253
)
 
(6,458
)
Total liabilities and stockholders’ equity (deficit)
$
15,180

 
$
13,583

See accompanying notes to the consolidated financial statements.

43

Sonic Foundry, Inc.
Consolidated Statements of Operations
(in thousands, except for share and per share data)




 
Years Ended September 30,
 
2019
 
2018
Revenue:
 
 
 
Product and other
$
11,631

 
$
12,311

Services
23,150

 
22,233

Total revenue
34,781

 
34,544

Cost of revenue:
 
 
 
Product and other
4,387

 
5,231

Services
4,893

 
4,425

Total cost of revenue
9,280

 
9,656

Gross margin
25,501

 
24,888

Operating expenses:
 
 
 
Selling and marketing
14,727

 
15,622

General and administrative
5,929

 
6,354

Product development
7,353

 
7,142

Impairment of goodwill and intangible assets

 
11,809

Total operating expenses
28,009

 
40,927

Loss from operations
(2,508
)
 
(16,039
)
Non-operating income (expenses):
 
 
 
Interest expense, net
(897
)
 
(601
)
Other income (expense), net
(117
)
 
142

Total non-operating expenses
(1,014
)
 
(459
)
Loss before income taxes
(3,522
)
 
(16,498
)
Income tax benefit (provision)
(90
)
 
4,332

Net loss
$
(3,612
)
 
$
(12,166
)
Dividends on preferred stock
(122
)
 
(257
)
Net loss attributable to common stockholders
$
(3,734
)
 
$
(12,423
)
Loss per common share:
 
 
 
Basic net loss per common share
$
(0.64
)
 
$
(2.67
)
Diluted net loss per common share
$
(0.64
)
 
$
(2.67
)
Weighted average common shares – Basic
5,833,301

 
4,655,520

                    – Diluted
5,833,301

 
4,655,520

See accompanying notes to the consolidated financial statements.

44

Sonic Foundry, Inc.
Consolidated Statements of Comprehensive Loss
(in thousands)




 
Years Ended September 30,
 
2019
 
2018
Net loss
$
(3,612
)
 
$
(12,166
)
Foreign currency translation adjustment
130

 
(81
)
Comprehensive loss
$
(3,482
)
 
$
(12,247
)
See accompanying notes to the consolidated financial statements.

45

Sonic Foundry, Inc.
Consolidated Statements of Stockholders’ Equity (Deficit)
(in thousands)




 
Preferred stock
 
Common
stock
 
Additional
paid-in
capital
 
Accumulated
deficit
 
Accumulated
other
comprehensive
loss
 
Receivable
for
common
stock issued
 
Treasury
stock
 
Total
Balance, September 30, 2017
$
1,280

 
$
45

 
$
197,836

 
$
(195,253
)
 
$
(595
)
 
$
(26
)
 
$
(169
)
 
$
3,118

Stock compensation

 

 
476

 

 

 

 

 
476

Issuance of preferred stock
1,531

 

 

 

 

 

 

 
1,531

Conversion of preferred stock
(1,390
)
 
4

 
1,386

 

 

 

 

 

Issuance of common stock

 
2

 
592

 

 

 

 

 
594

Beneficial conversion feature on convertible debt

 

 
70

 

 

 

 

 
70

Preferred stock dividends
230

 

 
(230
)
 

 

 

 

 

Foreign currency translation adjustment

 

 

 

 
(81
)
 

 

 
(81
)
Net loss

 

 

 
(12,166
)
 

 

 

 
(12,166
)
Balance, September 30, 2018
$
1,651

 
$
51

 
$
200,130

 
$
(207,419
)
 
$
(676
)
 
$
(26
)
 
$
(169
)
 
$
(6,458
)
Cumulative effect of ASC 606 adoption Note 9

 

 

 
1,691

 

 

 

 
1,691

Adjusted balance, October 1, 2018
1,651

 
51

 
200,130

 
(205,728
)
 
(676
)
 
(26
)
 
(169
)
 
(4,767
)
Stock compensation

 

 
177

 

