SONIC FOUNDRY INC - FORM 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly period ended June 30, 2012

¨	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 West Washington Ave, Madison, WI 53703

(Address of principal executive offices)

(608) 443-1600

(Registrant’s telephone number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes x No ¨

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 x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (see definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

State the number of shares outstanding of each of the issuer’s common equity as of the last practicable date:


Class	Outstanding July 26, 2012
Common Stock, $0.01 par value		3,873,691

TABLE OF CONTENTS


		PAGE NO.
*PART I*	*FINANCIAL INFORMATION*

Item 1.	Condensed Consolidated Financial Statements

	Condensed Consolidated Balance Sheets (Unaudited) – June 30, 2012 and September 30, 2011		3

	Condensed Consolidated Statements of Operations (Unaudited) – Three and nine months ended June 30, 2012 and 2011		4

	Condensed Consolidated Statements of Cash Flows (Unaudited) – Three and nine months ended June 30, 2012 and 2011		5

	Notes to Condensed Consolidated Financial Statements (Unaudited)		6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		24

Item 4.	Controls and Procedures		24

*PART II*	*OTHER INFORMATION*

Item 1A.	Risk Factors		25

Item 6.	Exhibits		26

Signatures			29

Item 1

Sonic Foundry, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except for share data)

(Unaudited)


	June 30, 2012			September 30, 2011
Assets
Current assets:
Cash and cash equivalents	$	4,253		$	5,515
Accounts receivable, net of allowances of $85 and $90		6,609			5,799
Inventories		749			536
Prepaid expenses and other current assets		922			740

Total current assets		12,533			12,590
Property and equipment:
Leasehold improvements		1,728			980
Computer equipment		4,350			3,586
Furniture and fixtures		775			461

Total property and equipment		6,853			5,027
Less accumulated depreciation and amortization		4,005			3,391

Net property and equipment		2,848			1,636
Other assets:
Goodwill		7,576			7,576
Investment in Mediasite KK		250			—
Other intangibles, net of amortization of $175 and $137		20			38

Total assets	$	23,227		$	21,840

Liabilities and stockholders’ equity
Current liabilities:
Revolving line of credit	$	—		$	—
Accounts payable		1,408			1,373
Accrued liabilities Accrued severance		1,385 100			1,073 528
Unearned revenue		5,330			5,547
Current portion of capital lease obligation		123			89
Current portion of notes payable		667			897

Total current liabilities		9,013			9,507

Long-term portion of unearned revenue		376			471
Long-term portion of capital lease obligation		163			177
Long-term portion of notes payable		933			694
Leasehold improvement liability		554			—
Deferred tax liability		1,910			1,730

Total liabilities		12,949			12,579

Stockholders’ equity:
Preferred stock, $.01 par value, authorized 500,000 shares; none issued		—			—
5% preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 1,000,000 shares, none issued		—			—
Common stock, $.01 par value, authorized 10,000,000 shares; 3,875,229 and 3,845,531 shares issued and 3,862,513 and 3,832,815 shares outstanding		39			38
Additional paid-in capital		189,096			188,339
Accumulated deficit		(178,662	)		(178,921	)
Receivable for common stock issued		(26	)		(26	)
Treasury stock, at cost, 12,716 shares		(169	)		(169	)

Total stockholders’ equity		10,278			9,261

Total liabilities and stockholders’ equity	$	23,227		$	21,840

See accompanying notes to the condensed consolidated financial statements

Sonic Foundry, Inc.

Condensed Consolidated Statements of Operations

(in thousands, except for share and per share data)

(Unaudited)


	Three Months Ended June 30,						Nine Months Ended June 30,
	2012			2011			2012			2011
Revenue:
Product	$	4,099		$	3,911		$	9,315		$	9,386
Services		3,567			3,108			10,317			8,972
Other		91			71			238			187

Total revenue		7,757			7,090			19,870			18,545

Cost of revenue:
Product		1,850			1,848			4,466			4,489
Services		352			314			1,058			997

Total cost of revenue		2,202			2,162			5,524			5,486

Gross margin		5,555			4,928			14,346			13,059

Operating expenses:
Selling and marketing		3,399			2,984			8,875			7,889
General and administrative		668			720			2,143			2,056
Product development		1,089			863			3,033			2,559

Total operating expenses		5,156			4,567			14,051			12,504

Income from operations		399			361			295			555

Equity in earnings from investment in Mediasite KK		250			—			250			—
Other expense, net		(30	)		(89	)		(106	)		(212	)

Income before income taxes		619			272			439			343
Provision for income taxes		(60	)		(60	)		(180	)		(180	)

Net income	$	559		$	212		$	259		$	163

Net income per common share:
– basic	$	0.14		$	0.06		$	0.07		$	0.04

– diluted	$	0.14		$	0.05		$	0.07		$	0.04

Weighted average common shares
– basic		3,856,536			3,786,349			3,849,667			3,724,413

– diluted		3,900,435			3,979,288			3,904,281			3,929,401

See accompanying notes to the condensed consolidated financial statements

Sonic Foundry, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)


	Nine months ended June 30,
	2012			2011
Operating activities
Net income	$	259		$	163
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity in earnings from investment in Mediasite KK		(250	)		—
Amortization of other intangibles		38			52
Amortization of debt discount		32			78
Depreciation and amortization of property and equipment		614			508
Deferred taxes		180			180
Stock-based compensation expense related to stock options		591			527
Provision for doubtful accounts		(5	)		(15	)
Changes in operating assets and liabilities:
Accounts receivable		(805	)		(1,181	)
Inventories		(213	)		(116	)
Prepaid expenses and other current assets		(182	)		(205	)
Accounts payable and accrued liabilities		(81	)		377
Other long-term liabilities		(59	)		(64	)
Unearned revenue		(312	)		(331	)

Net cash used in operating activities		(193	)		(27	)

Investing activities
Purchases of property and equipment		(1,119	)		(417	)

Net cash used in investing activities		(1,119	)		(417	)

Financing activities
Proceeds from notes payable		1,200			400
Payments on notes payable		(1,223	)		(559	)
Payments on debt issuance costs		(20	)		(20	)
Proceeds from exercise of common stock options and warrants		104			1,450
Proceeds from issuance of common stock		63			32
Payments on capital lease obligations		(74	)		(4	)

Net cash provided by financing activities		50			1,299

Net increase (decrease) in cash and cash equivalents		(1,262	)		855
Cash and cash equivalents at beginning of period		5,515			3,358

Cash and cash equivalents at end of period	$	4,253		$	4,213

Non-cash transactions:
Issuance of common stock for the conversion of warrants	$	—		$	300
Property and equipment financed by accrued liabilities and other long-term liabilities		707			65

See accompanying notes to the condensed consolidated financial statements

Sonic Foundry, Inc.

Notes to Condensed Consolidated Financial Statements

June 30, 2012

(Unaudited)

1.	Basis of Presentation and Significant Accounting Policies

Sonic Foundry, Inc. (the Company) is in the business of providing enterprise solutions and services for the web communications market.

Interim Financial Data

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of adjustments of a normal and recurring nature) considered necessary for fair presentation of the results of operations have been included. Operating results for the three and nine month periods ended June 30, 2012 are not necessarily indicative of the results that might be expected for the year ending September 30, 2012.

