| SONIC FOUNDRY INC ITEM 1A RISK FACTORS The occurrences or any of the following risks could materially and adversely affect our business, financial condition and operating results |
| We may need to raise additional capital if we do not quickly become profitable |
| Based on our cash balance at September 30, 2006 of dlra2dtta8 million and our expectation that we’ll generate positive cash from operations in fiscal 2007, we anticipate having sufficient cash resources for at least the next twelve months |
| Despite our belief that we have sufficient cash to fund operations in 2007, we may decide to raise additional cash from the sale of new shares of common stock or issuance of debt in 2007 |
| The business environment may not be conducive to raising additional debt or equity financing |
| If we borrow money, we may incur significant interest charges, which could harm our profitability |
| Holders of debt would also have rights, preferences or privileges senior to those of existing holders of our common stock |
| If we raise additional equity, the terms of such financing may dilute the ownership interests of current investors and cause our stock price to fall significantly |
| We may not be able to secure financing upon acceptable terms at all |
| If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, which could seriously harm our business, operating results, and financial condition We have a history of losses |
| For the year ended September 30, 2006, we had a gross margin of dlra9dtta35 million on revenues of dlra12dtta6 million with which to cover sales, marketing, research, development and general administrative costs |
| Our sales, marketing, research, development and general administration costs have historically been a significant percentage of our revenues, due partly to the expense of developing leads and the relatively long period required to convert leads into sales associated with 10 ______________________________________________________________________ [42]Table of Contents Sonic Foundry, Inc |
| Annual Report on Form 10-K For the Year Ended September 30, 2006 selling products that are not yet considered “mainstream” technology investments |
| For the year ended September 30, 2006, our operating expenses exceeded our gross margin by 38prca |
| Although we expect our operating losses as a percentage of revenues to continue to decline and reach break-even during fiscal 2007, we may never achieve profitability |
| We cannot predict how the market for our products will develop, and part of our strategic challenge will be to convince enterprise customers of the productivity, improved communications, cost savings and other benefits of our products |
| Our future revenues and revenue growth rates will depend in large part on our success in delivering these products effectively and creating market acceptance for these products |
| If we fail to do so, our products will not achieve widespread market acceptance, and we may not generate significant revenues to offset our development and sales and marketing costs, which will hurt our business |
| We may not be able to innovate to meet the needs of our target market |
| Our future success will continue to depend upon our ability to develop new products or product enhancements that address future needs of our target markets and to respond to these changing standards and practices |
| Our revenue could be reduced if we do not capitalize on our current market leadership by timely developing innovative new products or product enhancements that will increase the likelihood that our products will be accepted in preference to the products of our current and future competitors |
| Our ability to develop new products or product enhancements may require increases in research and development costs |
| Such increases may cause our near-term operational results to suffer |
| Multiple unit sales may fail to materialize |
| We need to sell multiple units to educational, corporate and government institutions in order to sell most efficiently and become profitable |
| In fiscal 2006, 42prca of unit revenues were to existing customers compared to 46prca in fiscal 2005 |
| At September 30, 2006, 210 customers had purchased multiple units compared to 89 customers at September 30, 2005 |
| While we have addressed a strategy to leverage existing customers and close multiple unit transactions, a customer may choose not to make expected purchases of our products |
| The failure of our customers to adopt our products throughout their organizations by making expected purchases will harm our business |
| If our marketing and lead generation efforts are not successful, our business will be harmed |
| We believe that continued marketing efforts will be critical to achieve widespread acceptance of our products |
| Our marketing campaign may not be successful given the expense required |
| For example, failure to adequately generate and develop sales leads could cause our future revenue growth to decrease |
| In addition, our inability to generate and cultivate sales leads into key accounts in targeted, large organizations, where there is the potential for significant use of our products, could have a material effect on our business |
| We may not be able to identify and secure the number of strategic sales leads necessary to help generate marketplace acceptance of our products |
| The length of our sales and deployment cycle is uncertain, which may cause our revenues 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 revenues |