 

 

 

 
177

Conversion of preferred stock
(1,773
)
 
6

 
1,767

 

 

 

 

 

Issuance of common stock and warrants

 
10

 
1,109

 

 

 

 

 
1,119

Warrants issued in connection with subordinated notes payable

 

 
674

 

 

 

 

 
674

Preferred stock dividends
122

 

 
(122
)
 

 

 

 

 

Cancellation of receivable for common stock issued

 

 

 

 

 
26

 

 
26

Foreign currency translation adjustment

 

 

 

 
130

 

 

 
130

Net loss

 

 

 
(3,612
)
 

 

 

 
(3,612
)
Balance, September 30, 2019
$

 
$
67

 
$
203,735

 
$
(209,340
)
 
$
(546
)
 
$

 
$
(169
)
 
$
(6,253
)
See accompanying notes to the consolidated financial statements.

46

Sonic Foundry, Inc.
Consolidated Statements of Cash Flows
(in thousands)




 
Years Ended
September 30,
 
2019
 
2018
Operating activities
 
 
 
Net loss
$
(3,612
)
 
$
(12,166
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Amortization of other intangibles
307

 
621

Depreciation and amortization of property and equipment
970

 
1,118

Impairment of goodwill and intangible assets

 
11,809

Loss on sale of fixed assets
8

 

Provision for doubtful accounts - including financing receivables
116

 
475

Deferred taxes

 
(4,450
)
Stock-based compensation expense related to stock options and warrants
177

 
476

Stock issued for board of director's fees
246

 

Deferred loan interest to related party
259

 

Conversion of accrued interest to preferred stock

 
31

Beneficial conversion feature recognized on debt converted to preferred stock

 
70

Remeasurement gain on derivative liability
(8
)
 
(28
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
950

 
348

Financing receivables
293

 
1,630

Inventories
472

 
(41
)
Investment in lease
120

 
158

Capitalized commissions
123

 

Prepaid expenses and other current assets
15

 
132

Accounts payable and accrued liabilities
(204
)
 
268

Other long-term liabilities
(68
)
 
(169
)
Unearned revenue
(900
)
 
(920
)
Net cash used in operating activities
(736
)
 
(638
)
Investing activities
 
 
 
Purchases of property and equipment
(433
)
 
(840
)
Net cash used in investing activities
(433
)
 
(840
)
Financing activities
 
 
 
Proceeds from notes payable
5,500

 
3,000

Proceeds from lines of credit
9,199

 
22,236

Payments on notes payable
(833
)
 
(815
)
Payments on lines of credit
(10,098
)
 
(23,422
)
Payments of debt issuance costs
(110
)
 
(97
)
Payments to settle put on term debt

 
(200
)
Proceeds from issuance of preferred stock and common stock
873

 
1,094

Payments on capital lease and financing arrangements
(250
)
 
(298
)
Net cash provided by financing activities
4,281

 
1,498

Changes in cash and cash equivalents due to changes in foreign currency
(6
)
 
(42
)
Net increase (decrease) in cash and cash equivalents
3,106

 
(22
)
Cash and cash equivalents at beginning of year
1,189

 
1,211

Cash and cash equivalents at end of year
$
4,295

 
$
1,189

Supplemental cash flow information:
 
 
 

47

Sonic Foundry, Inc.
Consolidated Statements of Cash Flows
(in thousands)



Interest paid
$
618

 
$
409

Income taxes paid, foreign
99

 
112

Non-cash financing and investing activities:
 
 
 
Property and equipment financed by capital lease or accounts payable
186

 
460

Debt discount and warrant
679

 
127

Deemed dividend for beneficial conversion feature of preferred stock

 
28

Preferred stock dividend paid in additional shares
122

 
230

Subordinated note payable converted to preferred stock

 
1,000

Conversion of preferred shares to common shares
1,773

 
1,390

See accompanying notes to the consolidated financial statements.