The condensed consolidated balance sheet at September 30, 2011 has been derived from audited financial statements at that date, but does not include all of the information and disclosures required by GAAP. For a more complete discussion of accounting policies and certain other information, refer to the Company’s annual report filed on Form 10-K for the fiscal year ended September 30, 2011.

Revenue Recognition

General

Revenue is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price is fixed and determinable and collectability is reasonably assured. Revenue is deferred when undelivered products or services are essential to the functionality of delivered products, customer acceptance is uncertain, significant obligations remain, or the fair value of undelivered elements is unknown. The Company does not offer customers the right to return product, other than for exchange or repair pursuant to a warranty or stock rotation. The Company’s policy is to reduce revenue when it incurs an obligation for price rebates or other such programs during the period the obligation and sale occurs. The following policies apply to the Company’s major categories of revenue transactions.

Products

Products are considered delivered, and revenue is recognized, when title and risk of loss have been transferred to the customer. Under the terms and conditions of the sale, this occurs at the time of shipment to the customer. Product revenue currently represents sales of our Mediasite recorder and Mediasite related products such as our server software.

Services

The Company sells support and content hosting contracts to their customers, typically one year in length and records the related revenue ratably over the contractual period. Support contracts cover phone and electronic technical support availability over and above the level provided by our distributors, software upgrades on a when and if available basis, advance hardware replacement and an extension of the standard hardware warranty from 90 days to one year. The manufacturer the Company contracts with to build the units provides 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. Service amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met.

Revenue Arrangements that Include Multiple Elements

The Company has historically applied the software revenue recognition rules as prescribed by Accounting Standards Codification (ASC) Subtopic 985-605. In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) Number 2009-14, “Certain Revenue Arrangements That Include Software Elements,” which amended ASC Subtopic 985-605. This ASU removes tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of the software revenue recognition rules. In the case of the Company’s hardware products with embedded software, the Company has determined that the hardware and software components function together to deliver the product’s essential functionality, and therefore, the revenue from the sale of these products no longer falls within the scope of the software revenue recognition rules. Revenue from the sale of software-only products remains within the scope of the software revenue recognition rules. Installation, training, and post customer support no longer fall within the scope of the software revenue recognition rules, except when they are sold with and relate to a software-only product. Revenue recognition for products that no longer fall under the scope of the software revenue recognition rules is similar to that for other tangible products. ASU Number 2009-13, “Multiple-Deliverable Revenue Arrangements,” which amended ASC Topic 605 and was also issued in October 2009, is applicable for multiple-deliverable revenue arrangements. ASU 2009-13 allows companies to allocate revenue in a multiple-deliverable arrangement in a manner that better reflects the transaction’s economics. ASU 2009-13 and 2009-14 were adopted and are effective for revenue arrangements entered into or materially modified beginning in the Company’s fiscal year 2011.

Under the software revenue recognition rules, the fee from a multiple-deliverable arrangement is allocated to each of the undelivered elements based upon vendor-specific objective evidence (VSOE), which is limited to the price charged when the same deliverable is sold separately, with the residual value from the arrangement allocated to the delivered element. The portion of the fee that is allocated to each deliverable is then recognized as revenue when the criteria for revenue recognition are met with respect to that deliverable. If VSOE does not exist for all of the undelivered elements, then all revenue from the arrangement is typically deferred until all elements have been delivered to the customer. All revenue arrangements, with the exception of hosting contracts, entered into prior to October 1, 2010 and the sale of all software-only products and associated services have been accounted for under this guidance.

Under the revenue recognition rules for tangible products as amended by ASU 2009-13, the fee from a multiple-deliverable arrangement is allocated to each of the deliverables based upon their relative selling prices as determined by a selling-price hierarchy. A deliverable in an arrangement qualifies as a separate unit of accounting if the delivered item has value to the customer on a stand-alone basis. A delivered item that does not qualify as a separate unit of accounting is combined with the other undelivered items in the arrangement and revenue is recognized for those combined deliverables as a single unit of accounting. The selling price used for each deliverable is based upon VSOE if available, third-party evidence (TPE) if VSOE is not available, and best estimate of selling price (ESP) if neither VSOE nor TPE are available. TPE is the price of the Company’s or any competitor’s largely interchangeable products or services in stand-alone sales to similarly situated customers. ESP is the price at which the Company would sell the deliverable if it were sold regularly on a stand-alone basis, considering market conditions and entity-specific factors. All revenue arrangements negotiated after September 30, 2010, excluding the sale of all software-only products and associated services, have been accounted for under this guidance.

The selling prices used in the relative selling price allocation method are as follows: (1) the Company’s products and services are based upon VSOE and (2) hardware products with embedded software, for which VSOE does not exist, are based upon ESP. The Company does not believe TPE exists for any of these products and services because they are differentiated from competing products and services in terms of functionality and performance and there are no competing products or services that are largely interchangeable. Management establishes ESP for hardware products with embedded software using a cost plus margin approach with consideration for market conditions, such as the impact of competition and geographic considerations, and entity-specific factors, such as the cost of the product and the Company’s profit objectives. Management believes that ESP is reflective of reasonable pricing of that deliverable as if priced on a stand-alone basis. When a sales transaction includes deliverables that are divided

between ASC Topic 605 and ASC Subtopic 985-605, the Company allocates the selling price using the relative selling price method whereas value is allocated using an ESP for software developed using a percent of list price approach. The other deliverables are valued using ESP or VSOE as previously discussed.

While the pricing model, currently in use, captures all critical variables, unforeseen changes due to external market forces may result in a revision of the inputs. These modifications may result in the consideration allocation differing from the one presently in use. Absent a significant change in the pricing inputs or the way in which the industry structures its deals, future changes in the pricing model are not expected to materially affect our allocation of arrangement consideration.

Management has established VSOE for hosting services. Billings for hosting are spread ratably over the term of the hosting agreement, with the typical hosting agreement having a term of 12 months, with renewal on an annual basis. The Company sells most hosting contracts without the inclusion of products. When the hosting arrangement is sold in conjunction with product, the product revenue is recognized immediately while the remaining hosting revenue is spread ratably over the term of the hosting agreement. The selling price is allocated between these elements using the relative selling price method. The Company uses ESP for development of the selling price for hardware products with embedded software.

The Company also offers hosting services bundled with events services. The Company uses VSOE to establish relative selling prices for its events services. The Company recognizes events revenue when the event takes place and recognizes the hosting revenue over the term of the hosting agreement. The total amount of the arrangement is allocated to each element based on the relative selling price method.

Reserves

The Company records reserves for stock 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, additional reserves may be required. Also, if the Company determines that it can no longer accurately estimate amounts for stock rotations and sales incentives, the Company would not be able to recognize revenue until resellers sell the inventory to the final end user.

Shipping and Handling

The Company’s shipping and handling costs billed to customers are included in other revenue. Costs related to shipping and handling are included in cost of revenue and are recorded at the time of shipment to the customer.

Concentration of Credit Risk and Other Risks and Uncertainties

The Company’s cash and cash equivalents are deposited with two major financial institutions. At times, deposits in these institutions exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on such amounts and believes that it is not exposed to any significant credit risk on these balances.

