-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FyIVRsV7YbCt9ds+k6SGGH6Qpr8+SatLf4PBkpzPzsUz8H3xiWOvLj/UJKEMCx+w RvVzaQ0iMn39ZA/tmcR2VA== 0000950131-98-000875.txt : 19980211 0000950131-98-000875.hdr.sgml : 19980211 ACCESSION NUMBER: 0000950131-98-000875 CONFORMED SUBMISSION TYPE: SB-2 PUBLIC DOCUMENT COUNT: 16 FILED AS OF DATE: 19980210 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SONIC FOUNDRY INC CENTRAL INDEX KEY: 0001029744 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 39173372 STATE OF INCORPORATION: MD FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: SB-2 SEC ACT: SEC FILE NUMBER: 333-46005 FILM NUMBER: 98529996 BUSINESS ADDRESS: STREET 1: 100 SOUTH BALDWIN STSTE 204 CITY: MADISON STATE: WI ZIP: 53703 BUSINESS PHONE: 6082563133 MAIL ADDRESS: STREET 1: 754 WILLIAMSON ST CITY: MADISON STATE: WI ZIP: 53703 SB-2 1 FORM SB-2 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 10, 1998 REGISTRATION NO. 33- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- FORM SB-2 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------- SONIC FOUNDRY, INC. (NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER) -------------- MARYLAND 7372 39-1783372 (STATE OR OTHER (PRIMARY STANDARD (I.R.S. JURISDICTION OF INDUSTRIAL CLASSIFICATION EMPLOYERIDENTIFICATION INCORPORATION OR CODE NUMBER) NO.) ORGANIZATION) 754 WILLIAMSON STREET 754 WILLIAMSON STREET MADISON, WISCONSIN 53703 MADISON, WISCONSIN 53703 (608) 256-3133 (ADDRESS OF PRINCIPAL PLACE OR (ADDRESS AND TELEPHONE NUMBER OF INTENDED PRINCIPAL PLACE OF BUSINESS) PRINCIPAL EXECUTIVE OFFICES) -------------- RIMAS BUINEVICIUS CHAIRMAN AND CHIEF EXECUTIVE OFFICER SONIC FOUNDRY, INC. 754 WILLIAMSON STREET MADISON, WISCONSIN 53703 (608) 256-3133 (NAME, ADDRESS, AND TELEPHONE NUMBER OF AGENT FOR SERVICE) COPIES TO: FREDERICK H. KOPKO, JR., ESQ. LAWRENCE B. FISHER, ESQ. MCBREEN, MCBREEN & KOPKO ORRICK, HERRINGTON & SUTCLIFFE LLP 20 NORTH WACKER DRIVE 666 FIFTH AVENUE CHICAGO, ILLINOIS 60606 NEW YORK, NEW YORK 10103 (312) 332-6405 (212) 506-5000 -------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [X] If this form is filed to register additional securities for an offering pursuant to Rule 426(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [_] If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [_] If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: [_] CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
DOLLAR PROPOSED PROPOSED AMOUNT MAXIMUM MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE REGISTRATION SECURITIES TO BE REGISTERED REGISTERED PER UNIT(1) OFFERING PRICE(1) FEE - -------------------------------------------------------------------------------------- Common Stock, par value $.01 per share(2)....... $20,010,450 $ 7.50 $20,010,450 $ 5,903.08 Redeemable Common Stock Purchase Warrants ("Warrants")(3)......... $ 115,000 $ 0.10 $ 115,000 $ 33.93 Common Stock issuable upon exercise of Warrants(4)............. $12,937,500 $11.25 $12,937,500 $ 3,816.56 Representatives' Warrants(5)............. $ 20.00 $.0001 $ 20.00 -- Common Stock issuable upon exercise of Representatives' Warrants(5)............. $ 1,800,000 $ 9.00 $ 1,800,000 $ 531.00 Warrants issuable upon exercise of Representatives' Warrants(5)............. $ 12,000 $ 0.12 $ 12,000 $ 3.54 Common Stock underlying Warrants issuable upon exercise of Representatives' Warrants(5)............. $ 1,125,000 $11.25 $ 1,125,000 $ 331.88 - -------------------------------------------------------------------------------------- Total................... $35,999,970 -- $35,999,970 $10,619.99
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(a) of the Securities Act of 1933, as amended. (2) Includes 300,000 shares of Common Stock that the Underwriters have the option to purchase to cover over-allotments, if any. Also includes 368,060 shares of Common Stock registered on behalf of the Selling Stockholders. (3) Includes 150,000 Warrants that the Underwriters have the option to purchase to cover over-allotments, if any. (4) Includes 150,000 shares of Common Stock issuable upon exercise of Warrants that the Underwriters have the option to purchase to cover over- allotments, if any. (5) In connection with the Registrant's sale of securities, the Registrant is granting to the Representatives of the several Underwriters warrants to purchase 200,000 Shares of Common Stock and 100,000 Warrants. -------------- THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8 (A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + +THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + +SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + +UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + +ANY SUCH STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ SUBJECT TO COMPLETION, DATED FEBRUARY 10, 1998 PROSPECTUS SONIC FOUNDRY, INC. 2,000,000 SHARES OF COMMON STOCK AND 1,000,000 REDEEMABLE COMMON STOCK PURCHASE WARRANTS [INSERT LOGO]] Sonic Foundry, Inc., a Maryland corporation (the "Company"), hereby offers (the "Offering") 2,000,000 shares (the "Shares") of common stock, $0.01 par value (the "Common Stock") and 1,000,000 redeemable common stock purchase warrants (the "Warrants"). The Shares and Warrants are sometimes hereinafter collectively referred to as the "Securities." Until the completion of this Offering, the Shares and Warrants may only be purchased together on the basis of two shares of Common Stock and one Warrant, but will be transferable separately immediately following completion of this Offering. Each Warrant entitles the registered holder thereof to purchase one share of Common Stock at an exercise price of $ [150% of the initial public offering price of the Common Stock], subject to adjustment, at any time from , 1998 [six months after the date of this Prospectus] until , 2003 [60 months after the date of this Prospectus]. Commencing , 1999 [18 months after the date of this Prospectus], the Warrants will be subject to redemption by the Company, in whole but not in part, at $0.10 per Warrant on 30 days prior written notice, provided that the average closing sale price of the Common Stock as reported on the American Stock Exchange (the "Amex") equals or exceeds $20.00 per share of Common Stock, subject to adjustment, for any 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the date of the notice of redemption. See "Description of Securities--Warrants." Prior to this Offering, there has been no public market for the Common Stock or the Warrants, and there can be no assurance that such a market will develop after the completion of the Offering or, if developed, that it will be sustained. It is currently anticipated that the initial public offering prices of the Shares and Warrants will be $7.50 per Share and $.10 per Warrant. For information regarding the factors considered in determining the initial public offering price of the Securities and the terms of the Warrants, see "Risk Factors" and "Underwriting." The Company intends to apply to include the Common Stock and the Warrants on the Amex under the symbols "SFO" and "SFOW," respectively. (continued on the following page) THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK AND IMMEDIATE SUBSTANTIAL DILUTION. SEE "RISK FACTORS" LOCATED ON PAGE 7, AND "DILUTION." THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURI- TIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
UNDERWRITING PROCEEDS TO PRICE TO PUBLIC DISCOUNTS(1) COMPANY(2) - -------------------------------------------------------------------------------- Per Share of Common Stock.................. $ $ $ - -------------------------------------------------------------------------------- Per Warrant............. $ $ $ - -------------------------------------------------------------------------------- Total(3)................ $ $ $ - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- (1) Does not include additional compensation payable to Dirks & Company, Inc. and Security Capital Trading Corp., the representatives ("Representatives") of the several underwriters (the "Underwriters") in the form of a non- accountable expense allowance. In addition, see "Underwriting" for information concerning indemnification and contribution arrangements with the Underwriters and other compensation payable to the Representatives. (2) Before deducting estimated expenses of $500,000 payable by the Company, excluding the Representatives' non-accountable expense allowance. (3) The Company has granted the Underwriters an option (the "Over-Allotment Option"), exercisable for a period of 45 days after the date of this Prospectus, to purchase up to an additional 300,000 shares of Common Stock and/or an additional 150,000 Warrants upon the same terms and conditions set forth above, solely to cover over-allotments, if any. If the Over- Allotment Option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to Company will be $ , $ and $ , respectively. See "Underwriting." The Securities are being offered by the Underwriters, subject to prior sale, when, as and if delivered to and accepted by the Underwriters, and subject to approval of certain legal matters by their counsel and subject to certain other conditions. The Underwriters reserve the right to withdraw, cancel or modify this Offering and to reject any order in whole or in part. It is expected that delivery of the Securities offered hereby will be made against payment, at the offices of Dirks & Company, Inc., New York, New York, on or about , 1998. DIRKS & COMPANY, INC. SECURITY CAPITAL TRADING CORP. The date of this Prospectus is , 1998. [Photograph of Company's products, consisting of a batch converter plug-in, a spectrum analysis plug-in, Soft Encode, Sound Forge 4.0, noise reduction plug- in, CD Architect, an XFX plug-in, and Sound Forge XP. Products are pictured on a factory conveyor-belt.] CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK AND WARRANTS, INCLUDING PURCHASES OF THE COMMON STOCK AND/OR WARRANTS TO STABILIZE THEIR RESPECTIVE MARKET PRICES, PURCHASES OF THE COMMON STOCK AND/OR WARRANTS TO COVER SOME OR ALL OF A SHORT POSITION MAINTAINED BY THE UNDERWRITERS IN THE COMMON STOCK AND/OR WARRANTS, RESPECTIVELY, AND THE IMPOSITION OF PENALTY BIDS. FOR A DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITING." ---------------- The Company intends to furnish its stockholders with annual reports containing financial statements audited by its independent auditors and quarterly reports for the first three quarters of each fiscal year containing unaudited interim financial information. (continued from cover page) This Prospectus also relates to the registration by the Company, at its expense, for the account of various stockholders ("Selling Stockholders") of 368,060 shares of Common Stock (the "Selling Stockholders Shares"). The Selling Stockholders Shares may be not sold for a period of ninety (90) days from the effective date of the Registration Statement without the prior written consent of the Representatives. The Company will not receive any proceeds from the sale of the Selling Stockholders Shares by the holders thereof. See "Selling Stockholders." The sale of the Selling Stockholders Shares may be effected from time to time in transactions (which may include block transactions by or for the account of the Selling Stockholders) in the over-the-counter market or in negotiated transactions, through the writing of options on the Selling Stockholders Shares, through a combination of such methods of sale, or otherwise. Sales may be made at fixed prices which may be changed, at market prices prevailing at the time of sale, or at negotiated prices. If any Selling Stockholder sells his, her or its Shares, or options thereon, pursuant to this Prospectus at a fixed price or at a negotiated price which is, in either case, other than the prevailing market price or in a block transaction to a purchaser who resells, or if any Selling Stockholder pays compensation to a broker-dealer that is other than the usual and customary discounts, concessions or commissions, or if there are any arrangements either individually or in the aggregate that would constitute a distribution of the Selling Stockholders Shares, a post-effective amendment to the Registration Statement of which this Prospectus is a part, would need to be filed and declared effective by the Securities and Exchange Commission before such Selling Stockholders could make such sale, pay such compensation or make such a distribution. The Company is under no obligation to file a post-effective amendment to the Registration Statement of which this Prospectus is a part under such circumstances. PROSPECTUS SUMMARY This Prospectus contains forward-looking statements that involve risk and uncertainties. The Company's actual results could differ materially from those anticipated in such forward-looking statements as a result of certain factors, including these set forth under "Risk Factors" and elsewhere in this Prospectus. The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and Financial Statements and Notes thereto appearing elsewhere in this Prospectus. Unless otherwise indicated, all information in this Prospectus does not give effect to the (a) exercise of the Over-Allotment Option, (b) exercise of the Representatives' Warrants, including the exercise of the Warrants underlying the Representatives' Warrants, (c) exercise of the Warrants, (d) the issuance of 699,050 shares of Common Stock upon the exercise of options granted under the Company's 1995 Stock Option Plan (the "Plan"), (e) the issuance of 300,950 shares of Common Stock upon the exercise of options that may be granted under the Plan, (f) the issuance of 30,000 shares of Common Stock upon the exercise of options granted under the Company's Non-Employee Directors' Stock Option Plan (the "Directors' Stock Option Plan"), (g) the issuance of 60,000 shares of Common Stock upon the exercise of options that may be granted under the Directors' Stock Option Plan, (h) the issuance of 3,439,866 shares of Common Stock upon the conversion of the outstanding 6,879,732 shares of Series B 5% Cumulative Convertible Preferred Stock ("Series B Preferred Stock") and (i) the issuance of 60,000 shares of Common Stock upon the exercise of a warrant currently outstanding. As used in this Prospectus and unless the context otherwise requires, the "Company" refers to the Company and its predecessor. THE COMPANY The Company is a leading provider of personal computer ("PC")-based software products that enable users to easily work with and edit digital media. The Company's products are designed to run under both the Windows and Windows NT operating systems. Current products include Sound Forge 4.0 and Sound Forge XP, both of which allow users to create, record, edit and design digital audio files, CD Architect, which gives musicians, audio engineers and home users the ability to record and master their own audio CD's, and Soft Encode, which encodes audio to the Dolby Laboratories, Inc. ("Dolby") AC-3 multi-speaker format, for playback in movie theaters and on home theater systems. The Company is currently developing two new products, ACID and VEGAS, which are expected to dramatically impact the digital media industry. ACID, currently in Beta- testing, will allow musicians and non-musicians an easy way to create and play- back sound samples via a computer in a multi-track format. VEGAS will allow users to be able to store, edit, manipulate and transfer multiple tracks of audio data along with video data, via Windows NT. ACID and VEGAS are expected to be released by the summer of 1998. In the past, audio production system users relied upon analog tape-based solutions. Analog tape-based systems suffered from relatively poor fidelity, crude editing capabilities and poor process integration. Increasingly, audio production users are adopting digital technology which offers several key advantages over analog tape-based systems including efficient use and reuse of storage media, transferability of media, minimal obsolescence and independence from dedicated hardware. The Company believes that there is a wide variety of markets and customers within these markets which require digital-based media authoring tools. These markets include the music, multimedia, digital video, audio/video and broadcast industries, and the Internet, which the Company believes will be a point of convergence for the other markets. Customers within these markets can be as diverse as a musician desiring optimal audio editing software to an automotive engineer who desires sound frequency analysis capability, to a website or multimedia developer who desires an enhanced overall presentation. In attempting to meet the needs of its customers in a variety of markets, the Company strives to give its products features which can be tailored to individual specific needs, are reliable and can be expanded upon. The 4 Company believes it can achieve long term commitment to its products from its target customers by obtaining the endorsement of industry opinion leaders, emphasizing quality, maintaining stringent compatibility with Windows, gaining development efficiency through a common code base and being able to adapt and address new market opportunities by bringing new products to market quickly. The Company's objective is to be the leading digital-based media software company to every industry and market in which the Company competes. The Company plans to achieve this objective by extending its technology leadership, maximizing its market penetration and brand recognition and continuing to develop products for the digital based media software market for professional and consumer use. In addition, the Company plans to strengthen and expand its strategic relationships with companies such as Dolby and pursue other strategic relationships. In this connection, the Company entered into a letter of intent with Microsoft Corporation ("Microsoft") in January 1998 pursuant to which Microsoft will license to the Company NetShow software production and rendering tools to enable the Company to develop and distribute production tools, such as Sound Forge and ACID, to create NetShow content. NetShow is Microsoft's proprietary format to view media on demand over the Internet. In addition, the letter of intent provides that the Company will be designated a preferred independent software vendor partner of NetShow with benefits including technical, marketing and sales assistance to the Company from Microsoft in connection with NetShow. The letter of intent is subject to a definitive agreement to be negotiated between the parties and there can be no assurance that a definitive agreement will be entered into, or if entered into, be on favorable terms to the Company. Management believes that developing products based on the NetShow platform will allow it to expand its customer base in the Internet market. Designation as a preferred independent software vendor partner of NetShow, as well as Microsoft technical, marketing and sales assistance, is also expected to have significant competitive benefits to the Company, which the Company believes will allow it to reach more potential customers by being included in Microsoft mailings, product groupings and references on Microsoft's website. The Company was incorporated in the State of Wisconsin in 1994 and merged into a Maryland corporation of the same name in 1996. Its offices are located at 754 Williamson Street, Madison, Wisconsin, 53703 and its telephone number is 608-256-3133. Information contained on the Company's website will not be deemed to be part of this Prospectus. The names of "Sonic Foundry," "Sound Forge," "VEGAS," "ACID," "CD Architect," and "Soft Encode" and the logo utilized by the Company, are registered and unregistered trademarks, service marks and trade names of the Company. This Prospectus also includes trademarks, service marks and trade names other than those identified in this paragraph, all of which are the property of their respective holders. THE OFFERING Securities Offered........ 2,000,000 Shares of Common Stock and 1,000,000 Warrants. The Shares and the Warrants will be separately tradeable immediately following the completion of this Offering. Terms of Warrants......... Each Warrant entitles the holder to acquire one share of Common Stock at an exercise price of $ per share [150% of the initial public offering price of the Common Stock] at any time from , 1998 [six months after the date of the Prospectus] until , 2003 [5 years after the date of this Prospectus]. Commencing , 1999 [18 months after the date of this Prospectus], the Warrants will be subject to redemption by the Company, in whole but not in part, at $.10 per Warrant provided that the average closing sale price of the Common Stock as reported on the Amex equals or exceeds $20.00 per 5 share of Common Stock for any 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the date of notice of redemption. See "Description of Securities." Securities Outstanding Prior to the Offering:(1) Common Stock .......... 368,060 shares Series B Preferred 6,879,732 shares Stock ................. Securities Outstanding After the Offering:(1) Common Stock .......... 2,368,060 shares Series B Preferred 6,879,732 shares Stock ................. Warrants .............. 1,000,000 Warrants Use of Proceeds........... The Company intends to use the net proceeds from the Offering for (i) the development of new products and the enhancement of current products, (ii) capital expenditures, including costs associated with additional facilities and equipment purchases, (iii) sales and marketing, including the opening of sales offices, (iv) repayment of existing indebtedness, (v) expansion of internal operations, including improvement of management information systems and (vi) working capital and general corporate purposes. The Company may also use a portion of the net proceeds from this Offering for the acquisition of or investment in complementary businesses, products, or technologies. The Company does not have any present understandings, commitments or agreements with respect to any material acquisition or investment. See "Use of Proceeds." Proposed Amex Symbols..... Common Stock SFO Warrants SFOW Risk Factors ............. An investment in the Securities offered hereby involves a high degree of risk and immediate and substantial dilution and should be made only by investors who can afford the loss of their entire investment. See "Risk Factors" and "Dilution." - -------- (1) Does not include: (i) 699,050 shares of Common Stock issuable upon the exercise of options granted under the Plan; (ii) 300,950 shares of Common Stock issuable upon the exercise of options that may be granted under the Plan; (iii) 30,000 shares of Common Stock issuable upon the exercise of options granted under the Directors' Stock Option Plan; (iv) 60,000 shares of Common Stock issuable upon the exercise of options that may be granted under the Directors' Stock Option Plan; (v) 3,439,866 shares of Common Stock issuable upon conversion of the 6,879,732 outstanding shares of Series B Preferred Stock; and (vi) 60,000 shares of Common Stock issuable upon the exercise of a warrant currently outstanding. See "Management-- Directors' Compensation," "Management--1995 Stock Option Plan" and "Description of Securities." 6 SUMMARY FINANCIAL INFORMATION
YEARS ENDED NINE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, ------------------- --------------------- 1995 1996 1996 1997 -------- ---------- ---------- ---------- STATEMENT OF OPERATIONS DATA: Software license fees............... $757,579 $2,442,047 $1,623,066 $2,242,512 Gross profit........................ 675,526 2,069,775 1,423,717 1,835,413 -------- ---------- ---------- ---------- Income (loss) from operations....... 34,391 214,128 231,357 (818,951) Income (loss) before income taxes... 33,324 199,094 221,065 (859,091) Income tax expense (benefit)........ 0 20,000 0 (20,000) -------- ---------- ---------- ---------- Net income (loss)................... $ 33,324 $ 179,094 $ 221,065 $ (839,091) ======== ========== ========== ========== Pro forma net income (loss) per common share(1).................... $ .07 $ .08 $ .27 $ (1.11) ======== ========== ========== ========== Pro forma weighted average common and common equivalent shares(1).... 392,116 1,712,669 523,443 760,111 ======== ========== ========== ==========
SEPTEMBER 30, 1997 ----------------------- PRO FORMA, DECEMBER 31, AS 1996 ACTUAL ADJUSTED(2) ------------ ---------- ----------- BALANCE SHEET DATA: Working capital (deficit)................. $ 515,385 $ (264,853) $13,314,821 Total assets.............................. 1,627,122 2,332,963 14,707,846 Long-term liabilities..................... 20,000 702,443 0 Stockholders' equity...................... 1,076,705 684,414 14,012,914
- -------- (1) See Note 1 to the Financial Statements of the Company. (2) Gives effect on a pro forma basis to (i) the sale of 130,300 shares of Common Stock in the quarter ended December 31, 1997 and (ii) the conversion of a note payable in the principal amount of $40,000 into 8,000 shares of Common Stock in October 1997, and as adjusted to give effect to the receipt and the initial application of the estimated net proceeds of the Offering. See "Use of Proceeds" and "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 7 RISK FACTORS This Prospectus contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those discussed in the forward-looking statements as a result of certain factors, including those set forth below and elsewhere in this Prospectus. An investment in the Securities offered hereby involves a high degree of risk and should be made only by investors who can afford the loss of their entire investment. Prospective investors should carefully review and consider the risk factors described below and other information in this Prospectus before purchasing the Securities. Limited Operating History; Working Capital Deficit and Anticipated Future Losses. The Company was incorporated in February, 1994 and has only a limited operating history upon which prospective investors may judge the Company's performance and prospects. The Company is subject to all of the business risks associated with a new enterprise, including constraints on its financial and personnel resources, lack of established business relationships and uncertainties regarding future revenue. As of September 30, 1997, the Company had a working capital deficit of $264,853. Future operating results will depend upon many factors, including fluctuations in the economy, the degree and nature of competition, demand for the Company's products, the availability of additional capital and the Company's ability to manage its growth, including recruiting additional personnel, expanding into new markets, and maintaining gross margins in the face of pricing pressures. To achieve and sustain profitability in the future, the Company must, among other things, establish widespread market acceptance of its existing products, successfully develop new products, respond quickly and effectively to competitive, market and technological developments, expand sales and marketing operations, broaden customer support capabilities, control expenses and continue to attract, train and retain qualified personnel. There can be no assurance that the Company will achieve or sustain profitability in the future. Risks Associated With Growth and Potential Fluctuation in Quarterly Operating Results. The Company intends to expand primarily by increasing sales personnel and marketing activities and by increasing product development activities. The Company expects that the expenses related to the planned expansion generally will precede the Company's realization of the benefits, if any, of such expansion. Accordingly, the Company expects that the incurrence of these expenses will adversely affect the Company's earnings and working capital in the periods prior to the Company's realization of the benefits, if any, of any expansion. There can be no assurance that the Company's systems, procedures or controls will be adequate to support its current or future operations or that the Company's management will be able to manage the expansion and still achieve the rapid execution necessary to exploit fully the market for the Company's products. If the Company were to fail to manage its growth effectively, its business, financial condition and results of operations would be materially adversely affected. As part of its growth strategy, the Company may consider acquisitions of complementary businesses and, although the Company does not presently have any plans, arrangements or agreements with respect to any potential acquisitions, there can be no assurance that if the Company consummates an acquisition, it will be able to successfully integrate any acquired businesses into the Company's operations. There also can be no assurance that future acquisitions will not have a material adverse effect upon the Company's results of operations and earnings per share, particularly in the fiscal quarters immediately following consummation of such transactions while the operations of the acquired business are being integrated into the Company's operations. See "Use of Proceeds" and "Business." The Company expects to experience significant fluctuations in its future quarterly operating results due to a variety of factors, many of which are outside the Company's control, including (i) demand for the Company's products, (ii) introduction or enhancement of products by the Company and its competitors, (iii) market acceptance of new products of the Company and its competitors, (iv) price reductions by the Company or its competitors or changes in how products are placed, (v) the mix of products sold by the Company and its competitors, (vi) the mix of distribution channels through which the Company's products are licensed and sold, (vii) the mix of international and U.S. revenues, (viii) costs of litigation and intellectual property protection, (ix) 8 the Company's ability to attract, train and retain qualified personnel, (x) the amount and timing of operating costs and capital expenditures related to expansion of the Company's business, operations and infrastructure, (xi) technical difficulties with respect to the use of the Company's products, (xii) governmental regulations and (xiii) general economic conditions and economic conditions specifically related to the Internet. It often is difficult to forecast the effect such factors, or any combination thereof, would have on the Company's results of operations for any given fiscal quarter. There can be no assurance that the Company will be able to achieve historical revenue levels or maintain its historical growth rate. The Company has used, and expects to continue to use, price promotions to increase trial, purchase and use of its products, as well as to increase the overall recognition of its brands. The effect of such promotions on revenues in a particular period may be significant and extremely difficult to forecast. Based on the foregoing, the Company believes that its quarterly revenues, expenses and operating results could vary significantly in the future, and that period-to-period comparisons should not be relied on as indications of future performance. Control By Current Management. At the completion of this Offering, the Company's officers, directors and their affiliates will beneficially own all of the outstanding shares of Series B Preferred Stock, and will have voting control over approximately 74% of the outstanding voting securities of the Company. Therefore, current management will have the ability to control the election of directors of the Company and the outcome of all issues submitted to a vote of stockholders of the Company. Such control could adversely affect the market price of the Securities or delay or prevent a change in control of the Company. See "Principal Stockholders" and "Description of Securities." Risks Associated With Product Development; Technological Obsolescence. The markets for the Company's products are characterized by evolving industry standards, changing technologies and frequent new product introductions. The Company's future success will depend in part upon its ability to enhance its existing products and to develop and introduce new products and features which meet changing customer requirements and emerging industry standards on a timely basis. There can be no assurance that the Company will successfully complete the development or introduction of products on a timely basis or that the Company's current or future products will achieve market acceptance. Any such failure would have a material adverse effect on the Company. Furthermore, products such as those offered by the Company may contain undetected or unresolved software errors when they are first introduced or as new versions are released. There can be no assurance that, despite significant testing by the Company, software errors will not be found in new products and upgrades after commencement of commercial shipments, resulting in delay in or loss of market acceptance. In addition, from time to time the Company or others may announce products, features or technologies which have the potential to shorten the life cycle of or replace the Company's then-existing products. Such announcements could cause customers to defer the decision to buy or determine not to buy the Company's products or cause the Company's distributors and dealers to seek to return products to the Company, any of which would have a material adverse effect on the Company. In addition, there can be no assurance that products or technologies developed by others will not render the Company's products or technologies non-competitive or obsolete. Further, it may be possible for others to illegally obtain copies of, reverse engineer and/or use the Company's products or technology without authorization. Finally, additional risks are presented due to the fact that certain of the Company's products depend upon products of other companies, outside of the Company's control, to achieve commercial success. An example is Soft Encode, which depends upon the commercial acceptability of the Dolby Digital Surround (also known as AC-3) Digital Versatile Disc ("DVD"). There can be no assurance that the products of other companies upon which the Company's products may depend, such as Dolby's DVD, will achieve commercial acceptance in the marketplace. Any failure relating to commercial acceptance of such companies products could have a material adverse effect on the commercial acceptance of certain of the Company's products which would have a material adverse effect on the Company. Competition. The markets for the Company's products are intensely competitive. Pricing pressure, rapid development, feature upgrades, and new undefined technologies characterize the general nature of the industry. Numerous companies including Adaptec, Inc. ("Adaptec"), Avid Technology, Inc. ("Avid"), Digidesign, Inc. ("Digidesign"), Cakewalk Company L.P. ("Cakewalk"), CreamWare GmbH ("Creamware"), Euphonix, Inc. 9 ("Euphonix"), InSync Interactive Corp.("InSync"), Sonic Solutions, and Steinberg Soft-Und Hardware GmbH ("Steinberg") offer products which compete directly or indirectly with one or more of the Company's own products. Most of the Company's competitors or potential competitors have significantly greater financial, management, technical and marketing resources than the Company. The Company could also face future competition from Microsoft, Adobe Systems, Inc. ("Adobe"), Macromedia, Inc. ("Macromedia"), Autodesk, Inc.("Autodesk") or Oracle Corporation ("Oracle"). Each of these potential competitors has substantially greater resources than the Company and could become a significant competitor. Moreover, many of the Company's competitors and potential competitors offer software products for the MacIntosh operating system, which many musicians have traditionally utilized. There can be no assurance that such potential customers will accept the Company's Windows- based software products. In addition, there can be no assurance that market sentiment for MacIntosh or other competing operating systems, such as Java, will not overtake the current dominant market position of Windows-based systems, upon which the Company's products are based. In addition, due to the low barriers to entry in the computer software market, there can be no assurance that a new company will not be able to effectively compete with the Company. The Company's competitors may be able to develop products comparable or superior to those offered by the Company or adapt more quickly than the Company to new technologies or evolving customer requirements. Accordingly, there can be no assurance that the Company will be able to compete effectively in its target markets, that competition will not intensify or that future competition will not have a material adverse effect on the Company. See "Business--Competition." Possible Need For Additional Financing. The Company anticipates that the net proceeds from this Offering and cash provided by operations will enable it to meet its capital and operational requirements for at least the 12 months following the date of this Prospectus, although there can be no assurance that such resources will be sufficient to satisfy the Company's capital and operational requirements for such period. This expectation is based on the Company's current operating plan which can change as a result of many factors, and the Company could require additional funding sooner than anticipated. In addition, unplanned acquisition and development opportunities and other contingencies may arise, which also could require additional capital. Sources of funds may include the issuance of common or preferred stock sold in a public offering or in private placements, or the issuance of debt or bank financing. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in dilution to the Company's stockholders. Warrants may also be issued in connection with debt or bank financing, which could also result in dilution to the Company's stockholders. The Company may seek additional financing prior to the effective date of the Offering in order to exercise an option, which expires on March 31, 1998, to purchase an additional facility. See "Business-- Facilities." Moreover, under the terms of the Company's Amended and Restated Articles of Incorporation ("Articles of Incorporation"), subject to certain exceptions, holders of the Company's Series B Preferred Stock must consent to the incurrence of any debt (as defined therein) by the Company. Failure to obtain such consent could adversely affect the Company's ability to raise sufficient cash to pay operating expenses, if needed. There can be no assurance that the Company would be able to obtain capital on a timely basis, on favorable terms, or at all. If the Company is unable to obtain such financing, or generate funds from operations sufficient to meet its needs, the Company would be materially adversely affected. See "Use of Proceeds." Microsoft Relationship. The Company has in the past been given access by Microsoft to certain of its new software codes. This has given the Company the ability to quickly produce new software products that are adaptable to new Windows software. In connection with this grant of access, the Company has entered into a non-disclosure agreement with Microsoft. There can be no assurance that Microsoft will continue to give the Company access to its new software codes. In the event Microsoft does not continue to give the Company access to its new software codes, the Company's ability to adapt its products to new Windows software will be materially adversely impacted, which in turn could have a material adverse effect on the Company. Third-Party Distributor. The Company recently signed an agreement with Ingram Micro, Inc. ("Ingram Micro") to handle sales and distribution to various computer resellers, value-added resellers ("VARs"), catalog 10 distributors and smaller retail outlets. Under the distribution agreement, the Company has granted Ingram Micro the right to return unsold inventories in exchange for credit against open invoices. Likewise, price protection support is offered contractually, whereby the distributor is protected from price reductions. Returns of large amounts of unsold inventory, or a large amount of claims for refunds due to price reduction, could have a material adverse effect on the Company. See "Business--Sales--Computer Distributor." Uncertain Protection Of Intellectual Property; Risks Associated With Licensed Third-Party Technology. The Company's success depends in part on its ability to protect its proprietary software. The Company relies on a combination of trade secret, contract, copyright and trademark law to establish and protect its proprietary rights in its products and technology. The Company does not currently have any patent protection for its products. The Company's software products are sold pursuant to "shrink wrap" licenses which set forth the terms and conditions under which the purchaser can use the product and which bind the purchaser by its acceptance and purchase of the products to such terms and conditions. Such shrink wrap licenses are not signed by licensees and may be unenforceable under the laws of certain jurisdictions. The Company also licenses certain of its proprietary rights to third parties. There can be no assurance that the licensees of such licenses will abide by compliance and quality control guidelines with respect to such proprietary rights or that such licensees will not take actions that would materially adversely affect the Company's business. Although the Company relies to a great extent on trade secret protection for much of its technology and has obtained confidentiality agreements from most of its key employees, there can be no assurance that third parties will not independently develop the same or similar technology, obtain unauthorized access to the Company's proprietary technology or misuse technology to which the Company has granted access. The Company believes that the rapid pace of innovation in the industry renders the innovation, skill and creativity of its development staff more influential to the Company's competitive success than the various legal protections of its technology. The computer software industry is characterized by frequent and substantial intellectual property litigation that often is complex and expensive and involves a significant diversion of resources and uncertainty of outcome. In the future, the Company may need to pursue litigation to enforce and protect its intellectual property and trade secrets or to defend against a claim of infringement or invalidity. The Company attempts to avoid infringing known proprietary rights of third parties in its product development efforts. However, the Company has not conducted and does not conduct comprehensive patent or trademark searches to determine whether it infringes patents or other proprietary rights held by third parties. In addition, it is difficult to proceed with certainty in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. If the Company were to discover that its products violate third-party proprietary rights, there can be no assurance that it would be able to obtain licenses to continue offering such products without substantial reengineering or that any effort to undertake such reengineering would be successful, that any such licenses would be available on commercially reasonable terms, if at all, or that litigation regarding alleged infringement could be avoided or settled without substantial expense and damage awards. Any claims against the Company relating to the infringement of third-party proprietary rights, even if not meritorious, could result in the expenditure of significant financial and managerial resources and in injunctions preventing the Company from distributing certain products. Such claims could materially adversely affect the Company. Although the Company believes that its products and their use do not infringe the proprietary rights of third parties, the Company received a communication in December, 1997 from a third party asserting that one of the Company's product names, "Acoustics Modeler," infringes the proprietary rights of such third party. The Company disagrees with the position of the third party, but plans in any event to phase out use of the product name "Acoustics Modeler" over the next six months. The Company has also received communication from an additional third party relating to an alleged infringement of such third party's patent by the Company. The Company has not received any further communication from such third party since May 1996, and such third party's patent expires in May 1998; however, there can be no assurance that such third party will not take legal action against the Company. The Company may in the future receive communications from other third parties asserting that the Company's products infringe, or may infringe, the proprietary rights of such third parties. 11 The Company also relies on certain technology that it licenses from third parties, including software that is integrated with the Company's internally developed software and used in the Company's products, to perform key functions. There can be no assurance that such third-party technology licenses will continue to be available to the Company on commercially reasonable terms. The loss of any of these technologies could have a material adverse effect on the Company. In addition, the Company has agreed to indemnify certain distributors and original equipment manufacturers ("OEMs") from claims that its technology infringes the proprietary rights of others. There can be no assurance that infringement or invalidity claims arising from the incorporation of third-party technology, and claims for indemnification from the Company's distributors and OEMs resulting from such claims, will not be asserted or prosecuted against the Company. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources in addition to potential product redevelopment costs and delays, all of which could materially adversely affect the Company. The Company has also signed nondisclosure agreements to protect the trade secrets and confidential information of other companies. While the Company has made and continues to make diligent efforts to protect such third party information, there can be no assurance that such information will be adequately protected, or that, notwithstanding the Company's efforts to protect such trade secrets and confidential information, a third party will not attempt to hold the Company liable for disclosure of such information. Any liability to a third party for failing to protect trade secrets or confidential information may have a material adverse effect on the Company. The laws of foreign countries treat the protection of proprietary rights of the Company in its products differently from and may not protect the Company's proprietary rights to the same extent as do laws in the United States. See "Business--Intellectual Property." Sales and Other Taxes. The Company currently does not collect sales or similar taxes with respect to the sale of products, license of technology, or provision of services in states and countries other than states in which the Company has offices. However, one or more states or foreign countries may seek to impose sales or other tax obligations on companies that engage in online commerce within their jurisdictions. A successful assertion by one or more states or any foreign country that the Company should collect sales or other taxes on the sale of products, license of technology, or provision of services, or remit payment of sales or other taxes for prior periods, could have a material adverse effect on the Company. Risks Associated With International Expansion. For the year ended December 31, 1996 and the nine months ended September 30, 1997, approximately 18% and 27%, respectively, of the Company's total net revenues were generated from sources outside the United States. As a result, the Company is subject to the risks of doing business abroad, including unexpected changes in regulatory requirements, export and import restrictions, tariffs and other trade barriers, difficulties in staffing and managing foreign operations, longer payment cycles, problems in collecting accounts receivable, potential adverse tax consequences, exchange rate fluctuations, increased risks of piracy, limits on the Company's ability to enforce its intellectual property rights, limits on repatriation of funds and political risks that may limit or disrupt international sales. Such limitations and interruptions could have a material adverse effect on the Company. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Sales." Dependence On Key Personnel. The Company's future success depends in large part on the continued services of Rimas Buinevicius, Monty R. Schmidt, and Curtis Palmer, the Company's Chief Executive Officer, President, and Chief Technology Officer, respectively, and on its ability to continue to attract, motivate and retain highly qualified employees. The Company has entered into employment agreements with Messrs. Buinevicius, Schmidt and Palmer, and the Company is the beneficiary of $1,000,000 key man life insurance policies on the lives of each of these individuals; however, one of the Company's lenders is an assignee of such policies. Competition for highly qualified employees is intense and the process of locating key technical and management personnel with the combination of skills and attributes required to execute the Company's strategy is often lengthy. There can be no assurance that the Company will be successful in attracting, motivating and retaining key personnel. The loss of the services of one or more members of management or key employees, or the inability to hire additional personnel as needed, could have a material adverse effect on the Company. See "Management." 