| Our expense levels are relatively fixed in the short-term and based in part on our expectations of future revenues |
| 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 revenues |
| We anticipate that some of our largest sources of revenues will be government entities, educational institutions and large corporations that often require long testing and approval processes before making a decision to purchase our products |
| In general, the process of selling our products to a potential customer may involve lengthy negotiations |
| Annual Report on Form 10-K For the Year Ended September 30, 2006 result, we anticipate that our sales cycle will be unpredictable |
| Our sales cycle will also be subject to delays as a result of customer-specific factors over which we have little or no control, including budgetary constraints and internal approval procedures |
| Our products are aimed toward a broadened business user base within our key markets |
| These products are relatively early in their product life cycles and we are relatively inexperienced with their sales cycle |
| We cannot predict how the market for our products will develop and part of our strategic challenge will be to convince targeted users of the productivity, improved communications, cost savings and other benefits |
| Accordingly, it is likely that delays in our sales cycles with these products will occur and this could cause significant variations in our operating results |
| We currently depend on international sales and our business strategy includes growing international sales |
| Any economic downturn, changes in laws, changes in currency exchange rates or political unrest in other countries could have a material adverse effect on our business |
| For the fiscal year ended September 30, 2006, total revenues derived from international sales were approximately dlra2dtta1 million, representing approximately 17prca of total revenues |
| For the fiscal year ended September 30, 2005, revenues derived from international sales were approximately dlra1dtta5 million, representing approximately 18prca of total revenues |
| Our international operations have historically exposed us to longer accounts receivable and payment cycles |
| Additional, because our sales are denominated in US dollars, changes in exchange rates could harm our foreign business by raising the price of our products in foreign countries |
| Our international operations expose us to a variety of other risks that could impede our financial condition and growth |
| These risks include the following: • potentially adverse tax consequences; • difficulties in complying with regulatory requirements and standards; • trade restrictions and changes in tariffs; and • uncertainty of the effective protection of our intellectual property rights in certain foreign countries |
| If any of these risks described above materialize, our international sales could decrease and our foreign operations could suffer |
| One of our strategies is to expand our business in the Federal sector |
| This sector includes defense contractors, the United States military, Department of Defense organizations, and Homeland Security |
| In securing contracts and doing business with these organizations, we must comply with laws and regulations relating to the award, administration and performance of US government contracts |
| If we are unable to comply with these laws and regulations, or if the cost of compliance becomes too high, we will have misallocated resources to this sector and our business will be harmed |
| If we do not grow sales to key partners, our business will be harmed |
| One of our objectives is to grow our business with certain of these key partners |
| If we are unable to do so, either because we cannot integrate our operations or because our products do not satisfy key partner demands, our business will be harmed |
| Our marketing and sales resources are limited and may not be sufficient to achieve widespread acceptance of our products |
| The success of our marketing efforts in large part is dependent upon our marketing and sales resources |
| If we are unable to significantly increase our marketing and sales resources our marketing campaign may not be successful and our business and operating results will be harmed |
| Substantial increases in market and sales resources may, however, cause near term operational results to suffer |
| There is a great deal of competition in the market for our products, which could lower the demand for our products |
| The market for one-to-many multimedia web communication is relatively new, and we face competition from other companies that provide related digital media applications |
| Companies like WebEx, Microsoft and Citrix offer web conferencing applications |
| Although part of the overall web communications landscape, these solutions are designed primarily for smaller group collaborative communications versus one-to-many communications |
| Adobe, Accordent and other vendors provide presentation authoring and capture capabilities, but currently lack the breadth or depth of content management capabilities required for online multimedia presentations in an enterprise-wide deployment |
| Current and potential customers may choose to develop their own home-grown web communications software and services which may compete with Mediasite |
| We may also compete indirectly with larger system integrators who embed or integrate competing technologies into their custom-built product offerings |