We assess the realization of our receivables by performing ongoing credit evaluations of our customers’ financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. Our reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. Our reserves are also based on amounts determined by using percentages applied to certain aged receivable categories. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. Allowance for doubtful accounts for accounts receivable was $85,000 as of June 30, 2012 and $90,000 at September 30, 2011.

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.

Inventory Valuation

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


	June 30, 2012		September 30, 2011
Raw materials and supplies	$	281	$	232
Finished goods		468		304

	$	749	$	536

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.

The fair value of each option grant is estimated using the assumptions in the following table:


	Nine months ended June 30,
	2012	2011
Expected life	4.8 years	4.4 - 4.6 years
Risk-free interest rate	0.4%	0.7% - 1.4%
Expected volatility	55.0%-64.0%	74.9%-83.0%
Expected forfeiture rate	12.0%-12.2%	15.4%-17.7%
Expected exercise factor	1.34-1.36	1.15-1.29
Expected dividend yield	0%	0%

A summary of option activity as of June 30, 2012 and changes during the nine months then ended is presented below:


	Options			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Period
Outstanding at October 1, 2011		785,547		$	11.52		6.5
Granted		182,600			9.12		9.4
Exercised		(19,866	)		5.22		5.5
Forfeited		(64,109	)		8.20		2.7

Outstanding at June 30, 2012		884,172			11.14		6.8
Exercisable at June 30, 2012		537,672			11.94		5.4

A summary of the status of the Company’s non-vested shares and changes during the nine month period ended June 30, 2012 is presented below:


	2012
Non-vested Shares	Shares			Weighted-Average Grant Date Fair Value
Non-vested at October 1, 2011		249,879		$	5.05
Granted		182,600			3.50
Vested		(77,045	)		4.58
Forfeited		(8,934	)		4.32

Non-vested at June 30, 2012		346,500		$	4.36

The weighted average grant date fair value of options granted during the nine months ended June 30, 2012 was $3.50. As of June 30, 2012, there was $895 thousand of total unrecognized compensation cost related to non-vested stock-based compensation, including $579 thousand of estimated forfeitures. The cost is expected to be recognized over a weighted-average remaining life of 1.9 years.

Stock-based compensation recorded in the three month period ended June 30, 2012 of $176 thousand was allocated $112 thousand to selling and marketing expenses, $10 thousand to general and administrative expenses, and $54 thousand to product development expenses. Stock-based compensation recorded in the nine month period ended June 30, 2012 of $591 thousand was allocated $388 thousand to selling and marketing expenses, $34 thousand to general and administrative expenses, and $169 thousand to product development expenses. Stock-based compensation recorded in the three month period ended June 30, 2011 of $157 thousand was allocated $107 thousand to selling and marketing expenses, $12 thousand to general and administrative expenses, and $38 thousand to product development expenses. Stock-based compensation recorded in the nine month period ended June 30, 2011 of $527 thousand was allocated $361 thousand to selling and marketing expenses, $36 thousand to general and administrative expenses, and $130 thousand to product development expenses. Cash received from exercises under all stock option plans and warrants for the three and nine month periods ended June 30, 2012 was $49 thousand and $104 thousand, respectively. Cash received from exercises under all stock option plans and warrants for the three and nine month periods ended June 30, 2011 was $418 thousand and $1.45 million, respectively. There were no tax benefits realized for tax deductions from option exercises in either of the nine month periods ended June 30, 2012 or 2011. The Company currently expects to satisfy share-based awards with registered shares available to be issued.

The Company also has an Employee Stock Purchase Plan (Purchase Plan) under which an aggregate of 100,000 common shares may be issued. The Shareholders approved an amendment to increase the number of shares of common stock subject to the plan from 50,000 to 100,000 at the Company’s annual meeting in March 2011. All employees who have completed 90 days of employment with the Company on the first day of each offering period and customarily work twenty hours per week or more are eligible to participate in the Purchase Plan. An employee who, after the grant of an option to purchase, would hold common stock and/or hold outstanding options to purchase stock possessing 5% or more of the total combined voting power or value of the Company will not be eligible to participate. Eligible employees may make contributions through payroll deductions of up to 10% of their compensation. No participant in the Purchase Plan is permitted to purchase common stock under the Purchase Plan if such option would permit his or her rights to purchase stock under the Purchase Plan to accrue at a rate that exceeds $25,000 of the fair market value of such shares, or that exceeds 1,000 shares, for each calendar year. The Company makes a bi-annual offering to eligible employees of options to purchase shares of common stock under the Purchase Plan on the first trading day of January and July. Each offering period is for a period of six months from the date of the offering, and each eligible employee as of the date of offering is entitled to purchase shares of common stock at a purchase price equal to the lower of 85% of the fair market value of common stock on the first or last trading day of the offering period. A total of 29,408 shares are available to be issued under the plan. There were 11,178 shares purchased by employees for the six month offering ended June 30, 2012 which were issued in July 2012. The Company recorded stock compensation expense under this plan for the three and nine month periods ended June 30, 2012 of $8 thousand and $23 thousand, respectively. The Company recorded stock compensation expense under this plan for the three and nine month periods ended June 30, 2011 of $0 and $4 thousand, respectively.

Per share computation

Basic and diluted net income (loss) per share information for all periods is presented under the requirements of FASB ASC 260-10. Basic earnings (loss) per share has been computed using the weighted-average number of

shares of common stock outstanding during the period, less shares that may be repurchased, and excludes any dilutive effects of options and warrants. In periods where the Company reports net income, diluted net income per share is computed using common equivalent shares related to outstanding options and warrants to purchase common stock. The numerator for the calculation of basic and diluted earnings per share is net income (loss). The following table sets forth the computation of basic and diluted weighted average shares used in the earnings per share calculations:


	Three Months Ended June 30,				Nine Months Ended June 30,
	2012		2011		2012		2011
Denominator
Denominator for basic earnings per share – weighted average common shares		3,856,536		3,786,349		3,849,667		3,724,413
Effect of dilutive options and warrants (treasury method)		43,899		192,939		54,614		204,988
Denominator for diluted earnings per share – adjusted weighted average common shares		3,900,435		3,979,288		3,904,281		3,929,401

New Accounting Pronouncements

In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts by requiring an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This update was effective for fiscal years beginning after December 15, 2010. The Company’s adoption of ASU 2010-28 did not have a material impact on its consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04 “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and IFRSs”, which amends ASC 820. This update clarifies the existing guidance and amends the wording used to describe many of the requirements in US GAAP for measuring fair value and for disclosing information about fair value measurements. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, with prospective application required. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the Company’s consolidated financial statements upon adoption.

2.	Related Party Transactions

During the three and nine month periods ended June 30, 2012, the Company incurred fees of $53 thousand and $162 thousand, respectively, to a law firm, a partner of which is a director and stockholder of the Company. The Company incurred similar fees of $63 thousand and $180 thousand, respectively, during the three and nine month periods ended June 30, 2011. The Company had accrued liabilities for unbilled services of $90 thousand at June 30, 2012 and $50 thousand at September 30, 2011, respectively, to the same law firm.