12 Lack Of Experience Of Representatives. Dirks & Company, Inc., one of the Representatives, commenced operations in July 1997, and Securities Capital Trading Corp., the other Representative, commenced operations in June 1995. Neither of the Representatives has co-managed or participated as an underwriter in any public offering of securities. Accordingly, neither of the Representatives have any experience as a co-manager or underwriter of public offerings of securities. See "Underwriting." Shares Eligible For Future Sale. All of the 2,368,060 shares of Common Stock (assuming no exercise of outstanding options or warrants) and 1,000,000 Warrants to be outstanding upon completion of this Offering (2,668,060 shares of Common Stock and 1,150,000 Warrants if the Over-Allotment Option is exercised in full) will be immediately freely tradeable without restriction under the Securities Act of 1933, as amended (the "Securities Act"), except for any securities purchased by an "affiliate" of the Company (as that term is defined in the Securities Act), which securities will be subject to the resale limitations of Rule 144 under the Securities Act. All of the 6,879,732 shares of Series B Preferred Stock outstanding are "restricted securities," as that term is defined in Rule 144 under the Securities Act, and may not be resold in a public distribution, except in compliance with the registration requirements of the Securities Act or unless converted into Common Stock and resold pursuant to Rule 144. The sale, or availability for sale, of substantial amounts of Common Stock resulting from conversion of the outstanding Series B Preferred Stock in the public market subsequent to this Offering pursuant to Rule 144 or otherwise could materially adversely affect the market price of the Securities and could impair the Company's ability to raise additional capital through the sale of its equity securities or debt financing. Each officer and director of the Company, all holders of the shares of Series B Preferred Stock and Common Stock, and all holders of options and warrants to acquire shares of Common Stock have agreed not to, directly or indirectly, offer, sell, transfer, pledge, assign, hypothecate or otherwise encumber or dispose of any of the Company's securities, whether or not presently owned, for a period of 12 months after the date of this Prospectus, or 90 days after the date of this Prospectus in the case of the Selling Stockholders, without the prior written consent of the Company and the Representatives. Beginning 12 months after the date of this Prospectus, all 3,439,866 shares of Common Stock issuable upon conversion of the 6,879,732 shares of Series B Preferred Stock, along with 330,000 shares of Common Stock which may be acquired upon the exercise of options granted under the Company's Plan and 60,000 shares of Common Stock which may be acquired upon the exercise of a warrant, may be sold in accordance with Rule 144. See "Shares Eligible for Future Sale." Portion of Offering Proceeds Benefiting Management. Net proceeds to the Company from the sale of the Securities offered hereby will be used to repay certain indebtedness guaranteed by Monty Schmidt and Curtis Palmer, the Company's President and Chief Technology Officer, respectively, thereby releasing such guarantees. See "Use of Proceeds" and "Certain Transactions." No Prior Public Market For The Securities; Arbitrary Determination Of Offering Price; Price Volatility. Prior to this Offering, there has been no public market for the Securities, and there can be no assurance that an active trading market for any of the Securities will develop or, if developed, be sustained after the Offering. See "Underwriting." The initial public offering prices of the Securities and the exercise price and terms of the Warrants have been determined arbitrarily by negotiations between the Company and the Representatives. Factors considered in such negotiations, in addition to prevailing market conditions, included the history of and prospects for the industry in which the Company competes, an assessment of the Company's management, the prospects of the Company, its capital structure and the market for initial public offerings. Therefore, the public offering prices of the Securities and the exercise prices and terms of the Warrants do not necessarily bear any relationship to the Company's assets, book value, results of operations or any other established valuation criteria and may not be indicative of prices that may prevail at any time or from time to time in the public market for the Securities. See "Underwriting." The securities markets have from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. In addition, the market prices of the common stock of many publicly traded software companies have in the past been, and can 13 in the future be expected to be, especially volatile. Economic and other external factors, as well as period-to-period fluctuations in the Company's financial results, may have a significant impact on the market prices of the Securities. Potential Adverse Effect Of Representatives' Warrants. At the consummation of the Offering, the Company will sell to the Representatives and/or their designees, for nominal consideration, warrants (the "Representatives' Warrants") to purchase up to 200,000 shares of Common Stock and/or 100,000 Warrants. The Representatives' Warrants will be exercisable for a period of four years commencing at the beginning of the second year after their issuance and sale, at an exercise price of $ per Share [120% of the public offering price of the Common Shares] and at an exercise price of $ per Warrant [120% of the public offering price of the Warrants]. The Warrants issuable upon exercise of the Representatives' Warrants will be initially exercisable, at an exercise price of $ per share [100% of the exercise price of the Warrants]. For the term of the Representatives' Warrants, the holders thereof will have, at nominal cost, the opportunity to profit from a rise in the market price of the Securities without assuming the risk of ownership, with a resulting dilution in the interest of other security holders. As long as the Representatives' Warrants remain unexercised, the Company's ability to obtain additional capital might be adversely affected. Moreover, the Representatives may be expected to exercise the Representatives' Warrants at a time when the Company would, in all likelihood, be able to obtain any needed capital through a new offering of its securities on terms more favorable than those provided by the Representatives' Warrants. See "Underwriting." Speculative Nature Of The Warrants. The Warrants do not confer any rights of Common Stock ownership on their holders, such as voting rights or the right to receive dividends, but rather merely represent the right to acquire shares of Common Stock at a fixed price for a limited period of time. Specifically, commencing , 1998 [six months after the date of this Prospectus], holders of the Warrants may exercise their right to acquire Common Stock and pay an exercise price of $ per share [150% of the initial public offering price of the Common Stock], subject to adjustment upon the occurrence of certain dilutive events, until , 2003 [60 months after the date of this Prospectus], after which date any unexercised Warrants will expire and have no further value. Moreover, following the completion of this Offering, the market value of the Warrants will be uncertain and there can be no assurance that the market value of the Warrants will equal or exceed their initial public offering price. There can be no assurance that the market price of the Common Stock will ever equal or exceed the exercise price of the Warrants and, consequently, whether it will ever be profitable for holders of the Warrants to exercise the Warrants. Potential Adverse Effect Of Redemption Of Warrants. Commencing , 1999 [18 months after the date of this Prospectus], the Warrants will be subject to redemption by the Company at $0.10 per Warrant on thirty days' prior written notice to the warrantholders if the average closing sale price of the Common Stock as reported on the Amex equals or exceeds $20.00 per share of Common Stock for any 20 trading days within a period of thirty (30) consecutive trading days ending on the fifth trading day prior to the date of the notice of redemption. If the Warrants are redeemed, holders of the Warrants will lose their rights to exercise the Warrants after the expiration of the 30-day notice of redemption period. Upon receipt of a notice of redemption, holders would be required to: (i) exercise the Warrants and pay the exercise price at a time when it may be disadvantageous for them to do so, (ii) sell the Warrants at the current market price, if any, when they might otherwise wish to hold the Warrants or (iii) accept the redemption price which is likely to be substantially less than the market value of the Warrants at the time of redemption. See "Description of Securities--Warrants." Potential Adverse Effect Of Substantial Shares Of Common Stock Reserved. The Company has reserved a total of 5,889,866 shares of Common Stock for issuance as follows: (i) 60,000 shares for issuance upon exercise of the outstanding warrant; (ii) 200,000 shares for issuance upon exercise of the Representatives' Warrants; (iii) 100,000 shares for issuance upon exercise of the Warrants issuable upon exercise of the Representatives' Warrants; (iv) 1,000,000 shares reserved for issuance upon exercise of the Warrants; (v) 699,050 shares in the aggregate for issuance upon exercise of options granted pursuant to the Plan; (vi) 30,000 shares reserved for issuance upon exercise of options granted pursuant to the Directors' Stock Option Plan; (vii) 3,439,866 shares 14 reserved for issuance upon the conversion of 6,879,732 shares of Series B Preferred Stock; (viii) 300,950 shares reserved for issuance pursuant to grants that may be made under the Plan; and (ix) 60,000 shares reserved for issuance pursuant to grants that may be made under the Directors' Stock Option Plan. The existence of the Warrants, the Representatives' Warrants and the other options or warrants, and the Series B Preferred Stock may adversely affect the Company's ability to consummate future equity financings. Further, the holders of the warrants and options may exercise them at a time when the Company would otherwise be able to obtain additional equity capital on terms more favorable to the Company. See "Shares Eligible for Future Sale." Legal Restrictions On Sales Of Shares Underlying The Warrants. The Warrants are not exercisable unless, at the time of the exercise, the Company has a current prospectus covering the shares of Common Stock issuable upon exercise of the Warrants, and such shares have been registered, qualified or deemed to be exempt under the securities laws of the state of residence of the exercising holder of the Warrants. Although the Company has agreed to use its best efforts to keep a registration statement covering the shares of Common Stock issuable upon the exercise of the Warrants effective for the term of the Warrants, if it fails to do so for any reason, the Warrants may be deprived of value. The Shares and Warrants are detachable and separately transferable immediately following completion of the Offering. Purchasers may buy Warrants in the aftermarket in or may move to jurisdictions in which the shares underlying the Warrants are not so registered or qualified during the period that the Warrants are exercisable. In this event, the Company would be unable to issue shares to those persons desiring to exercise their Warrants, and holders of Warrants would have no choice but to attempt to sell the Warrants in a jurisdiction where such sale is permissible or allow them to expire unexercised. See "Description of Securities." Limitations On Liability And Indemnification Matters. The Articles of Incorporation of the Company limit the liability of the directors of the Company to the Company or its stockholders (in their capacity as directors but not in their capacity as officers) to the fullest extent permitted by the Maryland General Corporation Law (the "MGCL"). Accordingly, pursuant to the terms of the MGCL as presently in effect, the Company may indemnify any director unless it is established that: (i) the act or omission of the director was material to the matter giving rise to the proceeding and was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the director actually received an improper personal benefit in money, property or services; or (iii) in the case of any criminal proceeding, the director had reasonable cause to believe that the act or omission was unlawful. In addition, the Company's Amended and Restated Bylaws (the "Bylaws"), require the Company to indemnify each person who is or was, a director, officer, employee or agent of the Company to the fullest extent permitted by the laws of the State of Maryland in the event he is involved in legal proceedings by reason of the fact that he is or was a director, officer, employee or agent of the Company, or is or was serving at the Company's request as a director, officer, employee or agent of another corporation, partnership or other enterprise. The Company may also advance to such persons expenses incurred in defending a proceeding to which indemnification might apply, upon terms and conditions, if any, deemed appropriate by the Board of Directors upon receipt of an undertaking by or on behalf of such director or officer to repay all such advanced amounts if it is ultimately determined that he is not entitled to be indemnified as authorized by the laws of the State of Maryland. See "Description of Securities--Limitation on Directors' and Officers' Liability; Indemnification." Risks Associated With Forward-Looking Statements Included In This Prospectus. This Prospectus contains certain forward-looking statements, including, without limitation, the plans and objectives of management for future products and future operations. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. The Company's plans and objectives are based on a successful execution of the Company's strategy, the assumption that the software industry will not change materially or adversely, and that there will be no unanticipated material adverse change in the Company's operations or business. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. 15 Although the Company believes that its assumptions underlying the forward- looking statements are reasonable, any of the assumptions could prove inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Prospectus will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, particularly in view of the Company's early stage of operations, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved. Dilution. Purchasers of Shares in this Offering will experience immediate and substantial dilution of $5.09 per share or 68% assuming an initial public offering price of $7.50 per Share and assuming all of the Series B Preferred Stock is converted into Common Stock. To the extent outstanding options and warrants to purchase shares of Common Stock are exercised, there will be further dilution. The current holders of Series B Preferred Stock of the Company, including officers and directors, acquired their shares of Series B Preferred Stock for nominal consideration or for consideration substantially less than the initial public offering price of the Shares offered hereby. As a result, new investors will bear substantially all of the risks inherent in an investment in the Company. See "Dilution." Dividend Policy. The Company has never declared or paid cash dividends on the Common Stock or Series B Preferred Stock and does not anticipate paying any cash dividends in the foreseeable future. Pursuant to the Company's Articles of Incorporation, no dividends may be paid on the Common Stock if the Company is in arrears in the payment of dividends on the Series B Preferred Stock. At September 30, 1997, the amount of dividends in arrears on the Series B Preferred Stock was $835. See "Dividend Policy." Anti-Takeover Considerations. Certain provisions of the Company's Articles of Incorporation and Bylaws may have the effect of discouraging, delaying or making more difficult a change in control of the Company or preventing the removal of incumbent directors even if some, or a majority, of the Company's stockholders were to deem such an attempt to be in the best interest of the Company. Among other things, the Articles of Incorporation provide for a classified Board of Directors and require the affirmative vote of holders of at least two-thirds of the Series B Preferred Stock to approve the creation of debt or certain classes of preferred stock, or to approve certain amendments to the Company's Articles of Incorporation. The Articles of Incorporation also allow the Board of Directors to issue up to five million shares of Preferred Stock and fix the rights, privileges and preferences of those shares without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. See "Description of Securities--Certain Articles of Incorporation and By-Law Provisions." USE OF PROCEEDS The net proceeds to the Company from the sale of the Securities offered hereby, after deduction of underwriting discounts and other estimated expenses relating to the Offering, are estimated to be approximately $12,637,000 (or $14,607,550 if the Over-Allotment Option is exercised in full). The Company intends to use the net proceeds as follows:
NET PROCEEDS PERCENT OF TOTAL ------------ ---------------- Product development expenses...................... $ 4,500,000 35% Facilities and other capital expenditures......... 1,700,000 13 Sales and marketing expenditures.................. 2,600,000 21 Expansion of internal operations.................. 750,000 6 Repayment of existing indebtedness................ 1,000,000 8 Working capital and general corporate purposes.... 2,087,000 17 ----------- --- Total......................................... $12,637,000 100% =========== ===
Product Development Expenses. The Company intends to use approximately $ 4,500,000 of the net proceeds of the Offering to significantly increase its investment in product development activities associated with the 16 development of new products, including new products to be used on the Internet, the completion of the development of its ACID and VEGAS software products, and the continued enhancement of the Company's existing products, including enhancement of products for use on the Internet. The Company also expects to make expenditures for the licensing of technology, for the acquisition of additional software products, and for the hiring of additional, experienced, software engineers. Facilities and Other Capital Expenditures. The Company intends to use approximately $1,000,000 of the net proceeds of the Offering to exercise its option to acquire and renovate a building adjacent to its principal facility for required expansion space. The purchase option is in the amount of $340,000 and expires on March 31, 1998. If the Offering is not completed before March 31, 1998, the Company will seek other financing in order to exercise the purchase option and the amount allocated for the exercise of the purchase option would be reallocated to working capital and general corporate purposes. Additionally, the Company expects to use $700,000 of the net proceeds of the Offering to lease additional space for sales and administrative offices, and to invest in additional personal computers, networking systems, furniture, fixtures, leasehold improvements, and related equipment. See "Business-- Facilities." Sales and Marketing Expenditures. The Company intends to use approximately $2,600,000 of the net proceeds of the Offering for the sale and marketing of the Company's existing and new products, including $1,600,000 for advertising and trade show related activities, $500,000 for expansion of the level of technical support offered to its dealers and customers and $500,000 for the opening of sales offices in several locations, including Europe and the eastern and western coasts of the United States. Repayment of Existing Indebtedness. The Company intends to use approximately $1,000,000 of the net proceeds of the Offering to repay the Company's existing indebtedness. Such indebtedness consists of (i) a $620,000 term loan due January 3, 2003, bearing interest at 7.71% per annum, (ii) a $250,000 revolving line of credit bearing interest at prime plus 1% per annum (9.5% at December 31, 1997) of which $70,000 was outstanding on December 31, 1997, and (iii) an equipment loan due February 2002, bearing interest at 9.75% per annum, of which $129,000 was outstanding on December 31, 1997. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." Expansion of Internal Operations. The Company intends to use approximately $750,000 of the net proceeds of the Offering for expansion of internal operations, including further improvement of the Company's management information systems and the continued development of the Company's website. Working Capital and General Corporate Purposes. The Company intends to use the remainder of the net proceeds of the Offering for working capital and general corporate purposes. The foregoing represents the Company's best estimate of its allocation of the net proceeds of the Offering, based on the current state of its operations, its current plans and current economic conditions. Proceeds may be reapportioned among the categories listed above. The amount and timing of expenditures will vary depending upon a number of factors, including progress of the Company's operations, technical advances, terms of collaborative arrangements, and changes in competitive conditions. The Company also expects, when the opportunity arises, to acquire or invest in complementary businesses, products or technologies. The Company has no present understandings, commitments or agreements with respect to any material acquisition or investment. The Company currently anticipates that the net proceeds of this Offering, along with cash provided by operations, will enable it to meet its operational and capital requirements for at least the 12 months following the date of this Prospectus. However, there can be no assurance that the net proceeds of this Offering and cash provided by operations will satisfy the Company's requirements for any particular period of time. To the extent capital resources are insufficient to meet future capital requirements, the Company will have to raise additional funds to satisfy the Company's requirements. There can be no assurance that such funds will be available on favorable terms, or at all. See "Risk Factors--Possible Need for Additional Financing." Pending application of the net proceeds of the Offering, the Company intends to invest such net proceeds in interest-bearing, short-term investment grade financial instruments. 17 DIVIDEND POLICY The Company has never declared or paid any cash dividends on its Common Stock or Series B Preferred Stock. The Company intends for the foreseeable future to reinvest earnings, if any, to fund the development and expansion of its business. The declaration of dividends in the future will be at the discretion of the Board of Directors and will depend upon the earnings, capital requirements and financial position of the Company, general economic conditions and other pertinent factors. In addition, pursuant to the Company's Articles of Incorporation, no dividends may be paid on the Company's Common Stock if the Company is in arrears in the payment of dividends on the Series B Preferred Stock. At September 30, 1997, the amount of dividends in arrears on the Series B Preferred Stock was $835. CAPITALIZATION The following table sets forth the capitalization of the Company as of September 30, 1997, (a) on an actual basis and (b) on a pro forma as adjusted basis giving effect to (i) the sale of 130,300 shares of Common Stock in the quarter ended December 31, 1997, (ii) the conversion of a note in the principal amount of $40,000 into 8,000 shares of Common Stock in October 1997, and (iii) the receipt by the Company of the estimated net proceeds from the sale of the Shares and Warrants at the assumed initial public offering price of $7.50 per Share and $0.10 per Warrant, and the use of a portion of the net proceeds toward repayment of long-term debt. This table should be read in conjunction with the Company's Financial Statements and related notes thereto appearing elsewhere in this Prospectus.
SEPTEMBER 30, 1997 ----------------------- PRO FORMA, ACTUAL AS ADJUSTED ---------- ----------- Long-Term Debt........................................ $ 702,443 $ 0 ---------- ----------- Stockholders' Equity:(1) Preferred Stock--$.01 par value, authorized 5,000,000 shares; none issued and outstanding; 5% Preferred Stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 10,000,000 shares, issued and outstanding 6,879,732 shares actual and pro forma, as adjusted........................................ 68,797 68,797 Common Stock, $.01 par value, authorized 20,000,000 shares; issued and outstanding 229,760 shares, actual and 2,368,060 shares pro forma, as adjusted. 2,298 23,681 Common stock warrant................................ 78,000 78,000 Additional paid-in capital.......................... 1,363,900 14,871,017 Retained earnings................................... (828,581) (828,581) ---------- ----------- Total stockholders' equity.......................... $ 684,414 $14,012,914 ---------- ----------- Total capitalization.............................. $1,386,857 $14,012,914 ========== ===========
- -------- (1) Does not include: (i) 699,050 shares of Common Stock issuable upon the exercise of options granted under the Plan; (ii) 300,950 shares of Common Stock issuable upon the exercise of options that may be granted under the Plan; (iii) 30,000 shares of Common Stock issuable upon the exercise of options granted under the Directors' Stock Option Plan; (iv) 60,000 shares of Common Stock issuable upon the exercise of options that may be granted under the Directors' Stock Option Plan; (v) 3,439,866 shares of Common Stock issuable upon conversion of the 6,879,732 outstanding shares of Series B Preferred Stock; and (vi) 60,000 shares of Common Stock issuable upon the exercise of a warrant currently outstanding. See "Management-- 1995 Stock Option Plan," "Management--Directors' Compensation" and "Description of Securities." 18 DILUTION As of September 30, 1997, the pro forma net tangible book value of the Common Stock was $1,375,914, or approximately $0.36 per share of Common Stock, calculated as if the Series B Preferred Stock was converted into Common Stock and giving effect to (a) the sale of 130,300 shares of Common Stock in the quarter ended December 31, 1997 and (b) the conversion of a note payable in the principal amount of $40,000 into 8,000 shares of Common Stock in October 1997. Pro forma net tangible book value per share represents the total amount of tangible assets less total liabilities divided by the number of shares of Common Stock issued and outstanding. After giving effect to the sale of the Shares and Warrants offered hereby and assuming conversion of the Series B Preferred Stock (after deducting underwriting discounts and commissions and estimated offering expenses payable by the Company), the pro forma net tangible book value of the Company at September 30, 1997 would have been $14,012,914, or approximately $2.41 per share of Common Stock. This represents an immediate increase in net tangible book value of $2.05 per share of Common Stock to existing stockholders and an immediate dilution in net tangible book value of $5.09 per share of Common Stock or 68% to new investors. The following table illustrates this per share dilution: Assumed initial public offering price per Share.................... $7.50 Pro forma net tangible book value per share prior to this Offering ................................................... $0.36 Increase per share attributable to this Offering ............ 2.05 ----- Pro forma net tangible book value per share after this Offering ... 2.41 ----- Dilution per share to new investors ............................... $5.09 =====
The computations in the table set forth above assume that the Over-Allotment Option is not exercised. If the Over-Allotment Option is exercised in full, the pro forma net tangible book value as of September 30, 1997 would have been $15,983,464 or $2.62 per share of Common Stock, resulting in dilution to new investors of $4.88 per share of Common Stock. The following table summarizes, on a pro forma basis to reflect the same adjustments described above, the number of shares of Common Stock purchased from the Company, the total consideration paid and the average price per share paid by (i) existing stockholders of Common Stock, and (ii) new stockholders in the Offering, assuming the sale of the Common Stock and Warrants offered hereby. The calculations are based upon total consideration given by new investors and existing stockholders before any deduction of underwriting discounts and offering expenses payable by the Company. All figures in this table are presented as if the Series B Preferred Stock was converted into Common Stock upon the purchase thereof.
SHARES PURCHASED TOTAL CONSIDERATION ----------------- ------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE --------- ------- ----------- ------- ------------- Existing stockholders....... 3,807,926 66% $ 2,023,322 12% $0.53 New investors(1)............ 2,000,000 34% 15,000,000 88% $7.50 --------- ---- ----------- ---- Total................... 5,807,926 100% $17,023,322 100% ========= ==== =========== ====
- -------- (1)Attributes no value to the Warrants. 19 SELECTED FINANCIAL DATA The following table presents selected statement of operations and balance sheet data for the periods presented. The selected financial and operating data as of and for the nine months ended September 30, 1997 were derived from the Company's financial statements, which have been audited by Ernst & Young LLP, independent auditors. The selected financial and operating data as of and for the years ended December 31, 1995 and 1996 were derived from the Company's financial statements, which have been audited by Williams, Young & Associates LLC, independent auditors. The selected financial and operating data as of and for the nine months ended September 30, 1996 have been derived from the Company's unaudited financial statements. In the opinion of management, such data for such interim period presented below includes all adjustments (consisting only of normal, recurring accruals) necessary to present fairly the financial position and results of operations of the Company as of the dates and for the periods indicated on a basis consistent with the Financial Statements. The results for any interim period are not necessarily indicative of results for a full year. The selected financial data set forth below is qualified in its entirety by, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Financial Statements and notes thereto appearing elsewhere in this Prospectus.
YEAR ENDED DECEMBER NINE MONTHS ENDED 31, SEPTEMBER 30, -------------------- ---------------------- 1995 1996 1996 1997 -------- ---------- ---------- ---------- STATEMENT OF OPERATIONS DATA: Software license fees............ $757,579 $2,442,047 $1,623,066 $2,242,512 Cost of software license fees.... 82,053 372,272 199,349 407,099 -------- ---------- ---------- ---------- Gross profit..................... 675,526 2,069,775 1,423,717 1,835,413 -------- ---------- ---------- ---------- Selling and marketing expenses... 234,636 954,243 627,349 1,445,302 General and administrative expenses........................ 256,417 717,664 467,940 834,934 Product development expenses..... 150,082 183,740 97,071 374,128 -------- ---------- ---------- ---------- Total operating expenses......... 641,135 1,855,647 1,192,360 2,654,364 -------- ---------- ---------- ---------- Income (loss) from operations.... 34,391 214,128 231,357 (818,951) Other income (expense)........... (1,067) (15,034) (10,292) (40,140) -------- ---------- ---------- ---------- Income (loss) before income taxes........................... 33,324 199,094 221,065 (859,091) Income tax expense (benefit)..... 0 20,000 0 (20,000) -------- ---------- ---------- ---------- Net income (loss)................ $ 33,324 $ 179,094 $ 221,065 $ (839,091) ======== ========== ========== ========== Pro forma net income (loss) per common share(1) ................ $ .07 $ .08 $ .27 $ (1.11) ======== ========== ========== ========== Pro forma weighted average common and common equivalent shares(1). 392,116 1,712,669 523,443 760,111 ======== ========== ========== ==========
DECEMBER 31, ------------------- SEPTEMBER 30, 1995 1996 1997 -------- ---------- ------------- BALANCE SHEET DATA: Working capital (deficit)..................... $ 52,904 $ 515,385 $ (264,853) Total assets.................................. 238,086 1,627,122 2,332,963 Long-term liabilities......................... 0 20,000 702,443 Stockholders' equity.......................... 175,316 1,076,705 684,414
- -------- (1) See Note 1 to the Financial Statements of the Company. 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the financial statements and notes thereto included elsewhere in this Prospectus. This Prospectus contains forward-looking statements which involve risks and uncertainties. Actual events or results may differ materially from those discussed in forward-looking statements as a result of certain factors, including but not limited to, those set forth under "Risk Factors" and elsewhere in this Prospectus. OVERVIEW The Company is a leading provider of PC-based software products designed to run under the Windows and Windows NT operating systems. The Company's current products allow musicians, audio engineers and home users the ability to create, record, edit and design digital audio files and record or master their own audio CD's. The Company was incorporated in 1994 and immediately began shipment of Sound Forge, an entry-level digital-based audio editor developed by one of the Company's founders. Initially, the Company's efforts were focused on research activities aimed at developing an improved version of Sound Forge that would meet the needs of musicians and audio engineers. In December 1994 the Company released Sound Forge 3.0 and shifted its efforts to developing complementary add-on products, marketing Sound Forge and recruitment of support and development personnel. The Company's product line expanded in 1995 with the introduction of Sound Forge XP, a scaled down version of Sound Forge, and again in August 1996 with the introduction of Sound Forge 4.0 and plug-in products whose functions include noise reduction, spectrum analysis and batch conversion. In late 1996 the Company raised capital from the sale of additional equity to fund continued investments in research, development and recruitment activities, to purchase operating assets and to significantly expand marketing and brand recognition efforts. The Company released CD Architect, an audio mastering software product, in June 1997 and an acoustics modeler, a plug-in software product that allows users to overlay the acoustics of any environment upon an audio file, in August 1997. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," the Company capitalizes internal costs in developing software products upon determination that technological feasibility has been established for the product, whereas costs incurred prior to the establishment of technological feasibility are charged to product development expense. When the product is available for general release to customers, capitalization ceases and such costs are amortized on a product-by-product basis based on current and future revenue with an annual minimum equal to the straight-line amortization over the remaining estimated economic useful life of the product. Capitalized software development costs are reported at the lower of unamortized cost or net realizable value. The Company invested significant resources in sales, marketing, research and other operating activities during the nine-month period ended September 30, 1997. The Company believes that its success depends largely on building superior technology and quality into its products, extending its technological lead on the competition and developing brand recognition early in a product's life cycle. Accordingly, the Company expects to continue spending heavily on these activities in the near future. Despite these heavy investments in marketing and product development, the historical growth in software license fees may not be sustainable in the future. In light of the Company's limited operating history and rapid improvements in technology and marketing of its products, the Company believes that period-to-period comparisons of its revenues and operating results, including its gross profit and operating expenses as a percentage of total net revenues, are not necessarily meaningful and should not be relied upon as indications of future performance. The Company uses and expects to continue using sales promotions to encourage the purchase and use of its products. Additionally, the Company plans to build its brand awareness by expanding its efforts in developing OEM bundling arrangements with hardware and software developers which tend to have lower costs and much 21 higher volumes than traditional distribution arrangements. The effect of such sales promotions and OEM transactions may be material in certain periods and are difficult to predict. No assurances can be given that discount pricing and high volume OEM transactions will not have a permanent negative effect on the pricing of the Company's products. For the year ended December 31, 1996 and the nine months ended September 30, 1997, approximately 18% and 27%, respectively, of the Company's total revenues were generated from sources outside the U.S., including 4% and 6%, respectively, of the Company's total revenues which were generated from Asia. Although all products are priced in U.S. dollars, foreign currency fluctuations and general economic conditions abroad may have a significant impact on revenues. The Company does not expect the current economic situation in Asia to have a material impact on its results of operations. On September 30, 1997, the Company changed its fiscal year end to September 30 of each year. As a result, the Company's most recent fiscal year ended on September 30, 1997 and previous fiscal years ended on December 31, 1995 and 1996. The following table sets forth certain items from the Company's statement of operations as a percentage of net revenues for the periods indicated.
YEARS ENDED NINE MONTHS DECEMBER ENDED 31, SEPTEMBER 30, ------------ -------------- 1995 1996 1996 1997 ----- ----- ------ ------ Software license fees............................ 100.0% 100.0% 100.0% 100.0% Cost of software license fees.................... 10.8 15.2 12.3 18.2 ----- ----- ------ ------ Gross profit..................................... 89.2 84.8 87.7 81.8 Operating expenses: Selling and marketing.......................... 31.0 39.1 38.7 64.4 General and administrative..................... 33.8 29.4 28.8 37.2 Product development............................ 19.8 7.5 6.0 16.7 ----- ----- ------ ------ Total operating expenses......................... 84.6 76.0 73.5 118.3 ----- ----- ------ ------ Income (loss) from operations.................... 4.6 8.8 14.2 (36.5) Interest expense................................. 0.0 0.9 0.8 1.9 Other income (expense)........................... (0.2) 0.3 0.2 0.1 ----- ----- ------ ------ Income before income taxes....................... 4.4 8.2 13.6 (38.3) Income tax expense (benefit)..................... 0.0 0.9 0.0 (0.9) ----- ----- ------ ------ Net income (loss)................................ 4.4% 7.3% 13.6% (37.4)% ===== ===== ====== ======
RESULTS OF OPERATIONS Nine Months Ended September 30, 1996 and 1997 SOFTWARE LICENSE FEES The Company's revenues relate to software license fees, net of returns, charged for distribution of "shrink-wrapped" software packages sold to end users and dealers as well as license fees and royalties received from bundling of the Company's software with various hardware devices or software packages. Revenues for packaged software and OEM bundling arrangements are recorded when the product is delivered to the customer, net of any allowance for potential future returns and assuming no further significant obligations of the Company remain and collection is deemed probable. Royalty revenues are typically recorded quarterly upon acknowledgement from the licensee of amounts due. 22 Net software license fees increased by $620,000 to $2,243,000 for the nine- month period ended September 30, 1997 from $1,623,000 for the nine-month period ended September 30, 1996. The 1997 period realized the full impact of sales of Sound Forge 4.0 and plug-ins which were released in August 1996 as well as improved revenues associated with the appointment of additional dealers representing the Company's products in the music industry channel. To a lesser extent, the 1997 period was also impacted by the introduction of CD Architect and the Company's acoustics modeler product, released in June and August 1997, respectively. Software license fees to international customers accounted for 17% and 27% of software license fees for the nine-month periods ended September 30, 1996 and 1997, respectively. COST OF SOFTWARE LICENSE FEES Cost of software license fees include product material costs, assembly labor, freight and amortization of previously capitalized product development costs. Such costs increased by $208,000 to $407,000 for the nine-month period ended September 30, 1997 from $199,000 for the nine-month period ended September 30, 1996. Cost of software license fees were 12.3% and 18.2% of software license fees for the 1996 and 1997 periods, respectively. The increase in absolute dollars was primarily due to the substantial growth in revenues experienced during the 1997 period. Cost of license fees and the increase in costs as a percentage of software license fees were also affected by an increase in the amount of amortization of capitalized software development costs associated with the release of several new products in August 1996. Total amortization increased from $16,000 during the nine-month period ended September 30, 1996 to $86,000 for the nine-month period ended September 30, 1997. To a lesser extent, cost of software license fees were also affected by increased freight charges in the 1997 period as compared to the 1996 period due in part to the switch to more expensive freight carriers during the United Parcel Service strike. SELLING AND MARKETING EXPENSES Selling and marketing expenses include wages and commissions of sales, marketing and technical support personnel as well as advertising, direct mail, trade show and various promotional expenses. Such expenses increased by $818,000 to $1,445,000 during the nine-month period ended September 30, 1997 from $627,000 for the nine-month period ended September 30, 1996. Selling and marketing expenses, as a percentage of software license fees were 38.7% and 64.4% for the 1996 and 1997 periods, respectively. The increase in absolute dollars was primarily related to increased advertising, trade show and personnel costs incurred to support the increased growth in revenues. The higher level of selling and marketing costs as a percentage of software license fees resulted primarily from the Company's decision to hire and train sales and technical support personnel in advance of the introduction of new products. In addition, the Company expanded its presence at trade shows in an effort to build brand awareness, attract prospective dealers and distributors and expand its OEM business. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses consist of costs associated with facilities, finance, management information systems, and various employee benefits not fully allocated to functional areas. These costs increased by $367,000 to $835,000 during the nine-month period ended September 30, 1997 from $468,000 for the nine-month period ended September 30, 1996. General and administrative expenses, as a percentage of software license fees were 28.8% and 37.2% for the 1996 and 1997 periods, respectively. Increased costs primarily related to increases in salaries, benefits, rent, utilities, depreciation, bad debts and professional fees required to build an infrastructure to support the Company's new products. PRODUCT DEVELOPMENT EXPENSES Product development expenses include salaries and wages of the software research and development staff and an allocation of benefits, facility and administrative expenses, net of product development expenses 23 capitalized pursuant to SFAS No. 86, "Accounting for the Cost of Computer Software to be Sold, Leased, or Otherwise Marketed." Product development costs, less capitalized development costs increased by $277,000 to $374,000 during the nine-month period ended September 30, 1997 from $97,000 for the nine-month period ended September 30, 1996. Product development expenses, as a percentage of software license fees were 6.0% and 16.7% for the 1996 and 1997 periods, respectively. The percentage of total development effort expended on products that had reached the level of technological feasibility but were not ready for general release was significantly greater during the nine-month period in 1996 than in 1997, which contributed to the increase as a percentage of software license fees. Total product development costs capitalized in the 1996 period was $176,000 as compared to $114,000 in the 1997 period. The combined increase in product development expenses in the 1997 period as compared to the 1996 period, inclusive of capitalized product development costs, resulted primarily from an increase in the number of software developers needed to accelerate the release of products in 1996 and 1997 and to expand research efforts in the area of multi-threading and multi-processor implementations. INCOME TAX EXPENSE (BENEFIT) Income tax expense was affected by the Company's decision to terminate its election to be treated as a sub-chapter S Corporation for Federal and State income tax purposes as of October 31, 1996. Accordingly, during the nine-month period ended September 30, 1996, the income tax impact of earnings was passed through to the individual returns of the owners of the Company. The pre-tax loss of $859,091 during the nine-month period ended September 30, 1997 resulted in a reversal benefit of a deferred charge recorded in November and December 1996. Years Ended December 31, 1995 and 1996 SOFTWARE LICENSE FEES Software license fees increased by $1,684,000 to $2,442,000 in 1996 from $758,000 in 1995. The 1996 increase was primarily due to improved marketing efforts, growing market acceptance of the Company's products and the expanding suite of products available. In late 1995 the Company released its scaled down OEM oriented audio editor, Sound Forge XP, and in August 1996 released Sound Forge 4.0 and the noise reduction, spectrum analysis and batch converter plug- in products. Software license fees to international customers accounted for 25% and 18% of software license fees for the fiscal years ended December 31, 1995 and 1996, respectively. COST OF SOFTWARE LICENSE FEES Cost of software license fees increased by $290,000 to $372,000 in 1996 from $82,000 in 1995 and were 10.8% and 15.2% of software license fees for 1995 and 1996, respectively. The increase in absolute dollars was primarily due to the substantial growth in revenues experienced during 1996. Cost of software license fees and the increase in costs as a percentage of software license fees were also affected by increased amortization of previously capitalized software development costs consistent with the release of several new products in 1996. Total amortization increased from $12,000 in 1995 to $41,000 in 1996. SELLING AND MARKETING EXPENSES Selling and marketing expenses increased by $719,000 to $954,000 in 1996 from $235,000 in 1995. Selling and marketing expenses, as a percentage of software license revenues were 31.0% and 39.1% for 1995 and 1996, respectively. The increase in absolute dollars was primarily related to increased advertising, trade show and personnel costs incurred to market and support the increased growth in revenues. The higher level of sales and marketing expenses as a percentage of software license fees resulted primarily from the Company's decision to incur certain advertising costs and hire sales and technical support personnel in advance of the introduction of new products. In addition, the Company expanded its presence at trade shows in an effort to build brand awareness, attract prospective dealers and distributors and expand its OEM business. 24 GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses increased by $462,000 to $718,000 in 1996 from $256,000 in 1995. General and administrative expenses, as a percentage of software license fees were 33.8% and 29.4% for 1995 and 1996, respectively. The increase in absolute dollars primarily related to increases in salaries, benefits, rent, utilities, depreciation and other expenses required to build an infrastructure to support the Company's new products. To a lesser extent, general and administrative expenses increased in 1996 in connection with costs associated with the granting of warrants and other consulting fees paid to the Company's stockholder relations consultant. PRODUCT DEVELOPMENT EXPENSES Product development expenses, less any costs capitalized pursuant to SFAS No. 86, increased by $34,000, to $184,000 in 1996 from $150,000 in 1995. Product development expenses as a percentage of software license fees were 19.8% and 7.5% for 1995 and 1996, respectively. The level of effort expended on products that had reached the level of technological feasibility but were not ready for general release significantly increased in 1996 resulting in an increase in the amount of capitalization of software development from $0 in 1995 to $176,000 in 1996. The combined increase in research and development costs incurred in 1996 over 1995, inclusive of capitalized software development costs, resulted primarily from an increase in the number of software developers needed to accelerate the release of a new suite of audio products released in August 1996. INCOME TAX EXPENSE (BENEFIT) Income tax expense was affected in 1995 and through October 1996 by the Company's election to be treated as a sub-chapter S Corporation for Federal and State income tax purposes. During those periods, the income tax impact of earnings was passed through to the individual returns of the owners of the Company. The tax impact on pre-tax profits for the two-month period ended December 31, 1996 resulted in a deferred charge of $20,000 for Federal and state income taxes. The deferred nature of the charge resulted primarily from tax and book differences in treatment of depreciation and software development costs. Factors Affecting Operating Results As a result of the Company's limited operating history and the emerging nature of the markets in which it competes, the Company is unable to forecast its revenues accurately. The Company's expense levels are based in part on its expectations for future revenues. The Company may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, any significant shortfall in demand for the Company's products relative to the Company's expectations would have an immediate material adverse effect on the Company's business, financial condition and results of operations. Further, as a strategic response to changes in the competitive environment, the Company may from time to time implement pricing, service or marketing changes that could have a material adverse effect on its business, financial condition and results of operations. The Company expects to experience significant fluctuations in its future quarterly operating results due to a variety of factors, many of which are outside the Company's control, including (i) demand for the Company's products, (ii) introduction or enhancement of products by the Company and its competitors, (iii) market acceptance of new products of the Company and its competitors, (iv) price reductions by the Company or its competitors or changes in how products and services are priced, (v) the mix of products sold by the Company and its competitors, (vi) the mix of distribution channels through which the Company's products are licensed and sold, (vii) the mix of international and North American revenues, (viii) costs of litigation and intellectual property protection, (ix) the growth in the use of the Internet, (x) the Company's ability to attract and retain qualified personnel, (xi) the amount and timing of operating costs and capital expenditures related to expansion of the Company's business, operations and infrastructure, (xii) technical difficulties with respect to the use of the Company's products, (xiii) governmental regulations and (xiv) general economic conditions and economic 25 conditions specifically related to the Internet. It is often difficult to forecast what the effect of such factors would be, or the effect that any such factors or any combination thereof would have on the Company's results of operations for any given fiscal quarter. The Company has used, and expects to continue to use, price promotions to increase trial, purchase and use of its products, as well as to increase the overall brand awareness of the Company. The effect of such promotions on revenues in a particular period may be significant and extremely difficult to forecast. Based on the foregoing, the Company believes that its quarterly revenues, expenses and operating results could vary significantly in the future and the period-to-period comparisons should not be relied upon as indications of future performance. Due to the foregoing factors, it is likely that in some future quarters the Company's operating results will fall below the expectations of securities analysts and investors, which would likely have a material adverse affect on the trading price of the Securities. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has funded its operations largely through private sales of common stock and proceeds from issuances of notes payable. Cash provided by operating activities of $45,000 and $185,000 for fiscal years ended December 31, 1995 and 1996, respectively, were largely affected by net income of $33,000 and $179,000, respectively. Both periods were also impacted by the add-back of non-cash depreciation, amortization, deferred tax and stock compensation charges of $43,000 and $223,000, respectively, additional investments in accounts receivable and other assets of $64,000 and $500,000, respectively, and partially offset by increased trade credit from suppliers of $32,000 and $283,000, respectively. Cash provided by operating activities of $289,000 during the nine-month period ended September 30, 1996 was largely attributable to net income of $221,000, add-back of non-cash depreciation, amortization and stock compensation charges of $160,000, and additional credit obtained from trade creditors of $203,000 which was partially offset by an additional investment in accounts receivable and other assets of $295,000. The nine-month period ended September 30, 1997 resulted in cash used from operating activities of $325,000 largely attributable to the net loss of $839,000. The loss was partially offset by an add-back of non-cash depreciation, amortization and deferred tax charges of $164,000 and additional credit obtained from trade creditors of $325,000. Cash used in investing activities of $68,000 during the year ended December 31, 1995 was largely due to purchases of computer and office equipment. Cash used in investing activities of $560,000 during the year ended December 31, 1996 and $362,000 and $1,255,000 during the nine-month periods ended September 30, 1996 and 1997, respectively, were impacted by the purchase of computer and office equipment as well as the capitalization of software development costs of $176,000 in each of the 1996 periods and $212,000 during the nine-month period ended September 30, 1997. In addition, the Company spent $835,000 during the 1997 period to acquire and complete the renovation of a 10,000 square foot building to expand operations for sales, marketing, administrative and engineering efforts. Cash provided by financing activities of $805,000 during 1996 and $185,000 during the nine-month period ended September 30, 1996 were both impacted by the proceeds received from the issuance of notes payable in the principal amount of $100,000 and proceeds from a line of credit in the principal amount of $85,000. Cash provided by financing activities of $1,240,000 during the nine-month period ended September 30, 1997 were primarily affected by the proceeds of long-term notes payable of $748,000 and $510,000 in proceeds from the sale of Common Stock. In July 1996 the Company offered shares of Common Stock for sale in a private placement at a price of $5.00 per share. A total of 360,060 shares were sold as of December 31, 1997 with net proceeds to the Company of $1,782,000. Of the total sold, 127,800 shares ($620,000), was sold in the fourth quarter of 1996, 101,960 shares ($510,000), was sold during the nine- month period ended September 30, 1997 and 130,300 shares ($652,000), was sold during the quarter ended December 31, 1997. 26 In February 1997 the Company entered into a $620,000 construction loan with a bank to fund the purchase and renovation of a 10,000 square foot facility to house the Company's expanded operations. On January 8, 1998, the Company converted the construction loan into a term loan due January 3, 2003. The loan pays principal and interest monthly assuming a twenty year amortization and interest of 7.71% per annum. In February 1997 the Company repaid two $100,000 notes, one to a bank and the other to a group of private investors with the proceeds from a $250,000 revolving line of credit issued by a bank and bearing interest at prime plus 1% per annum (9.5% at December 31, 1997). As of December 31, 1997, there was $70,000 outstanding under the line of credit. In February 1997 the Madison Development Corporation provided the Company with a $150,000 equipment loan to fund the acquisition of computer and office equipment. The loan pays principal and interest monthly assuming a five-year amortization and an interest rate of 9.75% per annum and matures February, 2002. As of December 31, 1997, $129,000 was outstanding under such loan. The Company intends to pay its existing indebtedness with a portion of the net proceeds from this Offering. See "Use of Proceeds." The Company received the proceeds of a $40,000 unsecured note in August 1997 from certain relatives of a Company officer. The note paid interest monthly at 15% per annum and was convertible into Common Stock at $5.00 per share at the election of the Company. The Company exercised its right and converted the note into 8,000 shares of Common Stock in October 1997. Although the Company has no substantial commitments for capital expenditures, management anticipates there will be a need for increased capital expenditures and lease commitments in the next 12 months consistent with its anticipated growth in operations and infrastructure. The Company leases and holds a purchase option on approximately 8,000 square feet of partially heated storage space in a building adjacent to its principal facility. The purchase option is in the amount of $340,000 and expires on March 31, 1998. The Company expects to exercise its option and expend approximately $1,000,000 to purchase and renovate the space for office use in mid-1998. See "Risk Factors--Possible Need for Additional Financing," "Use of Proceeds" and "Business--Facilities." The Company has significantly increased its operating expenses since its inception and expects the need for significant investment in marketing and other support staff and associated costs to continue. Management believes that the net proceeds of this Offering and cash provided by operations will enable it to meet its operational and capital requirements for at least the 12 months following the date of this Prospectus. NET OPERATING LOSS CARRYFORWARDS At September 30, 1997, the Company had federal and state net operating loss carryforwards of approximately $919,000 and $925,000, respectively, available to offset future federal taxable income, expiring in 2012. In addition, the Company has research and development credits totaling approximately $50,000 which can be used to reduce federal and state taxable income through 2012. Federal and State tax laws limit the use of such carryforward benefits in certain circumstances. Although no event has taken place that would limit the Company's use of its net operating loss benefits, no assurances can be made that the Company will ultimately utilize them. NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share," which is required to be adopted effective for both interim and annual financial statements for periods ending after December 15, 1997. Among other provisions, the dilutive effect of stock options must be excluded under the new requirements for calculating basic earnings per share, which will replace primary earnings per share. This change is not expected to materially impact the Company's fully diluted earnings per share calculations. 27 In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes the standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) as part of a full set of financial statements. This statement requires that all elements of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The statement is effective for fiscal years beginning after December 15, 1997. Since this standard applies only to the presentation of comprehensive income, it will not have any impact on the Company's results of operations, financial position or cash flows. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which is effective for years beginning after December 15, 1997. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for financial statements for fiscal years beginning after December 15, 1997, and therefore the Company will adopt the new requirements retroactively in 1999. Management has not completed its review of SFAS No. 131, but does not anticipate that the adoption of this statement will have a significant effect on the Company's reported segments. YEAR 2000 IMPACT The Company has inventoried and evaluated the software applications it uses in its operations. In its evaluation, the Company assessed the age of the software, its sophistication with which it stores and uses dates and its relative importance to the Company's operations. Based on its evaluation, the Company believes the cost of any testing or remediation will not have a material adverse effect on the Company's financial condition or results of operations. BUSINESS The Company is a leading provider of PC-based software products that enable users to easily work with and edit digital media. The Company's products are designed to run under both the Windows and Windows NT operating systems. Current products include (i) Sound Forge 4.0 and Sound Forge XP, both of which allow users to create, record, edit and design digital audio files, (ii) CD Architect, which gives musicians, audio engineers and home users the ability to record and master their own audio CD's; and (iii) Soft Encode, which encodes audio to the Dolby AC-3 multi-speaker format for playback in movie theaters and on home theater systems. The Company is currently developing two new products, ACID and VEGAS, which are expected to dramatically impact the digital media industry. ACID, currently in Beta-testing, will allow musicians and non- musicians an easy way to create and play-back sound samples via a computer in a multi-track format. VEGAS will allow users to store, edit, manipulate, and transfer multiple tracks of audio data, along with video data, via Windows NT. ACID and VEGAS are expected to be released by the summer of 1998. The Company believes that there is a wide variety of markets and customers within these markets which require digital-based media authoring tools. These markets include the music, multimedia, digital video, audio/video and broadcast industries, and the Internet, which the Company believes will be a point of convergence for the other markets. Customers within these markets can be as diverse as a musician desiring the best in audio editing software to an automotive engineer who desires sound frequency analysis capability, to a website or multimedia developer who desires an enhanced overall presentation. In attempting to meet the needs of its customers in a variety of markets, the Company strives to give its products features which can be tailored to individual specific needs, are reliable and can be expanded upon. The Company believes it can achieve long term commitment to its products from its target customers by obtaining the endorsement of industry opinion leaders, emphasizing quality, maintaining stringent compatibility with Windows, gaining development efficiency through a common code base and being able to adapt and address new market opportunities by bringing new products to market quickly. 28 The Company's objective is to be the leading digital-based media software company to every industry and market in which the Company competes. The Company plans to achieve this objective by extending its technology leadership, maximizing its market penetration and brand recognition and continuing to develop products for the digital based media software market for professional and consumer use. In addition, the Company plans to strengthen and expand its strategic relationships with companies such as Microsoft and Dolby and pursue other strategic relationships. In this connection, the Company entered into a letter of intent with Microsoft in January 1998 pursuant to which Microsoft will license to the Company NetShow software production and rendering tools to enable the Company to develop and distribute production tools, such as Sound Forge and ACID, to create NetShow content. NetShow is Microsoft's proprietary format to view media on demand over the Internet. In addition, the letter of intent provides that the Company will be designated a preferred independent software vendor partner of NetShow with benefits including technical, marketing and sales assistance to the Company from Microsoft in connection with NetShow. The letter of intent is subject to a definitive agreement to be negotiated between the parties and there can be no assurance that a definitive agreement will be entered into, or if entered into, be on favorable terms to the Company. Management believes that developing products based on the NetShow platform will allow it to expand its customer base in the Internet market. Designation as a preferred independent software vendor partner of NetShow, as well as Microsoft technical, marketing and sales assistance, is also expected to have significant competitive benefits to the Company, which the Company believes will allow it to reach more potential customers by being included in Microsoft mailings, product groupings and references on Microsoft's website. INDUSTRY BACKGROUND In the past, audio production system users relied upon analog tape-based solutions. Analog tape-based systems suffered from relatively poor fidelity, crude editing capabilities, and poor process integration. The poor fidelity of analog tapes was due to their limited frequency range, hiss and distortion. The process of mixing each audio track often resulted in significant degradation of the audio as it passed through various audio mixing and processing devices. Moreover, due to the linearity of analog tapes, editing was difficult and time-consuming. These problems were particularly pronounced with low-cost analog systems. As a result, artists generally patronized commercial studios to create commercial quality recordings. In an effort to overcome the limitations of conventional analog recording, audio production users are increasingly adopting digital technologies. In recent years, numerous technological trends have made digital audio production systems increasingly practical. Powerful, cost-effective personal computers with graphical user interfaces, featuring either the Windows or MacIntosh operating systems, have become widely available. Relatively low cost, high capacity hard disk drives that are capable of storing audio recordings have also become available. The development of the Internet and other computer networks have given users the ability to transfer files instantaneously regardless of geographical distance. Finally, high speed processors like the Pentium and Alpha brands, when used in conjunction with software running under the Windows and Windows NT operating systems, enable real time digital mixing and processing of multi-channel audio and other digital media. MARKET OPPORTUNITY The Company believes that there are a wide variety of markets and customers within these markets which require digital-based media authoring tools. Customers can have as diverse needs as a musician desiring optimal audio editing software to an automotive engineer who desires sound frequency analysis capability. The common thread among the Company's potential customers centers on processing audio or other digital media through a personal computer based on the Windows operating systems. Therefore, even though a web developer may have little in common with a musician, both desire an easy to use software application that can manipulate sound and other digital media quickly and in a professional manner, all through the use of their personal computer. The Company believes that its products can meet the needs of its customers in the following markets: 29 Music. Music industry customers typically in the past have conducted their editing in professional music recording studios, mastering studios, post- production firms or home studios. The Company's audio software tools appeal to music industry customers by providing these customers with a PC-based alternative to traditional studio analog recording and editing methods, resulting in cost savings and increased time efficiency. Multimedia. Multimedia is the incorporation and assembly of video, photos, illustrations and audio to produce a presentation. Multimedia developers require audio and other digital-based media authoring tools to help enhance a computer-based media production. Multimedia professionals consist of a wide range of users, including game developers and corporate presentation specialists. The end application produced can include presentations, interactive advertising kiosks, or web pages that achieve vitality through interactivity and motion. In almost all cases, the end product will have audio incorporated as a component, and will require audio and other digital-based media tools, such as the Company's, to help enhance their overall production. Digital Video. Digital video professionals use Windows NT-based systems to create digital video content for television, movies, the Internet, DVD, or computer-based media. Digital video users create a video montage which is synchronized with audio tracks. Because of the broad use of computer-based systems, these users require software tools which allow both audio and video manipulation and editing capabilities. They may use software to add dialogue, change the sound ambiance, or eliminate background noise. These users tend to demand the highest performance features in an editing, recording, mixing, and processing system. One of the Company's products, Soft Encode, gives end-users the ability to encode audio files on a personal computer for digital video and the DVD market. See "--Current Products--Soft Encode." Audio/Video and Broadcast. Audio/video and broadcast industry customers consist primarily of radio, television and broadcast engineers who perform editing and production work for television and radio networks and independent stations. The Company's audio and other digital-based media tools provide these cost-sensitive users with a relatively inexpensive means to edit and produce their work. The Internet. The Internet has grown rapidly in recent years, driven by the development of the Worldwide Web and graphically intuitive Web browsers, the proliferation of multimedia PCs, increasingly robust network architectures and the emergence of compelling Web-based content and commerce applications. International Data Corporation ("IDC") estimates that the number of Web users worldwide may continue to grow rapidly from 50 million in 1997 to 90 million by the end of 1998. The Internet market consists of a wide variety of potential users, including website developers, who wish to enhance their websites with high quality audio, and television networks, who wish to broadcast live media over interactive online services, such as MSNBC. The Company views the Internet market as a point of convergence for all of the Company's other markets. While the traditional broadcasting entities are expected to continue to exist, the adoption of the Internet as a broadcast, cable and interactive news combination is redefining the way people create and receive information. As an example, societies, clubs, towns, and schools now have the capability to broadcast on the Internet because of ease of production and low cost of entry. Similarly, the music, multimedia, and digital video industry are also converging on the Internet, in the form of "live" concerts and elaborate, sophisticated web pages. The Company believes its products will give users in all of these markets an enhanced ability to edit and manipulate audio and other digital media over the Internet. THE SONIC FOUNDRY ADVANTAGE The Company creates highly sophisticated software products designed to address the needs of customers in a variety of media markets. The present and future growth of the Company's product line is expected to result in a "product suite" offering of digital-based media software products, a market niche which to date the Company believes has not been fully addressed. It is the Company's belief that rather than "cherry picking" products from numerous vendors, consumers prefer to purchase their software from one company in order to meet their need for reliability. By expanding functionality, incorporating reliability, and offering a variety of tailored products, the Company believes it can achieve long term commitment from its target customers. The Company believes it 30 can achieve this goal through obtaining the endorsement of industry opinion leaders, emphasizing quality, maintaining stringent compatibility with Windows, gaining development efficiency through a common code base, and being able to adapt to and address new market opportunities. Industry-Leading Technology. The Company has been a pioneer in the development of audio-based software and continues to develop and offer leading audio-based software products. By developing its products initially to appeal to the professional market, the Company believes it has been able to lead its competitors in the development of new technologies in the digital-based media software field. The Company has won numerous awards for its products, including: . Byte Magazine Award of Merit (Sound Forge 4.0, awarded in 1997) . Windows Source Multimedia Product Choice (Sound Forge 4.0, 1997) . Seymour R. Cray Award of Excellence granted by the Wisconsin Society of Professional Engineers (Sound Forge 4.0, 1997) . Digital Video Magazine Award of Excellence (Sound Forge 4.0, 1996) . New Media Magazine Hyper Award (Sound Forge 3.0, 1996) Emphasis on Quality. The Company adheres to a strict design and development methodology that requires extensive testing and proven reliability prior to product shipment. The Company believes that extensive Alpha and Beta-testing of its products prior to release reduces any future software problems. The Company's emphasis on quality helps achieve and maintain customer satisfaction and reduces the costs associated with recalls and technical support. Windows Compatibility. The Company focuses its product development effort on digital-based media authoring tools designed to run exclusively under the Windows and Windows NT operating systems. The Company's products provide optimized speed and performance with specific enhancements designed for such systems. In addition, the user interface for the Company's various products are designed to conform to standard industry design practices, giving the user immediate familiarity and comfort. Moreover, the Company's product development group includes three former Microsoft employees who have extensive knowledge of Windows, as well as a clearly defined understanding of user interface design. Based on this knowledge and understanding of the workings and general nature of Windows, the Company has charted a product development cycle that is designed to meet the need for quality digital-based media tools used specifically for the Windows environment. The Company intends to continue this focus by developing quality products based on the Windows and Windows NT operating systems, which the Company believes will remain dominant in the industry. Common Code Base. From its inception, the Company has strived to develop and build its product line from a common code base. Because of its common code base and time-tested software, the Company believes it can develop new products quickly and efficiently. In addition, the Company believes that users will benefit from the common user interface, reliability, and functionality of the Company's products, all of which are designed to work together. The Company anticipates its product line will evolve further and will eventually provide a single source solution to meet a wide variety of audio and digital- based media processing needs. Adaptability to New Markets. Because of the efficiency in reusing and sharing a common code base, the Company believes it has a strong advantage in bringing new products to market quickly. Likewise, the Company believes it possesses one of the strongest software engineering groups in the audio software industry. These strengths translate into quick, efficient code writing and integration of new applications as the audio and digital-based media software market evolves. STRATEGY The Company's objective is to be the leading digital-based media software company to every industry and market in which the Company competes. To achieve this objective, the Company's strategy includes the following key elements: 31 Extend Technology Leadership. The Company believes it has established itself as a leader in the development of audio-based software and intends to build upon its reputation for quality and innovation by expanding the features and breadth of its software products. The Company's planned release of its ACID and VEGAS products demonstrates the Company's commitment to extending its technology leadership. The Company also intends to continue to broaden its product line by supporting and developing products for newly emerging Internet streaming standards and by offering its Soft Encode product for the DVD market. In developing its products, the Company solicits opinions from, and attempts to meet the needs of, the professional market. Through its rapport with professional users, its investment in product development, and its hiring of experienced software engineers, the Company believes it will stay on the leading edge of development. Maximize Market Penetration and Brand Recognition. The Company believes that its Sonic Foundry brand is one of the most widely recognized brands in the music software industry. The Company has consistently sought to achieve rapid and broad adoption of its technologies and strong brand recognition. This strategy has been pursued through various means, such as concentrating its products initially on the professional user and having the professional user attest to the quality of the product. The Company also pursues its strategy of brand recognition by extensive advertising in key trade publications, offering its products via the Internet, and combining the Company's products with those of other major vendors and using multiple distribution channels, including both direct sales and indirect OEM and retail relationships. The Company recently has intensified its efforts to broaden the distribution of its audio and other digital-based media software products by entering into a sales and distribution agreement with Ingram Micro. See "Risk Factors--Third-Party Distributor." Leverage Market Position to Expand Model. Management believes that the Company's technology leadership, market position and brand name are significant assets that the Company can leverage to maintain and increase its market share and diversify its revenue base. The Company intends to leverage these assets as follows: . Grow Digital Audio Software Business. The Company intends to capitalize on the growth in demand for digital-based audio software by continuing to develop, market and support products for the entire digital-based media software market. The Company also plans to strengthen its marketing, sales and customer support efforts as the size of its market opportunity and customer base increases. . Offer Products That Meet The Needs of The Consumer Market. After establishing brand recognition and meeting the needs of the professional market, the Company believes it will be able to define the features and functions that will appeal to the general consumer. The goal of the Company's consumer effort is to offer the same functionality offered in the professional product line, but with a simplified function/feature set. . Develop and Market Digital-Based Media Software Products For Windows. The Company's rapid growth is attributable in part to the popularity of the digital-based audio software products it has developed for the Windows market. In January 1998, a letter of intent was entered into between the Company and Microsoft pursuant to which Microsoft is to license NetShow software production and rendering tools to the Company, in order for the Company to integrate these tools with its Sound Forge and ACID software products. The letter of intent also provides that the Company will be a preferred independent software vendor for Microsoft NetShow. Certain of the Company's existing products, and its products in development, could be utilized in other significant and rapidly developing markets, such as the Internet and DVD. See "--Microsoft Relationship." . Expand Internal Operations. The Company intends to invest substantially in operations and systems in anticipation of future growth. This effort includes improving its management information systems, opening sales offices in several locations, integrating sales activities, investing in customer service, expanding its activities at trade shows, and developing on-line training programs which will help support an outside network of dealers and distributors. . Expand Internationally. The Company intends to expand its international customer base over the next several years by opening a European sales office, hiring additional employees, developing international distribution and sales networks, and increasing its expenditures for marketing. 32 Strengthen Strategic Relationships. The Company has established strategic relationships with a variety of industry participants, including software and hardware vendors and audio laboratories. The Company's relationship with Microsoft, for example, has given the Company early access to key technologies and software codes. In addition, the Company has formed strategic relationships with other companies. For example, the Company has licensed the AC-3 Dolby digital technology from Dolby Laboratories Licensing Corporation ("Dolby Licensing") and has developed its Soft Encode product in collaboration with Dolby. The Company pursues strategic relationships for a variety of purposes, such as maximizing rapid penetration, validation and adoption of its technologies, and expanding the range of commercial activities based on its technology and brand name. CURRENT PRODUCTS The Company develops and markets software products that allow audio and other digital data to be stored, edited, manipulated and transferred efficiently and economically for a variety of professional and non-professional uses. Sound Forge 4.0 and Sound Forge XP. The Sound Forge products can be used by professionals and non-professionals for a variety of digital audio editing needs. Just as a word-processor can store, edit and transfer textual data more effectively and efficiently than a typewriter, Sound Forge 4.0 and its scaled down consumer version, Sound Forge XP, can store, edit, manipulate, and transfer audio data more effectively and efficiently than traditional analog editing tools can, using the memory and processing power of a home or office computer. The advantages of the ability of Sound Forge to handle audio data digitally are several. First, digital files can be edited non-linearly, whereas in order to edit an analog recording, a user would have to rewind the tape to find the spot that needs editing. Second, editing on a digital audio file can be non-destructive, whereas audio analog editing destroys a portion of the tape. Third, digital audio files do not deteriorate over time, as opposed to the serious problem of degradation of audio tapes. Fourth, digital audio files can be transferred electronically, whereas audio tapes must be mailed or shipped. Fifth, multiple users can work on digital audio files on a shared basis, an impossibility with analog audio tapes. Finally, through the use of plug-ins, digital audio files can be manipulated in ways that analog audio tapes cannot. Plug-Ins. The Company has developed several plug-ins which enhance its products to address various specialized needs. Several of the Company's plug- ins employ "real-time" capability, i.e. the ability to process and produce special effects to digital audio at a rate which is as fast or faster than the actual event. One product, a real-time noise reduction plug-in, allows users to eliminate background noise from a prerecorded event. Examples of the many uses of the real-time noise reduction plug-in include broadcast users eliminating background noise and consumer users eliminating the hissing and clicking noises produced by vinyl phonograph records. Another useful and technologically sophisticated plug-in is known as an acoustics modeler plug-in. This product allows a user to manipulate digital audio so that sound will appear to emanate from any given site that has been pre-selected by the user. Customers have found varied uses for this product. For example, movie studios can use it to incorporate voice-over work after finishing production, and CD producers can use it to mimic the sound of a "live" concert. By using the impulses recorded on site, the acoustics modeler works by duplicating the acoustical signature of the original environment. By recording a "dry" recording in the studio and applying the signature to the voice over, the acoustics modeler is able to duplicate the reverberant sound of the original environment, essentially fooling the listener into believing the recording is authentic. In addition to a real-time noise reduction plug-in and an acoustics modeler plug-in, other plug-ins developed and offered by the Company include the XFX real-time plug-in, the batch converter plug-in and a spectrum analysis plug-in. The XFX real-time plug-in allows Sound Forge, and certain other software known as Direct X enabled software, to operate in real-time. The batch converter plug-in allows for audio files to be converted, processed, and/or effected in an automated manner. Finally, the spectrum analysis plug-in can graphically analyze sound sequences. 33 CD Architect. The Sound Forge products, along with the Company's various plug-ins, provide for the storage, editing, transfer and electronic manipulation of audio inputs. The end audio product produced is an audio "file" that can be outputted through the Internet or through certain broadcast mediums, but is otherwise stored in the computer. In order to address the needs of musicians, audio engineers and home users to have an easy way to output their completed audio file, the Company developed CD Architect. This device in effect converts a computer into a CD tape-recorder by allowing a completed audio file to be transferred to a CD. With CD Architect, users can create multiple copies of their completed audio work. A band, for example, can record their music direct to CD-R (CD Recordable) media without utilizing the services of traditional studios or production houses. Another use for CD Architect is to input an existing CD into a computer, where Sound Forge, in conjunction with the Company's plug-ins, can further edit, store or manipulate the audio file. Taken together, the CD Architect and the various plug-ins have enhanced the basic Sound Forge products and have made them available for a variety of users in markets such as music, multimedia, digital video, audio/visual and broadcast, and the Internet. Soft Encode. The Company has developed Soft Encode, in collaboration with Dolby, and has licensed AC-3 technology from Dolby Licensing to help create certified AC-3 files. Soft Encode has been certified by Dolby Licensing as a product which creates and adheres to the AC-3 file format. Prior to Soft Encode's availability, users have relied on dedicated hardware encoding systems priced higher than most professional recording studios were able to afford. Soft Encode offers an economical method of authoring Dolby certified AC-3 files and unburdens the user from more expensive hardware based systems. The Company believes that AC-3 will be incorporated as the standard audio format in use for the rapidly emerging DVD market, as well as for use as a compression format on the Internet. A DVD disk is equivalent in size to a standard audio CD, but is able to hold seven times more audio, video, and/or data information. As a result of its increased storage capacity, movies and other mixed media can be recorded to DVD. The Company believes that Soft Encode is important not only for its technical sophistication, but also because it demonstrates the ability of the Company to develop products in conjunction with prestigious audio laboratories. These type of relationships serve to strengthen the prestige and brand-impact of the Company's name. PRODUCTS CURRENTLY IN DEVELOPMENT The Company is currently developing two new products, ACID and VEGAS, which are expected to be released by the summer of 1998. ACID will offer both the musician and the non-musician an easy way to create and play back sound samples via a computer in a multi-track format. ACID will allow a user to merge audio "loops," such as drums, tunes, cymbals, piano snippets, or any other relatively small bits of audio information into another audio file or with each other. ACID will also allow the user to change the tempo, add new rhythms, and add vocals by embedding samples wherever desired, all in real-time. This product can be used on a stand-alone basis or in conjunction with Sound Forge or CD Architect by musicians who wish to edit and record music loops for output in a different format. The Company believes ACID will appeal to the consumer, to music markets such as the rap market and the techno market, and to anyone who wishes to create quality music quickly and easily. The Company will sell ACID with a small library of audio loops, but will have additional audio loop libraries available for sale. VEGAS is a multi-track editor and recorder which takes advantage of the latest advances in computer processing power. Whereas Sound Forge 4.0 and Sound Forge XP provide for processing only two audio tracks (stereo) at any given time, VEGAS will be able to store, edit, manipulate and transfer multiple tracks of audio data, along with video data. The number of tracks available for editing will only be limited by the processing power of the computer itself. By using the processing power of the personal computer, VEGAS will relieve users of the need to buy dedicated turnkey systems. In addition, by providing software-based upgrades, VEGAS will minimize the cost of obsolescence. VEGAS is expected to transcend multiple user categories by targeting the musician, audio engineer, and video engineer. Because of the broad range capability of the product, users will be able to eliminate many dissimilar or difficult to use products, while also being able to customize the product through the purchase of the Company's plug-in products. 34 PRODUCT DEVELOPMENT The Company devotes a substantial portion of its resources to developing new products and product features, to enhancing the Company's existing products, and to testing and integrating third party hardware and software. During the fiscal year ended December 31, 1996, and the nine months ended September 30, 1997, the Company expended approximately $360,000 and $488,000, or 14.7% and 21.8%, respectively, of its total net revenues on product development activities. The Company intends to devote approximately $4,500,000 of the net proceeds of the Offering toward product development and to continue to devote substantial resources toward product development over the next several years. See "Use of Proceeds." As of September 30, 1997, the Company had 15 employees, or approximately 35% of its workforce, engaged in product development activities. The product development group includes individuals with extensive experience designing Windows software. Areas of expertise include user interface design, digital signal processing, integration with third party hardware, and low-level driver work. The Company's engineers have had experience developing music software, media and graphics software, games, multimedia applications and operating system components, as well as hardware. The Company estimates the Company-owned codes have taken over 40 staff years of development time. The Company intends to continue to hire qualified employees. However, competition for highly qualified employees is intense and the process of locating key technical personnel with the combination of skills and attributes required to develop new software is extensive. There can be no assurance that the Company will be successful in attracting, motivating and retaining additional software engineers. See "Risk Factors--Dependence on Key Personnel." MANUFACTURING The production of the Company's software products includes CD duplication, component purchases (manuals, boxes, and inserts), and final packaging. CD duplication is currently performed by Maxell Corporation. User manuals, boxes, and inserts are printed and assembled by a variety of third-party manufacturers. The Company performs quality inspection, assembly, and shipment directly from its facilities. In some instances, particularly with OEM contracts, third parties may be involved in the actual production, assembly, and fulfillment process. The Company believes there are numerous sources and alternatives to the existing production process. To date, the Company has not experienced any material difficulties or delays in the manufacture and assembly of its products, or material returns due to product defects. SALES The Company currently sells and distributes its products through professional dealers, a direct sales force, computer distributors, OEMs, and the Internet. The Company also sells a large portion of its products internationally through a worldwide distribution network. As of December 31, 1997, the Company had 21 employees, or approximately 49% of its workforce, engaged in sales and marketing activities. During the fiscal year ended December 31, 1996, and the nine months ended September 30, 1997, 18% and 27% of the Company's net revenues, respectively, were derived from international sales. Professional. The Company's dealers in the music and professional audio industries provide a demonstration site for the Company's family of products. The Company, when dealing with the professional consumer, utilizes extensive sales training by its own network of representatives, and provides a large degree of marketing and promotion support. Training is an integral aspect of the entire sales and marketing process and is expected to become more important as the product line broadens. Direct Sales. The Company's direct sales force markets the Company's products to customers who will typically purchase more than ten units of software for an entire media production activity. These customers typically request on-site or remote training for their employees. The Company intends to address this opportunity by both building its direct sales force and its training and support efforts. The Company intends to explore the possibility of charging fees for training and support services. 35 Computer Distributor. The Company recently entered into an agreement with Ingram Micro to handle sales and distribution of certain of the Company's products to various computer resellers, VAR's, catalog distributors and smaller retail outlets. Under the distribution agreement, the Company has granted Ingram Micro the right to return unsold inventories of outdated products in exchange for credit against open invoices. Likewise, price protection support is offered contractually, whereby the distributor is protected from price reductions. The Company supports this distribution relationship by employing the services of Micro Tech Marketing Services, Inc. ("Micro Tech"). Micro Tech provides sales and marketing support by contacting large distributors and retailers and assisting them in the placement of orders and the management of inventory of the Company's products. Monthly sales and inventory reports are provided by Ingram Micro, Micro Tech, and the major retailers directly to the Company. See "Risk Factors--Third-Party Distributor." OEMs. The Company has entered into various distribution relationships with third parties pursuant to which the Company's products are incorporated into, or bundled with, the third party's products for delivery by the third party to end users. Such third parties include Event Electronics, LLC, Pinnacle Systems, Vivo Software, Inc., Macromedia, Inc., Intergraph Corporation and Intervoice, Inc. Electronic Commerce. The Company has recently developed a capacity to handle on-line sales via the Internet. Likewise, third parties have been granted licenses on their sites which allow for the sale and distribution of both electronic and fulfillment based orders. The Company expects sales over the Internet to become an increasingly important component of overall sales of the Company. Electronic distribution provides the Company with a low-cost, globally accessible 24-hour sales channel. International. Internationally, the Company maintains a network of over 25 worldwide music and professional audio distributors who handle various sales and marketing efforts in their respective countries. The Company's international distributors also provide product support to customers, local marketing efforts, and local language translation services for product literature and manuals. The Company provides its distributors with services similar to those the Company provides to its North American dealer network. See "Risk Factors--Risks Associated with International Expansion." New Sales Offices. The Company expects to open several regional sales offices in several locations, including Europe and the eastern and western coasts of the United States. See "Risk Factors--Risks Associated with International Expansion" and "Use of Proceeds." MARKETING The Company participates in trade shows, advertising, press tours, public relations, dealer events, and Internet advertising. The Company engages in direct mail efforts by sending newsletters, new product announcements, and special promotions to existing and prospective customers. The Company's Internet web site also is expected to be a critical marketing component as the Internet matures as a viable marketing medium. The Company's customers vary from high end professionals to general consumers. Because of this, different marketing methods are used to reach each respective audience. For the professional audience who tend to be early adopters, the Company relies on press announcements, product reviews and advertising in publications such as Keyboard, Electronic Musician, Mix, EQ, and Pro Audio Review to help spread product awareness. The Company also uses "Not For Resale" copies of its software installed on computers within dealer stores as a promotional means of educating potential customers. On-site dealer training and clinics are also used to help market and promote the advantages of the Company's product line. Computer industry customers are reached through the Internet, advertising in publications such as New Media, Music and Computers, Interactivity, DV, and by direct mail. The Company informs distributors and end users about the benefits of its products through informative dealer kits and product brochures. The Company's direct mail process involves maintaining a database of over 40,000 dealers, distributors, opinion leaders, and 36 customers who are sent information on new products, product enhancements, and trade show schedules. The Company also publishes a newsletter with the title "Sample This" which assists in providing information and generating brand awareness. Various OEM relationships with hardware and software vendors help spread broad-based brand awareness to the consumer channel. The Company requires the proper placement and use of its logos and trademarks on third party products and literature. Continued expansion of its OEM presence will assist the Company in establishing greater brand identity and generate awareness that the Company's various products conform to industry specifications and are designed to operate with a variety of third party hardware. Marketing related functions such as graphic design, literature preparation, product launch planning, advertising preparation and placement are all provided for by the Company's marketing staff. The Company maintains tight controls over the creative process and management believes these controls have allowed the Company to respond quickly and economically to the ever-changing technology industry. MICROSOFT RELATIONSHIP In January 1998, the Company entered into a letter of intent with Microsoft pursuant to which Microsoft granted the Company a non-exclusive license to NetShow software production and rendering tools, for the purpose of allowing the Company to integrate these tools with its Sound Forge and ACID products. Pursuant to the letter of intent, Microsoft will provide appropriate non- exclusive, royalty free source code licenses in the various parts of the NetShow software platform to enable the Company to develop and distribute production tools based on the NetShow platform. The letter of intent also names the Company as a preferred independent software vendor ("ISV") partner of Microsoft NetShow. In connection with the Company's ISV partner status with Microsoft NetShow, Microsoft has agreed to make efforts to: (i) raise the visibility of the Company through press releases; (ii) assist the Company in its development efforts, and in particular, to include the Company in its beta program for NetShow 3.0; (iii) raise the visibility of the Company through the Worldwide Web, and in particular, to designate the Company as an ISV partner in the NetShow Website and potentially in other Microsoft Websites; (iv) assist the Company in its sales efforts, and in particular to include the Company in one or more pilot programs with Microsoft NetShow customers, to include the Company in any case studies which arise from such pilots, and to connect the Company with appropriate Microsoft sales representatives responsible for accounts targeted by the Company; (v) assist the Company in its marketing efforts by including the Company in: a) the NetShow Tools Pack CD program; b) Microsoft booths, as a preferred ISV, at trade shows; c) the launch efforts of NetShow 3.0; d) NetShow demonstrations at technical educational programs such as Tech Ed and Professional Developers Conferences; e) the marketing collateral which accompanies NetShow 3.0; and f) seminars, training, and roadshows for NetShow 3.0. The letter of intent also provides that the Company is to perform development efforts to enable its ACID and Sound Forge product lines to integrate with NetShow 3.0 and generate Active Streaming Format ("ASF") content. In particular, the Company is to use all reasonable efforts to have these features supported in demonstrable ASF compliant versions of ACID and Sound Forge 4.0 by March 1, 1998, and to ensure that its Sound Forge product line and ACID product lines remain compatible with ASF through Microsoft's version 2 of ASF. The letter of intent is subject to a definitive agreement to be negotiated between the parties, and there is no assurance that a definitive agreement will be entered into, or, if entered into, be on favorable terms to the Company. CUSTOMER SUPPORT The Company intends to use approximately $500,000 of the net proceeds from this Offering to expand the level of technical support, training and telephone support offered to its dealers and customers. This plan includes establishing an on-site training facility at the Company's corporate offices in Madison, Wisconsin. Likewise, remote training will be offered through the Company's own representatives or third party representatives, dealers or distributors who handle the Company's product line. See "Use of Proceeds." 37 The Company provides free customer support for a 90-day period following product purchase. After the initial 90 day term, customers are able to receive technical information through the Company's website, newsletters, and third party articles and technical notes. The Company currently does not offer extended maintenance contracts to its customers, but may do so in the future. The Company offers a 30-day money-back guarantee on all of its software products. The Company also provides a 90 day replacement warranty covering product defects, shipping damage, or missing materials. Under these circumstances, dealers, distributors, and customers may return their software directly to the Company for free replacement. In the case of upgrades, the Company attempts to offer incentives to sell existing inventory. The Company replaces existing inventory with new inventory after a product is upgraded. As a result of the recent signing of a distribution agreement with Ingram Micro, the Company expects greater sales to occur in the computer retail channel, and as a result, the Company will allocate a greater allowance for product returns. There can be no assurance that the level of returns will not exceed the budgeted allowance. See "Risk Factors--Third-Party Distributor." COMPETITION The markets for the Company's products are intensely competitive. Pricing pressure, rapid development, feature upgrades, and undefined new technologies characterize the industry. Numerous companies including Adaptec, Avid, Cakewalk, Creamware, Digidesign, Euphonix, InSync, Sonic Solutions, and Steinberg offer products which compete directly or indirectly with one or more of the Company's own products, although none of these companies can independently offer a matching product line which competes one for one with the Company's own product line. Most of the Company's competitors or potential competitors have significantly greater financial, management, technical and marketing resources than the Company. The Company could also face future competition from Microsoft, Adobe, Macromedia, Autodesk, or Oracle. Each of these potential competitors has substantially greater resources than the Company and could become a significant competitor. The primary factors on which the Company competes are system independence, quality, pricing, product features, cross-platform file support, brand marketing, and customer support. The relative importance of each factor is dependent on the market and customer group targeted. The Company believes it competes favorably with respect to these factors, but there can be no assurance that it will continue to do so. In addition, the Company's Internet-based products may compete with companies such as Adobe, Macromedia, Microsoft, and RealNetworks, Inc. These companies are currently providing low cost web authoring tools which offer some features which satisfy the media authoring requirements of professionals, corporate users, and serious hobbyists. Although the Company has chosen to carve out distinct product niches, there can be no assurance that these companies will not introduce products which are more directly competitive or undercut the Company's own products. Moreover, many of the Company's competitors and potential competitors offer software products for the MacIntosh operating system, which many musicians have traditionally utilized. There can be no assurance that such potential customers will accept the Company's Windows-based software products. Likewise, there can be no assurance that market sentiment for MacIntosh or other competing operating systems, such as Java, will not overtake the current dominant market position of Windows- based systems, upon which the Company's products are based. In addition, due to the low barriers to entry in the computer software market, there can be no assurance that a new company will not be able to effectively compete with the Company. The Company's competitors may be able to develop products comparable or superior to those offered by the Company or adapt more quickly than the Company to new technologies or evolving customer requirements. Accordingly, there can be no assurance that the Company will be able to compete effectively in its target markets, that competition will not intensify or that future competition will not have a material adverse effect on the Company. 38 INTELLECTUAL PROPERTY The Company's success depends in part on its ability to protect its proprietary software. The Company relies on a combination of trade secret, contract, copyright and trademark law to establish and protect its proprietary rights in its products and technology. The Company does not currently have any patent protection for its products. The Company's software products are sold pursuant to "shrink wrap" licenses which sets forth the terms and conditions under which the purchaser can use the product and which bind the purchaser by its acceptance and purchase of the products to such terms and conditions. Such shrink wrap licenses are not signed by licensees and may be unenforceable under the laws of certain jurisdictions. The Company also licenses certain of its proprietary rights to third parties. Although the Company relies to a great extent on trade secret protection for much of its technology and has obtained confidentiality agreements from most of its key employees, there can be no assurance that third parties will not independently develop the same or similar technology, obtain unauthorized access to the Company's proprietary technology or misuse technology to which the Company has granted access. The Company believes that the rapid pace of innovation in the industry renders the innovation, skill and creativity of its development staff more influential to the Company's competitive success than the various legal protections of its technology. The computer software industry is characterized by frequent and substantial intellectual property litigation that often is complex and expensive and involves a significant diversion of resources and uncertainty of outcome. In the future, the Company may need to pursue litigation to enforce and protect its intellectual property and trade secrets or to defend against a claim of infringement or invalidity. The Company attempts to avoid infringing known proprietary rights of third parties in its product development efforts. However, the Company has not conducted and does not conduct comprehensive patent or trademark searches to determine whether it infringes patents or proprietary rights held by third parties. In addition, it is difficult to proceed with certainty in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. If the Company were to discover that its products violate third-party proprietary rights, there can be no assurance that it would be able to obtain licenses to continue offering such products without substantial reengineering or that any effort to undertake such reengineering would be successful, that any such licenses would be available on commercially reasonable terms, if at all, or that litigation regarding alleged infringement could be avoided or settled without substantial expense and damage awards. Any claims against the Company relating to the infringement of third-party proprietary rights, even if not meritorious, could result in the expenditure of significant financial and managerial resources and in injunctions preventing the Company from distributing certain products. Such claims could materially adversely affect the Company. Although the Company believes that its products and their use do not infringe the proprietary rights of third parties, the Company received in December, 1997 a communication from a third party asserting that one of the Company's product names, "Acoustics Modeler," infringes the proprietary rights of such third party. The Company disagrees with the position of the third party, but plans in any event to phase out use of the product name "Acoustics Modeler" over the next six months. The Company has also received communications from an additional third party relating to an alleged infringement of such third party's patent by the Company. The Company has not received any further communication from such third party since May 1996 and such third party's patent expires in May 1998, however, there can be no assurance that such third party will not take legal action against the Company. The Company may in the future receive communications from other third parties asserting that the Company's products infringe, or may infringe, the proprietary rights of such third parties. See "Risk Factors--Uncertain Protection of Intellectual Property; Risks Associated with Licensed Third Party Technology." The Company also relies on certain technology that it licenses from third parties, including software that is integrated with the Company's internally developed software and used in the Company's products, to perform key functions. There can be no assurance that such third-party technology licenses will continue to be available to the Company on commercially reasonable terms. The loss of any of these technologies could have a material 39 adverse effect on the Company. In addition, the Company has agreed to indemnify certain distributors and OEMs from claims that its technology infringes the proprietary rights of others. There can be no assurance that infringement or invalidity claims arising from the incorporation of third- party technology, and claims for indemnification from distributors and OEMs resulting from such claims, will not be asserted or prosecuted against the Company. Such claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources in addition to potential product redevelopment costs and delays, all of which could materially adversely affect the Company. The Company has also signed nondisclosure agreements to protect the trade secrets and confidential information of other companies. While the Company has made and continues to make diligent efforts to protect such third party information, there can be no assurance that such information will be adequately protected, or that, notwithstanding the Company's efforts to protect such trade secrets and confidential information, a third party will attempt to hold the Company liable for disclosure of such information. Any liability to a third party for failing to protect trade secrets or confidential information may have a material adverse effect on the Company. The laws of foreign countries may treat the protection of proprietary rights of the Company in its products differently from and may not protect the Company's proprietary rights to the same extent as do laws in the United States. See "Risk Factors--Uncertain Protection of Intellectual Property; Risks Associated with Licensed Third-Party Technology." LEGAL PROCEEDINGS The Company currently is not involved in any legal proceedings. EMPLOYEES As of December 31, 1997, the Company had 43 full-time employees, including 12 in product development, 21 in sales, marketing and customer support, 3 in manufacturing and 7 in administration and finance. The Company's employees are not represented by a labor union, nor are they subject to a collective bargaining agreement. The Company has never experienced a work stoppage and believes that its employee relations are satisfactory. FACILITIES The Company owns its principal facility, located in Madison, Wisconsin, consisting of approximately 10,000 square feet of office space. This space is used for product development, sales and marketing, customer support and administration. The Company also has a five year lease and an option to purchase an 8,000 square foot building directly adjacent to its principal facility. This space is currently used for storage, however, the Company intends to exercise the option, renovate the space and use it for future expansion. The option is in the amount of $340,000 and expires on March 31, 1998. The Company also has leased an additional 8,000 square feet in a third property located in the same complex as its principal facility. The Company intends to open additional sales offices both domestically and internationally as needed. See "Use of Proceeds." 40 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS, AND KEY EMPLOYEES The following table sets forth information with respect to each director, executive officer and key employee of the Company.