48

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019



1. Basis of Presentation and Significant Accounting Policies
Business
Sonic Foundry, Inc. (the Company) is in the business of providing enterprise solutions and services for the web communications market.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Sonic Foundry Media Systems, Inc., Sonic Foundry International B.V. (formerly Media Mission B.V.) and Mediasite K.K. All significant intercompany transactions and balances have been eliminated.
Use of Estimates
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the period. Actual results could differ from those estimates.
Assets Recognized From the Costs to Obtain a Contract With a Customer
Sales commissions and related expenses are considered incremental and recoverable costs of acquiring customer contracts. Effective October 1, 2018, these costs are capitalized and amortized on a straight-line basis over the anticipated period of benefit, which we have determined to be the contract period, typically around 12 months. Assets recorded are included in current assets and other long-term assets. Amortization expense is recorded in sales and marketing expense within our 2019 consolidated statement of operations. We calculate a quarterly average percentage based on actual commissions incurred on billings during the same period and apply that percentage to the respective periods’ unearned revenues to determine the capitalized commission amount.
Revenue Recognition
We generate revenues in the form of hardware sales of our Mediasite recorder and Mediasite related products, such as our server software and other software licenses and related customer support and services fees, including hosting, installations and training. Software license revenues include fees from sales of perpetual and term licenses. Maintenance and services revenues primarily consist of fees for maintenance services (including support and unspecified upgrades and enhancements when and if they are available), hosting, installation, training and other professional services.
Invoices are billed when a customer contract, purchase order or signed quote is obtained from the customer. No revenue is recognized prior to such a customer authorization. In some renewal circumstances, we continue to provide services, typically customer support, during the period when our sales team is working to obtain a customer authorization to avoid customer attrition. Typically, we would bill for this period such that the customer support contract does not lapse. Consistent with historical company practices, we would recognize revenue for the periods where services have already been rendered once customer authorization has occurred.

Products
Products are considered delivered, and revenue is recognized, when title and risk of loss have been transferred to the customer or upon customer acceptance if non-delivered products or services are essential to the functionality of delivered products. Under the terms and conditions of the sale, this occurs at the time of shipment to the customer. Product revenue currently represents sales of our Mediasite recorder and Mediasite related products such as our server software and other software licenses.

Services
The Company sells support and content hosting contracts to our customers, typically one year in length, and records the related revenue ratably over the contractual period. Our support contracts cover phone and electronic technical support availability over and above the level provided by our distributors, software upgrades on a when and if available basis, advance hardware replacement and an extension of the standard hardware warranty from 90 days to one year. The manufacturers the Company contracts with to build the units provide a limited one-year warranty on the hardware. The Company also sells installation, training, event webcasting, and customer content hosting services. Revenue for those services is recognized when performed in the case of installation, training and event webcasting services. Occasionally, the Company will sell customization services to enhance the server software. Revenue

49

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


from those services is recognized when performed, if perfunctory, or under contract accounting. Service amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met.