During the three and nine month periods ended June 30, 2012, the Company recorded Mediasite product and customer support billings of $208 thousand and $826 thousand, respectively, to Mediasite KK, a Japanese reseller in which the Company has an equity interest. The Company recorded billings of $190 thousand and $622 thousand, respectively, in the three and nine month periods ended June 30, 2011. Mediasite KK owed the Company $208 thousand at June 30, 2012 and $241 thousand at September 30, 2011. The Company accounts for its investment in Mediasite KK under the equity method. The recorded value of this investment is $250 thousand as of June 30, 2012 and $0 as of September 30, 2011.

As of June 30, 2012 and September 30, 2011, the Company had a loan outstanding to an executive totaling $26 thousand. This loan is collateralized by Company stock.

3.	Commitments

Inventory Purchase Commitments

The Company enters into unconditional purchase commitments on a regular basis for the supply of Mediasite product. At June 30, 2012, the Company has an obligation to purchase $736 thousand of Mediasite product, which is not recorded on the Company’s Condensed Consolidated Balance Sheet.

Operating Leases

In November 2011, the Company occupied office space related to a lease agreement entered into on June 28, 2011. The lease term is from November 2011 through October 2018. The lease includes a tenant improvement allowance of $613 thousand that was recorded as a leasehold improvement liability and is being amortized as a credit to rent expense on a straight-line basis over the lease term. At June 30, 2012, the unamortized balance is $554 thousand.

4.	Borrowing Arrangements

Silicon Valley Bank

On June 16, 2008, the Company and its wholly-owned subsidiary, Sonic Foundry Media Systems, Inc. (collectively, the “Companies”) entered into an Amended and Restated Loan and Security Agreement (the “Amended Loan Agreement”) with Silicon Valley Bank (“Silicon Valley Bank”) providing for a credit facility in the form of a $3,000,000 secured revolving line of credit and a $1,000,000 term loan. The ability to borrow up to the maximum $3,000,000 amount of the revolving line of credit is determined by applying an applicable percentage to eligible accounts receivable, which, is reduced by, among other things, a reserve. Prior to the First Amendment, discussed below, the reserve was equal to the balance of the term loan when EBITDA, as defined, would have been less than $200,000 during the preceding six month period. Prior to the Second Amended Agreement, discussed below, the revolving line of credit accrued interest at a per annum rate equal to the following: (i) during such period that Sonic Foundry maintained an Adjusted Quick Ratio (as defined) of greater than 2.00 to 1.00, the greater of one percentage point (1.0%) above Silicon Valley Bank’s prime rate, or seven percent (7.0%); or (ii) during such period that Sonic Foundry maintained an Adjusted Quick Ratio equal to or less than 2.00 to 1.00, the greater of one and one-half percent (1.5%) above Silicon Valley Bank’s prime rate, or seven and one-half percent (7.5%). Under the Amended Loan Agreement and the Second Amended Agreement, the outstanding term loan will continue to accrue interest at a per annum rate equal to the greater of (i) one percentage point (1.0%) above Silicon Valley’s prime rate; or (ii) eight and three quarters percent (8.75%). Prior to the First Amendment, the maturity of both the term loan and the revolving line of credit was June 1, 2010. At the maturity date all outstanding borrowings and any unpaid interest thereon must be repaid, and all outstanding letters of credit must be cash collateralized. Principal on the term loan is to be repaid in thirty-six (36) monthly installments, and prior to the First Amendment as defined below, was to be repaid in full on May 1, 2010.

On April 14, 2009, the Companies executed the First Amendment to the Amended Loan Agreement with Silicon Valley Bank (the “First Amendment”). The First Amendment, among other things, a) refinanced the $361,111 outstanding balance of the Term Loan with a new “Term Loan 2” in the amount of $1,000,000, due in 36 equal monthly installments of principal and interest; b) continued to require a reserve under the Revolving Line for the balance of the term loan unless , for three (3) consecutive monthly periods, the ratio of EBITDA to Debt Service, in each case for the three (3) month period then ending is greater than or equal to 1.25 to 1.00; c) modified the minimum requirements under the EBITDA covenant, but maintained a provision to override such covenant if the Company maintains a minimum Adjusted Quick Ratio of 1.75 to 1.00; and d) extended the maturity date of the Revolving Line to October 1, 2011 and the Term Loan 2 to April 1, 2012. The First Amendment also required the Company to continue to maintain certain of their depository, operating and securities accounts with Silicon Valley Bank, and to continue to comply with certain other restrictive loan covenants, including covenants limiting the Companies’ ability to dispose of assets, make acquisitions, be acquired, incur indebtedness, grant liens, make investments, pay dividends, and repurchase stock.

On June 27, 2011, the Companies executed the Second Amended and Restated Loan and Security Agreement with Silicon Valley Bank (the “Second Amended Agreement”). Under the Second Amended Agreement, the revolving line of credit will continue to have a maximum principal amount of $3,000,000. Interest will accrue on the revolving line of credit at the per annum rate of one percent (1.0%) above the Prime Rate (as defined), provided that Sonic Foundry maintains an Adjusted Quick Ratio (as defined) of greater than 2.0 to 1.0, or one-and-one half percent (1.5%) above the Prime Rate, if Sonic Foundry does not maintain an Adjusted Quick Ratio of greater than 2.0 to 1.0. The Second Amended Agreement does not provide for a minimum interest rate on the revolving loan. The Second Amended Agreement also provides for an increase in the advance rate on domestic receivables from 75% to 80%, and extends the facility maturity date to October 1, 2013. Under the Second Amended Agreement, the existing term loan will continue to accrue interest at a per annum rate equal to the greater of (i) one percentage point (1.0%) above Silicon Valley Bank’s prime rate; or (ii) eight and three quarters percent (8.75%). In addition, a new term loan can be issued in multiple draws provided that the total term loan from Silicon Valley Bank shall not exceed $2,000,000 and provided further that total term debt shall not exceed $2,400,000. Under the Second Amended Agreement, any new draws on the term loan will accrue interest at a per annum rate equal to the Prime Rate plus three and three quarters percent (3.75%). The Second Amended Agreement does not provide for a minimum interest rate on the new term loan. Each draw on the new term loan will be amortized over a 36-month period. All draws on the term loan must be made within ten (10) months of June 27, 2011. The Second Amended Agreement also requires Sonic Foundry to continue to comply with certain financial covenants, including covenants to maintain an Adjusted Quick Ratio (as defined) of at least 1.75 to 1.00 and Debt Service Coverage Ratio of at least 1.25 to 1.00, the latter of which will be waived if certain funds are reserved.

At June 30, 2012, a balance of $1.6 million was outstanding on the term loans with Silicon Valley Bank and no balance was outstanding on the revolving line of credit. At September 30, 2011, a balance of $982 thousand was outstanding on the term loans with Silicon Valley Bank and no balance was outstanding on the revolving line of credit. At June 30, 2012, there was $1.2 million available under this credit facility for advances. At June 30, 2012, the Company was in compliance with all covenants in the Second Amended Agreement.

The Second Amended Agreement contains events of default that include, among others, non-payment of principal or interest, inaccuracy of any representation or warranty, violation of covenants, bankruptcy and insolvency events, material judgments, cross defaults to certain other indebtedness, and material adverse changes. The occurrence of an event of default could result in the acceleration of the Companies’ obligations under the Second Amended Agreement.