NAME AGE POSITION ---- --- -------- Rimas P. Buinevicius............ 35 Chief Executive Officer and Chairman Monty R. Schmidt................ 33 President and Director Curtis J. Palmer................ 28 Chief Technology Officer and Director Kenneth A. Minor................ 35 Chief Financial Officer Roy Elkins...................... 38 Vice President, Sales and Marketing Frederick H. Kopko, Jr.......... 42 Director Arnold Pollard.................. 54 Director David C. Kleinman............... 62 Director
Rimas P. Buinevicius has been the Chairman of the Board since October, 1997 and Chief Executive Officer since January, 1997. Mr. Buinevicius joined the Company in 1994 as General Manager and Director of Marketing. Prior to joining the Company, from 1991 to 1994, Mr. Buinevicius was employed by Alkar, Division of DEC International, in Lodi, Wisconsin, where he was responsible for project development and management of industrial control systems. From 1990 to 1991, Mr. Buinevicius was employed as a Senior Electrical Engineer with Arzco Medical Electronics in Vernon Hills, Illinois, where he was responsible for both hardware and software design of cardiac pacing equipment. Mr. Buinevicius has an M.B.A. degree from the University of Chicago; a Master's degree in Electrical Engineering from the University of Wisconsin, Madison; and a Bachelor's degree in Electrical Engineering from the Illinois Institute of Technology, Chicago. Mr. Buinevicius has been elected as a Class 4 director. Monty R. Schmidt has been President since March 1994 and a director of the Company since February 1994. From October 1991 to February 1994, Mr. Schmidt performed certain pre-incorporation services for the Company. From March 1991 to September 1991, Mr. Schmidt worked with Lunar Corporation, Madison, Wisconsin where he was involved in the design of ultrasonic bone densitometry equipment. From 1988 to 1991 Mr. Schmidt held a position as a design engineer, designing hardware and software for the Berg Company in Madison, Wisconsin. Mr. Schmidt has a B.S. degree in Electrical Engineering from the University of Wisconsin, Madison. Mr. Schmidt has been elected as a Class 5 director. Mr. Schmidt is a co-founder of the Company. Curtis J. Palmer has been the Chief Technology Officer since January 1997 and a director of the Company since February 1994. From June 1990 to January 1994, Mr. Palmer was employed by Microsoft as a Software Design Engineer in the Multimedia Technologies group, where he worked on the Windows 3.0 and 3.1 operating system support for multimedia applications. In 1990, Mr. Palmer held a position as a Software Development Support Engineer at Microsoft, where he was responsible for assisting third party Windows driver developers in their development of communications, network and sound drivers for Windows 3.0. Mr. Palmer studied software engineering at the Oregon Institute of Technology. Mr. Palmer has been elected as a Class 5 director. Mr. Palmer is a co-founder of the Company. Kenneth A. Minor has been the Chief Financial Officer of the Company since June 1997. From September 1993 to April 1997, Mr. Minor was employed as Vice President and Treasurer for Fruehauf Trailer Corporation, a manufacturer and global distributor of truck trailers and related aftermarket parts and service. From May 1988 to September 1993 he was employed as Assistant Treasurer and Controller for Autodie Corporation, an automotive stamping die company. From 1984 to 1987 Mr. Minor was employed with Deloitte Haskins & Sells as a staff accountant. Mr. Minor is a certified public accountant and has a B.B.A. degree in accounting from Western Michigan University. 41 Roy Elkins has been the Vice President of Sales and Marketing of the Company since February 1997. From April 1987 to January 1997, Mr. Elkins was employed with Ensoniq Corporation, a manufacturer of music and multimedia hardware located in Malvern, Pennsylvania. At Ensoniq, Mr. Elkins held various positions including Director of Training, Director of Artist Relations, and manager of Ensoniq's dealer training program. Frederick H. Kopko, Jr. has been the Secretary of the Company since April 1997 and a director of the Company since December 1995. Mr. Kopko is a partner of the law firm of McBreen, McBreen & Kopko, Chicago, Illinois, and has been a partner of that firm since January, 1990. Mr. Kopko practices in the area of corporate law. He has been a director of Butler International, Inc. since 1985 and a director of Mercury Air Group, Inc. since 1992. Mr. Kopko received a B.A. degree in economics from the University of Connecticut, a J.D. degree from Notre Dame Law School, and an M.B.A. degree from the University of Chicago. Mr. Kopko has been elected as a Class 3 director. Arnold Pollard has been a director of the Company since December 1997 and a director of GKN Securities Corp. since August 1996. Since 1993, he has been the President and Chief Executive Officer of Chief Executive Group, which publishes "Chief Executive" magazine. For nearly 20 years, he has been President of Decision Associates, a management consulting firm specializing in organizational strategy and structure. Since 1996, Mr. Pollard has served as a director and a member of the compensation committee of Delta Financial Corp., a public company engaged in the business of home mortgage lending and the International Management Education Foundation, a non-profit educational organization. He also serves on the advisory board of Sequel Technology. From 1989 to 1991, Mr. Pollard served as Chairman and Chief Executive Officer of Biopool International, a biodiagnostic public company focusing on blood related testing; and previously served on the boards of Lillian Vernon Corp. and DEBE Systems Corp. From 1970 to 1973, Mr. Pollard served as adjunct professor at the Columbia Graduate School of Business. Mr. Pollard graduated from Cornell University (Tau Beta Pi), and holds a doctorate in Engineering- Economic systems from Stanford University. Mr. Pollard has been elected as a Class 2 director. David C. Kleinman has been a director of the Company since December 1997 and an Adjunct Professor of Strategic Management in the Graduate School of Business at the University of Chicago since 1971. Mr. Kleinman has been a director (Trustee) of the Acorn Funds since 1972 (of which he is also Chairman of the Audit Committee and a member of the Committee on the Investment Advisory Agreement), a director of the Irex Corporation (a contractor and distributor of insulation materials) since 1984, a director of the Plymouth Tube Company (a manufacturer of seamless and welded tubing) since 1993, a director of the Wisconsin Paper and Products Company (a jobber and distributor of paper and paper products) since 1994, and a director of the InterAmericas Communications Corporation (a developer, builder and operator of telecommunication facilities) since May 1997 and the Organics Management Company (an operator of a network of organic waste processing facilities) since April 1997. From 1964 to 1971, Mr. Kleinman was a member of the finance staff of the Ford Motor Company. Mr. Kleinman received a B.S. in mathematical statistics and a Ph.D. in business from the University of Chicago. Mr. Kleinman has been elected as a Class 1 director. Prior to December 1997, each director was elected to serve until the next annual meeting of stockholders or until the election and qualification of his or her successor or his or her earlier resignation or removal. In December 1997, the Company established a classified Board of Directors with five classes (Class 1, Class 2, Class 3, Class 4 and Class 5), each class as nearly equal in number of directors as possible. Each of the current directors was elected in December 1997 to one of these five classes. Mr. Kleinman was elected to Class 1 with a term expiring at the annual stockholders meeting in 1998; Mr. Pollard was elected to Class 2 with a term expiring at the annual stockholders meeting in 1999; Mr. Kopko was elected to Class 3 with a term expiring at the annual stockholders meeting in 2000; Mr. Buinevicius was elected to Class 4 with a term expiring at the annual stockholders meeting in 2001; and Messrs. Schmidt and Palmer were elected to Class 5 with terms expiring at the annual stockholders meeting in 2002. Commencing with the annual stockholders meeting in 1998 and thereafter, each newly elected director shall serve for a term ending at the fifth annual meeting of stockholders following such director's election. 42 DIRECTORS' COMPENSATION The directors of the Company who are not full-time employees of the Company will receive a fee of $1,500 for attendance at each meeting of the Board of Directors and $850 per Committee meeting attended. Such directors will also be reimbursed for their out-of-pocket expenses in connection with their attendance. No directors' fees have been paid to date. The Company has granted to each Non-Employee Director, upon initial appointment to the Board of Directors, in the case of Messrs. Pollard and Kleinman, and on December 1, 1997, in the case of Mr. Kopko, a stock option to purchase 10,000 shares of Common Stock pursuant to the Directors' Stock Option Plan, at a price of $5.00 per share. In addition, on the date of the 1998 annual meeting and each subsequent annual meeting of the Company's stockholders, the Company will grant to each Non-Employee Director who is then reelected or who is continuing as a member of the Board of Directors a stock option to purchase 10,000 shares of Common Stock. The exercise price of each stock option will be equal to the market price of Common Stock on the date the stock option is granted. Stock options issued under the Directors' Stock Option Plan generally will vest fully on the first anniversary of the date of grant and expire after five years. An aggregate of 90,000 shares are reserved for issuance under the Directors' Stock Option Plan. COMMITTEES OF DIRECTORS The Audit Committee consists of Messrs. Kopko, Pollard and Kleinman. The functions of the Audit Committee are to review with the Company's independent public auditors the scope and adequacy of the audit to be performed by such independent public auditors; the accounting practices, procedures, and policies of the Company; and all related party transactions. The Committee was organized in December 1997. The Executive Compensation Committee consists of Messrs. Kopko, Pollard and Kleinman. The Committee makes recommendations to the Board with respect to salaries of employees and is responsible for determining the amount and allocation of any incentive bonuses among the employees. In addition, the Committee is authorized to grant stock options under the Plan. The Committee was organized in December 1997. EXECUTIVE COMPENSATION The following table sets forth all the cash compensation paid by the Company during 1996 to the individual who served as Chief Executive Officer in 1996 and to the individual who is currently serving as Chief Executive Officer (the "Named Executive Officers"). Other than as set forth below, no executive officer of the Company received compensation in excess of $100,000 during 1996.
ANNUAL COMPENSATION --------------------- NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) --------------------------- ---- ---------- --------- Rimas Buinevicius (1)......................... 1996 64,616 37,149 Chairman and Chief Executive Officer Monty Schmidt (2)............................. 1996 64,616 6,462 President and Director
- -------- (1) Mr. Buinevicius has been serving as Chief Executive Officer since January, 1997. (2) Mr. Schmidt served as Chief Executive Officer from February 1994 (inception of the Company) until January 1997. None of the Named Executive Officers exercised options to purchase Common Stock during the fiscal year ended December 31, 1996, and no Named Executive Officer had exercised or unexercised stock options as of December 31, 1996. 43 1995 STOCK OPTION PLAN The Company has adopted the Plan pursuant to which it has awarded and may in the future award stock options to those individuals who have made significant contributions to the Company, including officers and directors who are employees of the Company. The Plan, as adopted on December 1, 1995 and made effective as of January 1, 1995, provides for the issuance to employees, including employee directors, of up to 1,000,000 shares of Common Stock pursuant to the grant of stock options. The maximum aggregate number of shares of stock that shall be subject to grants under the Plan may not exceed 1,000,000. The Plan is administered by the Executive Compensation Committee of the Board of Directors (the "Committee"). Subject to the provisions of the Plan, the Committee has the authority to determine to whom stock options will be granted and the terms of the awards granted. As of December 31, 1997, options to purchase a total of 699,050 shares of Common Stock, at a weighted average exercise price per share of $1.04, were outstanding. Of these options, options to purchase 320,000 shares were fully vested and exercisable as of December 31, 1997. As of December 31, 1997, the Company had an additional 300,950 shares of Common Stock available for future grants under the Plan. The option price per share of stock under the Plan is to be determined by the Committee at the time of each grant. The term of each stock option shall be fixed by the Committee, but may not exceed ten years. Stock options may be exercisable at such time or times as is to be determined by the Committee. Payment for the exercise of an option shall be made by cash, check or other instrument as the Committee may accept, including, in the discretion of the Committee, a non-interest bearing promissory note or stock of the Company. The Committee may amend or revise the terms of the Plan in any respect whatsoever, provided that certain amendments of the Plan are subject to stockholder approval. No grant of any option is valid under the Plan unless granted prior to January 1, 2005. EMPLOYMENT AGREEMENTS The Company has entered into employment agreements with Rimas Buinevicius, the Company's Chairman and Chief Executive Officer, Monty R. Schmidt, the Company's President, and Curtis Palmer, the Company's Chief Technology Officer. Each agreement continues in effect until January 1, 2001, unless earlier terminated pursuant to its terms. The salary of each of Messrs. Buinevicius, Schmidt and Palmer is $125,000 per year, subject to increase each year at the discretion of the Board of Directors. Messrs. Buinevicius, Schmidt, and Palmer are also entitled to incidental benefits of employment under the agreements. Each of the employment agreements provides that if (i) the Company breaches its duty under such employment agreement, (ii) the employee's status or responsibilities with the Company has been reduced, (iii) the Company fails to perform its obligations under such employment agreement, or (iv) after a Change in Control of the Company, the financial prospects of the Company have significantly declined, the employee may terminate his employment and receive all salary and bonus owed to him at that time, prorated, plus three times the highest annual salary and bonus paid to him in any of the three years immediately preceding the termination. If the employee becomes disabled, he may terminate his employment and receive all salary owed to him at that time, prorated, plus a lump sum equal to the highest annual salary and bonus paid to him in any of the three years immediately preceding the termination. Pursuant to the employment agreements, each of Messrs. Buinevicius, Schmidt and Palmer has agreed not to disclose the Company's confidential information and not to compete against the Company during the term of his employment agreement and for a period of two years thereafter. A "Change in Control" is defined in the employment agreements to mean: (i) a change in control of a nature that would have had to have been reported in the Company's proxy statement, if the Company were required to have filed proxy statements under the Securities Exchange Act of 1934 (the "Exchange Act"); (ii) the Company is merged or consolidated or reorganized into or with another corporation or other legal person and as a result of such merger, consolidation or reorganization less than 75% of the outstanding voting securities 44 or other capital interests of the surviving, resulting or acquiring corporation or other legal person are owned in the aggregate by the stockholders of the Company immediately prior to such merger, consolidation or reorganization; (iii) the Company sells all or substantially all of its business and/or assets to any other corporation or other legal person, less than 75% of the outstanding voting securities or other capital interests of which are owned in the aggregate by the stockholders of the Company, directly or indirectly, immediately prior to or after such sale; (iv) any person (as the term "person" is used in Section 13(d) (3) or Section 14(d) (2) of the Exchange Act) had become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) of 25% or more of the issued and outstanding shares of voting securities of the Company; or (v) during any period of two consecutive years, individuals who at the beginning of any such period constitute the directors of the Company cease for any reason to constitute at least a majority thereof unless the election, or the nomination or election by the Company's stockholders, of each new director of the Company was approved by a vote of at least two-thirds of such directors of the Company then still in office who were directors of the Company at the beginning of any such period. CERTAIN TRANSACTIONS The Chicago law firm of McBreen, McBreen & Kopko has performed legal services for the Company in connection with this Offering and may perform legal services for the Company following this Offering. Frederick H. Kopko, Jr., a director of the Company, is a partner in McBreen, McBreen & Kopko. During the nine month period ended September 30, 1997 and the twelve month period ended December 31, 1996, McBreen, McBreen & Kopko received $9,596 and $19,500, respectively, as compensation for legal services rendered. Pursuant to the Directors' Stock Option Plan, Mr. Kopko was granted an option to purchase 10,000 shares of Common Stock at an exercise price of $5.00 per share on December 1, 1997. The Company borrowed $100,000 in January 1996 from an affiliate of Frederick H. Kopko, Jr. The loan was in the form of a promissory note which was secured by a second position in all the Company's assets. The note accrued interest at the rate of 18% per annum and was paid in full in February 1997. Monty Schmidt and Curtis Palmer each guaranteed the Company's obligations pursuant to a certain promissory note in the principal amount of $150,000. Messrs. Schmidt and Palmer also each guaranteed the Company's obligations under a line of credit in the maximum amount of $250,000. See "Risk Factors-- Portion of Offering Proceeds Benefiting Management" and "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Liquidity and Capital Resources." 45 PRINCIPAL STOCKHOLDERS The following table sets forth certain information regarding the beneficial ownership of the Common Stock and the Series B Preferred Stock of the Company as of December 31, 1997, by (a) each person known by the Company to be the beneficial owner of more than 5% of the outstanding shares of Common Stock or the Series B Preferred Stock, (b) each of the Company's executive officers, directors and key employees, and (c) all executive officers, directors, and key employees of the Company as a group. No shares of Common Stock or Series B Preferred Stock are being sold by the Principal Stockholders in this Offering.
NUMBER OF SHARES PERCENTAGE OF CLASS OF CLASS BENEFICIALLY OWNED BENEFICIALLY ------------------------------ NAME OF BENEFICIAL OWNER(1) OWNED BEFORE OFFERING AFTER OFFERING - --------------------------- ---------------- --------------- -------------- COMMON STOCK(2) Rimas Buinevicius(3)........... 535,548 14.0% 9.2% 754 Williamson Street Madison, WI 53703 Monty Schmidt(4)............... 1,410,963 37.0 24.3 754 Williamson Street Madison, WI 53703 Curtis Palmer(4)............... 1,410,963 37.0 24.3 754 Williamson Street Madison, WI 53703 Kenneth A. Minor(5)............ 0 -- -- 754 Williamson Street Madison, WI 53703 Roy Elkins(6).................. 10,000 * * 754 Williamson Street Madison, WI 53703 Frederick H. Kopko, Jr.(7)..... 82,392 2.2 1.4 20 North Wacker Drive Chicago, IL 60606 Arnold Pollard(8).............. 0 -- -- 733 Third Avenue New York, NY 10017 David Kleinman(8).............. 0 -- -- 1101 East 58th Street Chicago, IL 60637 All Executive Officers and Directors as a Group (5 persons)(9)................ 3,449,866 90.4% 59.3% NUMBER OF SHARES PERCENTAGE OF CLASS OF CLASS BENEFICIALLY OWNED BENEFICIALLY ------------------------------ NAME OF BENEFICIAL OWNER(1) OWNED BEFORE OFFERING AFTER OFFERING - --------------------------- ---------------- --------------- -------------- SERIES B PREFERRED STOCK(10) Rimas Buinevicius.............. 1,071,096 15.6% 15.6% 754 Williamson Street Madison, WI 53703 Monty Schmidt.................. 2,821,926 41.0 41.0 754 Williamson Street Madison, WI 53703 Curtis Palmer.................. 2,821,926 41.0 41.0 754 Williamson Street Madison, WI 53703
46
NUMBER OF SHARES PERCENTAGE OF CLASS OF CLASS BENEFICIALLY OWNED BENEFICIALLY ------------------------------ NAME OF BENEFICIAL OWNER(1) OWNED BEFORE OFFERING AFTER OFFERING - --------------------------- ---------------- --------------- -------------- SERIES B PREFERRED STOCK(10) Frederick H. Kopko, Jr......... 164,784 2.4 2.4 20 North Wacker Drive Chicago, IL 60606 All Executive Officers and 6,879,732 100% 100% Directors as a Group (4 persons)......................
- -------- *less than 1% (1) The Company believes that the persons named in the table above, based upon information furnished by such persons, have sole voting and investment power with respect to the number of shares indicated as beneficially owned by them. (2) Beneficial ownership of the Common Stock is presented as if the shares of Series B Preferred Stock have been converted into shares of Common Stock. (3) Consists of 535,548 shares of Common Stock issuable upon conversion of 1,071,096 shares of Series B Preferred Stock. Does not include 10,000 shares of Common Stock subject to stock options which become exercisable on October 30, 1998. (4) Consists of 1,410,963 shares of Common Stock issuable upon conversion of 2,821,926 shares of Series B Preferred Stock. Does not include 10,000 shares of Common Stock subject to stock options which become exercisable on October 30, 1998. (5) Does not include 30,000 shares of Common Stock subject to stock options, 10,000 shares of which will become exercisable on each of June 1, 1998, June 1, 1999, and June 1, 2000. (6) Consists of 10,000 shares of Common Stock issuable pursuant to presently exercisable stock options. Does not include 30,000 shares of Common Stock subject to stock options, 10,000 shares of which will become exercisable on each of February 1, 1999, February 1, 2000, and February 1, 2001. (7) Consists of 82,392 shares of Common Stock issuable upon conversion of 164,784 shares of Series B Preferred Stock. Does not include 10,000 shares of Common Stock subject to stock options which become exercisable on December 1, 1998. (8) Does not include 10,000 shares subject to stock options which become exercisable on December 1, 1998. (9) Includes 10,000 shares of Common Stock issuable pursuant to presently exercisable stock options. (10) Series B 5% Cumulative Convertible Preferred Stock ("Series B Preferred Stock") consists of 6,879,732 outstanding shares, convertible into 3,439,866 shares of Common Stock. No shares of Series B Preferred Stock are being registered in this Offering. See "Description of Securities-- Series B Preferred Stock." 47 SELLING STOCKHOLDERS The registration statement, of which this Prospectus forms a part, also relates to the registration by the Company, for the account of the Selling Stockholders, of an aggregate of 368,060 shares of Common Stock. The Selling Stockholders Shares are not being underwritten by the Representative in connection with this Offering. The Selling Stockholders have agreed with the Company not to directly or indirectly offer, sell, transfer or otherwise encumber or dispose of any of their Common Stock for a period of 90 days after the date of this Prospectus. See "Shares Eligible for Future Sale" and "Underwriting." The sale of the Selling Stockholders Shares by the Selling Stockholders may be effected from time to time in transactions (which may include block transactions by or for the account of the Selling Stockholders) in the over- the-counter market or in negotiated transactions, or through the writing of options on the Selling Stockholders Shares, a combination of such methods of sale, or otherwise. Sales may be made at fixed prices which may be changed, at market prices prevailing at the time of sale, or at negotiated prices. The Selling Stockholders may effect such transactions by selling the Selling Stockholders Shares directly to purchasers, through broker-dealers acting as agents for the Selling Stockholders, or to broker-dealers who may purchase shares as principals and thereafter sell the Selling Stockholders Shares from time to time in the over-the-counter market, in negotiated transactions, or otherwise. Such broker-dealers, if any, may receive compensation in the form of discounts, concessions or commissions from the Selling Stockholders and/or the purchaser for whom such broker-dealers may act as agents or to whom they may sell as principals or both (which compensation as to a particular broker- dealer may be in excess of customary commissions). The Selling Stockholders and broker-dealers, if any, acting in connection with such sales, might be deemed to be "underwriters" within the meaning of Section 2(11) of the Securities Act and any commission received by them and any profit upon the resale of such securities might be deemed to be underwriting discounts and commissions under the Securities Act. Sales of any shares of Common Stock by the Selling Stockholders may depress the price of the Common Stock in any market that may develop for the Common Stock. The following table sets forth certain information with respect to Selling Stockholders for whom the Company is registering shares of Common Stock for resale of the public. Except for Algimantas and Cleopatra Buinevicius, Aris Buinevicius, and Tom and Pam Thieding who are the parents, brother and in-laws of Rimas Buinevicius, Kyle Brandon and Doug Nestler, who are employees of the Company, and VenCap, Inc., which is the Company's stockholder relations consultant, none of the Selling Stockholders has had any position with, held any office, or had any other material relationship with the Company.
NUMBER OF SHARES NUMBER OF SHARES OF NAME OF BENEFICIAL NUMBER OF SHARES OF OF COMMON STOCK COMMON STOCK OWNED OWNER(1) COMMON STOCK OWNED BEING REGISTERED AFTER OFFERING(2) - ------------------ ------------------- ---------------- ------------------- William D. Evans Trust.. 32,000 32,000 0 CCI International....... 20,000 20,000 0 VenCap, Inc............. 19,000 19,000 0 Valukin Trust dated 1- 18-97.................. 16,000 16,000 0 Net Gain International.. 15,000 15,000 0 EBI Ltd................. 14,000 14,000 0 Bank of Commerce Cust. FBO Charles A. McCue IRA No. 5659........... 12,300 12,300 0 John Kennedy............ 12,000 12,000 0 Greg Gentling........... 10,000 10,000 0 Brett Berkowitz......... 10,000 10,000 0 Interbac................ 10,000 10,000 0 Algimantas and Cleopatra Buinevicius............ 8,000 8,000 0
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NUMBER OF SHARES NUMBER OF SHARES OF NAME OF BENEFICIAL NUMBER OF SHARES OF OF COMMON STOCK COMMON STOCK OWNED OWNER(1) COMMON STOCK OWNED BEING REGISTERED AFTER OFFERING(2) - ------------------ ------------------- ---------------- ------------------- Eric Ebacher............ 8,000 8,000 0 Mark and Virginia Ebacher................ 8,000 8,000 0 Harrington Trust........ 6,400 6,400 0 Todd Rizzo.............. 6,400 6,400 0 James Justinger......... 6,000 6,000 0 George F. Sterne Savings Plan Retirement Trust.. 6,000 6,000 0 Everen Clearing Corp. Cust. F/B/O Robert B. Ruether IRA............ 5,000 5,000 0 Mark Ebacher............ 5,000 5,000 0 Miyamoto Investment Company................ 5,000 5,000 0 Masaji Ota & Naomi Ota.. 5,000 5,000 0 Daniel Dimacale and Denise Dimacale........ 5,000 5,000 0 Robert C.K. Lee......... 5,000 5,000 0 The Back Center Profit Sharing Plan........... 5,000 5,000 0 Phil Jones.............. 5,000 5,000 0 Charles Schwab & Co. Inc. FBO David Steven Bruck Contr. IRA............. 5,000 5,000 0 Sprau Family Limited Partnership............ 5,000 5,000 0 Souza Investments....... 5,000 5,000 0 Michael Moore........... 5,000 5,000 0 H. Hertner Associates, Inc. Defined Benefit Plan................... 5,000 5,000 0 J. Robert Gunther....... 5,000 5,000 0 Clinton Beachem......... 5,000 5,000 0 Jay Kopf................ 5,000 5,000 0 Douglas E. and Alejandra E. Nestler............. 5,000 5,000 0 Richard Christopherson.. 4,400 4,400 0 Kyle Brandon............ 4,000 4,000 0 John Phillip Hinderaker and Virginia Hinderaker............. 4,000 4,000 0 OTF Music Profit Sharing Plan................... 4,000 4,000 0 Joseph L. Knobbe Revocable Living Trust dated 12/28/95......... 3,500 3,500 0 Roger Klima............. 3,000 3,000 0 Harold Havenga Family Trust.................. 3,000 3,000 0 Bruce Wendorff.......... 3,000 3,000 0 Mary E. Hildebrand...... 3,000 3,000 0 Knobbe Living Trust U/A Dated 6/29/95.......... 2,500 2,500 0 William Owens........... 2,500 2,500 0 Wilma Streaker.......... 2,500 2,500 0 Steve Marker and Cindy Kahn................... 2,000 2,000 0 Steven D. & Dana I. Coutts................. 2,000 2,000 0 David Bruck............. 2,000 2,000 0 Robert T. Baker and Nancy Goodson.......... 2,000 2,000 0 John Sullivan and Mary Sullivan............... 2,000 2,000 0 Doug Erikson............ 2,000 2,000 0 Patty Lew and Butch Vig. 2,000 2,000 0 Martin Wimmer and Suzanne Wimmer......... 2,000 2,000 0 Tom and Pam Thieding.... 1,760 1,760 0 Carter Family Trust..... 1,200 1,200 0 Barbara Chrysler........ 1,000 1,000 0
49
NUMBER OF SHARES NUMBER OF SHARES OF NAME OF BENEFICIAL NUMBER OF SHARES OF OF COMMON STOCK COMMON STOCK OWNED OWNER(1) COMMON STOCK OWNED BEING REGISTERED AFTER OFFERING(2) - ------------------ ------------------- ---------------- ------------------- Donaldson, Lufkin, and Jenrette: Custodian Donald Terrian......... 1,000 1,000 0 Robert Hanson........... 1,000 1,000 0 Nick and Lisa Cable..... 1,000 1,000 0 Robert Zykofsky......... 1,000 1,000 0 Aris Buinevicius........ 400 400 0 John Jurkowski.......... 200 200 0
- -------- (1) The Company believes the persons named in the table above, based upon information furnished by such persons, have sole voting and investment power with respect to the number of shares beneficially owned by them. (2) Assumes that all shares of Common Stock being registered will be sold. 50 SHARES ELIGIBLE FOR FUTURE SALE Upon completion of this Offering, the Company will have 2,368,060 shares of Common Stock and 6,879,732 shares of Series B Preferred Stock outstanding. The 2,000,000 shares of Common Stock sold in this Offering will be freely tradeable without restriction under the Securities Act, except for any shares purchased by an "affiliate" of the Company (as that term is defined under the rules and regulations of the Securities Act), which will be subject to the resale limitations of Rule 144 under the Securities Act. All of the presently outstanding shares of Series B Preferred Stock are "restricted securities" for purposes of Rule 144 and may not be resold in a public distribution, except in compliance with the registration requirements of the Securities Act or unless the Series B Preferred Stock is converted into Common Stock and resold pursuant to Rule 144. In general, under Rule 144(e), as currently in effect, a stockholder (or stockholders whose shares are aggregated), including an affiliate, who has beneficially owned for at least one year shares of Common Stock that are treated as "restricted securities," would be entitled to sell publicly, within any three-month period, up to the greater of 1% of the then outstanding shares of Common Stock (23,681 shares immediately after the completion of this Offering) or the average weekly reported trading volume in the Common Stock during the four calendar weeks preceding the date on which notice of sale is given, provided certain requirements are satisfied. In addition, affiliates of the Company must comply with additional requirements of Rule 144 in order to sell shares of Common Stock (including shares acquired by affiliates in this offering). Under Rule 144, a stockholder deemed not to have been an affiliate of the Company at any time during the 90 days preceding a sale by him, and who has beneficially owned for at least two years shares of Common Stock that are treated as "restricted securities," would be entitled to sell those shares without regard to the foregoing requirements. Each officer and director of the Company, all holders of the shares of Series B Preferred Stock and Common Stock, and all holders of options and warrants to acquire shares of Common Stock have agreed not to, directly or indirectly, offer, sell, transfer, pledge, assign, hypothecate or otherwise encumber or dispose of any of the Company's securities, whether or not presently owned, for a period of 12 months after the date of this Prospectus, or 90 days after the date of this Prospectus in the case of the Selling Stockholders, without the prior written consent of the Company and the Representatives. Beginning 12 months after the date of this Prospectus, all 3,439,866 shares of Common Stock issuable upon conversion of the 6,879,732 of such shares of Series B Preferred Stock, along with 330,000 shares of Common Stock which may be acquired upon the exercise of options granted under the Company's Plan and 60,000 shares of Common Stock which may be acquired upon the exercise of a warrant, may be sold in accordance with Rule 144. DESCRIPTION OF SECURITIES The following description of the securities of the Company and certain provisions of the Company's Articles of Incorporation and Bylaws is a summary and is qualified in its entirety by the provisions of the Articles of Incorporation and Bylaws, which have been filed as exhibits to the Company's Registration Statement of which this Prospectus is a part. The authorized capital stock of the Company consists of 20,000,000 shares of Common Stock, $.01 par value and 15,000,000 shares of Preferred Stock, $.01 par value (the "Preferred Stock"), of which 10,000,000 shares are designated as Series B Preferred Stock. Upon completion of the Offering, there will be 2,368,060 shares of Common Stock issued and outstanding, 6,879,732 shares of Series B Preferred Stock issued and outstanding and 1,000,000 Warrants issued and outstanding. COMMON STOCK Holders of Common Stock are entitled to one vote per share on all matters to be voted upon by the stockholders of the Company. Subject to the preferences of the Series B Preferred Stock and to the other 51 preferences that may be applicable to any future shares of Preferred Stock outstanding, the holders of Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of funds legally available therefor. In the event of liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to the prior liquidation rights of the Series B Preferred Stock and of any future shares of Preferred Stock outstanding. The holders of Common Stock have no preemptive, redemption, conversion, sinking fund or other subscription rights. The outstanding shares of Common Stock are, and the shares offered by the Company in the Offering will be, when issued and paid for, fully paid and nonassessable. The rights, preferences and privileges of holders of Common Stock are subject to, and may be adversely affected by, the rights of the holders of shares of Series B Preferred Stock and of shares of any series of Preferred Stock which the Company may designate and issue in the future. PREFERRED STOCK Upon the closing of this Offering, the Board of Directors will have the authority, without further action by the stockholders, to issue up to 8,120,268 shares of Preferred Stock in one or more series and to fix the right, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, (which may be greater or lessor than the voting rights of the Common Stock), rights and terms of redemption, liquidation preferences, sinking fund terms and the number of shares constituting any series or the designation of such series without any further vote or action by the stockholders. The issuance of such shares of Preferred Stock could adversely affect the voting power of holders of Common Stock and the likelihood that such holders will receive dividend payments and payments upon liquidation and could have the effect of delaying, deferring or preventing a change in control of the Company. The Company has no present plans to issue any additional shares of Preferred Stock. SERIES B PREFERRED STOCK Ranking. The Series B Preferred Stock ranks senior to the Common Stock with respect to payment of dividends, and with respect to rights upon liquidation, dissolution, or winding up of the Company. Dividends. The Series B Preferred Stock accrues dividends at a rate of 5% per annum (the "Series B Dividend Rate") based on a Series B Liquidation Value of $.01 per share, payable in cash or in kind, at the option of the holder or the Company, on the dividend payment dates. Such dividends are fully cumulative to the extent not paid and will compound semi-annually at the Series B dividend rate. Conversions. Each share of Series B Preferred Stock is convertible at the option of the holder thereof at any time into shares of Common Stock determined by multiplying the number of shares of Series B Preferred Stock to be converted by the Series B Applicable Conversion Rate. The initial Series B Applicable Conversion Rate is equal to 0.5. The Series B Applicable Conversion Rate is subject to adjustment from time to time in the event of: (i) non-pro rata Common Stock dividends to security holders other than Common Stock holders, (ii) Common Stock dividends to Common Stock holders, or (iii) Common Stock splits or combinations. Voting Rights. Holders of Series B Preferred Stock are entitled to one vote per share (voting as one class with holders of the Common Stock, subject to certain exceptions) on each matter submitted to a vote of stockholders. Holders of Series B Preferred Stock are not entitled to cumulative voting rights with respect to the election of directors. The holders of 66 2/3% of the outstanding shares of Series B Preferred Stock, voting as a separate class, must approve any proposed amendment to the Company's Articles of Incorporation which would materially affect the rights of the holders of the Series B Preferred Stock. Liquidation Rights. In the event of any liquidation, dissolution or winding up of the affairs of the Company, the holders of Series B Preferred Stock are entitled to be paid out of the assets or surplus funds of the Company, before any distribution or payment to the holders of the Common Stock, an amount equal to the liquidation value thereof in cash (plus any accrued and unpaid dividends) for each share (or a pro rata portion thereof with respect 52 to fractional shares) outstanding. If the assets of the Company are insufficient to pay in full the liquidation payments payable to the holder of the Series B Preferred Stock and any other class or series of class of capital stock of the Company the terms of which expressly provide that the shares thereof rank on a parity as to the payment of dividends and the distribution of assets upon the liquidation, dissolution or winding up of the Company with the Series B Preferred Stock, such holders will share ratably in such distribution of assets or proceeds in proportion to the amount that would be payable in such distribution. Restriction on Dividends Payable on Common Stock. So long as there is any arrearage in the payment of dividends on Series B Preferred Stock, the Company may not pay dividends on any Common Stock (other than dividends payable solely in shares of Common Stock) nor may the Company redeem or retire any shares of Common Stock. Special Voting Rights. The terms of the Series B Preferred Stock provide that the Company shall not create, incur, permit or assume any Debt (as defined therein) or create, authorize or issue any class or series of preferred stock ranking senior to or pari passu with the Series B Preferred Stock unless such action is approved by the vote of at least 66 2/3% of the Series B Preferred Stock, voting as a separate class. This restriction does not apply to Debt or Preferred Stock the net proceeds of which are used, among other things, (i) for investments in working capital, or otherwise for the benefit of, the Company, or (ii) for acquisitions of, or mergers or consolidations with, any person in a similar line of business to that of the Company. OUTSTANDING WARRANT VenCap, Inc. ("VenCap") currently serves as the Company's stockholders relations consultant under a contract for the period August 1, 1996 to August 1, 1998. As partial consideration for VenCap's performance of services under such contract, the Company issued a warrant to VenCap on August 1, 1996, which gives VenCap the right until July 24, 2001 to purchase 60,000 shares of Common Stock at an exercise price of $5.00 per share. The exercise price and the number of shares of Common Stock purchasable upon the exercise of the warrant is subject to adjustment upon the occurrence of certain events, including stock dividends, stock splits, stock subdivisions, combinations or reclassifications of the Company's Common Stock, mergers, consolidations, or distributions of assets of the Company to the Company's stockholders. VenCap has piggyback registration rights with respect to the Common Stock issuable upon exercise of the warrant for the term of the warrant. VenCap has waived its registration rights in connection with the registration of the Securities offered hereby. WARRANTS The following is a brief summary of certain provisions of the Warrants but such summary does not purport to be complete and is qualified in all respects by reference to the actual text of the Warrant Agreement between the Company and Continental Stock Transfer & Trust Company (the "Warrant Agent"), a copy of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part. See "Additional Information." Exercise Price and Terms. Each Warrant entitles the registered holder thereof to purchase, at any time commencing , 1998 [6 months after date of this Prospectus] until , 2003 [60 months after the date of this Prospectus] one share of Common Stock at a price of $ [150% of the initial public offering price of the Common Stock] per share, subject to adjustment in accordance with the anti-dilution and other provisions referred to below. The holder of any Warrant may exercise such Warrant by surrendering the certificate representing the Warrant to the Warrant Agent, with the subscription form thereon properly completed and executed, together with payment of the exercise price. No fractional shares will be issued upon the exercise of the Warrants. The exercise price of the Warrants bears no relationship to any objective criteria of value and should in no event be regarded as an indication of any future market price of the Securities offered hereby. Adjustments. The exercise price and the number of shares of Common Stock purchasable upon the exercise of the Warrants are subject to adjustment upon the occurrence of certain events, including stock dividends, stock splits, combinations or reclassifications of the Common Stock or the sale by the Company of its Common Stock or other securities convertible into Common Stock at a price below the exercise price of the Warrants. 