Revenue Recognition - ASC 606 Adopted Effective October 1, 2018
In accordance with ASC Topic 606, Revenue from Contracts with Customers ("ASC 606"), revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods and services. To achieve this core principle, we apply the following five steps:
1.
Identify the contract with a customer. A contract with a customer exists when: (1) we and the customer have approved the contract and both parties are committed to perform their respective obligations; (2) we can identify each party’s rights regarding the products or services to be transferred; (3) we can identify the payment terms for the products or services to be transferred; (4) the contract has commercial substance as our future cash flows are expected to change; and (5) it is probable that we will collect substantially all of the consideration to which we are entitled in exchange for the products or services. Any subsequent contract modifications are analyzed to determine the treatment of the contract modification as a separate contract, prospectively or through a cumulative catch-up adjustment.
2.
Identify the performance obligations in the contract. Performance obligations are promises to transfer a good or service to the customer. Performance obligations may be each individual promise in a contract, or may be groups of promises within a contract that significantly affect one another. To the extent a contract includes multiple promises, we must apply judgment to determine whether promises are capable of being distinct and distinct in the context of the contract. If these criteria are not met, the promises are accounted for as a combined performance obligation.
3.
Determine the transaction price. The transaction price is the total amount of consideration to which we expect to be entitled in exchange for transferring promised products and services to a customer.
4.
Allocate the transaction price to performance obligations in the contract. The allocation of the transaction price to performance obligations is generally done in proportion to their standalone selling prices (“SSP”). SSP is the price that we would sell a distinct product or service separately to a customer and is determined at contract inception.
If SSP is not available through the analysis of observable inputs, this step is subject to significant judgment and additional analysis so that we can establish an estimated SSP. The estimated SSP considers historical information, including demand, trends and information about the customer or class of customers.
5.
Recognize revenues when or as the company satisfies a performance obligation. We recognize revenues when, or as, distinct performance obligations are satisfied by transferring control of the product or service to the customer. A performance obligation is considered transferred when the customer obtains control of the product or service. Transfer of control is typically evaluated from the customer's perspective. At contract inception, we determine whether we satisfy the performance obligation over time or at a point in time. Revenue is recognized when performance obligations are satisfied.
Our contract payment terms are typically net 30 days. We assess collectability based on a number of factors including collection history and creditworthiness of the customer, and we may mitigate exposures to credit risk by requiring payments in advance. If we determine that collectability related to a contract is not probable, we may not record revenue until collectability becomes probable at a later date.
Our revenues are recorded based on the transaction price excluding amounts collected on behalf of third parties such as sales taxes, which are collected on behalf of and remitted to governmental authorities.
Nature of Products and Services
Certain software licenses are sold either on-premise or through term-based hosting agreements. These hosting arrangements provide customers with the same product functionality and differ mainly in the duration over which the customer benefits from the software. We deliver our software licenses electronically. Electronic delivery occurs when we provide the customer with access to the software and license key via a secure portal. Revenue from on-premise software licenses is generally recognized upfront at the point in time when the software is made available to the customer. Revenue from term-based hosted licenses are recognized ratably over the term of the agreement.
Our contracts with customers for on-premise and hosted software licenses include maintenance services and may also include training and/or professional services. Maintenance services agreements consist of fees for providing software updates on an if and when available basis and for providing technical support for software products for a specified term. We believe that our software