Pursuant to the Second Amended Agreement, the Companies pledged as collateral to Silicon Valley Bank substantially all non-intellectual property business assets. The Companies also entered into an Intellectual Property Security Agreement with respect to intellectual property assets.

Partners for Growth

On March 5, 2010, the Companies executed a $1,250,000 Loan and Security Agreement (the “Term Loan”) and a $750,000 Revolving Loan and Security Agreement (the “Revolving Loan”) with Partners for Growth II, L.P. (“PFG”), (collectively the “Agreements”).

On June 28, 2011, the Companies entered into a Consent and Modification No. 1 to Loan and Security Agreement (“Consent and Modification Agreement”) with PFG. Under the Consent and Modification Agreement, PFG consented to the Companies incurring additional indebtedness to Silicon Valley Bank, provided that total outstanding term indebtedness owed to PFG and Silicon Valley Bank does not exceed $1,900,000.

The Term Loan accrued interest at 11.75% per annum with principal due in 36 equal monthly payments of $34,722 beginning April 1, 2011 and continuing through March 1, 2014. At September 30, 2011, a balance of $642 thousand was outstanding on the Term Loan. In October 2011, the Company paid the remaining balance of the Term Loan in full.

5.	Income Taxes

The Company is subject to taxation in the U.S. and various state jurisdictions. All of the Company’s tax years are subject to examination by the U.S. and state tax authorities due to the carryforward of unutilized net operating losses.

Deferred income taxes are provided for temporary differences between financial reporting and income tax basis of assets and liabilities, and are measured using currently enacted tax rates and laws. Deferred income taxes also arise from the future benefits of net operating loss carryforwards. A valuation allowance equal to 100% of the net deferred tax assets has been recognized due to uncertainty regarding future realization.

Beginning with an acquisition in fiscal year 2002, the Company has amortized Goodwill for tax purposes over a 15 year life. Goodwill is not amortized for book purposes.

The difference between the book and tax balance of Goodwill creates a Deferred Tax Liability and an annual tax expense. Because of the long term nature of the goodwill timing difference, tax planning strategies cannot be applied related to the Deferred Tax Liability. The balance of the Deferred Tax Liability at June 30, 2012 was $1.91 million and at September 30, 2011 was $1.73 million.

The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accruals for interest and penalties on the Company’s Condensed Consolidated Balance Sheets at September 30, 2011 or June 30, 2012, and has not recognized any interest or penalties in the Condensed Consolidated Statements of Operations for the three and nine month periods ended June 30, 2012 or 2011. The Company’s tax rate differs from the expected tax rate each reporting period as a result of the aforementioned items.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Risks and Uncertainties

The following discussion of the consolidated financial position and results of operations of the Company should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Form 10-Q and the Company’s annual report filed on Form 10-K for the fiscal year ended September 30, 2011. In addition to historical information, this discussion contains forward-looking statements such as statements of the Company’s expectations, plans, objectives and beliefs. These statements use such words as “may,” “will,” “expect,” “anticipate,” “believe,” “plan,” and other similar terminology.

Actual results could differ materially from expectations due to changes in the market acceptance of our products, competition, market introduction or product development delays; all of which would impact our strategy to develop a network of inside regional sales managers and distribution partners that target customer opportunities for multi-unit and repeat purchases. If the Company does not achieve multi-unit and repeat purchases, our business will be harmed.

Our future success will continue to depend upon our ability to develop new products, product enhancements or service offerings that address the future needs of our target markets and to respond to these changing standards and practices. The success of new products, product enhancements or service offerings depends on several factors, including the timely completion, quality and market acceptance of the product, enhancement or service. Our revenue could be reduced if we do not timely develop innovative new products, product enhancements or service offerings which address the needs of our customers or prospective customers or if our current or future competitors develop such new products, product enhancements or service offerings more timely or do so in a way that causes our customers or prospective customers to buy our competitors’ products instead of our products.

Uncertainty about current global economic conditions poses a risk as businesses, educational institutions and state governments are likely to postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values. Most of our customers and potential customers are public colleges, universities, schools and other education providers who depend substantially on government funding in order to purchase products and services such as the Company provides. Many state governments are under substantial budget constraints and will likely reduce spending for education providers, without Federal government support. Proposed federal government support for education may not be approved or, if approved, may not succeed in eliminating reductions in spending for our products and services.

In response to global economic conditions, many manufacturers and distributors have reduced the level of inventory they maintain as well as their staff levels. As a result, many components, including some of which the Company requires to build its products, are in short supply and have lengthening lead times for delivery. While we believe there are multiple sources of supply for our products and the component parts required to build them, even a short term disruption of supply of component parts or completed products near the end of a quarter would have a negative impact on our revenues. As a result 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.

Other factors that may impact actual results include: our ability to effectively integrate acquired businesses, length of time necessary to close on sales leads to multi-unit purchasers, our ability to service existing accounts, global and local business conditions, legislation and governmental regulations, competition, our ability to effectively maintain and update our product portfolio, shifts in technology, political or economic instability in local markets, and currency and exchange rate fluctuations, as well as other issues which may be identified from time to time in Sonic Foundry’s Securities and Exchange Commission filings and other public announcements.

Overview

Sonic Foundry, Inc. is a technology leader in the emerging web communications marketplace, providing enterprise solutions and services that link an information-driven world. The Company’s principal product line, Mediasite^®, is

a web communication and content management system that automatically and cost-effectively webcasts lectures and presentations. Trusted by Fortune 500 companies, top education institutions and Federal, state and local government agencies for a variety of critical communication needs, Mediasite is the leading one-to-many multimedia communication solution for capturing knowledge and sharing it online.

New Accounting Pronouncements

In December 2010, FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts by requiring an entity to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. This update was effective for fiscal years beginning after December 15, 2010. The Company’s adoption of ASU 2010-28 did not have a material impact on its consolidated financial statements.

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;

•

Valuation allowance for net deferred tax assets; and

•

Accounting for stock-based compensation.

Revenue Recognition, Allowance for Doubtful Accounts and Reserves

General

Revenue is recognized when persuasive evidence of an arrangement exists, delivery occurs or services are rendered, the sales price is fixed or determinable and collectability is reasonably assured. Revenue is deferred when undelivered products or services are essential to the functionality of delivered products, customer acceptance is uncertain, significant obligations remain, or the fair value of undelivered elements is unknown. The Company does not offer customers the right to return product, other than for exchange or repair pursuant to a warranty or stock

rotation. The Company’s policy is to reduce revenue if it incurs an obligation for price rebates or other such programs during the period the obligation is reasonably estimated to occur. The following policies apply to the Company’s major categories of revenue transactions.

Products

Products are considered delivered, and revenue is recognized, when title and risk of loss have been transferred to the customer. Under the terms and conditions of the sale, this occurs at the time of shipment to the customer. Product revenue currently represents sales of our Mediasite recorders and Mediasite related products such as server software revenue.

Services

The Company sells support and content hosting contracts to our customers, typically one year in length, and records the related revenue ratably over the contractual period. Our support contracts cover phone and electronic technical support availability over and above the level provided by our distribution partners, software upgrades on a when and if available basis, advance hardware replacement and an extension of the standard hardware warranty from 90 days to one year. The manufacturers we contract with to build the units provide a limited one-year warranty on the hardware. We also sell installation, training, event webcasting, and customer content hosting services. Revenue for those services is recognized when performed in the case of installation, training and event webcasting services. Service amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met.