53 Additionally, an adjustment would be made in the case of a reclassification or exchange of Common Stock, consolidation or merger of the Company with or into another corporation (other than a consolidation or merger in which the Company is the surviving corporation) or sale of all or substantially all of the assets of the Company, in order to enable warrantholders to acquire the kind and number of shares of stock or other securities or property receivable in such event by a holder of the number of shares of Common Stock that might otherwise have been purchased upon the exercise of the Warrant. Redemption Provisions. Commencing , 1999 [18 months after date of this Prospectus], the Warrants will be subject to redemption by the Company, in whole but not in part, at $.10 per Warrant on thirty (30) days' prior written notice to the warrantholders, if the average closing sale price of the Common Stock as reported on the Amex equals or exceeds $20.00 per share for any twenty (20) trading days within a period of thirty (30) consecutive trading days ending on the fifth trading day prior to the date of the notice of redemption. In the event the Company exercises the right to redeem the Warrants, such Warrants will be exercisable until the close of business on the business day immediately preceding the date for redemption fixed in such notice. If any Warrant called for redemption is not exercised by such time, it will cease to be exercisable and the holder will be entitled only to the redemption price. Transfer, Exchange and Exercise. The Warrants are in registered form and may be presented to the Warrant Agent for transfer, exchange or exercise at any time on or prior to their expiration date sixty (60) months after the date of this Prospectus, at which time the Warrants will become wholly void and of no value. If a market for the Warrants develops, the holder may sell the Warrants instead of exercising them. There can be no assurance, however, that a market for the Warrants will develop or, if developed, will continue. Warrantholder Not a Stockholder. The Warrants do not confer upon holders thereof any voting, dividend or other rights as stockholders of the Company. Modification of Warrants. The Company and the Warrant Agent may make such modifications to the Warrants as they deem necessary and desirable that do not adversely affect the interests of the warrantholders. The Company may, in its sole discretion, lower the exercise price of the Warrants for a period of not less than thirty (30) days on not less than thirty (30) days' prior written notice to the warrantholders and the Representatives. Modification of the number of securities purchasable upon the exercise of any Warrant, the exercise price (other than as provided in the preceding sentence) and the expiration date with respect to any Warrant requires the consent of two-thirds of the warrantholders. The Warrants are not exercisable unless, at the time of the exercise, the Company has a current prospectus covering the shares of Common Stock issuable upon exercise of the Warrants, and such shares have been registered, qualified or deemed to be exempt under the securities or "blue sky" laws of the state of residence of the exercising holder of the Warrants. Although the Company has undertaken to use its best efforts to have all of the shares of Common Stock issuable upon exercise of the Warrants registered or qualified on or before the exercise date and to maintain a current prospectus relating thereto until the expiration of the Warrants, there can be no assurance that it will be able to do so. Although the Securities will not knowingly be sold to purchasers in jurisdictions in which the Securities are not registered or otherwise qualified for sale, investors in such jurisdictions may purchase Warrants in the secondary market or investors may move to jurisdictions in which the shares underlying the Warrants are not so registered or qualified during the period that the Warrants are exercisable. In such event, the Company would be unable to issue shares to those persons desiring to exercise their Warrants, and holders of Warrants would have no choice but to attempt to sell the Warrants in a jurisdiction where such sale is permissible or allow them to expire unexercised. CERTAIN ARTICLES OF INCORPORATION AND BY-LAW PROVISIONS The Articles of Incorporation and the Bylaws of the Company contain provisions that could have an anti-takeover effect. These provisions are intended to enhance the likelihood of continuity and stability in the 54 composition of the Board of Directors of the Company and in the policies formulated by the Board of Directors and to discourage certain types of transactions which may involve an actual or threatened change of control of the Company. The provisions are designed to reduce the vulnerability of the Company to an unsolicited proposal for a takeover of the Company that does not contemplate the acquisition of all of its outstanding shares or an unsolicited proposal for the restructuring or sale of all or part of the Company. The provisions are also intended to discourage certain tactics that may be used in proxy contests. Set forth below is a description of such provisions in the Articles of Incorporation and the Bylaws. The Board of Directors has no current plans to formulate or effect additional measures that could have an anti-takeover effect. The Articles of Incorporation of the Company provide for the Board of Directors to be divided into five classes, with staggered five-year terms. As a result, only one class of directors will be elected at each annual meeting of stockholders of the Company, with the other classes continuing for the remainder of their respective five-year term. The classification of the Board of Directors makes it more difficult to replace the Board of Directors as well as for another party to obtain control of the Company by replacing the Board of Directors. Since the Board of Directors has the power to retain and discharge officers of the Company, these provisions could also make it more difficult for existing stockholders or another party to effect a change in management. In addition, the Company's Articles of Incorporation provide that in addition to any other vote required by law, the following actions involving the Company and an interested stockholder (an "interested stockholder" is defined in the Articles of Incorporation to generally include any person, entity or group which beneficially owns 10% or more of the outstanding Voting Stock of the Company) shall require the affirmative vote of the holders of shares constituting 66 2/3% of the Voting Stock of the Company, given in person or by proxy at a meeting called for such purpose: (a) any merger, consolidation or reorganization, (b) any sale, lease, exchange, mortgage, pledge, transfer or other disposition of (1) the Company's or its subsidiaries' assets to an interested stockholder or (2) an interested stockholder's assets to the Company or its subsidiaries, (c) any issuance, sale, exchange, disposition or other transfer or any reclassification or recapitalization of any securities of the Company or its subsidiaries to an interested stockholder in exchange for cash, securities or other property having an aggregate value of $1.0 million or more, and (d) certain other material corporate transactions with an interested stockholder; provided, however, in the event either (y) more than 66 2/3% of the Company's directors shall have expressly approved the transaction or (z) the stockholders receive a fair price for their holdings and other requirements are fulfilled as set forth in the Articles of Incorporation, such special vote of the stockholders shall not be required. A "fair price" shall be deemed to be an amount equal to the highest amount of consideration paid by the interested stockholder for a share of Common Stock at any time within a two year period immediately prior to the date such interested stockholder became an interested stockholder and during any time while such interested stockholder was an interested stockholder. LIMITATION ON DIRECTORS' AND OFFICERS' LIABILITY; INDEMNIFICATION The Articles of Incorporation of the Company limit the liability of the directors of the Company to the Company or its stockholders (in their capacity as directors but not in their capacity as officers) to the fullest extent permitted by the MGCL. Accordingly, pursuant to the terms of the MGCL as presently in effect, the Company may indemnify any director unless it is established that: (i) the act or omission of the director was material to the matter giving rise to the proceeding and was committed in bad faith or was the result of active and deliberate dishonesty; (ii) the director actually received an improper personal benefit in money, property or services; or (iii) in the case of any criminal proceeding, the director had reasonable cause to believe that the act or omission was unlawful. In addition, the Company's Bylaws require the Company to indemnify each person who is or was, a director, officer, employee or agent of the Company to the fullest extent permitted by the laws of the State of Maryland in the event he is involved in legal proceedings by reason of the fact that he is or was a director, officer, employee or agent of the Company, or is or was serving at the Company's request as a director, officer, employee or agent of another corporation, partnership or other enterprise. The Company may also advance to such persons expenses incurred in defending a proceeding to which indemnification might apply, upon terms and conditions, if any, deemed appropriate by the Board of Directors upon receipt of an undertaking by or on behalf of such director or officer to repay all such advanced amounts if it is ultimately determined that he is not entitled to be indemnified as authorized by the laws of the State of Maryland. 55 TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Stock and Series B Preferred Stock, and the warrant agent for the Warrants, is Continental Stock Transfer & Trust Company, New York, New York. UNDERWRITING The Underwriters named below (the "Underwriters"), for whom Dirks & Company, Inc., and Security Capital Trading Corporation are acting as Representatives, have severally agreed, subject to the terms and conditions contained in the Underwriting Agreement (the "Underwriting Agreement") to purchase from the Company, and the Company has agreed to sell to the Underwriters on a firm commitment basis, the respective number of shares of Common Stock and number of Warrants set forth opposite their names:
NUMBER OF NUMBER OF UNDERWRITER SHARES WARRANTS ----------- --------- --------- Dirks & Company, Inc.................................. Security Capital Trading Corporation.................. --------- --------- Total............................................. 2,000,000 1,000,000 ========= =========
The Underwriters are committed to purchase all the Securities offered hereby, if any of the Securities are purchased. The Underwriting Agreement provides that the obligations of the several Underwriters are subject to the conditions precedent specified therein. The Company has been advised by the Representatives that the Underwriters initially propose to offer the Shares and Warrants to the public at the public offering price set forth on the cover page of this Prospectus and to certain dealers concessions not in excess of $ per Share and $ per Warrant. Such dealers may reallow a concession not in excess of $ per Share and $ per Warrant to certain other dealers. After the commencement of the Offering, the public offering price, concessions and reallowances may be changed by the Representatives. The Representatives have informed the Company that they do not expect sales to discretionary accounts by the Underwriters to exceed five percent of the Shares or Warrants offered by the Company hereby. The Company has granted to the Underwriters the Over-Allotment Option, exercisable during the 45-day period from the date of this Prospectus, to purchase from the Company up to an additional 300,000 Shares and/or 150,000 Warrants at the initial public offering prices, less underwriting discounts and the non-accountable expense allowance. Such option may be exercised only for the purpose of covering over-allotments, if any, incurred in the sale of the Shares and Warrants offered hereby. To the extent such option is exercised in whole or in part, each Underwriter will have a firm commitment, subject to certain conditions, to purchase the number of the additional Securities proportionate to its initial commitment. The Company has agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or to contribute to payments the Underwriters may be required to make. The Company has agreed to pay to the Representatives a non-accountable expense allowance equal to three percent of the gross proceeds derived from the sale of the Securities underwritten, of which $25,000 has been paid to date. In connection with this Offering, certain Underwriters and selling group members and their respective affiliates may engage in transactions that stabilize, maintain or otherwise affect the market price of the Securities. Such transactions may include stabilization transactions effected in accordance with Rule 104 of Regulation M, 56 pursuant to which such persons may bid for or purchase the Common Stock and/or Warrants for the purpose of stabilizing their respective market prices. The Underwriters also may create a short position for the account of the Underwriters by selling more Securities in connection with the Offering than they are committed to purchase from the Company, and in such case may purchase Securities in the open market following completion of the Offering to cover all or a portion of such short position. The Underwriters may also cover all or a portion of such short position, up to 300,000 Shares and/or 150,000 Warrants, by exercising the Over-Allotment Option referred to above. In addition, the Representatives may impose "penalty bids" under contractual arrangements with the Underwriters whereby it may reclaim from an Underwriter (or dealer participating in the Offering) for the account of other Underwriters, the selling concession with respect to the Securities that are distributed in the Offering but subsequently purchased for the account of the Underwriters in the open market. Any of the transactions described in this paragraph may result in the maintenance of the prices of the Securities at a level above that which might otherwise prevail in the open market. None of the transactions described in this paragraph is required, and, if they are undertaken, they may be discontinued at any time. The Company's directors and executive officers, and all holders of shares of Series B Preferred Stock, Common Stock, options, warrants or other securities convertible, exercisable or exchangeable for Common Stock, except for the Selling Stockholders, have, pursuant to certain lock-up agreements (the "Lock- up Agreements"), agreed not to offer, sell or otherwise dispose of any shares of Common Stock for a period of 12 months following the date of this Prospectus without the prior written consent of the Representatives and the Company. An appropriate legend shall be placed on the certificates representing such securities. The Representatives have no general policy with respect to the release of shares prior to the expiration of the lock-up period and no present intention to waive or modify any of these restrictions on the sale of Company securities. The Selling Stockholders have agreed to Lock-up Agreements for a period of 90 days following the date of this Prospectus. In connection with this Offering, the Company has agreed to sell to the Representatives, and/or their designees, for nominal consideration, Representatives' Warrants to purchase from the Company up to 200,000 shares of Common Stock and/or 100,000 Warrants. The Representatives' Warrants are initially exercisable at any time during a period of four (4) years commencing at the beginning of the second year after their issuance and sale at a price of $ [120% of the public offering price of the Common Stock] per share of Common Stock, and $ [120% of the public offering prior of the Warrants] per Warrant. The Warrants issuable upon exercise of the Representatives' Warrants are initially exercisable at a price of $ [100% of the exercise price of the Warrants] per Share. The Representatives' Warrants provide for adjustment in the number of securities issuable upon the exercise thereof as a result of certain subdivisions and combinations of the Common Stock. The Representatives' Warrants grant to the holders thereof certain rights of registration for the securities issuable upon exercise thereof. Prior to this Offering, there has been no public market for the Common Stock or the Warrants. Consequently, the initial public offering price of the Common Stock, the initial public offering price of the Warrants, and the terms of the Warrants have been determined by negotiation between the Company and the Representatives and does not necessarily bear any relationship to the Company's asset value, net worth or other established criteria of value. The factors considered in such negotiations, in addition to prevailing market conditions, included the history of and prospects for the industry in which the Company competes, an assessment of the Company's management, the prospects of the Company, its capital structure and such other factors as were deemed relevant. Dirks & Company, Inc., one of the Representatives, commenced operations in July 1997, and Security Capital Trading Corp., the other Representative, commenced operations in June 1995. Neither of the Representatives has co- managed or participated as an underwriter in any public offering of securities. Accordingly, neither of the Representatives has experience as a co-manager or underwriter of public offerings of securities. The foregoing is a summary of the principal terms of the agreements described above and does not purport to be complete. Reference is made to a copy of each such agreement which is filed as an exhibit to the Registration Statement of which this Prospectus is a part. See "Additional Information." 57 LEGAL MATTERS The validity of the Securities being offered by this Prospectus will be passed upon for the Company by McBreen, McBreen & Kopko, Chicago, Illinois. Frederick H. Kopko, Jr., a member of that firm and a director of the Company, beneficially owns 164,784 shares of the Company's Series B Preferred Stock and has an option to purchase 10,000 shares of the Company's Common Stock. Orrick, Herrington & Sutcliffe LLP, New York, New York has acted as counsel to the Underwriters in connection with this Offering. EXPERTS The financial statements of Sonic Foundry, Inc. at September 30, 1997, and for the nine months then ended, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors and at December 31, 1996, and for each of the two years in the period ended December 31, 1996, by Williams, Young & Associates, LLC, independent auditors, as set forth in their respective reports thereon appearing elsewhere herein, and are included in reliance upon such reports given upon the authority of such firms as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") a Registration Statement on Form SB-2 (together with all amendments, exhibits, schedules and supplements thereto, the "Registration Statement") under the Securities Act with respect to the Securities offered hereby. This Prospectus, which forms a part of the Registration Statement, does not contain all the information set forth in the Registration Statement, as permitted by the rules and regulations of the Commission. For further information with respect to the Company and the Securities offered hereby, reference is made to the Registration Statement. Statements contained in this Prospectus as to the contents of any contract or other document that has been filed as an exhibit to the Registration Statement are qualified in their entirety by reference to such exhibits for a complete statement of their terms and conditions. The Registration Statement and other information may be inspected and copied at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street N.W., Washington, D.C. 20549 or at certain of the regional offices of the Commission located at 7 World Trade Center, 13th Floor, New York, New York 10048 and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661, upon payment of the fees prescribed by the Commission. Copies of such material may be obtained from the Public Reference Section of the Commission at 450 Fifth Street N.W., Washington, D.C. 20549, at prescribed rates. The Commission also maintains a Web site (http://www.sec.gov) through which the Registration Statement and other information can be retrieved. 58 SONIC FOUNDRY, INC. INDEX TO HISTORICAL FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors.......................... F-2 Report of Williams, Young & Associates LLC, Independent Auditors........... F-3 Balance Sheets as of December 31, 1996 and September 30, 1997.............. F-4 Statements of Operations for the years ended December 31, 1995 and 1996 and for the nine months ended September 30, 1996 (unaudited) and 1997......... F-6 Statements of Stockholders' Equity for the years ended December 31, 1995 and 1996 and for the nine months ended September 30, 1997................. F-7 Statements of Cash Flows for the years ended December 31, 1995 and 1996 and for the nine months ended September 30, 1996 (unaudited) and 1997......... F-8 Notes to Financial Statements.............................................. F-9
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders Sonic Foundry, Inc. We have audited the accompanying balance sheet of Sonic Foundry, Inc. (the Company) as of September 30, 1997, and the related statements of operations, stockholders' equity and cash flows for the nine months then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company at September 30, 1997, and the results of its operations and its cash flows for the nine months then ended, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Milwaukee, Wisconsin November 7, 1997, except for Note 2 as to which the date is January 8, 1998 F-2 INDEPENDENT AUDITORS' REPORT Stockholders and Board of Directors Sonic Foundry, Inc. Madison, Wisconsin We have audited the accompanying balance sheets of Sonic Foundry, Inc. as of December 31, 1995 and 1996, and the related statements of income and retained earnings, stockholder's equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provided a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sonic Foundry, Inc. as of December 31, 1995 and 1996, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. WILLIAMS, YOUNG & ASSOCIATES, LLC Madison, Wisconsin May 28, 1997 F-3 SONIC FOUNDRY, INC. BALANCE SHEETS
DECEMBER 31 SEPTEMBER 30 1996 1997 ----------- ------------ ASSETS Current assets: Cash and cash equivalents........................... $ 453,574 $114,737 Accounts receivable, net of allowance for doubtful accounts of $20,090 at September 30, 1997.......... 470,025 428,484 Inventories......................................... 45,227 56,662 Prepaid expenses and other current assets........... 76,976 81,370 --------- -------- Total current assets.............................. 1,045,802 681,253
Property and equipment: Land........................................................ -- 95,000 Buildings and improvements.................................. 13,853 734,575 Equipment................................................... 461,040 674,695 Furniture and fixtures...................................... 23,588 36,877 ------- --------- 498,481 1,541,147 Less accumulated depreciation............................... 91,753 190,193 ------- --------- Net property and equipment.................................. 406,728 1,350,954
Capitalized software development costs, net.............. 173,723 300,078 Other assets............................................. 869 678 ---------- ---------- Total assets......................................... $1,627,122 $2,332,963 ========== ==========
F-4 SONIC FOUNDRY, INC. BALANCE SHEETS
DECEMBER 31 SEPTEMBER 30 1996 1997 ----------- ------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Line of credit...................................... $ 100,000 $ 220,000 Note payable to related party....................... 100,000 40,000 Accounts payable.................................... 258,116 570,650 Accrued liabilities................................. 72,301 84,282 Current portion of long-term obligations............ -- 31,174 ---------- ---------- Total current liabilities............................. 530,417 946,106 Long-term obligations................................. -- 702,443 Deferred income taxes................................. 20,000 -- Stockholders' equity: 5% preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 10,000,000 shares, issued and outstanding 6,680,000 and 6,879,732 shares at December 31, 1996 and September 30, 1997, respectively....................................... 66,800 68,797 Common stock, $.01 par value, authorized 20,000,000 shares; issued and outstanding 127,800 and 229,760 shares at December 31, 1996 and September 30, 1997 respectively....................................... 1,278 2,298 Common stock warrant................................ 78,000 78,000 Additional paid-in capital.......................... 735,439 1,363,900 Retained earnings (deficit)......................... 195,188 (828,581) ---------- ---------- 1,076,705 684,414 ---------- ---------- Total liabilities and stockholders' equity............ $1,627,122 $2,332,963 ========== ==========
See accompanying notes. F-5 SONIC FOUNDRY, INC. STATEMENTS OF OPERATIONS
YEARS ENDED NINE MONTHS ENDED DECEMBER 31 SEPTEMBER 30 -------------------- ----------------------- 1995 1996 1996 1997 -------- ---------- ----------- ---------- (UNAUDITED) Software license fees............ $757,579 $2,442,047 $1,623,066 $2,242,512 Cost of software license fees.... 82,053 372,272 199,349 407,099 -------- ---------- ---------- ---------- 675,526 2,069,775 1,423,717 1,835,413 Selling and marketing expenses... 234,636 954,243 627,349 1,445,302 General and administrative expenses........................ 256,417 717,664 467,940 834,934 Product development expenses..... 150,082 183,740 97,071 374,128 -------- ---------- ---------- ---------- 641,135 1,855,647 1,192,360 2,654,364 -------- ---------- ---------- ---------- Income (loss) from operations.... 34,391 214,128 231,357 (818,951) Other income (expense): Interest expense............... (159) (21,928) (13,445) (42,771) Other income (expense)......... (908) 6,894 3,153 2,631 -------- ---------- ---------- ---------- (1,067) (15,034) (10,292) (40,140) -------- ---------- ---------- ---------- Income (loss) before income taxes........................... 33,324 199,094 221,065 (859,091) Income tax expense (benefit)..... -- 20,000 -- (20,000) -------- ---------- ---------- ---------- Net income (loss)................ $ 33,324 $ 179,094 $ 221,065 $ (839,091) ======== ========== ========== ========== Pro forma data (unaudited): Income (loss) before income taxes......................... $ 33,324 $ 199,094 $ 221,065 $ (859,091) Income tax expense (benefit)... 7,000 70,000 79,000 (20,000) -------- ---------- ---------- ---------- Net income (loss).............. $ 26,324 $ 129,094 $ 142,065 $ (839,091) ======== ========== ========== ========== Net income (loss) per common share......................... $ .07 $ .08 $ .27 $ (1.11) ======== ========== ========== ========== Weighted average common and common equivalent shares........ 392,116 1,712,669 523,443 760,111 ======== ========== ========== ==========
See accompanying notes. F-6 SONIC FOUNDRY, INC. STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995 AND 1996 AND THE NINE MONTHS ENDED SEPTEMBER 30, 1997
PREFERRED STOCK-SERIES B COMMON STOCK COMMON ADDITIONAL RETAINED ------------------------------------------ STOCK PAID-IN EARNINGS SHARES DOLLARS SHARES DOLLARS WARRANT CAPITAL (DEFICIT) TOTAL ------------- ------------------- ------- ------- ---------- --------- --------- Balance, January 1, 1995................... -- $ -- 1,000 $ 10 $ -- $ 151,990 $ (1,230) $ 150,770 Stock issued for services.............. -- -- 53 1 -- 7,221 -- 7,222 Net income............. -- -- -- -- -- -- 33,324 33,324 Subchapter S distributions......... -- -- -- -- -- -- (16,000) (16,000) ------------- ----------- ------- ------ ------- ---------- --------- --------- Balance, December 31, 1995................... -- -- 1,053 11 -- 159,211 16,094 175,316 Stock issued for services.............. -- -- 124 1 -- 23,800 -- 23,801 Exchange of common stock for preferred stock................. 6,680,000 66,800 (1,177) (12) -- (66,788) -- -- Issuance of common stock, net............ -- -- 127,800 1,278 -- 619,216 -- 620,494 Issuance of common stock warrant......... -- -- -- -- 78,000 -- -- 78,000 Net income............. -- -- -- -- -- -- 179,094 179,094 ------------- ----------- ------- ------ ------- ---------- --------- --------- Balance, December 31, 1996................... 6,680,000 66,800 127,800 1,278 78,000 735,439 195,188 1,076,705 Issuance of common stock, net............ -- -- 101,960 1,020 -- 508,780 -- 509,800 Subchapter S distributions......... -- -- -- -- -- -- (63,000) (63,000) Preferred stock dividend.............. 199,732 1,997 -- -- -- -- (1,997) -- Undistributed Subchapter S Corporation earnings.. -- -- -- -- -- 119,681 (119,681) -- Net loss............... -- -- -- -- -- -- (839,091) (839,091) ------------- ----------- ------- ------ ------- ---------- --------- --------- Balance, September 30, 1997................... 6,879,732 $ 68,797 229,760 $2,298 $78,000 $1,363,900 $(828,581) $ 684,414 ============= =========== ======= ====== ======= ========== ========= =========
See accompanying notes. F-7 SONIC FOUNDRY, INC. STATEMENTS OF CASH FLOWS
YEARS ENDED NINE MONTHS ENDED DECEMBER 31 SEPTEMBER 30 ----------------- ---------------------- 1995 1996 1996 1997 ------- -------- ----------- ---------- (UNAUDITED) OPERATING ACTIVITIES Net income (loss).................. $33,324 $179,094 $221,065 $ (839,091) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.... 23,483 59,371 42,028 98,630 Amortization of capitalized software development costs...... 12,000 41,345 16,336 85,718 Deferred income taxes............ -- 20,000 -- (20,000) Noncash charges for stock issued. 7,221 101,801 101,801 -- Loss on disposal of equipment.... 908 -- -- -- Changes in operating assets and liabilities: Accounts receivable............ (63,620) (395,844) (213,160) 41,541 Inventories.................... (107) (26,692) (62,929) (11,435) Prepaid expenses and other current assets................ -- (76,976) (19,190) (4,394) Accounts payable and accrued liabilities................... 32,269 282,647 202,937 324,515 ------- -------- -------- ---------- Total adjustments.................. 12,154 5,652 67,823 514,575 ------- -------- -------- ---------- Net cash provided by (used in) operating activities.............. 45,478 184,746 288,888 (324,516) INVESTING ACTIVITIES Purchases of property and equipment......................... (72,654) (383,556) (185,518) (1,042,665) Proceeds from sale of equipment.... 350 -- -- -- Capitalized software development costs............................. -- (176,068) (176,068) (212,073) Other.............................. 4,076 -- -- -- ------- -------- -------- ---------- Net cash used in investing activities........................ (68,228) (559,624) (361,586) (1,254,738) FINANCING ACTIVITIES Proceeds from sale of common stock, net of issuance costs............. -- 620,494 -- 509,800 Proceeds from (payments on) note payable to related party.......... -- 100,000 100,000 (60,000) Proceeds from line of credit....... 15,000 85,000 85,000 120,000 Proceeds from long-term debt....... -- -- -- 747,800 Payments on long-term debt......... -- -- -- (14,183) Subchapter S distributions......... (16,000) -- -- (63,000) ------- -------- -------- ---------- Net cash provided by (used in) financing activities.............. (1,000) 805,494 185,000 1,240,417 ------- -------- -------- ---------- Net increase (decrease) in cash.... (23,750) 430,616 112,302 (338,837) Cash and cash equivalents at beginning of year................. 46,708 22,958 22,958 453,574 ------- -------- -------- ---------- Cash and cash equivalents at end of year.............................. $22,958 $453,574 $135,260 $ 114,737 ======= ======== ======== ========== Supplemental cash flow information: Interest paid.................... $ 159 $ 21,928 $ 13,445 $ 41,451 Noncash transactions: Exchange of common stock for preferred stock............... -- 183,023 -- -- Stock issued for services...... 7,222 23,801 23,801 -- Warrant issued for services.... -- 78,000 78,000 -- Preferred stock dividend....... -- -- -- 1,997
See accompanying notes. F-8 SONIC FOUNDRY, INC. NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1997 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES Business and Concentration of Credit Risk Sonic Foundry, Inc. (the Company) develops and licenses the use of digital- based media software. It sells to both retail and wholesale markets, primarily in North America, Asia and Europe. All domestic and international sales are denominated in U.S. dollars. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. Change in Year End On September 30, 1997, the Company changed its fiscal year so as to end on September 30 of each year. As a result, the Company's current fiscal year ended on September 30, 1997 and previous fiscal years ended on December 31, 1995 and 1996. Cash and Cash Equivalents For purposes of the statement of cash flows, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue Recognition Revenue is recognized when the product is shipped, in accordance with the provisions of AICPA Statement of Position (SOP) 91-1, "Software Revenue Recognition." The Company does not sell service, support, or upgrade contracts. In October 1997, SOP 97-2, "Software Revenue Recognition," was issued and supercedes SOP 91-1 for transactions entered into in fiscal years beginning after December 15, 1997. The Company has adopted SOP 97-2 in its fiscal year beginning October 1, 1997. The Company believes adoption of SOP 97-2 would not have had a material impact on historically reported revenue. Inventory Valuation Inventories are carried at the lower of cost or market with cost determined on a first-in, first-out (FIFO) basis. Software Development Costs In accordance with Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed," the Company capitalizes internal costs in developing software products upon determination that technological feasibility has been established for the F-9 SONIC FOUNDRY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) product, whereas costs incurred prior to the establishment of technological feasibility are charged to product development expense. When the product is available for general release to customers, capitalization ceases and such costs are amortized on a product-by-product basis based on current and future revenue with an annual minimum equal to the straight-line amortization over the remaining estimated economic useful life of the product. Capitalized software development costs are reported at the lower of unamortized cost or net realizable value. Capitalized software development costs at December 31, 1996 and September 30, 1997, are net of accumulated amortization of $62,345 and $148,063, respectively. Advertising Costs Advertising costs are expensed at the time the advertising takes place. Advertising costs were $148,795, $501,786 and $520,865 for the years ended December 31, 1995 and 1996 and the nine months ended September 30, 1997, respectively. Interim Financial Data The unaudited statements of operations and cash flows for the nine-month period ended September 30, 1996 have been prepared in accordance with generally accepted accounting principles for interim financial information and with Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of adjustments of a normal and recurring nature) considered necessary for a fair presentation of the results of operations have been included. Property and Equipment Property and equipment are recorded at cost and are depreciated using the straight-line method for financial reporting purposes. The estimated useful lives used to calculate depreciation are as follows:
YEARS ------------- Building and improvements................................... 5 to 40 years Equipment................................................... 3 to 5 years Furniture and fixtures...................................... 7 years
Income Taxes Effective November 1, 1996, the Company became a taxable entity. Previously, under the provisions of Subchapter S of the Internal Revenue Code, its earnings and losses were included in the personal tax returns of the stockholders, and the Company did not record an income tax provision. Effective with the change, current income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due. Deferred taxes are provided for temporary differences between financial reporting and income tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred taxes also arise from the tax effect of net operating loss carryforwards. In 1997, a valuation allowance equal to 100% of the net deferred tax assets has been recognized since future realization is not assured. F-10 SONIC FOUNDRY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) The pro forma income tax expense as presented for the years ended December 31, 1995 and 1996 and for the nine months ended September 30, 1996 is computed as if the Company had been a taxable entity in those periods. Pro Forma Net Income (Loss) Per Common Share Pro forma net income (loss) per common share is computed based on pro forma net income (loss) after preferred stock dividend requirements divided by the weighted average number of shares of common stock and common stock equivalents outstanding for each respective period after giving effect to dilutive stock options, warrants, convertible preferred stock and convertible debt. Pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 83, common stock sold and stock options granted by the Company during the 12 months immediately preceding the initial filing of the Registration Statement for the anticipated Initial Public Offering (IPO) have been included as common stock equivalents as if they were outstanding for each period presented, whether or not dilutive, because the sale or option price per share was below the anticipated IPO price per share. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash and cash equivalents, trade receivables, trade payables and debt instruments. The book values of cash and cash equivalents, trade receivables, and trade payables are considered to be representative of their respective fair values. None of the Company's debt instruments that are outstanding at September 30, 1997, have readily ascertainable market values; however, the carrying values are considered to approximate their respective fair values. See Note 2 for the terms and carrying values of the Company's various debt instruments. New Accounting Standards In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings Per Share," which is required to be adopted effective for both interim and annual financial statements for periods ending after December 15, 1997. Among other provisions, the dilutive effect of stock options must be excluded under the new requirements for calculating basic earnings per share, which will replace primary earnings per share. This change is not expected to materially impact the Company's fully diluted earnings per share calculations. In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes the standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) as part of a full set of financial statements. This statement requires that all elements of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. The statement is effective for fiscal years beginning after December 15, 1997. Since this standard applies only to the presentation of comprehensive income, it will not have any impact on the Company's results of operations, financial position or cash flows. In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which is effective for years beginning after December 15, 1997. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for financial statements for fiscal years beginning after December 15, 1997, and therefore the Company will adopt the new requirements F-11 SONIC FOUNDRY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) retroactively in 1999. Management has not completed its review of SFAS No. 131, but does not anticipate that the adoption of this statement will have a significant effect on the Company's reported segments. Reclassifications Certain reclassifications have been made to the 1995 and 1996 financial statements to conform to the 1997 presentation. 2. LONG-TERM DEBT AND NOTES PAYABLE Long-term obligations consist of the following:
DECEMBER 31 SEPTEMBER 30 1996 1997 ----------- ------------ Line of credit payable to a bank, paid in February 1997.............................................. $100,000 $ -- Line of credit payable to a bank, secured by substantially all assets, due February 1998, plus interest payable monthly at prime plus 1% per annum (9.5% at September 30, 1997)................ -- 220,000 Note payable to related party, paid in February 1997.............................................. 100,000 -- Construction loan payable to a bank, secured by a mortgage on the Company's principal facility, due February 1998, interest payable monthly at prime plus 1% per annum (9.5% at September 30, 1997).... -- 597,800 Note payable to the Madison Development Corporation, due February 2002, principal and interest payable monthly at 9.75% per annum, amortized over five years......................... -- 135,817 Convertible unsecured note payable to related party, payable on demand, plus interest payable monthly at 15% per annum.......................... -- 40,000 -------- -------- 200,000 993,617 Less amounts due within one year................... 200,000 291,174 -------- -------- Long-term debt..................................... $ -- $702,443 ======== ========
In February 1997, the Company repaid both the line of credit with a bank and the $100,000 note payable related party with the proceeds of a $250,000 revolving line of credit with another bank and a $150,000 five-year equipment loan with the Madison Development Corporation. The revolving line of credit facility is collateralized by substantially all the Company's assets, guarantees from two of the Company's principal stockholders and assignment of $1 million life insurance policies on each of their lives. The facility allows for the borrowing of $250,000. At September 30, 1997, the balance of the line was $220,000. In February 1997, the Company entered into a $620,000 construction loan with a bank to fund the purchase and renovation of a 10,000 square foot facility to house the Company's expanded operations. On January 8, 1998, the Company converted the construction loan into a term loan due January 3, 2003. The loan pays principal and interest monthly assuming a twenty-year amortization and interest of 7.71% per annum, and is collateralized by a first real-estate mortgage on the Company's principal facility. In February 1997, the Madison Development Corporation provided the Company with a $150,000 five-year equipment loan. The loan is payable monthly with interest at 9.75%. The loan is collateralized by a second position on substantially all the Company's assets, including a second real estate mortgage on the Company's principal facility, and personal guarantees of two of the Company's principal stockholders. The loan requires that the Company create a minimum number of new jobs for low and moderate income persons during the term of the loan. F-12 SONIC FOUNDRY NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 2. LONG-TERM DEBT AND NOTES PAYABLE--(CONTINUED) The Company received the proceeds of a $40,000 unsecured note in August 1997 from certain relatives of a Company officer. The note pays interest monthly at 15% per annum and is convertible into common stock at $5.00 per share at the election of the Company. The Company exercised its right and converted the note into 8,000 shares of common stock on October 17, 1997. Maturities of long-term debt at September 30, 1997 are as follows: 1998............................................................. $291,174 1999............................................................. 41,353 2000............................................................. 45,396 2001............................................................. 49,834 2002............................................................. 32,241 Thereafter....................................................... 533,619 -------- Total.......................................................... $993,617 ========
3. LEASE COMMITMENTS Total rent expense on all operating leases was approximately $10,658, $19,481 and $30,270 in the years ended December 31, 1995 and 1996 and the nine months ended September 30, 1997, respectively. 4. PREFERRED STOCK During 1996, each share of the outstanding common stock of the Company at that time was converted into 5,675.446 fully paid nonassessable shares of Series B preferred stock (total shares of 6,680,000 were issued). The Series B preferred stock accrues cumulative dividends at a 5% rate per annum (using a liquidation value of $.01 per share), and all dividends in arrears must be paid prior to any payment of dividends on common stock. Dividends, if declared by the board of directors, may be paid in cash or with additional shares of preferred stock at the Company's option. The Company declared a dividend on June 30, 1997 and issued 199,732 shares of preferred stock. The total amount of dividends in arrears on preferred stock is $835 at September 30, 1997. The Series B preferred stock is convertible to common stock at the preferred shareholders' option with an applicable conversion rate of two preferred shares into one common share, which is subject to adjustment. The adjustment may arise upon a dilutive event on common stock such as (i) non-pro rata Common Stock dividends to security holders other than Common stockholders, (ii) Common Stock dividends to Common stockholders, or (iii) Common Stock splits or combinations. The Series B preferred stockholders are entitled to one vote per share (voting as one class, with holders of common stock, subject to certain exceptions) on each matter submitted to a vote of stockholders. Series B preferred stockholders are not entitled to cumulative voting rights with respect to the election of directors. The preferred stockholders vote as a separate class to approve proposed amendments to the Articles of Incorporation which would materially affect their rights. The preferred stockholders also have special voting rights relating to issuance or assumption of debt or issuance of any series of preferred stock superior or equivalent in rank to the Series B preferred stock. There are 10,000,000 shares of Series B preferred stock and 15,000,000 total preferred shares authorized for issuance. These shares may be issued in series, and shares of each series will have such rights and preference as are fixed by the Board of Directors. F-13 SONIC FOUNDRY, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 5. COMMON STOCK WARRANT During 1996 the Company's stockholder relations consultant (consultant) received a warrant in connection with its stockholder relations contract with the Company. The contract gives the consultant the right, through August 1, 2001, to purchase 60,000 shares of common stock at an exercise price of $5.00 per share. As required by SFAS No. 123, "Accounting for Stock-Based Compensation," the Company calculated the fair value of the warrants using the minimum value option pricing model with a risk-free interest rate of 6.0%; dividend yield of 0%; and an expected life of five years. The Company recorded consulting expense of $78,000, or $1.30 per warrant, in August 1996. 6. STOCK OPTIONS The Company maintains an employee stock option plan under which the Company may grant options to acquire up to 1,000,000 shares of common stock. Each option entitles the holder to purchase one share of common stock at the specified option price. The exercise price of each option granted was set at the estimated market price of the Company's common stock at the grant dates. Options vest at various intervals, as determined by the Board of Directors at the date of grant, and expire at termination of employment, ten years from the grant date or at such times as are set by the Company at the date of grant. The following table summarizes information with respect to the Company's stock option plan for the years ended December 31, 1995 and 1996 and the nine months ended September 30, 1997.