50

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


updates and technical support each have the same pattern of transfer to the customer and are substantially the same. Therefore, we consider these updates and technical support to be a single distinct performance obligation. Revenues allocated to maintenance services are recognized ratably over the term of the agreement. Revenues related to training services are billed on a fixed fee basis and are recognized as the services are delivered. Payments received in advance of services performed are deferred and recognized when the related services are performed. Revenues related to professional services are recognized as the services are performed.
In the case of the Company’s hardware products with embedded software, the Company has determined that the hardware and software components function together to deliver the product’s essential functionality, and therefore, are considered to be one performance obligation. The revenue from the sale of these products along with other products and services we provide requires an allocation of transaction price based on the stand-alone selling price of each component.
The Company also offers hosting services bundled with events services. The Company recognizes events revenue when the event takes place and recognizes the hosting revenue over the term of the hosting agreement.
Judgments and Estimates
Our contracts with customers often include promises to transfer multiple products and services. Determining whether products and services are considered distinct performance obligations that should be accounted for separately from one another sometimes requires judgment.
Judgment is required to determine standalone selling prices (“SSP”) for each distinct performance obligation. We typically have more than one SSP for each of our products and services based on customer stratification, which is based on the size of the customer, their geographic region and market segment. We use a cost plus margin approach to determine SSPs for hardware. We use historical sales data to determine SSPs for perpetual software licenses. For both on-premise and term-hosted agreements, events services, training and professional services, SSPs are generally observable using internally developed pricing calculators and/or price sheets. For maintenance services, SSPs are generally observable using historical renewal data.
Our revenue recognition accounting policy for ASC 605 is included below. Information presented for 2018 and prior years is in accordance with ASC 605 revenue recognition policies.
Revenue Recognition - ASC 985-605 and 605
General
Revenue is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price is fixed or determinable and collectability is reasonably assured. Revenue is deferred when undelivered products or services are essential to the functionality of delivered products, customer acceptance is uncertain, significant obligations remain, or the fair value of undelivered elements is unknown. Typically, the Company does not offer customers the right to return product, other than for exchange or repair pursuant to a warranty or stock rotation. The Company’s policy is to reduce revenue if it incurs an obligation for price rebates or other such programs during the period the obligation is reasonably estimated to occur. The following policies apply to the Company’s major categories of revenue transactions.
Revenue Arrangements that Include Multiple Elements
Sales of software, with or without installation, training, and post customer support fall within the scope of the software revenue recognition rules. Under the software revenue recognition rules, the fee from a multiple-deliverable arrangement is allocated to each of the undelivered elements based upon vendor-specific objective evidence (VSOE), which is limited to the price charged when the same deliverable is sold separately, with the residual value from the arrangement allocated to the delivered element. The portion of the fee that is allocated to each deliverable is then recognized as revenue when the criteria for revenue recognition are met with respect to that deliverable. If VSOE does not exist for all of the undelivered elements, then all revenue from the arrangement is typically deferred until all elements have been delivered to the customer.
In the case of the Company’s hardware products with embedded software, the Company has determined that the hardware and software components function together to deliver the product’s essential functionality, and therefore, the revenue from the sale of these products is accounted for under the revenue recognition rules for tangible products whereby the fee from a multiple-deliverable arrangement is allocated to each of the deliverables based upon their relative selling prices as determined by a selling-price hierarchy. A deliverable in an arrangement qualifies as a separate unit of accounting if the delivered item has value to the customer on a stand-alone basis. A delivered item that does not qualify as a separate unit of accounting is combined with the other undelivered items in the arrangement and revenue is recognized for those combined deliverables as a single unit of accounting. The selling price used for each deliverable is based upon VSOE if available, from third-party evidence (TPE) if VSOE is not available, and best estimate of selling price (ESP) if neither VSOE nor TPE are available. TPE is the price of the Company’s or any competitor’s

51

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


largely interchangeable products or services in stand-alone sales to similarly situated customers. ESP is the price at which the Company would sell the deliverable if it were sold regularly on a stand-alone basis, considering market conditions and entity-specific factors. All revenue arrangements, excluding the sale of all software-only products and associated services, have been accounted for under this guidance.
The selling prices used in the relative selling price allocation method are as follows: (1)the Company’s products and services are based upon VSOE and (2) hardware products with embedded software, for which VSOE does not exist, are based upon ESP. The Company does not believe TPE exists for any of these products and services because they are differentiated from competing products and services in terms of functionality and performance and there are no competing products or services that are largely interchangeable. Management establishes ESP for hardware products with embedded software using a cost plus margin approach with consideration for market conditions, such as the impact of competition and geographic considerations, and entity-specific factors, such as the cost of the product and the Company’s profit objectives. Management believes that ESP is reflective of reasonable pricing of that deliverable as if priced on a stand-alone basis. When a sales transaction includes deliverables that are divided between Accounting Standards Codification (ASC) Topic 605 and ASC Subtopic 985-605, the Company allocates the selling price using the relative selling price method whereas value is allocated using an ESP for software developed using a percent of list price approach. The other deliverables are valued using ESP or VSOE as previously discussed.