| If one of these alternative approaches is received more favorably in the marketplace, a new approach or technology is developed or an existing or new competitor markets more effectively than we do or we otherwise do not compete effectively, our business will be harmed |
| In addition, the more successful we are in the emerging markets our products address, the more competitors are likely to emerge, including turnkey media application, streaming media platform developers, digital music infrastructure providers, and digital media applications service providers (including for digital musical subscription) |
| Many of our competitors have far greater financial resources than we do, and could easily and in a short period of time overtake the marketplace and severely harm our business |
| We may also face competition from foreign suppliers and competition from Course Management Systems (CMS) or education information technology (IT) companies |
| The presence of these competitors could reduce the demand for our systems, and we may not have the financial resources to compete successfully |
| Our customers may use our products to share confidential and sensitive information, and if our system security is breached, our reputation could be harmed and we may lose customers |
| Our customers may use our products to share confidential and sensitive information, the security of which is critical to their business |
| Third parties may attempt to breach our security or that of our customers |
| Customers may take inadequate security precautions with their sensitive information and we may inadvertently make that information public on our www |
| We may be liable to our customers for any breach in security, and any breach could harm our reputation and cause us to lose customers |
| In addition, customers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data |
| We may be required to expend significant capital and other resources to further protect against security breaches or to resolve problems caused by any breach, including litigation-related expenses if we are sued |
| The technology underlying our products and services is complex and may contain unknown defects that could harm our reputation, result in product liability or decrease market acceptance of our products |
| The technology underlying our products is complex and includes software that is internally developed, software licensed from third parties and hardware purchased from third parties |
| These products may contain errors or defects, particularly when first introduced or when new versions or enhancements are released |
| Annual Report on Form 10-K For the Year Ended September 30, 2006 discover defects that affect our current or new applications or enhancements until after they are sold |
| Any 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 us to lose sales; and • Delay market acceptance of our products |
| Our insurance coverage may not be sufficient to cover our complete liability exposure |
| If we are viewed only as a commodity supplier, our margins and valuations will shrink |
| If we fail to do so, our margins will shrink, and our stock may become less valued to investors |
| Our success depends upon the proprietary aspects of our technology |
| Our success and ability to compete depend to a significant degree upon the protection of our proprietary technology |
| We currently have one patent that has been issued, four patent applications pending in the United States, one which was recently allowed |
| We may seek additional patents in the future |
| Our current patent applications cover different aspects of the technology used in our products which is important to our ability to compete |
| However, it is possible that: • our pending patent applications may not result in the issuance of patents; • any patents acquired by or issued to us may not be broad enough to protect us; • any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents; • current and future competitors may independently develop similar technology, duplicate our services or design around any of our patents; and • effective patent protection, including effective legal-enforcement mechanisms against those who violate our patent-related assets, may not be available in every country in which we do or plan to do business |
| We also rely upon trademarks, copyrights and trade secrets to protect our technology, which may not be sufficient to protect our intellectual property |
| We also rely on a combination of laws, such as copyright, trademark and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our technology |
| We have filed for eight US and six foreign country trademarks, of which six US and four foreign country trademarks are registered |
| These forms of intellectual property protection are critically important to our ability to establish and maintain our competitive position |
| However, • third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights; • laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or to deter others from developing similar technologies; • effective trademark, copyright and trade secret protection, including effective legal-enforcement mechanisms against those who violate our trademark, copyright or trade secret assets, may be unavailable or limited in foreign countries; • other companies may claim common law trademark rights based upon state or foreign laws that precede the federal registration of our marks; and • policing unauthorized use of our services and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use |
| Annual Report on Form 10-K For the Year Ended September 30, 2006 Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business |