YEARS ENDED DECEMBER 31 --------------------------------- NINE MONTHS ENDED 1995 1996 SEPTEMBER 30, 1997 ---------------- ---------------- ------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE ------- -------- ------- -------- --------- --------- Outstanding--beginning of period.................. -- $ -- 200,000 $0.036 560,000 $ 0.051 Granted.................. 200,000 0.036 360,000 0.060 67,550 5.00 ------- ------- --------- Outstanding--end of peri- od...................... 200,000 0.036 560,000 0.051 627,550 0.584 ======= ======= ========= Exercisable at end of pe- riod.................... 40,000 120,000 320,000 ======= ======= ========= Weighted average fair value of options granted during period........... $.01 $0.02 $1.30
The options outstanding at September 30, 1997 have been segregated into three ranges for additional disclosure as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------- ----------------------- OPTIONS OPTIONS WEIGHTED CURRENTLY WEIGHTED OUTSTANDING AT WEIGHTED AVERAGE AVERAGE EXERCISABLE AT AVERAGE EXERCISE SEPTEMBER 30, REMAINING EXERCISE SEPTEMBER 30, EXERCISE PRICES 1997 CONTRACTUAL LIFE PRICE 1997 PRICE - -------- -------------- ---------------- -------- -------------- -------- $0.036 200,000 7.4 $0.036 200,000 $0.036 0.060 360,000 8.4 0.060 120,000 0.060 5.000 67,550 9.7 5.000 -- 5.000
The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its employee stock option plan. Had the Company accounted for its employee F-14 SONIC FOUNDRY, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 6. STOCK OPTIONS--(CONTINUED) stock option plan based upon the fair value at the grant date for options granted under the plan, based on the provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), the Company's pro forma net income (loss) and pro forma net income (loss) per share would have been as follows (for purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period):
YEARS ENDED DECEMBER 31 NINE MONTHS ENDED ---------------- SEPTEMBER 30 1995 1996 1997 ------- -------- ----------------- Pro forma net income (loss).................. $32,824 $177,574 $(845,370) Pro forma net income (loss) per share........ .08 .10 (1.11)
Pro forma information regarding net income (loss) and income (loss) per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options under the minimum value method of that Statement. The fair value for these options was estimated at the date of grant using a minimum value option pricing model with a risk-free interest rate of 6.0% and an expected life of five years. Option valuation models require the input of highly subjective assumptions. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The Company has reserved 1,000,000 shares of common stock at September 30, 1997, to provide for the exercise of outstanding stock options and the granting of stock options. The Company has also reserved 90,000 shares of common stock at September 30, 1997 to provide for the exercise of common stock warrants. The Company also has a non-employee directors' stock option plan. Each non- employee director who is re-elected or who is continuing as a member of the Company's board of directors on the 1997 annual meeting date and on each subsequent meeting of the Company's stockholders is granted options to purchase 10,000 shares of common stock at exercise prices equal to the estimated market price of the Company's common stock. There are no grants under this plan at September 30, 1997. The Company has reserved 90,000 shares of common stock at September 30, 1997 to provide for the granting of directors stock options. 7. INCOME TAXES Income tax expense (benefit) in the statement of operations consists of the following:
YEAR ENDED NINE MONTHS ENDED DECEMBER 31 SEPTEMBER 30 1996 1997 ----------- ----------------- Deferred....................................... $20,000 $(337,000) Change in valuation reserve.................... -- 317,000 ------- --------- $20,000 $ (20,000) ======= =========
F-15 SONIC FOUNDRY, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 7. INCOME TAXES--(CONTINUED) The reconciliation of income tax expense computed at the U.S. federal statutory rate to income tax expense is:
NINE MONTHS YEAR ENDED ENDED DECEMBER 31 SEPTEMBER 30 1996 1997 ----------- ------------ Tax (tax benefit) at U.S. statutory rate of 34%....... $ 68,000 $(292,000) State income taxes (benefit), net of federal benefit.. 10,000 (67,000) Nondeductible items................................... 1,600 5,500 Change in valuation allowance......................... -- 337,000 Adjustment of deferred tax liability for change in tax status............................................... (59,600) -- Other................................................. -- (3,500) -------- --------- $ 20,000 $ (20,000) ======== =========
The significant components of the deferred tax accounts recognized for financial reporting purposes were as follows:
DECEMBER 31 SEPTEMBER 30 1996 1997 ----------- ------------ Deferred tax liabilities: Capitalized computer software costs.................. $57,000 $88,000 Depreciation......................................... 23,000 41,000 ------- ------- Total deferred tax liabilities......................... 80,000 129,000 ======= ======= Deferred tax assets: Net operating loss and other carryforwards........... 29,000 427,000 Common stock warrants................................ 31,000 31,000 Allowance for doubtful accounts...................... -- 8,000 ------- ------- Total deferred tax assets.............................. 60,000 466,000 Valuation allowance.................................... -- 337,000 ------- ------- Net deferred tax liabilities........................... $20,000 $ -- ======= =======
At September 30, 1997, the Company had federal and state net operating loss carryforwards of approximately $919,000 and $925,000, respectively available to offset future federal taxable income, expiring in 2012. In addition, the Company has research and development credits totaling approximately $50,000 which can be used to reduce federal and state taxable income through 2012. 8. SAVINGS PLAN The Company established a defined contribution 401(k) savings plan on December 31, 1996 that covers substantially all employees meeting certain minimum eligibility requirements. Participating employees can elect to defer a portion of their compensation and contribute it to the plan on a pretax basis. The Company may also match certain amounts and/or provide additional discretionary contributions, as defined. The Company has not made any discretionary contributions to date. F-16 SONIC FOUNDRY, INC. NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 9. RELATED-PARTY TRANSACTIONS The Company incurred $20,835 and $55,165 in consulting fees to a common stockholder of the Company, during the year ended December 31, 1996 and the nine months ended September 30, 1997, respectively. The Company paid $22,698 and $9,596 in legal fees to a preferred stockholder during the year ended December 31, 1996 and the nine months ended September 30, 1997, respectively, related to a private stock placement and other matters. 10. SEGMENT DISCLOSURE AND MAJOR CUSTOMERS The Company operates in one industry segment. Sales to individual customers that exceeded 10% of revenues in each period were as follows: the year ended December 31, 1995: one customer at 26% of revenues; the year ended December 31, 1996: two customers at 18% and 19% of revenues, respectively, and the nine months ended September 30, 1997: one customer at 14% of revenues. International revenues accounted for 25%, 18% and 27% of total revenues for the years ended December 31, 1995 and 1996, and the nine months ended September 30, 1997, respectively. Revenues by geographic area were as follows:
YEAR ENDED DECEMBER 31 NINE MONTHS ENDED ------------------- SEPTEMBER 30 1995 1996 1997 -------- ---------- ----------------- North America............................. $564,967 $1,996,344 $1,643,892 International............................. 192,612 445,703 598,620 -------- ---------- ---------- $757,579 $2,442,047 $2,242,512 ======== ========== ==========
F-17 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- NO UNDERWRITER, DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CON- TAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESEN- TATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY UNDERWRITER OR ANY SELLING STOCKHOLDER. NEITHER THE DELIVERY OF THIS PROSPEC- TUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IM- PLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OF- FER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OFFERED HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AU- THORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUAL- IFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SO- LICITATION. ---------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 4 Risk Factors.............................................................. 8 Use of Proceeds........................................................... 16 Dividend Policy........................................................... 18 Capitalization............................................................ 18 Dilution.................................................................. 19 Selected Financial Data................................................... 20 Management's Discussion and Analysis of Financial Condition and Results of Operations .............................................................. 21 Business.................................................................. 28 Management................................................................ 41 Certain Transactions...................................................... 45 Principal Stockholders.................................................... 46 Selling Stockholders...................................................... 48 Shares Eligible for Future Sale........................................... 51 Description of Securities................................................. 51 Underwriting.............................................................. 56 Legal Matters............................................................. 58 Experts................................................................... 58 Additional Information.................................................... 58 Index to Financial Statements............................................. F-1
---------------- UNTIL , 1998 (25 DAYS AFTER THE DATE OF THE PROSPECTUS), ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- [LOGO] SONIC FOUNDRY, INC. 2,000,000 SHARES OF COMMON STOCK AND 1,000,000 REDEEMABLE COMMON STOCK PURCHASE WARRANTS ---------------- PROSPECTUS ---------------- DIRKS & COMPANY, INC. SECURITY CAPITAL TRADING CORPORATION , 1998 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF OFFICERS AND DIRECTORS Article Tenth of the Amended and Restated Articles of Incorporation of the Registrant (Exhibit 3.1 hereto) limit the liability of the directors of the Registrant to the Registrant or its stockholders (in their capacity as directors but not in their capacity as officers) to the fullest extent permitted by the Maryland General Corporation Law (the "MGCL"). Accordingly, pursuant to the terms of the MGCL as presently in effect, directors of the Registrant will not be personally liable for monetary damages for breach of a director's fiduciary duty as a director, except to the extent the director has received improper benefit or profit, or the director is adjudicated to have been guilty of active and deliberate dishonesty which was material to the cause of action. In addition, Article VI of the Amended and Restated By-Laws of the Registrant (Exhibit 3.2 hereto), in substance, require the Registrant to indemnify each person who is or was, a director, officer, employee or agent of the Registrant to the fullest extent permitted by the laws of the State of Maryland in the event he is involved in legal proceedings by reason of the fact that he is or was a director, officer, employee or agent of the Registrant, or is or was serving at the Registrant's request as a director, officer, employee or agent of another corporation, partnership or other enterprise. The Registrant may also advance to such persons expenses incurred in defending a proceeding to which indemnification might apply, upon terms and conditions, if any, deemed appropriate by the Board of Directors upon receipt of an undertaking by or on behalf of such director or officer to repay all such advanced amounts if it is ultimately determined that he is not entitled to be indemnified as authorized by the laws of the State of Maryland. Reference is also made to the Form of Underwriting Agreement to be filed as Exhibit 1.1 to this Registration Statement for certain provisions regarding the indemnification of officers and directors of the Registrant by the Underwriters. ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION* Securities and Exchange Commission Registration Fee............. $ 10,620 NASD Filing Fee................................................. 4,100 Amex Listing Fee................................................ 50,000 Legal Fees and Expenses......................................... 125,000 Accountants' Fees and Expenses.................................. 75,000 Blue Sky Filing Fees and Expenses............................... 40,000 Printing and Engraving Expenses................................. 75,000 Transfer Agent and Registrar Fees............................... 5,000 Directors' and Officers' Liability Insurance.................... 100,000 Miscellaneous Expenses.......................................... 15,280 -------- Total....................................................... $500,000 ========
- -------- *All expenses other than the Securities and Exchange Commission Registration Fee and the NASD Filing Fee are estimated. ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES Since January 1, 1995, the Registrant has issued and sold an aggregate of 360,060 shares of Common Stock issued from October 1996 through December 1997 to accredited and non-accredited investors. The aggregate consideration received for such shares was $1,800,300. No underwriters were engaged in connection with these issuances and sales, which were made in reliance upon the exemption from registration set forth in section 4(2) of the Securities Act, relating to sales by an issuer not involving a public offering. II-1 ITEM 27. EXHIBITS
NUMBER DESCRIPTION ------ ----------- --- 1.1 Form of Underwriting Agreement 3.1 Amended and Restated Articles of Incorporation of the Registrant 3.2 Amended and Restated By-Laws of the Registrant 4.1* Specimen Common Stock Certificate 4.2 Form of Warrant Agreement, including Warrant Certificate 4.3 Form of Representatives' Warrant Agreement, including Representatives' Warrant Certificate 5.1* Opinion of McBreen, McBreen & Kopko regarding the legality of the Common Stock 10.1* Registrant's 1995 Stock Option Plan 10.2* Registrant's Non-Employee Directors' Stock Option Plan 10.3 Commercial Lease between Registrant and The Williamson Center, LLC regarding 740 and 744 Williamson Street, Madison, Wisconsin dated January 20, 1998. 10.4 Employment Agreement between Registrant and Rimas Buinevicius dated as of November 30, 1997 and effective as of January 1, 1997. 10.5 Employment Agreement between Registrant and Monty R. Schmidt dated as of November 30, 1997 and effective as of January 1, 1997. 10.6 Employment Agreement between Registrant and Curtis J. Palmer dated as of November 30, 1997 and effective as of January 1, 1997. 10.7 Digital Audio System License Agreement between the Registrant and Dolby Laboratories Licensing Corporation dated July 28, 1997. 10.8 Digital Audio System License Agreement between the Registrant and Dolby Laboratories Licensing Corporation dated July 28, 1997. 10.9* Start-Up Agreement between the Registrant and Ingram Micro Inc. dated October 16, 1997. 11.1 Statement re: Computation of Net Profit (Loss) Per Share 23.1* Consent of McBreen, McBreen & Kopko (included in its opinion to be filed as Exhibit 5.1 hereto) 23.2 Consent of Ernst & Young LLP 23.3 Consent of Williams, Young & Associates LLC 24.1 Power of Attorney (included on signature page) 27.1 Financial Data Schedule
- -------- * To be filed by amendment. ITEM 28. UNDERTAKINGS Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. II-2 The undersigned Registrant hereby undertakes to provide to the underwriters, at the closing specified in the Underwriting Agreement, certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. The undersigned Registrant hereby undertakes that: (1) For determining any liability under the Securities Act, treat the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to rule 424(b) (1) or (4) or 497 (h) under the Securities Act as part of this Registration Statement as of the time the Commission declared it effective. (2) For determining any liability under the Securities Act, treat each post-effective amendment that contains a form of prospectus as a new registration statement for the securities offered in the registration statement, and that offering of the securities at that time as the initial bona fide offering of those securities. The undersigned Registrant hereby undertakes that it will: (1) File, during any period in which it offers or sells securities, a post-effective amendment to this registration statement to: (i) Include any prospectus required by Section 10(a)(3) of the Securities Act; (ii) Reflect in the prospectus any facts or events which, individually or together, represent a fundamental change in the information in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement. (iii) Include any additional or changed material information on the plan of distribution. (2) For determining liability under the Securities Act, treat each post- effective amendment as a new registration statement of the securities offered, and the offering of the securities at that time to be the initial bona fide offering. (3) File a post-effective amendment to remove from registration any of the securities that remain unsold at the end of the offering. II-3 SIGNATURES IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE REQUIREMENTS ON FILING ON FORM SB-2 AND AUTHORIZED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF MADISON, STATE OF WISCONSIN, ON FEBRUARY , 1998. Sonic Foundry, Inc. /s/ Rimas P. Buinevicius By: _________________________________ Rimas P. Buinevicius Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS BELOW CONSTITUTES AND APPOINTS RIMAS P. BUINEVICIUS AND MONTY R. SCHMIDT, AND EACH OF THEM, HIS TRUE AND LAWFUL ATTORNEYS-IN-FACT AND AGENTS, WITH FULL POWER OF SUBSTITUTION AND RESUBSTITUTION, FOR HIM AND HIS NAME, PLACE AND STEAD, AND IN ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS TO THIS REGISTRATION STATEMENT (INCLUDING POST-EFFECTIVE AMENDMENTS AND REGISTRATION STATEMENTS FILED PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT OF 1933, AS AMENDED AND OTHERWISE), AND TO FILE THE SAME WITH ALL EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING TO SAID ATTORNEYS-IN-FACT AND AGENTS, AND EACH OF THEM, FULL POWER AND AUTHORITY TO DO AND PERFORM SUCH AND EVERY ACT AND THING REQUISITE AND NECESSARY TO BE DONE, AS FULLY TO ALL INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON, HEREBY RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT AND AGENTS, OR ANY OF THEM, OR HIS SUBSTITUTE OR SUBSTITUTES, MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE THEREOF. IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES STATED.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Rimas P. Buinevicius Chairman of the Board and February , 1998 ____________________________________ Chief Executive Officer Rimas P. Buinevicius (Principal Executive Officer) /s/ Monty R. Schmidt President and Director February , 1998 ____________________________________ Monty R. Schmidt /s/ Curtis J. Palmer Chief Technology Officer February , 1998 ____________________________________ and Director Curtis J. Palmer /s/ Kenneth A. Minor Chief Financial Officer February , 1998 ____________________________________ (Principal Financial and Kenneth A. Minor Accounting Officer) /s/ Frederick H. Kopko, Jr. Director February , 1998 ____________________________________ Frederick H. Kopko, Jr. /s/ Arnold Pollard Director February , 1998 ____________________________________ Arnold Pollard /s/ David C. Kleinman Director February , 1998 ____________________________________ David C. Kleinman
II-4 SIGNATURES IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT CERTIFIES THAT IT HAS REASONABLE GROUNDS TO BELIEVE THAT IT MEETS ALL OF THE REQUIREMENTS ON FILING ON FORM SB-2 AND AUTHORIZED THIS REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF MADISON, STATE OF WISCONSIN, ON FEBRUARY , 1998. Sonic Foundry, Inc. By: _________________________________ Rimas P. Buinevicius Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS BELOW CONSTITUTES AND APPOINTS RIMAS P. BUINEVICIUS AND MONTY R. SCHMIDT, AND EACH OF THEM, HIS TRUE AND LAWFUL ATTORNEYS-IN-FACT AND AGENTS, WITH FULL POWER OF SUBSTITUTION AND RESUBSTITUTION, FOR HIM AND HIS NAME, PLACE AND STEAD, AND IN ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS TO THIS REGISTRATION STATEMENT (INCLUDING POST-EFFECTIVE AMENDMENTS AND REGISTRATION STATEMENTS FILED PURSUANT TO RULE 462(B) UNDER THE SECURITIES ACT OF 1933, AS AMENDED AND OTHERWISE), AND TO FILE THE SAME WITH ALL EXHIBITS THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, GRANTING TO SAID ATTORNEYS-IN-FACT AND AGENTS, AND EACH OF THEM, FULL POWER AND AUTHORITY TO DO AND PERFORM EACH AND EVERY ACT AND THING REQUISITE AND NECESSARY TO BE DONE, AS FULLY TO ALL INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN PERSON, HEREBY RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT AND AGENTS, OR ANY OF THEM, OR HIS SUBSTITUTE OR SUBSTITUTES, MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE THEREOF. IN ACCORDANCE WITH THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE DATES STATED.
SIGNATURE TITLE DATE --------- ----- ---- Chairman of the Board and February , 1998 ____________________________________ Chief Executive Officer Rimas P. Buinevicius (Principal Executive Officer) President and Director February , 1998 ____________________________________ Monty R. Schmidt Chief Technology Officer February , 1998 ____________________________________ and Director Curtis J. Palmer Chief Financial Officer February , 1998 ____________________________________ (Principal Financial and Kenneth A. Minor Accounting Officer) Director February , 1998 ____________________________________ Frederick H. Kopko, Jr. Director February , 1998 ____________________________________ Arnold Pollard Director February , 1998 ____________________________________ David C. Kleinman
EX-1.1 2 FORM OF UNDERWRITING AGREEMENT EXHIBIT 1.1 OHS DRAFT 1/26/98 [Form of Underwriting Agreement - Subject to Additional Review] 2,000,000 Shares of Common Stock and 1,000,000 Redeemable Common Stock Purchase Warrant SONIC FOUNDRY, INC. UNDERWRITING AGREEMENT ---------------------- New York, New York , 1998 DIRKS & COMPANY, INC. SECURITY CAPITAL TRADING CORP. As Representatives of the several Underwriters named in Schedule A to Exhibit A annexed hereto 520 Madison Avenue 10th Floor New York, New York 10022 Ladies and Gentlemen: Sonic Foundry, Inc., a Maryland corporation (the "Company"), confirms its agreement with Dirks & Company, Inc. ("Dirks") and Security Capital Trading Corp. ("Security Capital") and each of the underwriters named in Schedule A hereto (collectively, the "Underwriters," which term shall also include any underwriter substituted as hereinafter provided in Section 11), for whom Dirks and Security Capital are acting as Representatives (in such capacity, Dirks and Security Capital shall hereinafter be referred to as "you" or the "Representatives"), with respect to the sale by the Company and the purchase by the Underwriters, acting severally and not jointly, of the respective number of shares ("Shares") of the Company's common stock, $0.01 par value per share ("Common Stock"), and redeemable common stock purchase warrants (the "Redeemable Warrants"), each to purchase one share of Common Stock set forth in Schedule A hereto. The aggregate 2,000,000 shares of Common Stock and 1,000,000 Redeemable Warrants will be separately tradable upon issuance and are hereinafter referred to as the "Firm Securities." Each Redeemable Warrant is exercisable commencing on ____________, 1998 [6 months from the date of this Agreement] until ____________, 2003 [60 months from the date of this Agreement], unless previously redeemed by the Company, at an initial exercise price of $_______ [150% of the initial public offering price per share of Common Stock] per share of Common Stock. The Redeemable Warrants may be redeemed by the Company at a redemption price of $.10 per Redeemable Warrant at any time after _____________, 1999 [18 months from the date of this Agreement] on thirty (30) days' prior written notice, provided that the closing bid price of the Common Stock equals or exceeds $20.00 per share, for any twenty (20) trading days within a period of thirty (30) consecutive trading days ending on the fifth trading day prior to the notice of redemption, all in accordance with the terms and conditions of the Warrant Agreement (herein defined). Upon your request, as provided in Section 2(b) of this Agreement, the Company shall also issue and sell to the Underwriters, acting severally and not jointly, up to an additional 300,000 shares of Common Stock and/or 150,000 Redeemable Warrants for the purpose of covering over-allotments, if any. Such 300,000 shares of Common Stock and 150,000 Redeemable Warrants are hereinafter collectively to as the "Option Securities." The Company also proposes to issue and sell to you warrants (the "Representatives' Warrants") pursuant to the Representatives' Warrant Agreement (the "Representatives' Warrant Agreement") for the purchase of an additional 200,000 shares of Common Stock and/or 100,000 Redeemable Warrants. The shares of Common Stock and Redeemable Warrants issuable upon exercise of the Representatives' Warrants are hereinafter referred to as the "Representatives' Securities." The Firm Securities, the Option Securities, the Representatives' Warrants and the Representatives' Securities (collectively, hereinafter referred to as the "Securities") are more fully described in the Registration Statement and the Prospectus referred to below. 1. Representations and Warranties of the Company. The Company represents and warrants to, and agrees with, each of the Underwriters as of the date hereof, and as of the Closing Date (as hereinafter defined) and each Option Closing Date (as hereinafter defined), if any, as follows: (a) The Company has prepared and filed with the Securities and Exchange Commission (the "Commission") a registration statement, and an amendment or amendments thereto, on Form SB-2 (No. 333-_________), including any related preliminary prospectus ("Preliminary Prospectus"), for the registration of the Firm Securities, the Option Securities and the Representatives' Securities under the Securities Act of 1933, as amended (the "Act"), which registration statement and amendment or amendments have been prepared by the Company in conformity with the requirements of the Act, and the rules and regulations (the "Regulations") of the Commission under the Act. The Company will promptly file a further amendment to said registration statement in the form heretofore delivered to the Underwriters and will not file any other amendment thereto to which the Underwriters shall have objected in writing after having been furnished with a copy thereof. Except as the context may otherwise require, such registration statement, as amended, on file with the Commission at the time the registration statement becomes effective (including the prospectus, financial statements, schedules, exhibits and all other documents filed as a part thereof or incorporated therein (including, but not limited to those documents or information incorporated by reference therein) and all information deemed 2 to be a part thereof as of such time pursuant to paragraph (b) of Rule 430(A) of the Regulations), is hereinafter called the "Registration Statement", and the form of prospectus in the form first filed with the Commission pursuant to Rule 424(b) of the Regulations, is hereinafter called the "Prospectus." For purposes hereof, "Rules and Regulations" mean the rules and regulations adopted by the Commission under either the Act or the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as applicable. (b) Neither the Commission nor any state regulatory authority has issued any order preventing or suspending the use of any Preliminary Prospectus, the Registration Statement or Prospectus or any part of any thereof and no proceedings for a stop order suspending the effectiveness of the Registration Statement or any of the Company's securities have been instituted or are pending or threatened. Each of the Preliminary Prospectus, the Registration Statement and Prospectus at the time of filing thereof conformed with the requirements of the Act and the Rules and Regulations, and none of the Preliminary Prospectus, the Registration Statement or Prospectus at the time of filing thereof contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, except that this representation and warranty does not apply to statements made in reliance upon and in conformity with written information furnished to the Company with respect to the Underwriters by or on behalf of the Underwriters expressly for use in such Preliminary Prospectus, Registration Statement or Prospectus or any amendment thereof or supplement thereto. (c) When the Registration Statement becomes effective and at all times subsequent thereto up to the Closing Date (as defined herein) and each Option Closing Date (as defined herein), if any, and during such longer period as the Prospectus may be required to be delivered in connection with sales by the Underwriters or a dealer, the Registration Statement and the Prospectus will contain all statements which are required to be stated therein in accordance with the Act and the Rules and Regulations, and will conform to the requirements of the Act and the Rules and Regulations; neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, will contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, provided, however, that this representation and warranty does not apply to statements made or statements omitted in reliance upon and in strict conformity with information furnished to the Company in writing by or on behalf of any Underwriter expressly for use in the Preliminary Prospectus, Registration Statement or Prospectus or any amendment thereof or supplement thereto. (d) The Company has been duly organized and is validly existing as a corporation in good standing under the laws of the state of its incorporation. Except as set forth in the Prospectus, the Company does not own an interest in any corporation, partnership, trust, joint venture or other business entity. The Company is duly qualified and licensed and in good standing as a foreign corporation in each jurisdiction in which its ownership or leasing of any properties or the character of its operations requires such qualification or licensing. The Company has all requisite power and authority (corporate and other), and has obtained any and all necessary authorizations, approvals, orders, licenses, certificates, franchises and permits of and from all governmental or regulatory officials and bodies (including, without limitation, those 3 having jurisdiction over environmental or similar matters), to own or lease its properties and conduct its business as described in the Prospectus; the Company is and has been doing business in compliance with all such authorizations, approvals, orders, licenses, certificates, franchises and permits and all applicable federal, state, local and foreign laws, rules and regulations; and the Company has not received any notice of proceedings relating to the revocation or modification of any such authorization, approval, order, license, certificate, franchise, or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would materially and adversely affect the condition, financial or otherwise, or the earnings, position, prospects, value, operation, properties, business or results of operations of the Company. The disclosures in the Registration Statement concerning the effects of federal, state, local, and foreign laws, rules and regulations on the Company's business as currently conducted and as contemplated are correct in all material respects and do not omit to state a material fact required to be stated therein or necessary to make the statements contained therein not misleading in light of the circumstances under which they were made. (e) The Company has a duly authorized, issued and outstanding capitalization as set forth in the Prospectus under "Capitalization" and "Description of Securities" and will have the adjusted capitalization set forth therein on the Closing Date and each Option Closing Date, if any, based upon the assumptions set forth therein, and the Company is not a party to or bound by any instrument, agreement or other arrangement providing for it to issue any capital stock, rights, warrants, options or other securities, except for this Agreement, the Warrant Agreement, the Representatives' Warrant Agreement and as described in the Prospectus. The Securities and all other securities issued or issuable by the Company conform or, when issued and paid for, will conform, in all respects to all statements with respect thereto contained in the Registration Statement and the Prospectus. All issued and outstanding securities of the Company have been duly authorized and validly issued and are fully paid and non- assessable and the holders thereof have no rights of rescission with respect thereto, and are not subject to personal liability by reason of being such holders; and none of such securities were issued in violation of the preemptive rights of any holders of any security of the Company or similar contractual rights granted by the Company. The Securities are not and will not be subject to any preemptive or other similar rights of any stockholder, have been duly authorized and, when issued, paid for and delivered in accordance with the terms hereof, will be validly issued, fully paid and non-assessable and will conform to the description thereof contained in the Prospectus; the holders thereof will not be subject to any liability solely as such holders; all corporate action required to be taken for the authorization, issue and sale of the Securities has been duly and validly taken; and the certificates representing the Securities will be in due and proper form. Upon the issuance and delivery pursuant to the terms hereof of the Securities to be sold by the Company hereunder, the Underwriters or the Representatives, as the case may be, will acquire good and marketable title to such Securities free and clear of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever. (f) The financial statements of the Company, together with the related notes and schedules thereto, included in the Registration Statement, each Preliminary Prospectus and the Prospectus fairly present the financial position, income, changes in cash flow, changes in stockholders' equity and the results of operations of the Company at the respective dates and for the respective periods to which they apply and such financial statements have been prepared in conformity with generally accepted accounting principles and the Rules and Regulations, 4 consistently applied throughout the periods involved and such financial statements as are audited have been examined by Ernst & Young LLP, who are independent certified public accountants within the meaning of the Act and the Rules and Regulations, as indicated in their reports filed therewith. There has been no adverse change or development involving a prospective adverse change in the condition, financial or otherwise, or in the earnings, position, prospects, value, operation, properties, business, or results of operations of the Company, whether or not arising in the ordinary course of business, since the date of the financial statements included in the Registration Statement and the Prospectus and the outstanding debt, the property, both tangible and intangible, and the business of the Company, conform in all material respects to the descriptions thereof contained in the Registration Statement and the Prospectus. Financial information (including, without limitation, any pro forma financial information) set forth in the Prospectus under the headings "Summary Financial Data," "Selected Financial Data," "Capitalization," and "Management's Discussion and Analysis of Financial Condition and Results of Operations," fairly present, on the basis stated in the Prospectus, the information set forth therein, and have been derived from or compiled on a basis consistent with that of the audited financial statements included in the Prospectus; and, in the case of pro forma financial information, if any, the assumptions used in the preparation thereof are reasonable and the adjustments used therein are appropriate to give effect to the transactions and circumstances referred to therein. The amounts shown as accrued for current and deferred income and other taxes in such financial statements are sufficient for the payment of all accrued and unpaid federal, state, local and foreign income taxes, interest, penalties, assessments or deficiencies applicable to the Company, whether disputed or not, for the applicable period then ended and periods prior thereto; adequate allowance for doubtful accounts has been provided for unindemnified losses due to the operations of the Company; and the statements of income do not contain any items of special or nonrecurring income not earned in the ordinary course of business, except as specified in the notes thereto. (g) The Company (i) has paid all federal, state, local, and foreign taxes for which it is liable, including, but not limited to, withholding taxes and amounts payable under Chapters 21 through 24 of the Internal Revenue Code of 1986, as amended (the "Code"), and has furnished all information returns it is required to furnish pursuant to the Code, (ii) has established adequate reserves for such taxes which are not due and payable, and (iii) does not have any tax deficiency or claims outstanding, proposed or assessed against it. (h) No transfer tax, stamp duty or other similar tax is payable by or on behalf of the Underwriters in connection with (i) the issuance by the Company of the Securities, (ii) the purchase by the Underwriters of the Firm Securities and the Option Securities from the Company and the purchase by the Representatives of the Representatives' Warrants from the Company, (iii) the consummation by the Company of any of its obligations under this Agreement, or (iv) resales of the Firm Securities and the Option Securities in connection with the distribution contemplated hereby. (i) The Company maintains insurance policies, including, but not limited to, general liability, malpractice and property insurance, which insures each of the Company and its employees, against such losses and risks generally insured against by comparable businesses. The Company (A) has not failed to give notice or present any insurance claim with respect to any matter, including but not limited to the Company's business, property or employees, under any 5 insurance policy or surety bond in a due and timely manner, (B) does not have any disputes or claims against any underwriter of such insurance policies or surety bonds or has failed to pay any premiums due and payable thereunder, or (C) has failed to comply with all conditions contained in such insurance policies and surety bonds. There are no facts or circumstances under any such insurance policy or surety bond which would relieve any insurer of its obligation to satisfy in full any valid claim of the Company. (j) There is no action, suit, proceeding, inquiry, arbitration, investigation, litigation or governmental proceeding (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, pending or threatened against (or circumstances that may give rise to the same), or involving the properties or business of, the Company which (i) questions the validity of the capital stock of the Company, this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement, or of any action taken or to be taken by the Company pursuant to or in connection with this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement, (ii) is required to be disclosed in the Registration Statement which is not so disclosed (and such proceedings as are summarized in the Registration Statement are accurately summarized in all material respects), or (iii) might materially and adversely affect the condition, financial or otherwise, or the earnings, position, prospects, stockholders' equity, value, operation, properties, business or results of operations of the Company. (k) The Company has full legal right, power and authority to authorize, issue, deliver and sell the Securities, enter into this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement and to consummate the transactions provided for in this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement; and this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement have each been duly and properly authorized, executed and delivered by the Company. Each of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement constitutes a legal, valid and binding agreement of the Company enforceable against the Company in accordance with its terms, and none of the Company's issue and sale of the Securities, execution or delivery of this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement, its performance hereunder and thereunder, its consummation of the transactions contemplated herein and therein, or the conduct of its business as described in the Registration Statement, the Prospectus, and any amendments or supplements thereto, conflicts with or will conflict with or results or will result in any breach or violation of any of the terms or provisions of, or constitutes or will constitute a default under, or result in the creation or imposition of any lien, charge, claim, encumbrance, pledge, security interest, defect or other restriction or equity of any kind whatsoever upon, any property or assets (tangible or intangible) of the Company pursuant to the terms of (i) the certificate of incorporation or by-laws of the Company, (ii) any license, contract, collective bargaining agreement, indenture, mortgage, deed of trust, lease, voting trust agreement, stockholders agreement, note, loan or credit agreement or any other agreement or instrument to which the Company is a party or by which the Company is or may be bound or to which its or assets (tangible or intangible) is or may be subject, or any indebtedness, or (iii) any statute, judgment, decree, order, rule or regulation applicable to the Company of any arbitrator, court, regulatory body or administrative agency or other governmental agency or body (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, having jurisdiction over the Company or any of its activities or properties. 6 (l) No consent, approval, authorization or order of, and no filing with, any court, regulatory body, government agency or other body, domestic or foreign, is required for the issuance of the Securities pursuant to the Prospectus and the Registration Statement, the performance of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement and the transactions contemplated hereby and thereby, including without limitation, any waiver of any preemptive, first refusal or other rights that any entity or person may have for the issue and/or sale of any of the Securities, except such as have been or may be obtained under the Act or may be required under state securities or Blue Sky laws in connection with the Underwriters' purchase and distribution of the Firm Securities and the Option Securities, and the Representatives' Warrants to be sold by the Company hereunder. (m) All executed agreements, contracts or other documents or copies of executed agreements, contracts or other documents filed as exhibits to the Registration Statement to which the Company is a party or by which it or they may be bound or to which its or their respective assets, properties or business may be subject have been duly and validly authorized, executed and delivered by the Company and constitute the legal, valid and binding agreements of the Company, as the case may be, enforceable against it in accordance with its terms. The descriptions in the Registration Statement of agreements, contracts and other documents are accurate and fairly present the information required to be shown with respect thereto by Form SB-2, and there are no contracts or other documents which are required by the Act to be described in the Registration Statement or filed as exhibits to the Registration Statement which are not described or filed as required, and the exhibits which have been filed are complete and correct copies of the documents of which they purport to be copies. (n) Subsequent to the respective dates as of which information is set forth in the Registration Statement and Prospectus, and except as may otherwise be indicated or contemplated herein or therein, the Company has not (i) issued any securities or incurred any liability or obligation, direct or contingent, for borrowed money, (ii) entered into any transaction other than in the ordinary course of business, or (iii) declared or paid any dividend or made any other distribution on or in respect of its capital stock of any class, and there has not been any change in the capital stock, or any change in the debt (long or short term) or liabilities or material adverse change in or affecting the general affairs, management, financial operations, stockholders' equity or results of operations of the Company. (o) No default exists in the due performance and observance of any term, covenant or condition of any license, contract, collective bargaining agreement, indenture, mortgage, installment sale agreement, lease, deed of trust, voting trust agreement, stockholders agreement, partnership agreement, note, loan or credit agreement, purchase order, or any other agreement or instrument evidencing an obligation for borrowed money, or any other material agreement or instrument to which the Company is a party or by which the Company may be bound or to which the property or assets (tangible or intangible) of the Company is subject or affected. (p) The Company has generally enjoyed a satisfactory employer-employee relationship with its employees and is in compliance with all federal, state, local and foreign laws and regulations respecting employment and employment practices, terms and conditions of employment and wages and hours. There are no pending investigations involving the Company 7 by the U.S. Department of Labor, or any other governmental agency responsible for the enforcement of such federal, state, local, or foreign laws and regulations. There is no unfair labor practice charge or complaint against the Company pending before the National Labor Relations Board or any lockout, strike, picketing, boycott, dispute, slowdown or stoppage pending or threatened against or involving the Company, or any predecessor entity, and none has ever occurred. No representation question exists respecting the employees of the Company, and no collective bargaining agreement or modification thereof is currently being negotiated by the Company. No grievance or arbitration proceeding is pending under any expired or existing collective bargaining agreements of the Company. No labor dispute with the employees of the Company exists, or, is imminent. (q) The Company does not maintain, sponsor or contribute to any program or arrangement that is an "employee pension benefit plan," an "employee welfare benefit plan," or a "multiemployer plan" as such terms are defined in Sections 3(2), 3(1) and 3(37), respectively, of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") ("ERISA Plans"). The Company does not maintain or contribute, now or at any time previously, to a defined benefit plan, as defined in Section 3(35) of ERISA. No ERISA Plan (or any trust created thereunder) has engaged in a "prohibited transaction" within the meaning of Section 406 of ERISA or Section 4975 of the Code, which could subject the Company or the Subsidiaries to any tax penalty on prohibited transactions and which has not adequately been corrected. Each ERISA Plan is in compliance with all reporting, disclosure and other requirements of the Code and ERISA as they relate to any such ERISA Plan. Determination letters have been received from the Internal Revenue Service with respect to each ERISA Plan which is intended to comply with Code Section 401(a), stating that such ERISA Plan and the attendant trust are qualified thereunder. The Company has never completely or partially withdrawn from a "multiemployer plan." (r) Neither the Company, nor any of its employees, directors, stockholders, partners, or affiliates (within the meaning of the Rules and Regulations) of any of the foregoing has taken or will take, directly or indirectly, any action designed to or which has constituted or which might be expected to cause or result in, under the Exchange Act, or otherwise, stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Securities or otherwise. (s) Except as otherwise disclosed in the Prospectus, none of the patents, patent applications, trademarks, service marks, trade names and copyrights, and licenses and rights to the foregoing presently owned or held by the Company, are in dispute so far as known by the Company or are in any conflict with the right of any other person or entity. The Company (i) owns or has the right to use, free and clear of all liens, charges, claims, encumbrances, pledges, security interests, defects or other restrictions or equities of any kind whatsoever, all patents, trademarks, service marks, trade names and copyrights, technology and licenses and rights with respect to the foregoing, used in the conduct of its business as now conducted or proposed to be conducted without infringing upon or otherwise acting adversely to the right or claimed right of any person, corporation or other entity under or with respect to any of the foregoing and (ii) is not obligated or under any liability whatsoever to make any payment by way of royalties, fees or otherwise to any owner or licensee of, or other claimant to, any patent, 8 trademark, service mark, trade name, copyright, know-how, technology or other intangible asset, with respect to the use thereof or in connection with the conduct of its business or otherwise. (t) The Company has good and marketable title to, or valid and enforceable leasehold estates in, all items of real and personal property stated in the Prospectus to be owned or leased by it, free and clear of all liens, charges, claims, encumbrances, pledges, security interests, defects, or other restrictions or equities of any kind whatsoever, other than those referred to in the Prospectus and liens for taxes not yet due and payable. (u) Ernst & Young LLP, whose report is filed with the Commission as a part of the Registration Statement, are independent certified public accountants as required by the Act and the Rules and Regulations. (v) The Company has caused to be duly executed legally binding and enforceable agreements pursuant to which each of the Company's officers, directors, stockholders (except for the stockholders whose shares of Common Stock are being registered in the Registration Statement) and holders of securities exchangeable or exercisable for or convertible into shares of Common Stock has agreed not to, directly or indirectly, issue, offer, offer to sell, sell, grant any option for the sale or purchase of, assign, transfer, pledge, hypothecate or otherwise encumber or dispose of any shares of Common Stock or securities convertible into, exercisable or exchangeable for or evidencing any right to purchase or subscribe for any shares of Common Stock (either pursuant to Rule 144 of the Rules and Regulations or otherwise) or dispose of any beneficial interest therein for a period of not less than twelve (12) months following the effective date of the Registration Statement (the "Lock-Up Period") without the prior written consent of the Representatives and the Company. During the 12 month period commencing on the effective date of the Registration Statement, the Company shall not, without the prior written consent of the Representatives, sell, contract or offer to sell, issue, transfer, assign, pledge, distribute, or otherwise dispose of, directly or indirectly, any shares of Common Stock or any options, rights or warrants with respect to any shares of Common Stock. In the case of the stockholders whose shares of Common Stock are being registered in the Registration Statement, the Lock-Up Period shall be 90 days following the effective date of the Registration Statement. The Company will cause the Transfer Agent (as hereinafter defined) to mark an appropriate legend on the face of stock certificates representing all of such securities and to place "stop transfer" orders on the Company's stock ledgers. (w) There are no claims, payments, issuances, arrangements or understandings, whether oral or written, for services in the nature of a finder's or origination fee with respect to the sale of the Securities hereunder or any other arrangements, agreements, understandings, payments or issuance with respect to the Company, or any of its officers, directors, stockholders, partners, employees or affiliates, that may affect the Underwriters' compensation, as determined by the National Association of Securities Dealers, Inc. ("NASD"). (x) The Common Stock has been approved for quotation on the Nasdaq SmallCap Market ("Nasdaq"). (y) None of the Company, nor any of its officers, employees, agents or any other person acting on behalf of the Company has, directly or indirectly, given or agreed to give 9 any money, gift or similar benefit (other than legal price concessions to customers in the ordinary course of business) to any customer, supplier, employee or agent of a customer or supplier, or official or employee of any governmental agency (domestic or foreign) or instrumentality of any government (domestic or foreign) or any political party or candidate for office (domestic or foreign) or other person who was, is, or may be in a position to help or hinder the business of the Company (or assist the Company in connection with any actual or proposed transaction) which (a) might subject the Company, or any other such person to any damage or penalty in any civil, criminal or governmental litigation or proceeding (domestic or foreign), (b) if not given in the past, might have had a material adverse effect on the assets, business or operations of the Company, or (c) if not continued in the future, might adversely affect the assets, business, condition, financial or otherwise, earnings, position, properties, value, operations or prospects of the Company. The Company's internal accounting controls are sufficient to cause the Company to comply with the Foreign Corrupt Practices Act of 1977, as amended. (z) Except as set forth in the Prospectus, no officer, director, stockholder or partner of the Company, or any "affiliate" or "associate" (as these terms are defined in Rule 405 promulgated under the Rules and Regulations) of any of the foregoing persons or entities has or has had, either directly or indirectly, (i) an interest in any person or entity which (A) furnishes or sells services or products which are furnished or sold or are proposed to be furnished or sold by the Company, or (B) purchases from or sells or furnishes to the Company any goods or services, or (ii) a beneficiary interest in any contract or agreement to which the Company is a party or by which it may be bound or affected. Except as set forth in the Prospectus under "Certain Transactions," there are no existing agreements, arrangements, understandings or transactions, or proposed agreements, arrangements, understandings or transactions, between or among the Company, and any officer, director, or 5% or greater securityholder of the Company, or any partner, affiliate or associate of any of the foregoing persons or entities. (aa) Any certificate signed by any officer of the Company, and delivered to the Underwriters or to Underwriters' Counsel (as defined herein) shall be deemed a representation and warranty by the Company to the Underwriters as to the matters covered thereby. (bb) The minute books of the Company have been made available to the Underwriters and contain a complete summary of all meetings and actions of the directors (including committees thereof) and stockholders of the Company, since the time of its incorporation, and reflect all transactions referred to in such minutes accurately in all material respects. (cc) Except and to the extent described in the Prospectus, no holders of any securities of the Company or of any options, warrants or other convertible or exchangeable securities of the Company have the right to include any securities issued by the Company in the Registration Statement or any registration statement to be filed by the Company or to require the Company to file a registration statement under the Act and no person or entity holds any anti-dilution rights with respect to any securities of the Company. (dd) The Company has as of the effective date of the Registration Statement (i) entered into an employment agreement with each of Rimas Buinevicius, Curtis Palmer and Monty Schmidt in the form filed as Exhibits ____, ____ and ____, respectively, to the 10 Registration Statement and (ii) purchased term key person insurance on the lives of each of Rimas Buinevicius, Curtis Palmer and Monty Schmidt in the amount of $1 million each which policies name the Company as the sole beneficiary thereof. (ee) The Company confirms as of the date hereof that it is in compliance with all provisions of Section 1 of Laws of Florida, Chapter 92-198, An Act Relating to Disclosure of Doing Business with Cuba, and the Company further agrees that if it or any affiliate commences engaging in business with the government of Cuba or with any person or affiliate located in Cuba after the date the Registration Statement becomes or has become effective with the Commission or with the Florida Department of Banking and Finance (the "Department"), whichever date is later, or if the information reported or incorporated by reference in the Prospectus, if any, concerning the Company's, or any affiliate's, business with Cuba or with any person or affiliate located in Cuba changes in any material way, the Company will provide the Department notice of such business or change, as appropriate, in a form acceptable to the Department. (ff) The Company is not, and upon the issuance and sale of the Securities as herein contemplated and the application of the net proceeds therefrom as described in the Prospectus under the caption "Use of Proceeds" will not be, an "investment company" or an entity "controlled" by an "investment company" as such terms are defined in the Investment Company Act of 1940, as amended (the "1940 Act"). (gg) The Company maintains a system of internal accounting controls sufficient to provide reasonable assurance that (i) transactions are executed in accordance with management's general or specific authorizations; (ii) transactions are recorded as necessary to permit preparations of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets; (iii) access to assets is permitted only in accordance with management's general or specific authorizations; and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (hh) The Company has entered into a warrant agreement substantially in the form filed as Exhibit ____ to the Registration Statement (the "Warrant Agreement") with Continental Stock Transfer and Trust Company, as Warrant Agent, in form and substance satisfactory to the Representatives, with respect to the Redeemable Warrants. 