While the pricing model captures all critical variables, unforeseen changes due to external market forces may result in a revision of the inputs. These modifications may result in the consideration allocation differing from the one presently in use. Absent a significant change in the pricing inputs or the way in which the industry structures its transactions, future changes in the pricing model are not expected to materially affect our allocation of arrangement consideration.
Management has established VSOE for hosting services. Billings for hosting are spread ratably over the term of the hosting agreement, with the typical hosting agreement having a term of 1 year, with renewal on an annual basis. The Company sells most hosting contracts without the inclusion of products. When the hosting arrangement is sold in conjunction with product, the product revenue is recognized immediately while the remaining hosting revenue is spread ratably over the term of the hosting agreement. The selling price is allocated between these elements using the relative selling price method. The Company uses ESP for development of the selling price for hardware products with embedded software.
The Company also offers hosting services bundled with events services. The Company uses VSOE to establish relative selling prices for its events services. The Company recognizes events revenue when the event takes place and recognizes the hosting revenue over the term of the hosting agreement. The total amount of the arrangement is allocated to each element based on the relative selling price method.
Reserves
The Company reserves for stock rotations, price adjustments, rebates, and sales incentives to reduce revenue and accounts receivable for these and other credits granted to customers. Such reserves are recorded at the time of sale and are calculated based on historical information (such as rates of product stock rotations) and the specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, it may compromise our ability to recognize revenue to these distributors at the time of shipment. Also, if the Company determines that it can no longer accurately estimate amounts for stock rotations and sales incentives, the Company would not be able to recognize revenue until resellers sell the inventory to the final end user.
Shipping and Handling
The Company’s shipping and handling costs billed to customers are included in other revenue. Costs related to shipping and handling are included in cost of revenue and are recorded at the time of shipment to the customer. As a result of the adoption of ASC 606, shipping and handling revenue is included in the relative selling price allocation method effective October 1, 2018.
Concentration of Credit Risk and Other Risks and Uncertainties
As of September 30, 2019, of the $4.3 million in cash and cash equivalents, $3.0 million is deposited with 2 major U.S. financial institutions. At times, deposits in these institutions exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on such amounts and believes that it is not exposed to any significant credit risk on these balances. The remaining $1.3 million of cash and cash equivalents is held by our foreign subsidiaries in financial institutions in Japan and the

52

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Netherlands and held in their local currency. The cash held in foreign financial institutions is not guaranteed. If the funds held by our foreign subsidiaries were needed for our operations in the United States, the repatriation of some of these funds to the United States could require payment of additional U.S. taxes.
The Company’s wholly-owned subsidiaries operate in Japan and the Netherlands, and utilize the Japanese Yen and Euro, respectively, as their functional currency. Assets and liabilities of the Company’s foreign operations are translated into US dollars at period end exchange rates whiles revenues and expenses are translated using average rates for the period. Gains and losses from the translation are deferred and included in accumulated other comprehensive loss on the consolidated statements of operations.
During fiscal 2019, the Company recorded an aggregate transaction loss of $157 thousand compared to an aggregate gain of $6 thousand during fiscal 2018. The aggregate transaction gain or loss is included in the other expense line of the consolidated statements of operations.
We assess the realization of our receivables by performing ongoing credit evaluations of our customers’ financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. Our reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. Our reserves are also based on amounts determined by using percentages applied to certain aged receivable categories. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. Allowance for doubtful accounts for accounts receivable and financing receivables was $661 thousand at September 30, 2019 and $1.0 million at September 30, 2018.

We had billings for Mediasite product and support services as a percentage of total billings to one distributor of less than 1% in 2019 and approximately 6% in 2018 and to a second distributor of less than 1% in 2019 and approximately 11% in 2018. At September 30, 2019 and 2018, these two distributors represented 0% and 28% of total accounts receivable, respectively. The reduction in both billings and accounts receivable concentration is a result of the planned reduction in inventory sold through distribution.
Currently all of our product inventory purchases are from one third-party contract manufacturer. Although we believe there are multiple sources of supply from other contract manufacturers as well as multiple suppliers of component parts required by the contract manufacturers, a disruption of supply of component parts or completed products, even if short term, would have a material negative impact on our revenues. At September 30, 2019 and 2018, this supplier represented 31% and 29%, respectively, of total accounts payable. We also license technology from third parties that is embedded in our software. We believe there are alternative sources of similar licensed technology from other third parties that we could also embed in our software, although it could create potential programming related issues that might require engineering resources.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Trade Accounts Receivable
The majority of the Company’s accounts receivable are due from entities in, or distributors or value-added resellers to, the education, corporate and government sectors. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are typically due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered to be past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Interest is not accrued on past due receivables.
Financing Receivables


53

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Financing receivables consist of customer receivables resulting from the sale of the Company's products and services, primarily software and long-term customer support contracts, and are presented net of allowance for losses. The Company has a single portfolio consisting of fixed-term receivables, which is further segregated into two classes based on type of product and lease.