| If other parties bring infringement or other claims against us, we may incur significant costs or lose customers |
| Other companies may obtain patents or other proprietary rights that would limit our ability to conduct our business and could assert that our technologies infringe their proprietary rights |
| We could incur substantial costs to defend any legal proceedings, even if without merit, and intellectual property litigation could force us to cease using key technology, obtain a license, or redesign our products |
| In the course of our business, we may sell certain systems to our customers, and in connection with such sale, we may agree to indemnify these customers from claims made against them by third parties for patent infringement related to these systems |
| In particular, claims are currently being made by holders of patents against educational institutions using streaming in their curriculum |
| We could be subject to similar claims, which could harm our business |
| If we lose the services of Rimas P Buinevicius, our Chief Executive Officer, or Monty R Schmidt, our Chief Technology Officer, our business may be harmed |
| Our success will depend on our senior executives |
| In particular, the loss of the services of our Chief Executive Officer, Rimas P Buinevicius, or our co-founder and Chief Technology Officer, Monty R Schmidt, would harm our business |
| Although we have long-term employment agreements with Messrs |
| Buinevicius and Schmidt, we do not have life insurance policies on any of our senior executives |
| 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-US countries and political organizations may impose, or favor, more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation |
| In addition, state and local governments within the United States may impose regulations in addition to, inconsistent with, or stricter than federal regulations |
| The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for, and the costs associated with, our products and services |
| The adoption of such laws and regulations may harm our business |
| The price of our stock has been volatile and we could be delisted from the Nasdaq Global Market |
| Our common stock price, like that of many companies in the Internet industry, has been and may continue to be extremely volatile, and there is a risk we could be delisted from the Nasdaq Global Market |
| The market price of our common stock has been and may continue to be subject to significant fluctuations as a result of variations in our quarterly operating results and volatility in the financial markets |
| Our stock has traded below dlra1dtta00 on multiple occasions, including during fiscal 2006, and we previously received notice from the Nasdaq Global Market that we need to comply with the requirements for continued listing on the Nasdaq Global Market or be delisted, although we have demonstrated compliance and have been informed that the hearing file was closed |
| If our stock trades below dlra1dtta00 for 30 consecutive business days, we may receive another notice from the Nasdaq Global Market that we need to comply with the requirements for continued listing on the Nasdaq Global Market within 90 calendar days from such notification or be delisted |
| If our stock is delisted from the Nasdaq Global Market, an investor could find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock |
| Additionally, our stock may be subject to “penny stock” regulations if it is delisted from the Nasdaq Global Market |
| If our common stock were subject to “penny stock” regulations, which apply to certain equity securities not traded on the Nasdaq Global Market which have a market price of less than dlra5dtta00 per share, subject to limited exceptions, additional disclosure would be required by broker-dealers in connection with any trades involving such stock |
| Annual Report on Form 10-K For the Year Ended September 30, 2006 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, 2006, we had outstanding options and warrants to acquire 5dtta3 million shares of common stock, 1dtta1 million of which are subject to future vesting; included in the foregoing are 4dtta6 million options which have been granted under our 1995 Employee Stock Option Plan, our 1999 Non-Qualified Stock Option Plan and our Non-Employee Director Stock Option Plan, 3dtta5 million of which are immediately exercisable |
| To the extent that these stock options or warrants are exercised, dilution to the interests of our stockholders will likely occur |
| Additional options and warrants may be issued in the future at prices not less than 85prca of the fair market value of the underlying security on the date of grant |
| Exercises of these options or warrants, or even the potential of their exercise may have an adverse effect on the trading price of our common stock |
| The holders of our options or our warrants are likely to exercise them at times when the market price of the common stock exceeds the exercise price of the securities |
| Accordingly, the issuance of shares of common stock upon exercise of the options and warrants will likely result in dilution of the equity represented by the then outstanding shares of common stock held by other stockholders |
| We may need to make acquisitions or form strategic alliances or partnerships in order to remain competitive in our market, and potential future acquisitions, strategic alliances or partnerships could be difficult to integrate, disrupt our business and dilute stockholder value |
| We may acquire or form strategic alliances or partnerships with other businesses in the future in order to remain competitive or to acquire new technologies |