11 2. Purchase, Sale and Delivery of the Securities. (a) On the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, the Company agrees to sell to each Underwriter, and each Underwriter, severally and not jointly, agrees to purchase from the Company at a price of $_______ [90% of the initial public offering price per share of Common Stock] per share of Common Stock and $____ [90% of the initial public offering price per Redeemable Warrant] per Redeemable Warrant, that number of Firm Securities set forth in Schedule A opposite the name of such Underwriter, subject to such adjustment as the Representatives in its sole discretion shall make to eliminate any sales or purchases of fractional shares, plus any additional number of Firm Securities which such Underwriter may become obligated to purchase pursuant to the provisions of Section 11 hereof. (b) In addition, on the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, the Company hereby grants an option to the Underwriters, severally and not jointly, to purchase all or any part of an additional 300,000 shares of Common Stock at a price of $_________ per share of Common Stock [90% of the initial public offering price per share of Common Stock] and/or an additional 150,000 Redeemable Warrants at a price of $____ per Redeemable Warrant [90% of the initial public offering price per Redeemable Warrant]. The option granted hereby will expire forty-five (45) days after (i) the date the Registration Statement becomes effective, if the Company has elected not to rely on Rule 430A under the Rules and Regulations, or (ii) the date of this Agreement if the Company has elected to rely upon Rule 430A under the Rules and Regulations, and may be exercised in whole or in part from time to time only for the purpose of covering over-allotments which may be made in connection with the offering and distribution of the Firm Securities upon notice by the Representatives to the Company setting forth the number of Option Securities as to which the several Underwriters are then exercising the option and the time and date of payment and delivery for any such Option Securities. Any such time and date of delivery (an "Option Closing Date") shall be determined by the Representatives, but shall not be later than three (3) full business days after the exercise of said option, nor in any event prior to the Closing Date, as hereinafter defined, unless otherwise agreed upon by the Representatives and the Company. Nothing herein contained shall obligate the Underwriters to make any over-allotments. No Option Securities shall be delivered unless the Firm Securities shall be simultaneously delivered or shall theretofore have been delivered as herein provided. (c) Payment of the purchase price for, and delivery of certificates for, the Firm Securities shall be made at the offices of Dirks at 520 Madison Avenue, 10th Floor, New York, New York 10022, or at such other place as shall be agreed upon by the Representatives and the Company. Such delivery and payment shall be made at 10:00 a.m. (New York City time) on ________, 1998 or at such other time and date as shall be agreed upon by the Representatives and the Company, but not less than three (3) nor more than five (5) full business days after the effective date of the Registration Statement (such time and date of payment and delivery being herein called the "Closing Date"). In addition, in the event that any or all of the Option Securities are purchased by the Underwriters, payment of the purchase price for, and delivery of certificates for, such Option Securities shall be made at the above-mentioned office of the Representatives or at such other place as shall be agreed upon by the Representatives and the Company on each Option Closing Date as specified in the notice from the Representatives to 12 the Company. Delivery of the certificates for the Firm Securities and the Option Securities, if any, shall be made to the Underwriters against payment by the Underwriters, severally and not jointly, of the purchase price for the Firm Securities and the Option Securities, if any, to the order of the Company for the Firm Securities and the Option Securities, if any, by New York Clearing House funds. In the event such option is exercised, each of the Underwriters, acting severally and not jointly, shall purchase that proportion of the total number of Option Securities then being purchased which the number of Firm Securities set forth in Schedule A hereto opposite the name of such Underwriter bears to the total number of Firm Securities, subject in each case to such adjustments as the Representatives in its discretion shall make to eliminate any sales or purchases of fractional shares. Certificates for the Firm Securities and the Option Securities, if any, shall be in definitive, fully registered form, shall bear no restrictive legends and shall be in such denominations and registered in such names as the Underwriters may request in writing at least two (2) business days prior to the Closing Date or the relevant Option Closing Date, as the case may be. The certificates for the Firm Securities and the Option Securities, if any, shall be made available to the Representatives at such office or such other place as the Representatives may designate for inspection, checking and packaging no later than 9:30 a.m. on the last business day prior to the Closing Date or the relevant Option Closing Date, as the case may be. (d) On the Closing Date, the Company shall issue and sell to the Representatives Representatives' Warrants at a purchase price of $.0001 per warrant, which Representatives' Warrants shall entitle the holders thereof to purchase an aggregate of 200,000 shares of Common Stock and/or 100,000 Redeemable Warrants. The Representatives' Warrants shall be exercisable for a period of four (4) years commencing one (1) year from the effective date of the Registration Statement at a price equaling one hundred twenty percent (120%) of the respective initial public offering price of the Shares and the Redeemable Warrants. The Representatives' Warrant Agreement and form of Warrant Certificate shall be substantially in the form filed as Exhibit [___] to the Registration Statement. Payment for the Representatives' Warrants shall be made on the Closing Date. 3. Public Offering of the Shares and Redeemable Warrants. As soon after the Registration Statement becomes effective as the Representatives deems advisable, the Underwriters shall make a public offering of the Shares and Redeemable Warrants (other than to residents of or in any jurisdiction in which qualification of the Securities is required and has not become effective) at the price and upon the other terms set forth in the Prospectus. The Representatives may from time to time increase or decrease the public offering price after distribution of the Shares and Redeemable Warrants has been completed to such extent as the Representatives, in its sole discretion deems advisable. The Underwriters may enter into one of more agreements as the Underwriters, in each of their sole discretion, deem advisable with one or more broker-dealers who shall act as dealers in connection with such public offering. 4. Covenants and Agreements of the Company. The Company covenants and agrees with each of the Underwriters as follows: (a) The Company shall use its best efforts to cause the Registration Statement and any amendments thereto to become effective as promptly as practicable and will not at any time, whether before or after the effective date of the Registration Statement, file any amendment 13 to the Registration Statement or supplement to the Prospectus or file any document under the Act or Exchange Act before termination of the offering of the Shares and the Redeemable Warrants by the Underwriters of which the Representatives shall not previously have been advised and furnished with a copy, or to which the Representatives shall have objected or which is not in compliance with the Act, the Exchange Act or the Rules and Regulations. (b) As soon as the Company is advised or obtains knowledge thereof, the Company will advise the Representatives and confirm the notice in writing (i) when the Registration Statement, as amended, becomes effective, if the provisions of Rule 430A promulgated under the Act will be relied upon, when the Prospectus has been filed in accordance with said Rule 430A and when any post- effective amendment to the Registration Statement becomes effective; (ii) of the issuance by the Commission of any stop order or of the initiation, or the threatening, of any proceeding suspending the effectiveness of the Registration Statement or any order preventing or suspending the use of the Preliminary Prospectus or the Prospectus, or any amendment or supplement thereto, or the institution of proceedings for that purpose; (iii) of the issuance by the Commission or by any state securities commission of any proceedings for the suspension of the qualification of any of the Securities for offering or sale in any jurisdiction or of the initiation, or the threatening, of any proceeding for that purpose; (iv) of the receipt of any comments from the Commission; and (v) of any request by the Commission for any amendment to the Registration Statement or any amendment or supplement to the Prospectus or for additional information. If the Commission or any state securities commission shall enter a stop order or suspend such qualification at any time, the Company will make every effort to obtain promptly the lifting of such order. (c) The Company shall file the Prospectus (in form and substance satisfactory to the Representatives) or transmit the Prospectus by a means reasonably calculated to result in filing with the Commission pursuant to Rule 424(b)(1) (or, if applicable and if consented to by the Representatives, pursuant to Rule 424(b)(4)) not later than the Commission's close of business on the earlier of (i) the second business day following the execution and delivery of this Agreement and (ii) the fifth business day after the effective date of the Registration Statement. (d) The Company will give the Representatives notice of its intention to file or prepare any amendment to the Registration Statement (including any post-effective amendment) or any amendment or supplement to the Prospectus (including any revised prospectus which the Company proposes for use by the Underwriters in connection with the offering of the Securities which differs from the corresponding prospectus on file at the Commission at the time the Registration Statement becomes effective, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) of the Rules and Regulations), and will furnish the Representatives with copies of any such amendment or supplement a reasonable amount of time prior to such proposed filing or use, as the case may be, and will not file any such prospectus to which the Representatives or Orrick, Herrington & Sutcliffe LLP ("Underwriters' Counsel") shall object. (e) The Company shall endeavor in good faith, in cooperation with the Representatives, at or prior to the time the Registration Statement becomes effective, to qualify the Securities for offering and sale under the securities laws of such jurisdictions as the Representatives may designate to permit the continuance of sales and dealings therein for as long 14 as may be necessary to complete the distribution, and shall make such applications, file such documents and furnish such information as may be required for such purpose; provided, however, the Company shall not be required to qualify as a foreign corporation or file a general or limited consent to service of process in any such jurisdiction. In each jurisdiction where such qualification shall be effected, the Company will, unless the Representatives agrees that such action is not at the time necessary or advisable, use all reasonable efforts to file and make such statements or reports at such times as are or may reasonably be required by the laws of such jurisdiction to continue such qualification. (f) During the time when a prospectus is required to be delivered under the Act, the Company shall use all reasonable efforts to comply with all requirements imposed upon it by the Act and the Exchange Act, as now and hereafter amended and by the Rules and Regulations, as from time to time in force, so far as necessary to permit the continuance of sales of or dealings in the Securities in accordance with the provisions hereof and the Prospectus, or any amendments or supplements thereto. If at any time when a prospectus relating to the Securities is required to be delivered under the Act, any event shall have occurred as a result of which, in the opinion of counsel for the Company or Underwriters' Counsel, the Prospectus, as then amended or supplemented, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary at any time to amend the Prospectus to comply with the Act, the Company will notify the Representatives promptly and prepare and file with the Commission an appropriate amendment or supplement in accordance with Section 10 of the Act, each such amendment or supplement to be satisfactory to Underwriters' Counsel, and the Company will furnish to the Underwriters copies of such amendment or supplement as soon as available and in such quantities as the Underwriters may request. (g) As soon as practicable, but in any event not later than forty-five (45) days after the end of the 12-month period beginning on the day after the end of the fiscal quarter of the Company during which the effective date of the Registration Statement occurs (ninety (90) days in the event that the end of such fiscal quarter is the end of the Company's fiscal year), the Company shall make generally available to its security holders, in the manner specified in Rule 158(b) of the Rules and Regulations, and to the Representatives, an earnings statement which will be in the detail required by, and will otherwise comply with, the provisions of Section 11(a) of the Act and Rule 158(a) of the Rules and Regulations, which statement need not be audited unless required by the Act, covering a period of at least twelve (12) consecutive months after the effective date of the Registration Statement. (h) During a period of seven (7) years after the date hereof, the Company will furnish to its stockholders, as soon as practicable, annual reports (including financial statements audited by independent public accountants) and unaudited quarterly reports of earnings, and will deliver to the Representatives: 15 (i) concurrently with furnishing such quarterly reports to its stockholders, statements of income of the Company for each quarter in the form furnished to the Company's stockholders and certified by the Company's principal financial or accounting officer; (ii) concurrently with furnishing such annual reports to its stockholders, a balance sheet of the Company as at the end of the preceding fiscal year, together with statements of operations, stockholders' equity, and cash flows of the Company for such fiscal year, accompanied by a copy of the certificate thereon of independent certified public accountants; (iii) as soon as they are available, copies of all reports (financial or other) mailed to stockholders; (iv) as soon as they are available, copies of all reports and financial statements furnished to or filed with the Commission, the NASD or any securities exchange; (v) every press release and every material news item or article of interest to the financial community in respect of the Company, or its affairs, which was released or prepared by or on behalf of the Company; and (vi) any additional information of a public nature concerning the Company (and any future subsidiary) or its businesses which the Representatives may request. During such seven-year period, if the Company has an active subsidiary, the foregoing financial statements will be on a consolidated basis to the extent that the accounts of the Company and its subsidiary(ies) are consolidated, and will be accompanied by similar financial statements for any significant subsidiary which is not so consolidated. (i) The Company will maintain a transfer agent and warrant agent ("Transfer Agent") and, if necessary under the jurisdiction of incorporation of the Company, a Registrar (which may be the same entity as the Transfer Agent) for its Common Stock and Redeemable Warrants. (j) The Company will furnish to the Representatives or on the Representatives' order, without charge, at such place as the Representatives may designate, copies of each Preliminary Prospectus, the Registration Statement and any pre-effective or post-effective amendments thereto (two of which copies will be signed and will include all financial statements and exhibits), the Prospectus, and all amendments and supplements thereto, including any prospectus prepared after the effective date of the Registration Statement, in each case as soon as available and in such quantities as the Representatives may request. (k) On or before the effective date of the Registration Statement, the Company shall provide the Representatives with true original copies of duly executed, legally binding and enforceable agreements pursuant to which, for a period of twelve (12) months from the effective date of the Registration Statement, each of the Company's stockholders (except for 16 the stockholders whose shares of Common Stock are being registered in the Registration Statement) and holders of securities exchangeable or exercisable for or convertible into shares of Common Stock agrees that it or he or she will not, directly or indirectly, issue, offer to sell, sell, grant an option for the sale or purchase of, assign, transfer, pledge, hypothecate or otherwise encumber or dispose of any shares of Common Stock or securities convertible into, exercisable or exchangeable for or evidencing any right to purchase or subscribe for any shares of Common Stock (either pursuant to Rule 144 of the Rules and Regulations or otherwise) or dispose of any beneficial interest therein without the prior consent of the Representatives (collectively, the "Lock-up Agreements"). During the 12 month period commencing on the effective date of the Registration Statement, the Company shall not, without the prior written consent of the Representatives, sell, contract or offer to sell, issue, transfer, assign, pledge, distribute, or otherwise dispose of, directly or indirectly, any shares of Common Stock or any options, rights or warrants with respect to any shares of Common Stock. In the case of the stockholders whose shares of Common Stock are being registered in the Registration Statement, the Lock-up Agreement shall be for a period of 90 days following the effective date of the Registration Statement. On or before the Closing Date, the Company shall deliver instructions to the Transfer Agent authorizing it to place appropriate legends on the certificates representing the securities subject to the Lock-up Agreements and to place appropriate stop transfer orders on the Company's ledgers. (l) None of the Company, nor any of its officers, directors, stockholders, nor any of its affiliates (within the meaning of the Rules and Regulations) will take, directly or indirectly, any action designed to, or which might in the future reasonably be expected to cause or result in, stabilization or manipulation of the price of any securities of the Company. (m) The Company shall apply the net proceeds from the sale of the Securities in the manner, and subject to the conditions, set forth under "Use of Proceeds" in the Prospectus. No portion of the net proceeds will be used, directly or indirectly, to acquire any securities issued by the Company. (n) The Company shall timely file all such reports, forms or other documents as may be required (including, but not limited to, a Form SR as may be required pursuant to Rule 463 under the Act) from time to time, under the Act, the Exchange Act, and the Rules and Regulations, and all such reports, forms and documents filed will comply as to form and substance with the applicable requirements under the Act, the Exchange Act, and the Rules and Regulations. (o) The Company shall furnish to the Representatives as early as practicable prior to each of the date hereof, the Closing Date and each Option Closing Date, if any, but no later than two (2) full business days prior thereto, a copy of the latest available unaudited interim financial statements of the Company (which in no event shall be as of a date more than thirty (30) days prior to the date of the Registration Statement) which have been read by the Company's independent public accountants, as stated in their letters to be furnished pursuant to Sections 6(l) and 6(m) hereof. (p) The Company shall cause the Common Stock and Redeemable Warrants to be quoted on Nasdaq and, for a period of seven (7) years from the date hereof, use its best 17 efforts to maintain the Nasdaq quotation of the Common Stock and the Redeemable Warrants to the extent outstanding. (q) For a period of five (5) years from the Closing Date, the Company shall furnish to the Representatives at the Company's sole expense, (i) daily consolidated transfer sheets relating to the Common Stock and Redeemable Warrants (ii) the list of holders of all of the Company's securities and (iii) a Blue Sky "Trading Survey" for secondary sales of the Company's securities prepared by counsel to the Company. (r) As soon as practicable, (i) but in no event more than five (5) business days before the effective date of the Registration Statement, file a Form 8-A with the Commission providing for the registration under the Exchange Act of the Securities and (ii) but in no event more than thirty (30) days after the effective date of the Registration Statement, take all necessary and appropriate actions to be included in Standard and Poor's Corporation Descriptions and Moody's OTC Manual and to continue such inclusion for a period of not less than seven (7) years. (s) The Company hereby agrees that it will not, for a period of twelve (12) months from the effective date of the Registration Statement, adopt, propose to adopt or otherwise permit to exist any employee, officer, director, consultant or compensation plan or similar arrangement permitting (i) the grant, issue, sale or entry into any agreement to grant, issue or sell any option, warrant or other contract right (x) at an exercise price that is less than the greater of the public offering price of the Shares set forth herein and the fair market value on the date of grant or sale or (y) to any of its executive officers or directors or to any holder of 5% or more of the Common Stock; (ii) the maximum number of shares of Common Stock or other securities of the Company purchasable at any time pursuant to options or warrants issued by the Company to exceed the aggregate 1,000,000 shares reserved for future issuance under the Company's Stock Option Plan; (iii) the payment for such securities with any form of consideration other than cash; or (iv) the existence of stock appreciation rights, phantom options or similar arrangements. (t) Until the completion of the distribution of the Securities, the Company shall not, without the prior written consent of the Representatives and Underwriters' Counsel, issue, directly or indirectly, any press release or other communication or hold any press conference with respect to the Company or its activities or the offering contemplated hereby, other than trade releases issued in the ordinary course of the Company's business consistent with past practices with respect to the Company's operations. (u) For a period equal to the lesser of (i) seven (7) years from the date hereof, and (ii) the sale to the public of the Representatives' Securities, the Company will not take any action or actions which may prevent or disqualify the Company's use of Form SB-2 (or other appropriate form) for the registration under the Act of the Representatives' Securities. The Company further agrees to use its best efforts to file such post-effective amendments to the Registration Statement, as may be necessary, in order to maintain its effectiveness and to keep such Registration Statement effective while any of the Redeemable Warrants or Representatives' Warrants remain outstanding. 18 5. Payment of Expenses. (a) The Company hereby agrees to pay on each of the Closing Date and the Option Closing Date (to the extent not paid at the Closing Date) all expenses and fees (other than fees of Underwriters' Counsel, except as provided in (iv) below) incident to the performance of the obligations of the Company under this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement, including, without limitation, (i) the fees and expenses of accountants and counsel for the Company, (ii) all costs and expenses incurred in connection with the preparation, duplication, printing (including mailing and handling charges), filing, delivery and mailing (including the payment of postage with respect thereto) of the Registration Statement and the Prospectus and any amendments and supplements thereto and the printing, mailing (including the payment of postage with respect thereto) and delivery of this Agreement, the Warrant Agreement, the Representatives' Warrant Agreement, the Agreement Among Underwriters, the Selected Dealer Agreements, and related documents, including the cost of all copies thereof and of the Preliminary Prospectuses and of the Prospectus and any amendments thereof or supplements thereto supplied to the Underwriters and such dealers as the Underwriters may request, in quantities as hereinabove stated, (iii) the printing, engraving, issuance and delivery of the Securities including, but not limited to, (x) the purchase by the Underwriters of the Firm Securities and the Option Securities and the purchase by the Representatives of the Representatives' Warrants from the Company, (y) the consummation by the Company of any of its obligations under this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement, and (z) resale of the Firm Securities and the Option Securities by the Underwriters in connection with the distribution contemplated hereby, (iv) the qualification of the Securities under state or foreign securities or "Blue Sky" laws and determination of the status of such securities under legal investment laws, including the costs of printing and mailing the "Preliminary Blue Sky Memorandum", the "Supplemental Blue Sky Memorandum" and "Legal Investments Survey," if any, and disbursements and fees of counsel in connection therewith, (v) costs and expenses incurred by the Company in connection with the "road show", (vi) fees and expenses of the Transfer Agent and registrar and all issue and transfer taxes, if any, (vii) applications for assignment of a rating of the Securities by qualified rating agencies, (viii) the fees payable to the Commission and the NASD, and (ix) the fees and expenses incurred in connection with the quotation of the Securities on Nasdaq and any other exchange. (b) If this Agreement is terminated by the Underwriters in accordance with the provisions of Section 6 or Section 12, the Company shall reimburse and indemnify the Underwriters for all of their actual out-of-pocket expenses, including the fees and disbursements of Underwriters' Counsel, less any amounts already paid pursuant to Section 5(c) hereof. (c) The Company further agrees that, in addition to the expenses payable pursuant to subsection (a) of this Section 5, it will pay to the Representatives on the Closing Date by certified or bank cashier's check or, at the election of the Representatives, by deduction from the proceeds of the offering of the Firm Securities, a non-accountable expense allowance equal to 3% of the gross proceeds received by the Company from the sale of the Firm Securities, $25,000 of which has been paid to date. In the event the Representatives elects to exercise the overallotment option described in Section 2(b) hereof, the Company further agrees to pay to the Representatives on each Option Closing Date, by certified or bank cashier's check, or at the Representatives' election, by deduction from the proceeds of the Option Securities purchased on 19 such Option Closing Date, a non-accountable expense allowance equal to 3% of the gross proceeds received by the Company from the sale of such Option Securities. 6. Conditions of the Underwriters' Obligations. The obligations of the Underwriters hereunder shall be subject to the continuing accuracy of the representations and warranties of the Company herein as of the date hereof and as of the Closing Date and each Option Closing Date, if any, as if they had been made on and as of the Closing Date or each Option Closing Date, as the case may be; the accuracy on and as of the Closing Date or Option Closing Date, if any, of the statements of the officers of the Company made pursuant to the provisions hereof; and the performance by the Company on and as of the Closing Date and each Option Closing Date, if any, of its covenants and obligations hereunder and to the following further conditions: (a) The Registration Statement shall have become effective not later than 12:00 P.M., New York time, on the date of this Agreement or such later date and time as shall be consented to in writing by the Representatives, and, at the Closing Date and each Option Closing Date, if any, no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or contemplated by the Commission and any request on the part of the Commission for additional information shall have been complied with to the reasonable satisfaction of Underwriters' Counsel. If the Company has elected to rely upon Rule 430A of the Rules and Regulations, the price of the Units and any price- related information previously omitted from the effective Registration Statement pursuant to such Rule 430A shall have been transmitted to the Commission for filing pursuant to Rule 424(b) of the Rules and Regulations within the prescribed time period and, prior to the Closing Date, the Company shall have provided evidence satisfactory to the Representatives of such timely filing, or a post-effective amendment providing such information shall have been promptly filed and declared effective in accordance with the requirements of Rule 430A of the Rules and Regulations. (b) The Representatives shall not have advised the Company that the Registration Statement, or any amendment thereto, contains an untrue statement of fact which, in the Representatives' opinion, is material, or omits to state a fact which, in the Representatives' opinion, is material and is required to be stated therein or is necessary to make the statements therein not misleading, or that the Prospectus, or any supplement thereto, contains an untrue statement of fact which, in the Representatives' opinion, is material, or omits to state a fact which, in the Representatives' opinion, is material and is required to be stated therein or is necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. (c) On or prior to each of the Closing Date and each Option Closing Date, if any, the Representatives shall have received from Underwriters' Counsel, such opinion or opinions with respect to the organization of the Company, the validity of the Securities, the Registration Statement, the Prospectus and other related matters as the Representatives may request and Underwriters' Counsel shall have received such papers and information as they request to enable them to pass upon such matters. (d) At the Closing Date, the Underwriters shall have received the favorable opinion of McBreen, McBreen & Kopko, counsel to the Company, dated the Closing Date, 20 addressed to the Underwriters and in form and substance satisfactory to Underwriters' Counsel, to the effect that: (i) the Company (A) has been duly organized and is validly existing as a corporation in good standing under the laws of its jurisdiction, (B) is duly qualified and licensed and in good standing as a foreign corporation in each jurisdiction in which its ownership or leasing of any properties or the character of its operations requires such qualification or licensing, and (C) has all requisite corporate power and authority, and has obtained any and all necessary authorizations, approvals, orders, licenses, certificates, franchises and permits of and from all governmental or regulatory officials and bodies (including, without limitation, those having jurisdiction over environmental or similar matters), to own or lease its properties and conduct its business as described in the Prospectus; the Company is and has been doing business in compliance with all such authorizations, approvals, orders, licenses, certificates, franchises and permits and all federal, state and local laws, rules and regulations; and, the Company has not received any notice of proceedings relating to the revocation or modification of any such authorization, approval, order, license, certificate, franchise, or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would materially adversely affect the business, operations, condition, financial or otherwise, or the earnings, business affairs, position, prospects, value, operation, properties, business or results of operations of the Company. The disclosures in the Registration Statement concerning the effects of federal, state and local laws, rules and regulations on the Company's business as currently conducted and as contemplated are correct in all material respects and do not omit to state a fact required to be stated therein or necessary to make the statements contained therein not misleading in light of the circumstances in which they were made. (ii) except as described in the Prospectus, the Company does not own an interest in any other corporation, partnership, joint venture, trust or other business entity; (iii) the Company has a duly authorized, issued and outstanding capitalization as set forth in the Prospectus, and any amendment or supplement thereto, under "CAPITALIZATION", and the Company is not a party to or bound by any instrument, agreement or other arrangement providing for it to issue, sell, transfer, purchase or redeem any capital stock, rights, warrants, options or other securities, except for this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement and as described in the Prospectus. The Securities and all other securities issued or issuable by the Company conform in all material respects to all statements with respect thereto contained in the Registration Statement and the Prospectus. All issued and outstanding securities of the Company have been duly authorized and validly issued and are fully paid and non- assessable; the holders thereof have no rights of rescission with respect thereto, and are not subject to personal liability by reason of being such holders; and none of such securities were issued in violation of the preemptive rights of any holders of any security of the Company or any similar rights granted by the Company. The Securities to be sold by the Company hereunder and under the Warrant Agreement and the Representatives' Warrant Agreement are not and will not be subject to any 21 preemptive or other similar rights of any stockholder, have been duly authorized and, when issued, paid for and delivered in accordance with the terms hereof, will be validly issued, fully paid and non-assessable and conform to the description thereof contained in the Prospectus; the holders thereof will not be subject to any liability solely as such holders; all corporate action required to be taken for the authorization, issue and sale of the Securities has been duly and validly taken; and the certificates representing the Securities are in due and proper form. The Representatives' Warrants and the Redeemable Warrants constitute valid and binding obligations of the Company to issue and sell, upon exercise thereof and payment therefor, the number and type of securities of the Company called for thereby. Upon the issuance and delivery pursuant to this Agreement of the Firm Securities and the Option Securities and the Representatives' Warrants to be sold by the Company, the Underwriters and the Representatives, respectively, will acquire good and marketable title to the Firm Securities and the Option Securities and the Representatives' Warrants free and clear of any pledge, lien, charge, claim, encumbrance, pledge, security interest, or other restriction or equity of any kind whatsoever. No transfer tax is payable by or on behalf of the Underwriters in connection with (A) the issuance by the Company of the Securities, (B) the purchase by the Underwriters of the Firm Securities and the Option Securities from the Company, and the purchase by the Representatives of the Representatives' Warrants from the Company (C) the consummation by the Company of any of its obligations under this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement, or (D) resales of the Firm Securities and the Option Securities in connection with the distribution contemplated hereby. (iv) the Registration Statement is effective under the Act, and, if applicable, filing of all pricing information has been timely made in the appropriate form under Rule 430A, and no stop order suspending the use of the Preliminary Prospectus, the Registration Statement or Prospectus or any part of any thereof or suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are pending or, to the best of such counsel's knowledge, threatened or contemplated under the Act; (v) each of the Preliminary Prospectus, the Registration Statement, and the Prospectus and any amendments or supplements thereto (other than the financial statements and other financial and statistical data included therein, as to which no opinion need be rendered) comply as to form in all material respects with the requirements of the Act and the Rules and Regulations. (vi) to the best of such counsel's knowledge, (A) there are no agreements, contracts or other documents required by the Act to be described in the Registration Statement and the Prospectus and filed as exhibits to the Registration Statement other than those described in the Registration Statement (or required to be filed under the Exchange Act if upon such filing they would be incorporated, in whole or in part, by reference therein) and the Prospectus and filed as exhibits thereto, and the exhibits which have been filed are correct copies of the documents of which they purport to be copies; (B) the descriptions in the Registration Statement and the Prospectus and any supplement or amendment thereto of contracts and other documents to which the 22 Company is a party or by which it is bound, including any document to which the Company is a party or by which it is bound, incorporated by reference into the Prospectus and any supplement or amendment thereto, are accurate and fairly represent the information required to be shown by Form SB-2; (C) there is not pending or threatened against the Company any action, arbitration, suit, proceeding, inquiry, investigation, litigation, governmental or other proceeding (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, pending or threatened against (or circumstances that may give rise to the same), or involving the properties or business of the Company which (x) is required to be disclosed in the Registration Statement which is not so disclosed (and such proceedings as are summarized in the Registration Statement are accurately summarized in all respects), (y) questions the validity of the capital stock of the Company or this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement, or of any action taken or to be taken by the Company pursuant to or in connection with any of the foregoing; (D) no statute or regulation or legal or governmental proceeding required to be described in the Prospectus is not described as required; and (E) there is no action, suit or proceeding pending, or threatened, against or affecting the Company before any court or arbitrator or governmental body, agency or official (or any basis thereof known to such counsel) in which there is a reasonable possibility of a decision which may result in a material adverse change in the condition, financial or otherwise, or the earnings, position, prospects, stockholders' equity, value, operation, properties, business or results of operations of the Company, which could adversely affect the present or prospective ability of the Company to perform its obligations under this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement or which in any manner draws into question the validity or enforceability of this Agreement, the Warrant Agreement or the Representatives' Warrant Agreement; (vii) the Company has full legal right, power and authority to enter into each of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement, and to consummate the transactions provided for therein; and each of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement has been duly authorized, executed and delivered by the Company. Each of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement, assuming due authorization, execution and delivery by each other party thereto constitutes a legal, valid and binding agreement of the Company enforceable against the Company in accordance with its terms (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law), and none of the Company's execution or delivery of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement, its performance hereunder or thereunder, its consummation of the transactions contemplated herein or therein, or the conduct of its business as described in the Registration Statement, the Prospectus, and any amendments or supplements thereto, conflicts with or will conflict with or results or will result in any breach or violation of any of the terms or provisions of, or constitutes or will constitute a default under, or result in the creation or imposition of any lien, charge, claim, encumbrance, pledge, security interest, defect or 23 other restriction or equity of any kind whatsoever upon, any property or assets (tangible or intangible) of the Company pursuant to the terms of, (A) the certificate of incorporation or by-laws of the Company, (B) any license, contract, collective bargaining agreement, indenture, mortgage, deed of trust, lease, voting trust agreement, stockholders agreement, note, loan or credit agreement or any other agreement or instrument to which the Company is a party or by which it is or they are or may be bound or to which any of its or their respective properties or assets (tangible or intangible) is or may be subject, or any indebtedness, or (C) any statute, judgment, decree, order, rule or regulation applicable to the Company of any arbitrator, court, regulatory body or administrative agency or other governmental agency or body (including, without limitation, those having jurisdiction over environmental or similar matters), domestic or foreign, having jurisdiction over the Company or any of its activities or properties. (viii) no consent, approval, authorization or order, and no filing with, any court, regulatory body, government agency or other body (other than such as may be required under Blue Sky laws, as to which no opinion need be rendered) is required in connection with the issuance of the Firm Securities and the Option Securities pursuant to the Prospectus and the Registration Statement, the issuance of the Representatives' Warrants, the performance of this Agreement, the Warrant Agreement and the Representatives' Warrant Agreement, and the transactions contemplated hereby and thereby; (ix) the properties and business of the Company conforms in all material respects to the description thereof contained in the Registration Statement and the Prospectus; and the Company has good and marketable title to, or valid and enforceable leasehold estates in, all items of real and personal property stated in the Prospectus to be owned or leased by it, in each case free and clear of all liens, charges, claims, encumbrances, pledges, security interests, defects or other restrictions or equities of any kind whatsoever, other than those referred to in the Prospectus and liens for taxes not yet due and payable; (x) the Company is not in breach of, or in default under, any term or provision of any license, contract, collective bargaining agreement, indenture, mortgage, installment sale agreement, deed of trust, lease, voting trust agreement, stockholders' agreement, partnership agreement, note, loan or credit agreement or any other agreement or instrument evidencing an obligation for borrowed money, or any other agreement or instrument to which the Company is a party or by which the Company may be bound or to which the properties or assets (tangible or intangible) of the Company is subject or affected; and the Company is not in violation of any term or provision of its Articles of Incorporation or By-Laws or in violation of any franchise, license, permit, judgment, decree, order, statute, rule or regulation; (xi) the statements in the Prospectus under "RISK FACTORS," "THE COMPANY," "BUSINESS," "MANAGEMENT," "PRINCIPAL STOCKHOLDERS," "SELLING SHAREHOLDERS," "CERTAIN TRANSACTIONS," "DESCRIPTION OF SECURITIES," and "SHARES ELIGIBLE FOR FUTURE SALE" have been reviewed 24 by such counsel, and insofar as they refer to statements of law, descriptions of statutes, licenses, rules or regulations or legal conclusions, are correct in all material respects; (xii) the Securities have been accepted for quotation on Nasdaq; (xiii) the persons listed under the caption "PRINCIPAL STOCKHOLDERS" in the Prospectus are the respective "beneficial owners" (as such phrase is defined in regulation 13d-3 under the Exchange Act) of the securities set forth opposite their respective names thereunder as and to the extent set forth therein; (xiv) none of the Company, nor any of its officers, stockholders, employees or agents, nor any other person acting on behalf of the Company has, directly or indirectly, given or agreed to give any money, gift or similar benefit (other than legal price concessions to customers in the ordinary course of business) to any customer, supplier, employee or agent of a customer or supplier, or official or employee of any governmental agency or instrumentality of any government (domestic or foreign) or any political party or candidate for office (domestic or foreign) or other person who is or may be in a position to help or hinder the business of the Company (or assist it in connection with any actual or proposed transaction) which (A) might subject the Company to any damage or penalty in any civil, criminal or governmental litigation or proceeding, (B) if not given in the past, might have had an adverse effect on the assets, business or operations of the Company, as reflected in any of the financial statements contained in the Registration Statement, or (C) if not continued in the future, might adversely affect the assets, business, operations or prospects of the Company; (xv) no person, corporation, trust, partnership, association or other entity has the right to include and/or register any securities of the Company in the Registration Statement, require the Company to file any registration statement or, if filed, to include any security in such registration statement; (xvi) except as described in the Prospectus, there are no claims, payments, issuances, arrangements or understandings for services in the nature of a finder's or origination fee with respect to the sale of the Securities hereunder or financial consulting arrangements or any other arrangements, agreements, understandings, payments or issuances that may affect the Underwriters' compensation, as determined by the NASD; (xvii) assuming due execution by the parties thereto other than the Company, the Lock-up Agreements are legal, valid and binding obligations of the parties thereto, enforceable against the party and any subsequent holder of the securities subject thereto in accordance with its terms (except as such enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application relating to or affecting enforcement of creditors' rights and the application of equitable principles in any action, legal or equitable, and except as rights to indemnity or contribution may be limited by applicable law); 25 (xviii) except as described in the Prospectus, the Company does not (A) maintain, sponsor or contribute to any ERISA Plans, (B) maintain or contribute, now or at any time previously, to a defined benefit plan, as defined in Section 3(35) of ERISA, and (C) has ever completely or partially withdrawn from a "multiemployer plan"; (xix) the Company is in compliance with all provisions of Section 1 of Laws of Florida, Chapter 92-198, An Act Relating to Disclosure of Doing Business with Cuba; (xx) none of the Company or any of its affiliates shall be subject to the requirements of or shall be deemed an "Investment Company," pursuant to and as defined under, respectively, the Investment Company Act. Such counsel shall state that such counsel has participated in conferences with officers and other Representatives of the Company, and Representatives of the independent public accountants for the Company, at which conferences such counsel made inquiries of such officers, Representatives and accountants and discussed the contents of the Preliminary Prospectus, the Registration Statement, the Prospectus, and related matters and, although such counsel is not passing upon and does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Preliminary Prospectus, the Registration Statement and Prospectus, on the basis of the foregoing, no facts have come to the attention of such counsel which lead them to believe that either the Registration Statement or any amendment thereto, at the time such Registration Statement or amendment became effective or the Preliminary Prospectus or Prospectus or amendment or supplement thereto as of the date of such opinion contained any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading (it being understood that such counsel need express no opinion with respect to the financial statements and schedules and other financial and statistical data included in the Preliminary Prospectus, the Registration Statement or the Prospectus). Such counsel shall further state that its opinions may be relied upon by Underwriters' Counsel in rendering its opinion to the Underwriters. In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws other than the laws of the United States and jurisdictions in which they are admitted, to the extent such counsel deems proper and to the extent specified in such opinion, if at all, upon an opinion or opinions (in form and substance satisfactory to Underwriters' Counsel) of other counsel acceptable to Underwriters' Counsel, familiar with the applicable laws; (B) as to matters of fact, to the extent they deem proper, on certificates and written statements of responsible officers of the Company and certificates or other written statements of officers of departments of various jurisdictions having custody of documents respecting the corporate existence or good standing of the Company, provided that copies of any such statements or certificates shall be delivered to Underwriters' Counsel if requested. The opinion of such counsel for the Company shall state that the opinion of any such other counsel is in form satisfactory to such counsel and that the Representatives, Underwriters' Counsel and they are each justified in relying thereon. Any opinion of counsel for the Company and the Subsidiaries shall not state that it is to be governed or qualified by, or that it is otherwise subject to, any treatise, written policy or other document relating to legal opinions, including, without limitation, the Legal Opinion Accord of the ABA Section of Business Law (1991) or any comparable state accord. 