Revenue Arrangements that Include Multiple Elements

by a selling-price hierarchy. A deliverable in an arrangement qualifies as a separate unit of accounting if the delivered item has value to the customer on a stand-alone basis. A delivered item that does not qualify as a separate unit of accounting is combined with the other undelivered items in the arrangement and revenue is recognized for those combined deliverables as a single unit of accounting. The selling price used for each deliverable is based upon VSOE if available, third-party evidence (TPE) if VSOE is not available, and best estimate of selling price (ESP) if neither VSOE nor TPE are available. TPE is the price of the Company’s or any competitor’s largely interchangeable products or services in stand-alone sales to similarly situated customers. ESP is the price at which the Company would sell the deliverable if it were sold regularly on a stand-alone basis, considering market conditions and entity-specific factors. All revenue arrangements negotiated after September 30, 2010, excluding the sale of all software-only products and associated services, have been accounted for under this guidance.

Reserves

We record reserves for stock rotations, price adjustments, rebates, and sales incentives to reduce revenue and accounts receivable for these and other credits we may grant to customers. Such reserves are recorded at the time of sale and are calculated based on historical information (such as rates of product stock rotations) and the specific terms of sales programs, taking into account any other known information about likely customer behavior. If actual customer behavior differs from our expectations, additional reserves may be required. Also, if we determine that we can no longer accurately estimate amounts for stock rotations and sales incentives, we would not be able to recognize revenue until the customers exercise their rights, or such rights lapse, whichever is later.

Credit Evaluation and Allowance for Doubtful Accounts

Impairment of long-lived assets

We assess the impairment of goodwill on an annual basis or whenever events or changes in circumstances indicate that the fair value of these assets is less than the carrying value.

If we determine that the fair value of goodwill is less than its carrying value, based upon the annual test or the existence of one or more indicators of impairment, we would then measure impairment based on a comparison of the implied fair value of goodwill with the carrying amount of goodwill. To the extent the carrying amount of goodwill is greater than the implied fair value of goodwill, we would record an impairment charge for the difference.

We evaluate all of our long-lived assets, including intangible assets other than goodwill, for impairment in accordance with the provisions of FASB ASC 360-10. Long-lived assets and intangible assets other than goodwill are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset.

Valuation allowance for net deferred tax assets

Accounting for stock-based compensation

The Company uses a lattice valuation model to account for all stock options granted. The lattice valuation model provides a flexible analysis to value options because of its ability to incorporate inputs that change over time, such as actual exercise behavior of option holders. The Company uses historical data to estimate the option exercise and employee departure behavior in the lattice valuation model. Expected volatility is based on historical volatility of the Company’s stock. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogenous groups for valuation. The expected term of options granted is derived from the output of the option pricing model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods the options are expected to be outstanding is based on the U.S. Treasury yields in effect at the time of grant. Forfeitures are based on actual behavior patterns.

Results of Continuing Operations

Revenue

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

Q3-2012 compared to Q3-2011

Revenue in Q3-2012 increased $667 thousand, or 9% from Q3-2011 revenue of $7.1 million to $7.8 million. Revenue consisted of the following:

•

Product revenue from sale of Mediasite recorder units and server software increased from $3.9 million in Q3-2011 to $4.1 million in Q3-2012.


	Q3-2012	Q3-2011
Recorders sold	466	419
Rack units to mobile units ratio	2.9 to 1	2.9 to 1
Average sales price, excluding service (000’s)	$9.4	$9.5

•

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 $3.1 million in Q3-2011 to $3.6 million in Q3-2012 primarily due to an increase in event services billings. At June 30, 2012, $5.7 million of revenue was deferred, of which we expect to recognize $5.3 million in the next twelve months, including approximately $2.2 million in the quarter ending September 30, 2012. At September 30, 2011, $5.7 million of revenue was deferred.

•

Other revenue relates to freight charges billed separately to our customers.

YTD-2012 (nine months) compared to YTD-2011 (nine months)

Revenues for YTD-2012 totaled $19.9 million compared to YTD-2011 revenues of $18.5 million. Revenues included the following:

•

$9.3 million product revenue from the sale of 957 Mediasite recorders and software in 2012 versus $9.4 million from the sale of 935 Mediasite recorders and software in 2011. The product revenue decrease relates to a decrease in recorders sold to domestic higher education customers and an increase in discounted upgrade recorders sold to customers whose product had reached the end of hardware warranty eligibility.

•

$10.3 million from Mediasite customer support contracts, installation, training, event and hosting services in 2012 versus $9.0 million in 2011. Services revenue increased primarily due to an increase in event services billings as well as an increase in customer support contracts on Mediasite recorder units.

Gross Margin

Q3-2012 compared to Q3-2011

Gross margin for Q3-2012 was $5.6 million or 72% of revenue compared to Q3-2011 of $4.9 million or 70%. Gross margin increased due to operational efficiencies in recorder and services costs and a decrease in direct and outsourced event labor costs with lower markups for services which the Company does not provide, such as closed captioning. These improvements were partially offset by an increase in high definition material cost. The significant components of cost of revenue include:

•

Material and freight costs for the Mediasite recorders. Costs for Q3-2012 Mediasite recorder hardware and other costs totaled $1.5 million, along with $106 thousand of freight costs, and $216 thousand of labor and allocated costs compared to Q3-2011 Mediasite recorder costs of $1.6 million for hardware and other costs, $83 thousand for freight and $210 thousand of labor and allocated costs.

•

Services costs. Staff wages and other costs allocated to cost of service revenue were $352 thousand in Q3-2012 and $314 thousand in Q3-2011, resulting in gross margin on services of 90% in Q3-2012 and Q3-2011.

YTD-2012 (nine months) compared to YTD-2011 (nine months)

Gross margin for YTD-2012 was $14.3 million or 72% of revenue compared to YTD-2011 of $13.1 million or 70%. Gross margin increased due to operational efficiencies in recorder and services costs and a decrease in direct and outsourced event labor costs with lower markups for services which the Company does not provide, such as closed captioning. These improvements were partially offset by a greater volume of discounted upgrade units for customers whose product had reached the end of hardware warranty eligibility and by an increase in high definition material cost. The significant components of cost of revenue include:

•

Material and freight costs for the Mediasite recorders. Costs for YTD-2012 Mediasite recorder hardware and other costs totaled $3.5 million, along with $296 thousand of freight costs, and $651 thousand of labor and allocated costs compared to YTD-2011 Mediasite recorder costs of $3.6 million for hardware and other costs, $278 thousand for freight and $620 thousand of labor and allocated costs.

•

Services costs. Staff wages and other costs allocated to cost of service revenue were $1.1 million in YTD-2012 and $1.0 million in YTD-2011, resulting in gross margin on services of 90% in YTD-2012 and 89% in YTD-2011.

Operating Expenses

Selling and Marketing Expenses

Selling and marketing expenses include wages and commissions for sales, marketing and business development personnel, print advertising and various promotional expenses for our products. Timing of these costs may vary greatly depending on introduction of new products and services or entrance into new markets, or participation in major tradeshows.