| As a result of these acquisitions, strategic alliances or partnerships, we may need to integrate products, technologies, widely dispersed operations and distinct corporate cultures |
| The products, services or technologies of the acquired companies may need to be altered or redesigned in order to be made compatible with our software products and services, or the software architecture of our customers |
| These integration efforts may not succeed or may distract our management from operating our existing business |
| Our failure to successfully manage future acquisitions, strategic alliances or partnerships could seriously harm our operating results |
| In addition, our stockholders would be diluted if we finance the acquisition, strategic alliances or partnerships by incurring convertible debt or issuing equity securities |
| Our corporate compliance program cannot guarantee that we are in compliance with all potentially applicable regulations |
| As a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002, some of the provisions of which are not yet applicable to us |
| 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 |
| For example, we cannot assure that in the future our management will not find a material weakness in connection with its annual review of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, which, under proposed SEC rules, would require us as a non-accelerated filer to provide a report by management assessing the effectiveness of our internal control over financial reporting for our fiscal year ending September 30, 2008 and provide an auditor’s attestation report for our fiscal year ending September 30, 2009 |
| If our non-affiliate market capitalization is dlra75 million or greater at March 31, 2007, as it was as of October 12, 2006, we will be required to be fully compliant with both the management assessment and auditor attestation at the end of fiscal 2007 |
| We also cannot assure that we could 15 ______________________________________________________________________ [47]Table of Contents Sonic Foundry, Inc |
| Annual Report on Form 10-K For the Year Ended September 30, 2006 correct any such weakness to allow our management to assess the effectiveness of our internal control over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in our Annual Report on Form 10-K to be filed with the Securities and Exchange Commission or attest that we have maintained effective internal control over financial reporting as of the end of our fiscal year |
| If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines, or other sanctions or litigation |
| In addition, if we must disclose any material weakness in our internal control over financial reporting, this may cause our stock price to decline |
| We are subject to risks associated with governmental regulation and legal uncertainties |
| It is likely that a number of laws and regulations may be adopted in the United States and other countries with respect to the Internet that might affect us |
| Those laws may relate to areas such as: • changes in telecommunications regulations; • copyright and other intellectual property rights; • encryption; • personal privacy concerns, including the use of “cookies” and individual user information; • e-commerce liability; • email, network and information security |
| Changes in telecommunications regulations could substantially increase the costs of communicating on the Internet or over Voice over Internet Protocol (VoIP) networks |
| This, in turn, could slow the growth in the internet use of VoIP networks and thereby decrease the demand for our services |
| Several telecommunications carriers are advocating that the Federal Communications Commission regulate the Internet and VoIP networks in the same manner as other telecommunications services by imposing access fees |
| Recent events suggest that the FCC may begin regulating the Internet and VoIP networks in such a way |
| In addition, we operate our services throughout the United States and state regulatory authorities may seek to regulate aspects of our services as telecommunications activities |
| Other countries and political organizations are likely to impose or favor more and different regulations than those that have been proposed in the United States, thus furthering the complexity of the regulation |
| The adoption of such laws or regulations, and uncertainties associated with their validity and enforcement, may affect the available distribution channels for and costs associated with our services, and may affect the growth of the Internet or VoIP networks |
| Such laws or regulations may therefore harm our business |
| Provisions of our charter documents and Maryland law could also discourage an acquisition of our company that would benefit our stockholders |
| Provisions of our articles of incorporation and by-laws may make it more difficult for a third party to acquire control of our company, even if a change in control would benefit our stockholders |
| Our articles of incorporation authorize our board of directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock |
| Furthermore, our articles of incorporation provide for a classified board of directors, which means that our stockholders may vote upon the retention of only one or two of our seven directors each year |
| Moreover, Maryland corporate law restricts certain business combination transactions with “interested stockholders” and limits voting rights upon certain acquisitions of “control shares |