The Company generally determines its allowance for losses on financing receivables at the customer class level by considering a number of factors, including the length of time financing receivable are past due, historical and anticipated experience, the customer’s current ability to pay its obligation, and the condition of the general economy and the industry as a whole. The Company writes-off financing receivables when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for financing receivable losses. Interest is not accrued on past due receivables. There was an allowance of $526 thousand at both September 30, 2019 and September 30, 2018.

The Company's financing receivables are aggregated into the following categories:

Long-term customer support contracts: These contracts are typically entered into in conjunction with sale-type lease arrangements, over the life of which the Company agrees to provide support services similar to those offered within Mediasite Customer Care plans. Contract terms range from 3-5 years, and payments are generally due from the customer annually on the contract anniversary. All amounts due were current as of the balance sheet date and there are no credit losses expected to be incurred related to long-term support contracts.

Product receivables: Amounts due primarily represent sales of perpetual software licenses to a single international distributor on invoices outstanding for product delivered from March 2016 through June 2017. The entire balance of product receivables as of September 30, 2019 is made up of the product finance receivable that is fully reserved. The entire allowance for losses on financing receivables of $526 thousand is considered attributable to this class of customer as of September 30, 2019 and 2018. A balance of $281 thousand was outstanding on the product receivables, net of allowance, as of September 30, 2018.

Investment in Sales-Type Lease
The Company has entered into sales-type lease arrangements with certain customers, consisting of recorders leased with terms ranging from 3-5 years.
Investment in sales-type leases consisted of the following (in thousands) as of September 30, 2019:
 
 
Investment in sales-type lease, gross:


   2020
$
167

   2021
134

Gross investment in sales-type lease
301

Less: Unearned income
(4
)
Total investment in sales-type lease
$
297

 
 
Current portion of total investment in sales-type lease
$
163

Long-term portion of total investment in sales-type lease
134

 
$
297

Inventory
Inventory consists of raw materials and supplies used in the assembly of Mediasite recorders and finished units. Inventory of completed units and spare parts are carried at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis.
Inventory consists of the following (in thousands):

54

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


 
September 30,
 
2019
 
2018
Raw materials and supplies
$
163

 
$
358

Finished goods
395

 
669

 
$
558

 
$
1,027


Software Development Costs
Software development costs incurred in conjunction with product development are charged to research and development expense until technological feasibility is established. Thereafter, until the product is released for sale, software development costs are capitalized and reported at the net realizable value of the related product. Typically, the period between achieving technological feasibility of the Company’s products and the general availability of the products has been short. Consequently, software development costs qualifying for capitalization are typically immaterial and are generally expensed to research and development costs.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the straight-line method for financial reporting purposes. The estimated useful lives used to calculate depreciation are as follows:
 
Years
Leasehold improvements
5 to 15 years
Computer equipment
1.5 to 5 years
Furniture and fixtures
3 to 15 years

Depreciation expense is not included in cost of good sold.

Impairment of Long-Lived Assets
Goodwill had an indefinite useful life and was recorded at cost and not amortized but, instead, tested at least annually for impairment. We assessed the impairment of goodwill on an annual basis or whenever events or changes in circumstances indicated that the fair value of these assets was less than the carrying value. If a qualitative assessment was used and the Company determined that the fair value of goodwill was more likely than not (i.e., a likelihood of more than 50%) less than its carrying amount, a quantitative impairment test would be performed. If goodwill was quantitatively assessed for impairment, the Company compared the estimated fair value of the reporting unit to which goodwill was allocated to its carrying value. The amount of impairment, if any, is equal to the amount by which the carrying value of the reporting unit exceeds its fair value.
Long-lived assets and intangible assets other than goodwill are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. Key assumptions utilized in the analysis of undiscounted cash flows for each asset or asset group being tested included 1) whether cash flows were attributable solely to the asset or group, or to an entire reporting unit; and 2) the useful lives of the asset or asset group. Forecasts used in the analysis were also consistent with those used in determining fair value of reporting units during goodwill impairment testing.
Asset Retirement Obligation
An asset retirement obligation (“ARO”) associated with the retirement of a tangible long-lived asset is recognized as a liability in the period in which it is incurred or becomes determinable, with an associated increase in the carrying amount of the related long-term asset.  The cost of the tangible asset, including the initially recognized asset retirement cost, is depreciated over the useful life of the asset.  As of September 30, 2019, the Company has recorded a liability of $129 thousand for retirement obligations associated with returning the MSKK leased property to the respective lessors upon the termination of the lease arrangement. 
A summary of the changes in the ARO is included in the table below (amounts in thousands):