Q3-2012 compared to Q3-2011

Selling and marketing expenses increased $415 thousand or 14% from $3.0 million in Q3-2011 to $3.4 million in Q3-2012. Differences in the major categories include:

•

Tradeshows, market research and travel increased by $276 thousand.

•

Costs allocated from General and Administrative increased by $126 thousand primarily as a result of higher compensation and depreciation expense.

YTD-2012 compared to YTD-2011

Selling and marketing expenses increased $986 thousand or 12% from $7.9 million in YTD-2011 to $8.9 million in YTD-2012. YTD increases in the major categories include:

•

YTD-2012 salary, incentive compensation and benefits increased $195 thousand from YTD-2011 due to slightly higher staff levels in 2012 and an increase in sales and related commission compensation compared to 2011.

•

YTD-2012 General and Administrative costs allocated to selling and marketing increased by $287 thousand from YTD-2011 primarily due to higher stock and other compensation expense and depreciation expense.

•

YTD-2012 tradeshow, market research and travel expense increased by $550 thousand from YTD-2011.

We anticipate selling and marketing headcount to remain consistent throughout the remainder of the fiscal year.

General and Administrative Expenses

General and administrative (“G&A”) expenses consist of personnel and related costs associated with the facilities, finance, legal, human resource and information technology departments, as well as other expenses not fully allocated to functional areas.

Q3-2012 compared to Q3-2011

G&A expenses decreased $52 thousand or 7% over the prior period from $720 thousand in Q3-2011 to $668 thousand in Q3-2012 resulting primarily from a decrease in compensation and benefits of $68 thousand, primarily related to a decrease in headcount.

YTD-2012 compared to YTD-2011

G&A increased $87 thousand or 4% from $2.1 million in YTD-2011 to $2.1 million in YTD-2012. YTD increases in the major categories include:

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An increase in compensation and benefits of $36 thousand.

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Professional services increase of $36 thousand, partially due to timing of certain accounting and director fees as well as an increase in investor relations services.

We anticipate general and administrative headcount to remain the same during the remainder of the fiscal year.

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.

Q3-2012 compared to Q3-2011

Product development expenses increased $226 thousand, or 26% from $863 thousand in Q3-2011 to $1.1 million in Q3-2012 resulting primarily from an increase in compensation, benefits and outsourced labor of $144 thousand related primarily to an increase in headcount. Costs allocated from General and Administrative increased by $74 thousand primarily as a result of higher compensation and depreciation expense.

YTD-2012 compared to YTD-2011

Product development expenses increased $474 thousand, or 19% from $2.6 million in YTD-2011 to $3.0 million in YTD-2012. YTD increases in the major categories include:

•

Increase in compensation and benefits of $345 thousand related to an increase in headcount and performance related incentive compensation.

•

Costs allocated from General and Administrative increased by $123 thousand primarily as a result of higher stock and other compensation expense and depreciation expense.

We anticipate product development headcount to be consistent during the remainder of the fiscal year. We do not anticipate that any fiscal 2012 software development efforts will qualify for capitalization.

Other Expense, Net

Under the equity method of accounting, we record our proportional share of earnings in Mediasite KK. We recorded $250 thousand of net equity in earnings during the quarter ending June 30, 2012. Other expense primarily consists of interest costs related to outstanding debt and amortization of a debt discount. Other income is primarily interest income from overnight investment vehicles.

Liquidity and Capital Resources

Cash used in operating activities was $193 thousand in YTD-2012 compared to $27 thousand in YTD-2011, an increase of $166 thousand. Cash used in YTD-2012 was partly offset by the positive effects of a $96 thousand change in net income, from net income of $163 thousand in YTD-2011 to net income of $259 thousand in YTD-2012. Working capital and other changes included the positive effects of $591 thousand of stock based compensation, $614 thousand of depreciation expense and $180 thousand of deferred taxes. These were more than offset by the negative effects of an $805 thousand increase in accounts receivable, a $312 decrease in unearned revenue, an increase of $213 thousand in inventory and an increase in $182 thousand of prepaid expenses and other current assets. In YTD-2011, working capital and other changes included the negative effects of a $1.2 million increase in accounts receivable, a $331 thousand decrease in unearned revenue and a $205 thousand increase in prepaid expenses and other current assets. These were mostly offset by the positive effects of an increase in accounts payable and accrued liabilities of $377 thousand, $508 thousand of depreciation expense, $527 thousand of stock based compensation and $180 thousand of deferred taxes.

Cash used in investing activities was $1.1 million in YTD-2012 compared to a use of $417 thousand in YTD-2011 for the purchase of property and equipment.

Cash provided by financing activities was $50 thousand in YTD-2012 compared to $1.3 million in YTD-2011. Cash provided in YTD-2012 was due primarily to $1.2 million from proceeds from notes payable, $104 thousand proceeds from exercise of common stock options and $63 thousand proceeds from issuance of common stock. This was mostly offset by $1.3 million of cash used for payments on notes payable and capital leases. The payments on notes payable during YTD-2012 include an additional payment of $607 thousand to pay the remaining balance of the note payable to PFG in full and before its maturity due to its relatively high interest rate. Cash provided in YTD-2011 was primarily due to $1.5 million of proceeds from exercise of common stock options and $400 thousand from proceeds from notes payable. This was partially offset by $559 thousand of cash used for payments on notes payable.

The Company believes its cash position is adequate to accomplish its business plan through at least the next twelve months. We will likely evaluate operating or capital lease opportunities to finance equipment purchases in the future and anticipate utilizing the Company’s revolving line of credit to support working capital needs. We may also seek additional equity financing, or issue additional shares previously registered in our available shelf registration, although we currently have no plans to do so.

At June 30, 2012, a balance of $1.6 million was outstanding on the term loans with Silicon Valley Bank and no balance was outstanding on the revolving line of credit. At June 30, 2012, there was $1.2 million available under this credit facility for advances. At June 30, 2012 the Company was in compliance with all covenants in the Second Amended Agreement.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Derivative Financial Instruments

We are not party to any derivative financial instruments or other financial instruments for which the fair value disclosure would be required under FASB ASC 815-10. Our cash equivalents consist of overnight investments in money market funds that are carried at fair value. Accordingly, we believe that the market risk of such investments is minimal.

Interest Rate Risk

Our cash equivalents, 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 June 30, 2012, all of our $1.6 million of debt outstanding is variable rate. We do not expect that an increase in the level of interest rates would have a material impact on our Consolidated Financial Statements. We monitor our positions with, and the credit quality of, the financial institutions that are party to any of our financial transactions.

Foreign Currency Exchange Rate Risk

All international sales of our products are denominated in US dollars.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Based on evaluations at June 30, 2012, our principal executive officer and principal financial officer, with the participation of our management team, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15 (e) and 15d-15 (e) under the Securities Exchange Act) are effective. Disclosure controls and procedures ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that material information relating to the Company is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate to allow timely decisions regarding required disclosures.

Changes in Internal Controls

During the period covered by this quarterly report on Form 10-Q, the Company has not made any changes to its internal control over financial reporting (as referred to in Paragraph 4(b) of the Certifications of the Company’s principal executive officer and principal financial officer included as exhibits to this report) that have materially affected, or are reasonably likely to affect the Company’s internal control over financial reporting.