55

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


Asset retirement obligation at September 30, 2017
$
120

   Accretion expense
1

Asset retirement obligation at September 30, 2018
121

   Accretion expense
2

   Foreign currency changes
6

Asset retirement obligation at September 30, 2019
$
129

Comprehensive Loss
Comprehensive loss includes disclosure of financial information that historically has not been recognized in the calculation of net income. Our comprehensive loss encompasses net loss and foreign currency translation adjustments. Assets and liabilities of international operations that have a functional currency that is not in U.S. dollars are translated into U.S. dollars at year-end exchange rates, and revenue and expense items are translated using weighted average exchange rates. Any adjustments arising on translation are included in stockholders’ equity (deficit) as an element of accumulated other comprehensive loss.
Advertising Expense
Advertising costs included in selling and marketing, are expensed when the advertising first takes place. Advertising expense was $444 thousand and $451 thousand for years ended September 30, 2019 and 2018, respectively.
Research and Development Costs
Research and development costs are expensed in the period incurred, unless they meet the criteria for capitalized software development costs.
Income Taxes
Deferred tax assets and liabilities are determined based on differences between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. We do not provide for U.S. income taxes on the undistributed earnings of our foreign subsidiaries, which we consider to be permanently invested outside of the U.S.

We make judgments regarding the realizability of our deferred tax assets. The balance sheet carrying value of our net deferred tax assets is based on whether we believe that it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets after consideration of all available evidence. We regularly review our deferred tax assets for recoverability considering historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. Generally, cumulative losses in recent years is a significant piece of negative evidence that is difficult to overcome in determining that a valuation allowance is not needed.
As of September 30, 2019 and 2018, valuation allowances have been established for all U.S. and for certain foreign deferred tax assets which we believe do not meet the “more likely than not” criteria for recognition.
The Company also accounts for the uncertainty in income taxes related to the recognition and measurement of a tax position and measurement of a tax position taken or expected to be taken in an income tax return. The Company follows the applicable accounting guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure related to the uncertainty in income tax positions.
Fair Value of Financial Instruments

56

Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2019


In determining the fair value of financial assets and liabilities, the Company currently utilizes market data or other assumptions that it believes market participants would use in pricing the asset or liability in the principal or most advantageous market, and adjusts for non-performance and/or other risk associated with the Company as well as counterparties, as appropriate. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:
Level 1 Inputs: Unadjusted quoted prices which are available in active markets for identical assets or liabilities accessible to the Company at the measurement date.

Level 2 Inputs: Inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.
Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.
The hierarchy gives the highest priority to Level 1, as this level provides the most reliable measure of fair value, while giving the lowest priority to Level 3.
Financial Liabilities Measured at Fair Value on a Recurring Basis
The fair value of the bifurcated conversion feature represented by the warrant derivative liability associated with the PFG debt is measured at fair value on a recurring basis based on a Black Scholes option pricing model with assumptions for stock price, exercise price, volatility, expected term, risk free interest rate and dividend yield similar to those described for share-based compensation which were generally observable (Level 2).
Financial liabilities measured at fair value on a recurring basis are summarized below (in thousands):
September 30, 2019
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
Derivative liability
$

 
$
9

 
$

 
$
9

September 30, 2018
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
Derivative liability
$