PART II

OTHER INFORMATION

ITEM 1A.

RISK FACTORS

There have been no material changes in our risk factors from those disclosed in our Form 10-K for the fiscal year ended September 30, 2011 filed with the SEC.

ITEM 6.

EXHIBITS


NUMBER		DESCRIPTION

3.1		Articles of Amendment of Amended and Restated Articles of Incorporation, effective November 16, 2009, Amended and Restated Articles of Incorporation, effective January 26, 1998, and Articles of Amendment, effective April 9, 2000, filed as Exhibit No. 3.1 to the Annual Report on Form 10-K for the year ended September 30, 2009, and hereby incorporated by reference.

3.2		Amended and Restated By-Laws of the Registrant, filed as Exhibit No. 3.1 to the Form 8-K filed on October 11, 2011, and hereby incorporated by reference.

10.1*		Amended and Restated Employment Agreement between Registrant and Gary Weis dated as of September 30, 2011, filed as Exhibit 10.1 to the Form 8-K filed on October 4, 2011, and hereby incorporated by reference.

10.2*		Employment Agreement between Registrant and Rimas Buinevicius dated as of March 31, 2011, filed as Exhibit 10.1 to the form 8-K on April 4, 2011, and hereby incorporated by reference.

10.3*		Employment Agreement between Registrant and Gary Weis dated as of March 31, 2011, filed as Exhibit 10.2 to the Form 8-K filed on April 4, 2011, and hereby incorporated by reference.

10.4*		Consulting Agreement between Registrant and Monty R. Schmidt dated as of March 31, 2011, filed as Exhibit 10.3 to the Form 8-K filed on April 4, 2011, and hereby incorporated by reference.

10.5*		Registrant’s Amended 1999 Non-Qualified Plan, filed as Exhibit 4.1 to Form S-8 on December 21, 2001, and hereby incorporated by reference.

10.6		Intellectual Property Security Agreement dated May 2, 2007, between Sonic Foundry, Inc. and Silicon Valley Bank filed as Exhibit 10.2 to the Form 8-K on May 7, 2007, and hereby incorporated by reference.

10.7		Intellectual Property Security Agreement dated May 2, 2007, between Sonic Foundry Media Systems, Inc. and Silicon Valley Bank filed as Exhibit 10.3 to Form 8-K on May 7, 2007, and hereby incorporated by reference.

10.8*		Employment Agreement dated October 31, 2007 between Sonic Foundry, Inc. and Kenneth A. Minor, filed as Exhibit 10.1 to the Form 8-K filed on November 2, 2007, and hereby incorporated by reference.

10.9		Amended and Restated Loan and Security Agreement dated June 16, 2008 and entered into as of June 16, 2008 among registrant, Sonic Foundry Media Services, Inc. and Silicon Valley Bank, filed as Exhibit 10.1 to the Form 8-K filed on June 20, 2008, and hereby incorporated by reference.

10.10*		Employment Agreement dated August 4, 2008 between Sonic Foundry, Inc. and Robert M. Lipps, filed as Exhibit 10.1 to the Form 8-K filed on August 6, 2008, and hereby incorporated by reference.

10.11		First Amendment to the Amended and Restated Loan and Security Agreement executed as of April 14, 2009 and effective as of April 1, 2009, among registrant, Sonic Foundry Media Systems, Inc. and Silicon Valley Bank, filed as Exhibit 10.1 to the Form 8-K filed on April 15, 2009, and hereby incorporated by reference.


10.12*		Registrant’s 1995 Stock Option Plan, as amended, filed as Exhibit No. 4.1 to the Registration Statement on Form S-8 on September 8, 2000, and hereby incorporated by reference.

10.13*		Registrant’s 2008 Non-Employee Directors’ Stock Option Plan, as amended, filed as Exhibit 10.13 to the Form 10-Q filed on May 1, 2012, and hereby incorporated by reference.

10.14*		Registrant’s 2008 Employee Stock Purchase Plan filed as Exhibit C to Form 14A filed on January 28, 2008, and hereby incorporated by reference.

10.15*		Registrant’s 2009 Stock Incentive Plan, as amended, filed as Exhibit 10.15 to the Form 10-Q filed on May 1, 2012, and hereby incorporated by reference.

10.16		Loan and Security Agreement executed as of March 5, 2010 among registrant, Sonic Foundry Media Systems, Inc., and Partners for Growth II, L.P., filed as Exhibit 10.1 to the Form 8-K filed on March 10, 2010, and hereby incorporated by reference.

10.17		Revolving Loan and Security Agreement executed as of March 5, 2010 among Registrant, Sonic Foundry Media Systems, Inc., and Partners for Growth II, L.P., filed as Exhibit 10.2 to the Form 8-K filed on March 10, 2010, and hereby incorporated by reference.

10.18		Warrant Purchase Agreement executed as of March 5, 2010 among registrant and Partners for Growth II, L.P., filed as Exhibit 10.3 to the Form 8-K filed on March 10, 2010, and hereby incorporated by reference.

10.19		Warrant executed as of March 5, 2010 among Registrant and Partners for Growth II, L.P., filed as Exhibit 10.4 to the Form 8-K filed on March 10, 2010, and hereby incorporated by reference.

10.20		Lease Agreement between Registrant, as tenant, and West Washington Associates, LLC as landlord, dated June 28, 2011, filed as Exhibit 10.1 to the Form 8-K filed on July 1, 2011, and hereby incorporated by reference.

10.21		Second Amended and Restated Loan and Security Agreement dated June 27, 2011 among Registrant, Sonic Foundry Media Systems, Inc. and Silicon Valley Bank, filed as Exhibit 10.2 to the Form 8-K filed on July 1, 2011, and hereby incorporated by reference.

10.22		Consent and Modification No. 1 to Loan and Security Agreement entered into as of June 28, 2011, among Partners for Growth II, L.P., Registrant and Sonic Foundry Media Systems, Inc. filed as Exhibit 10.3 to the Form 8-K filed on July 1, 2011, and hereby incorporated by reference.

31.1		Section 302 Certification of Chief Executive Officer

31.2		Section 302 Certification of Chief Financial Officer, Chief Accounting Officer and Secretary

32		Section 906 Certification of Chief Executive Officer and Chief Financial Officer, Chief Accounting Officer and Secretary

101		The following materials from the Sonic Foundry, Inc. Form 10-Q for the quarter ended June 30, 2012 formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Statements of Operations, (ii) the Condensed Consolidated Balance Sheets, (iii) Condensed Consolidated Statements of Cash Flows and (iv) related notes, tagged as blocks of text.

Registrant will furnish upon request to the Securities and Exchange Commission a copy of all exhibits, annexes and schedules attached to each contract referenced in item 10.

*	Compensatory Plan or Arrangement

SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Sonic Foundry, Inc.

(Registrant)


August 1, 2012	By:	/s/ Gary R. Weis
		Gary R. Weis
		Chief Executive Officer

August 1, 2012	By:	/s/ Kenneth A. Minor
		Kenneth A. Minor
		Chief Financial Officer, Chief Accounting Officer and Secretary

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