26 (e) At the Closing Date, the Underwriters shall have received the favorable opinion of __________________ , patent counsel to the Company, dated the Closing Date, addressed to the Underwriters, in form and substance satisfactory to Underwriters' Counsel and in substantially the form of Schedule B hereto. (f) At each Option Closing Date, if any, the Underwriters shall have received the favorable opinions of each of McBreen, McBreen & Kopko, counsel to the Company, and __________________, patent counsel to the Company dated such Option Closing Date, addressed to the Underwriters and in form and substance satisfactory to Underwriters' Counsel confirming as of such Option Closing Date the statements made by each of McBreen, McBreen & Kopko, and __________________, in their respective opinions delivered on the Closing Date. (g) On or prior to each of the Closing Date and each Option Closing Date, if any, Underwriters' Counsel shall have been furnished such documents, certificates and opinions as they may reasonably require for the purpose of enabling them to review or pass upon the matters referred to in subsection (c) of this Section 6, or in order to evidence the accuracy, completeness or satisfaction of any of the representations, warranties or conditions of the Company, or herein contained. (h) Prior to each of the Closing Date and each Option Closing Date, if any, (i) there shall have been no material adverse change nor development involving a prospective change in the condition, financial or otherwise, earnings, position, value, properties, results of operations, prospects, stockholders' equity or the business activities of the Company, whether or not in the ordinary course of business, from the latest dates as of which such condition is set forth in the Registration Statement and Prospectus; (ii) there shall have been no transaction, not in the ordinary course of business, entered into by the Company, from the latest date as of which the financial condition of the Company is set forth in the Registration Statement and Prospectus which is adverse to the Company; (iii) the Company shall not be in default under any provision of any instrument relating to any outstanding indebtedness; (iv) none of the Company shall not have issued any securities (other than the Securities) or declared or paid any dividend or made any distribution in respect of its capital stock of any class and there has not been any change in the capital stock or any material change in the debt (long or short term) or liabilities or obligations of the Company (contingent or otherwise); (v) no material amount of the assets of the Company shall have been pledged or mortgaged, except as set forth in the Registration Statement and Prospectus; (vi) no action, suit or proceeding, at law or in equity, shall have been pending or threatened (or circumstances giving rise to same) against the Company, or affecting any of its or their respective properties or businesses before or by any court or federal, state or foreign commission, board or other administrative agency wherein an unfavorable decision, ruling or finding may adversely affect the business, operations, earnings, position, value, properties, results of operations, prospects or financial condition or income of the Company; and (vii) no stop order shall have been issued under the Act and no proceedings therefor shall have been initiated, threatened or contemplated by the Commission. (i) At each of the Closing Date and each Option Closing Date, if any, the Underwriters shall have received a certificate of the Company signed by the principal executive officer and by the chief financial or chief accounting officer of the Company, dated the Closing 27 Date or Option Closing Date, as the case may be, to the effect that each of such persons has carefully examined the Registration Statement, the Prospectus and this Agreement, and that: (i) The representations and warranties of the Company in this Agreement are true and correct, as if made on and as of the Closing Date or the Option Closing Date, as the case may be, and the Company has complied with all agreements and covenants and satisfied all conditions contained in this Agreement on its part to be performed or satisfied at or prior to such Closing Date or Option Closing Date, as the case may be; (ii) No stop order suspending the effectiveness of the Registration Statement or any part thereof has been issued, and no proceedings for that purpose have been instituted or are pending or, to the best of each of such person's knowledge, are contemplated or threatened under the Act; (iii) The Registration Statement and the Prospectus and, if any, each amendment and each supplement thereto, contain all statements and information required to be included therein, and none of the Registration Statement, the Prospectus nor any amendment or supplement thereto includes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading and neither the Preliminary Prospectus or any supplement thereto included any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; and (iv) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, (a) the Company has not incurred up to and including the Closing Date or the Option Closing Date, as the case may be, other than in the ordinary course of its business, any material liabilities or obligations, direct or contingent; (b) the Company has not paid or declared any dividends or other distributions on its capital stock; (c) the Company has not entered into any transactions not in the ordinary course of business; (d) there has not been any change in the capital stock or long-term debt or any increase in the short-term borrowings (other than any increase in the short-term borrowings in the ordinary course of business) of the Company; (e) the Company has not sustained any loss or damage to its properties or assets, whether or not insured; (f) there is no litigation which is pending or threatened (or circumstances giving rise to same) against the Company or any affiliated party which is required to be set forth in an amended or supplemented Prospectus which has not been set forth; and (g) there has occurred no event required to be set forth in an amended or supplemented Prospectus which has not been set forth. References to the Registration Statement and the Prospectus in this subsection (i) are to such documents as amended and supplemented at the date of such certificate. (j) By the Closing Date, the Underwriters will have received clearance from the NASD as to the amount of compensation allowable or payable to the Underwriters, as described in the Registration Statement. 28 (k) At the time this Agreement is executed, the Underwriters shall have received a letter, dated such date, addressed to the Underwriters in form and substance satisfactory (including the non-material nature of the changes or decreases, if any, referred to in clause (iii) below) in all respects to the Underwriters and Underwriters' Counsel, from Ernst & Young LLP: (i) confirming that they are independent certified public accountants with respect to the Company within the meaning of the Act and the applicable Rules and Regulations; (ii) stating that it is their opinion that the financial statements and supporting schedules of the Company included in the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Act and the Rules and Regulations thereunder and that the Representatives may rely upon the opinion of Ernst & Young LLP with respect to the financial statements and supporting schedules included in the Registration Statement; (iii) stating that, on the basis of a limited review which included a reading of the latest available unaudited interim financial statements of the Company, a reading of the latest available minutes of the stockholders and board of directors and the various committees of the board of directors of the Company, consultations with officers and other employees of the Company responsible for financial and accounting matters and other specified procedures and inquiries, nothing has come to their attention which would lead them to believe that (A) the unaudited financial statements and supporting schedules of the Company included in the Registration Statement do not comply as to form in all material respects with the applicable accounting requirements of the Act and the Rules and Regulations or are not fairly presented in conformity with generally accepted accounting principles applied on a basis substantially consistent with that of the audited financial statements of the Company included in the Registration Statement, or (B) at a specified date not more than five (5) days prior to the effective date of the Registration Statement, there has been any change in the capital stock or long-term debt of the Company, or any decrease in the stockholders' equity or net current assets or net assets of the Company as compared with amounts shown in the December 31, 1997 balance sheet included in the Registration Statement, other than as set forth in or contemplated by the Registration Statement, or, if there was any change or decrease, setting forth the amount of such change or decrease, and (C) during the period from December 31, 1997 to a specified date not more than five (5) days prior to the effective date of the Registration Statement, there was any decrease in net revenues, net earnings or increase in net earnings per common share of any of the Company or the Subsidiaries, in each case as compared with the corresponding period beginning December 31, 1996, other than as set forth in or contemplated by the Registration Statement, or, if there was any such decrease, setting forth the amount of such decrease; (iv) setting forth, at a date not later than five (5) days prior to the date of the Registration Statement, the amount of liabilities of the Company and the Subsidiaries taken as a whole (including a break-down of commercial paper and notes payable to banks); 29 (v) stating that they have compared specific dollar amounts, numbers of shares, percentages of revenues and earnings, statements and other financial information pertaining to the Company set forth in the Prospectus in each case to the extent that such amounts, numbers, percentages, statements and information may be derived from the general accounting records, including work sheets, of the Company and excluding any questions requiring an interpretation by legal counsel, with the results obtained from the application of specified readings, inquiries and other appropriate procedures (which procedures do not constitute an examination in accordance with generally accepted auditing standards) set forth in the letter and found them to be in agreement; (vi) statements as to such other matters incident to the transaction contemplated hereby as the Representatives may request. (l) At the Closing Date and each Option Closing Date, if any, the Underwriters shall have received from Ernst & Young LLP a letter, dated as of the Closing Date or the Option Closing Date, as the case may be, to the effect that they reaffirm that statements made in the letter furnished pursuant to subsection (k) of this Section, except that the specified date referred to shall be a date not more than five (5) days prior to the Closing Date or the Option Closing Date, as the case may be, and, if the Company has elected to rely on Rule 430A of the Rules and Regulations, to the further effect that they have carried out procedures as specified in clause (v) of subsection (k) of this Section with respect to certain amounts, percentages and financial information as specified by the Representatives and deemed to be a part of the Registration Statement pursuant to Rule 430A(b) and have found such amounts, percentages and financial information to be in agreement with the records specified in such clause (v). (m) On each of the Closing Date and each Option Closing Date, if any, there shall have been duly tendered to the Representatives for the several Underwriters' accounts the appropriate number of Securities. (n) No order suspending the sale of the Securities in any jurisdiction designated by the Representatives pursuant to subsection (e) of Section 4 hereof shall have been issued on either the Closing Date or the Option Closing Date, if any, and no proceedings for that purpose shall have been instituted or shall be contemplated. (o) On or before the Closing Date, the Company shall have executed and delivered to the Representatives, (i) the Representatives' Warrant Agreement substantially in the form filed as Exhibit [___] to the Registration Statement, in final form and substance satisfactory to the Representatives, and (ii) the Representatives' Warrants in such denominations and to such designees as shall have been provided to the Company. (p) On or before the Closing Date, the Firm Securities and Option Securities shall have been duly approved for quotation on Nasdaq, subject to official notice of issuance. (q) On or before the Closing Date, there shall have been delivered to the Representatives all of the Lock-up Agreements, in form and substance satisfactory to Underwriters' Counsel. 30 (r) On or before the Closing Date, the Company shall have executed and delivered to the Representatives and the Transfer Agent the Warrant Agreement substantially in the form filed as Exhibit [___] to the Registration Statement, in final form and substance satisfactory to the Representatives. If any condition to the Underwriters' obligations hereunder to be fulfilled prior to or at the Closing Date or the relevant Option Closing Date, as the case may be, is not so fulfilled, the Representatives may terminate this Agreement or, if the Representatives so elects, it may waive any such conditions which have not been fulfilled or extend the time for their fulfillment. 7. Indemnification. (a) The Company agrees to indemnify and hold harmless each of the Underwriters (for purposes of this Section 7 "Underwriter" shall include the officers, directors, partners, employees, agents and counsel of the Underwriter, including specifically each person who may be substituted for an Underwriter as provided in Section 11 hereof), and each person, if any, who controls the Underwriter ("controlling person") within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, from and against any and all losses, claims, damages, expenses or liabilities, joint or several (and actions, proceedings, investigations, inquiries, suits and litigation in respect thereof), whatsoever (including but not limited to any and all expenses whatsoever reasonably incurred in investigating, preparing or defending against any such claim, action, proceeding, investigation, inquiry, suit or litigation, commenced or threatened, or any claim whatsoever), as such are incurred, to which the Underwriter or such controlling person may become subject under the Act, the Exchange Act or any other statute or at common law or otherwise or under the laws of foreign countries, arising out of or based upon (A) any untrue statement or alleged untrue statement of a material fact contained (i) in any Preliminary Prospectus, the Registration Statement or the Prospectus (as from time to time amended and supplemented); (ii) in any post-effective amendment or amendments or any new registration statement and prospectus in which is included securities of the Company issued or issuable upon exercise of the Securities; or (iii) in any application or other document or written communication (in this Section 7 collectively called "application") executed by the Company or based upon written information furnished by the Company in any jurisdiction in order to qualify the Securities under the securities laws thereof or filed with the Commission, any state securities commission or agency, Nasdaq or any other securities exchange; (B) the omission or alleged omission therefrom of a material fact required to be stated therein or necessary to make the statements therein not misleading (in the case of the Prospectus, in the light of the circumstances under which they were made), or (C) any breach of any representation, warranty, covenant or agreement of the Company contained herein or in any certificate by or on behalf of the Company or any of its officers delivered pursuant hereto, unless, in the case of clause (A) or (B) above, such statement or omission was made in reliance upon and in strict conformity with written information furnished to the Company with respect to any Underwriter by or on behalf of such Underwriter expressly for use in any Preliminary Prospectus, the Registration Statement or Prospectus, or any amendment thereof or supplement thereto, or in any application, as the case may be. The indemnity agreement in this subsection (a) shall be in addition to any liability which the Company may have at common law or otherwise. 31 (b) Each of the Underwriters agrees severally, but not jointly, to indemnify and hold harmless the Company, each of its directors, each of its officers who has signed the Registration Statement, and each other person, if any, who controls the Company within the meaning of the Act, to the same extent as the foregoing indemnity from the Company to the Underwriters but only with respect to statements or omissions, if any, made in any Preliminary Prospectus, the Registration Statement or Prospectus or any amendment thereof or supplement thereto or in any application made in reliance upon, and in strict conformity with, written information furnished to the Company with respect to any Underwriter by such Underwriter expressly for use in such Preliminary Prospectus, the Registration Statement or Prospectus or any amendment thereof or supplement thereto or in any such application, provided that such written information or omissions only pertain to disclosures in the Preliminary Prospectus, the Registration Statement or Prospectus directly relating to the transactions effected by the Underwriters in connection with this Offering. The Company acknowledges that the statements with respect to the public offering of the Firm Securities and the Option Securities set forth under the heading "Underwriting" and the stabilization legend in the Prospectus have been furnished by the Underwriters expressly for use therein and constitute the only information furnished in writing by or on behalf of the Underwriters for inclusion in the Prospectus. (c) Promptly after receipt by an indemnified party under this Section 7 of notice of the commencement of any claim, action, suit, investigation, inquiry, proceeding or litigation, such indemnified party shall, if a claim in respect thereof is to be made against one or more indemnifying parties under this Section 7, notify each party against whom indemnification is to be sought in writing of the commencement thereof (but the failure so to notify an indemnifying party shall not relieve it from any liability which it may have under this Section 7 except to the extent that it has been prejudiced in any material respect by such failure or from any liability which it may have otherwise). In case any such claim, action, suit, investigation, inquiry, proceeding or litigation is brought against any indemnified party, and it notifies an indemnifying party or parties of the commencement thereof, the indemnifying party or parties will be entitled to participate therein, and to the extent it may elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party. Notwithstanding the foregoing, the indemnified party or parties shall have the right to employ its or their own counsel in any such case but the fees and expenses of such counsel shall be at the expense of such indemnified party or parties unless (i) the employment of such counsel shall have been authorized in writing by the indemnifying parties in connection with the defense of thereof at the expense of the indemnifying party, (ii) the indemnifying parties shall not have employed counsel reasonably satisfactory to such indemnified party to have charge of the defense thereof within a reasonable time after notice of commencement thereof, or (iii) such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to those available to one or all of the indemnifying parties (in which case the indemnifying parties shall not have the right to direct the defense thereof on behalf of the indemnified party or parties), in any of which events such fees and expenses of one additional counsel shall be borne by the indemnifying parties. In no event shall the indemnifying parties be liable for fees and expenses of more than one counsel (in addition to any local counsel) separate from their own counsel for all indemnified parties in connection with any one claim, action, suit, investigation, inquiry, proceeding or litigation or separate but similar or related claims, actions, suits, investigations, inquiries, proceedings or 32 litigation in the same jurisdiction arising out of the same general allegations or circumstances. Anything in this Section 7 to the contrary notwithstanding, an indemnifying party shall not be liable for any settlement of any claim, action, suit, investigation, inquiry, proceeding or litigation effected without its written consent; provided, however, that such consent was not unreasonably withheld. An indemnifying party will not, without the prior written consent of the indemnified parties, settle, compromise or consent to the entry of any judgment with respect to any pending or threatened claim, action, suit, investigation, inquiry, proceeding or litigation in respect of which indemnification or contribution may be sought hereunder (whether or not the indemnified parties are actual or potential parties to such claim, action, suit, investigation, inquiry, proceeding or litigation), unless such settlement, compromise or consent (i) includes an unconditional release of each indemnified party from all liability arising out of such claim, action, suit, investigation, inquiry, proceeding or litigation and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act by or on behalf of any indemnified party. (d) In order to provide for just and equitable contribution in any case in which (i) an indemnified party makes claim for indemnification pursuant to this Section 7, but it is judicially determined (by the entry of a final judgment or decree by a court of competent jurisdiction and the expiration of time to appeal or the denial of the last right of appeal) that such indemnification may not be enforced in such case notwithstanding the fact that the express provisions of this Section 7 provide for indemnification in such case, or (ii) contribution under the Act may be required on the part of any indemnified party, then each indemnifying party shall contribute to the amount paid as a result of such losses, claims, damages, expenses or liabilities (or actions in respect thereof) (A) in such proportion as is appropriate to reflect the relative benefits received by each of the contributing parties, on the one hand, and the party to be indemnified on the other hand, from the offering of the Firm Securities and the Option Securities or (B) if the allocation provided by clause (A) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of each of the contributing parties, on the one hand, and the party to be indemnified on the other hand in connection with the statements or omissions that resulted in such losses, claims, damages, expenses or liabilities, as well as any other relevant equitable considerations. In any case where the Company is the contributing party and the Underwriters are the indemnified party, the relative benefits received by the Company on the one hand, and the Underwriters, on the other, shall be deemed to be in the same proportion as the total net proceeds from the offering of the Firm Securities and the Option Securities (before deducting expenses) bear to the total underwriting discounts received by the Underwriters hereunder, in each case as set forth in the table on the Cover Page of the Prospectus. Relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, or by the Underwriters, and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The amount paid or payable by an indemnified party as a result of the losses, claims, damages, expenses or liabilities (or actions in respect thereof) referred to above in this subsection (d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this subsection (d), the Underwriters shall not be required to contribute any amount in excess of the underwriting discount applicable to the Firm Securities and the Option Securities purchased by the Underwriters hereunder. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was 33 not guilty of such fraudulent misrepresentation. For purposes of this Section 7, each person, if any, who controls the Company or the Underwriter within the meaning of the Act, each officer of the Company who has signed the Registration Statement, and each director of the Company shall have the same rights to contribution as the Company or the Underwriter, as the case may be, subject in each case to this subsection (d). Any party entitled to contribution will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect to which a claim for contribution may be made against another party or parties under this subsection (d), notify such party or parties from whom contribution may be sought, but the omission so to notify such party or parties shall not relieve the party or parties from whom contribution may be sought from any obligation it or they may have hereunder or otherwise than under this subsection (d), or to the extent that such party or parties were not adversely affected by such omission. The contribution agreement set forth above shall be in addition to any liabilities which any indemnifying party may have at common law or otherwise. 8. Representations and Agreements to Survive Delivery. All representations, warranties and agreements contained in this Agreement or contained in certificates of officers of the Company submitted pursuant hereto, shall be deemed to be representations, warranties and agreements at the Closing Date and the Option Closing Date, as the case may be, and such representations, warranties and agreements of the Company and the indemnity agreements contained in Section 7 hereof, shall remain operative and in full force and effect regardless of any investigation made by or on behalf of any Underwriter, the Company, any controlling person of any Underwriter or the Company, and shall survive termination of this Agreement or the issuance and delivery of the Securities to the Underwriters and the Representatives, as the case may be. 9. Effective Date. This Agreement shall become effective at 10:00 a.m., New York City time, on the next full business day following the date hereof, or at such earlier time after the Registration Statement becomes effective as the Representatives, in its discretion, shall release the Securities for sale to the public; provided, however, that the provisions of Sections 5, 7 and 10 of this Agreement shall at all times be effective. For purposes of this Section 9, the Securities to be purchased hereunder shall be deemed to have been so released upon the earlier of dispatch by the Representatives of telegrams to securities dealers releasing such securities for offering or the release by the Representatives for publication of the first newspaper advertisement which is subsequently published relating to the Securities. 10. Termination. (a) Subject to subsection (b) of this Section 10, the Representatives shall have the right to terminate this Agreement, (i) if any domestic or international event or act or occurrence has materially adversely disrupted, or in the Representatives' opinion will in the immediate future materially adversely disrupt, the financial markets; or (ii) if any material adverse change in the financial markets shall have occurred; or (iii) if trading generally shall have been suspended or materially limited on or by, as the case may be, any of the New York Stock Exchange, the American Stock Exchange, the NASD, the Boston Stock Exchange, the Commission or any governmental authority having jurisdiction over such matters; or (iv) if trading of any of the securities of the Company shall have been suspended, or any of the securities of the Company shall have been delisted, on any exchange or in any over-the-counter 34 market; (v) if the United States shall have become involved in a war or major hostilities, or if there shall have been an escalation in an existing war or major hostilities or a national emergency shall have been declared in the United States; or (vi) if a banking moratorium has been declared by a state or federal authority; or (vii) if a moratorium in foreign exchange trading has been declared; or (viii) if the Company shall have sustained a loss material or substantial to the Company by fire, flood, accident, hurricane, earthquake, theft, sabotage or other calamity or malicious act which, whether or not such loss shall have been insured, will, in the Representatives' opinion, make it inadvisable to proceed with the offering, sale and/or delivery of the Securities; or (ix) if there shall have been such a material adverse change in the conditions or prospects of the Company, or such material adverse change in the general market, political or economic conditions, in the United States or elsewhere, that, in each case, in the Representatives' judgment, would make it inadvisable to proceed with the offering, sale and/or delivery of the Securities or (x) if either Rimas P. Buinevicius, Monty R. Schmidt or Curtis J. Palmer shall no longer serve the Company in their respective present capacities. (b) If this Agreement is terminated by the Representatives in accordance with the provisions of Section 10(a) the Company shall promptly reimburse and indemnify the Representatives for all of its actual out-of-pocket expenses, including the fees and disbursements of counsel for the Underwriters (less amounts previously paid pursuant to Section 5(c) above). Notwithstanding any contrary provision contained in this Agreement, if this Agreement shall not be carried out within the time specified herein, or any extension thereof granted to the Representatives, by reason of any failure on the part of the Company to perform any undertaking or satisfy any condition of this Agreement by it to be performed or satisfied (including, without limitation, pursuant to Section 6 or Section 12) then, the Company shall promptly reimburse and indemnify the Representatives for all of its actual out-of-pocket expenses, including the fees and disbursements of counsel for the Underwriters (less amounts previously paid pursuant to Section 5(c) above). In addition, the Company shall remain liable for all Blue Sky counsel fees and disbursements, expenses and filing fees. Notwithstanding any contrary provision contained in this Agreement, any election hereunder or any termination of this Agreement (including, without limitation, pursuant to Sections 6, 10, 11 and 12 hereof), and whether or not this Agreement is otherwise carried out, the provisions of Section 5 and Section 7 shall not be in any way affected by such election or termination or failure to carry out the terms of this Agreement or any part hereof. 11. Substitution of the Underwriters. If one or more of the Underwriters shall fail (otherwise than for a reason sufficient to justify the termination of this Agreement under the provisions of Section 6, Section 10 or Section 12 hereof) to purchase the Securities which it or they are obligated to purchase on such date under this Agreement (the "Defaulted Securities"), the Representatives shall have the right, within 24 hours thereafter, to make arrangement for one or more of the non-defaulting Underwriters, or any other underwriters, to purchase all, but not less than all, of the Defaulted Securities in such amounts as may be agreed upon and upon the terms herein set forth; if, however, the Representatives shall not have completed such arrangements within such 24-hour period, then: (a) if the number of Defaulted Securities does not exceed 10% of the total number of Firm Securities to be purchased on such date, the non- defaulting Underwriters shall be obligated to purchase the full amount thereof in the proportions that their 35 respective underwriting obligations hereunder bear to the underwriting obligations of all non-defaulting Underwriters, or (b) if the number of Defaulted Securities exceeds 10% of the total number of Firm Securities, this Agreement shall terminate without liability on the part of any non-defaulting Underwriters (or, if such default shall occur with respect to any Option Securities to be purchased on an Option Closing Date, the Underwriters may at the Representatives' option, by notice from the Representatives to the Company, terminate the Underwriters' obligation to purchase Option Securities from the Company on such date). No action taken pursuant to this Section 11 shall relieve any defaulting Underwriter from liability in respect of any default by such Underwriter under this Agreement. In the event of any such default which does not result in a termination of this Agreement, the Representatives shall have the right to postpone the Closing Date for a period not exceeding seven (7) days in order to effect any required changes in the Registration Statement or Prospectus or in any other documents or arrangements. 12. Default by the Company. If the Company shall fail at the Closing Date or at any Option Closing Date, as applicable, to sell and deliver the number of Securities which it is obligated to sell hereunder on such date, then this Agreement shall terminate (or, if such default shall occur with respect to any Option Securities to be purchased on an Option Closing Date, the Underwriters may at the Representatives' option, by notice from the Representatives to the Company, terminate the Underwriters' obligation to purchase Option Securities from the Company on such date) without any liability on the part of any non- defaulting party other than pursuant to Section 5, Section 7 and Section 10 hereof. No action taken pursuant to this Section 12 shall relieve the Company from liability, if any, in respect of such default. 13. Notices. All notices and communications hereunder, except as herein otherwise specifically provided, shall be in writing and shall be deemed to have been duly given if mailed or transmitted by any standard form of telecommunication. Notices to the Underwriters shall be directed to the Representatives c/o Dirks & Company, Inc., 520 Madison Avenue, 10th Floor, New York, New York 10022, Attention: Jessy Dirks, President, with a copy to Orrick, Herrington & Sutcliffe LLP, 666 Fifth Avenue, New York, New York 10103, Attention: Lawrence B. Fisher, Esq. Notices to the Company shall be directed to the Company at 754 William Street, Madison, Wisconsin 53703, Attention: Rimas P. Buinevicius, Chief Executive Officer, with a copy to: McBreen, McBreen & Kopko, 20 North Wacker Drive, Suite 2520, Chicago, Illinois 60606, Attention: Frederick H. Kopko, Jr., Esq. 14. Parties. This Agreement shall inure solely to the benefit of and shall be binding upon, the Underwriters, the Company and the controlling persons, directors and officers referred to in Section 7 hereof, and their respective successors, legal Representatives and assigns, and no other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of or by virtue of this Agreement or any provisions herein contained. No purchaser of Securities from any Underwriter shall be deemed to be a successor by reason merely of such purchase. 36 15. Construction. This Agreement shall be governed by and construed and enforced in accordance with the laws of the State of New York without giving effect to the choice of law or conflict of laws principles. 16. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original, and all of which taken together shall be deemed to be one and the same instrument. 17. Entire Agreement; Amendments. This Agreement, the Warrant Agreement and the Representatives' Warrant Agreement constitute the entire agreement of the parties hereto and supersede all prior written or oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may not be amended except in a writing, signed by the Representatives and the Company. If the foregoing correctly sets forth the understanding between the Underwriters and the Company, please so indicate in the space provided below for that purpose, whereupon this letter shall constitute a binding agreement among us. Very truly yours, SONIC FOUNDRY, INC. By: -------------------------------- Rimas P. Buinevicius Chief Executive Officer Confirmed and accepted as of the date first above written. DIRKS & COMPANY, INC. SECURITY CAPITAL TRADING CORP. For themselves and as Representatives of the several Underwriters named in Schedule A hereto. By: DIRKS & COMPANY, INC. By: -------------------------------- Name: Title: 37 SCHEDULE A ----------
Number of Shares Number of Redeemable Name of Underwriters to be Purchased Warrants to be Purchased - -------------------- ---------------- ------------------------ Dirks & Company, Inc. ......................... Security Capital Trading Corp. ................ Total.......................................... --------------- ===============
A-1 SCHEDULE B ---------- [FORM OF INTELLECTUAL PROPERTY OPINION] ___________________, 1997 DIRKS & COMPANY, INC. As Representatives of the several Underwriters named in Schedule A to Exhibit A annexed hereto 520 Madison Avenue 10th Floor New York, New York 10022 Re: Initial Public Offering of 2,000,000 Shares of Common Stock and 1,000,000 Redeemable Warrants of Sonic Foundry, Inc. -------------------------------------------- Gentlemen: We have acted as special counsel to Sonic Foundry, Inc., a Maryland corporation (the "Company"), in connection with the entering into by the Company of that certain Underwriting Agreement by and between Dirks & Company, Inc. (as Representatives of the several underwriters named therein) (the "Representatives") and the Company, dated _______________, 1998 (the "Underwriting Agreement"). This opinion is provided to you pursuant to Section 6(e) of the Underwriting Agreement. For the purpose of rendering the opinions set forth below we have reviewed the following (collectively, the "Documents"): (i) the Underwriting Agreement; (ii) that certain Form SB-2 as filed by the Company with the Securities and Exchange Commission on ______, 1998, together with any and all exhibits and schedules and all heretofore filed amendments thereto (collectively, the "Registration Statement"); (iii) the Company's prospectus dated _______________, 1998 (the "Prospectus"); (iv) a search of the United States Patent and Trademark Office records relevant to ownership of any and all: patents and patent applications (including, without limitation, the patents and patent applications listed on Schedule A annexed hereto and hereby incorporated B-1 by reference herein (collectively, the "Patents")), and trademarks, trademark applications, service marks and service mark applications (collectively, the "Marks") (including, without limitation, the Marks listed on Schedule B annexed hereto and hereby incorporated by reference herein (collectively, the "Trademarks")), owned, purportedly owned or licensed by the Company (including, those patents, patent applications and Marks licensed, without limitation, pursuant to the licenses listed on Schedule C annexed hereto and hereby incorporated by reference herein (collectively, the "Licenses")), conducted by ______________________________ and certified as true and correct as of _______________________, 1998 (no earlier than 5 days prior to the effective date of the Registration Statement); (v) a search of the United States Copyright Office records relevant to ownership of any and all copyrighted material (including, without limitation, the copyright in, or license permitting the Company's actual use of, the material licensed or otherwise distributed by either the Company and listed on Schedule D annexed hereto and hereby incorporated by reference herein (collectively, the "Copyrighted Material")), owned, purportedly owned or licensed by the Company conducted by _____________________ and certified as true and correct as of __________________, 1998 (no earlier than 5 days prior to the effective date of the Registration Statement); (vi) an intellectual property litigation search with respect to all Patents, Trademarks, Licenses and Copyrighted Material, listed on Schedules A, B, C and D, respectively; (i) a search of the Uniform Commercial Code ("UCC") recordation offices, in the following jurisdictions Wisconsin, Maryland, Delaware and New York, with respect to the following two categories of general intangibles: (a) the intellectual property general intangibles of the Company, including, without limitation, the Company's patents, patent applications, inventions, know how, trademarks, service marks, copyrights, service and trade names, intellectual property licenses and other rights, and (b) the intellectual property general intangibles licensed to the Company, including, without limitation, the patents, patent applications, inventions, know how, trademarks, service marks, copyrights, service and trade names and other intellectual property rights licensed to the Company pursuant to the Licenses (listed on Schedule C), said search certified to us as complete and accurate by ________________ and current through ________________________, 1998 (no earlier than 5 days prior to the effective date of the Registration Statement) and said jurisdictions being the only jurisdictions in which filing of UCC financing statements or other documents may be filed to effectively evidence a security or other interest in said general intangibles; and B-2 (viii) any and all records, documents, instruments and agreements in our possession or under our control relating to the Company. We have also examined such corporate records, documents, instruments and agreements, and inquired into such other matters, as we have deemed necessary or appropriate as a basis for the opinions set forth herein. Whenever our opinion herein is qualified by the phrase "to the best of our knowledge" or "to the best of our knowledge, after due inquiry," such language means that, based upon (i) our inquiries of officers of the Company, (ii) our review of the Documents, and (iii) our review of such other corporate records, documents, instruments and agreements described in the first sentence of this paragraph, we believe that such opinions are factually correct. To the best of our knowledge, as to all matters of fact represented to you by the Company, we advise you that nothing has come to our attention that would cause us to believe that such facts are incorrect, incomplete or misleading or that reliance thereon is not warranted under the circumstances. We call to your attention that our opinion is limited to such facts as they exist on the date hereof and do not take into account any change of circumstances, fact or law subsequent thereto. Based upon and subject to the foregoing, we are of the opinion that: 1. To the best of our knowledge, after due inquiry, except as described in the Prospectus, the Company owns or has the right to use, free and clear of all liens, encumbrances, pledges, security interests, defects or other restrictions or equities of any kind whatsoever, (i) all patents and patent applications (including, without limitation, the Patents), (ii) all trademarks and service marks (including, without limitation, the Trademarks), (iii) all copyrights (including, without limitation, the Copyrighted Material), (iv) all service and trade names, and (v) all intellectual property licenses (including, without limitation, the Licenses), used in, or required for, the conduct of the Company's business. 2. To the best of our knowledge, after due inquiry, the Company possesses all material intellectual property licenses or rights used in, or required for, the conduct of its respective business (including, the Licenses and without limitation, any such licenses or rights described in the Prospectus as being owned, possessed or licensed by the Company) and such licenses and rights are in full force and effect. B-3 3. To the best of our knowledge, after due inquiry, there is no claim or action, pending, threatened or potential, which affects or could affect the rights of the Company with respect to any trademarks, service marks, copyrights, service names, trade names, patents, patent applications or licenses used in, or required for, the conduct of the Company's business. 4. To the best of our knowledge, after due inquiry, there is no intellectual property based claim or action, pending, threatened or potential, which affects or could affect the rights of the Company with respect to any products, services, processes or licenses, including, without limitation, the Licenses used in the conduct of the Company's business. 5. To the best of our knowledge, after due inquiry, except as described in the Prospectus, the Company is not under any obligation to pay royalties or fees to any third party with respect to any material, technology or intellectual properties developed, employed, licensed or used by the Company. 6. To the best of our knowledge, after due inquiry, the statements in the Prospectus under the headings, "Risk Factors - Uncertainty Regarding Patents and Proprietary Rights," and "Business - Patents and Proprietary Rights", are accurate in all material respects, fairly represent the information disclosed therein and do not omit to state any fact necessary to make the statements made therein complete and accurate. 7. To the best of our knowledge, after due inquiry, the statements in the Registration Statement and Prospectus do not contain any untrue statement of a material fact with respect to the intellectual property position of the Company, or omit to state any material fact relating to the intellectual property position of the Company which is required to be stated in the Registration Statement and the Prospectus or is necessary to make the statements therein not misleading. We call your attention to the fact that the members of this firm are licensed to practice law in the State of ______________ and before the United States Patent and Trademark Office as Registered Patent Attorneys. Accordingly, we express no opinion with respect to the laws, rules and regulations of any jurisdictions other than the State of ___________ and the United States of America. The opinions expressed herein are for the sole benefit of, and may be relied upon only by, the several Underwriters named in Schedule A to the Underwriting Agreement and Orrick, Herrington & Sutcliffe LLP. Very truly yours, B-4 EX-3.1 3 AMENDED & RESTATED ARTICLES OF INCORPORATION EXHIBIT 3.1 AMENDED AND RESTATED ARTICLES OF INCORPORATION OF SONIC FOUNDRY, INC. The Amended and Restated Articles of Incorporation of Sonic Foundry, Inc. set forth below have been duly approved by a majority of the entire board of directors and by the affirmative vote of the holders of a majority of the issued and outstanding capital stock of the Corporation. The Amended and Restated Articles of Incorporation of Sonic Foundry, Inc. are amended and as so amended are restated in their entirety by striking out Articles First through Fourteenth and inserting in lieu thereof the following: FIRST. The name of the Corporation is Sonic Foundry, Inc. SECOND. The purpose of the Corporation is to engage in any lawful business for which corporations may be organized under the Maryland General Corporation Law. THIRD. The address of the Corporation's registered office in the State of Maryland is c/o The Corporation Trust Incorporated, 300 East Lombard Street, Baltimore, Maryland 21202. The name of its registered agent at such address is Corporation Trust Company. FOURTH. A. AUTHORIZED SHARES. The total number of shares of capital stock which the Corporation has authority to issue is 35,000,000 shares, consisting of: 1. 20,000,000 shares of Common Stock, par value $.01 per share (the "Common Stock"); 2. 15,000,000 shares preference stock, par value $.01 per share, of which 10,000,000 shares have been designated as Series B 5% Cumulative Convertible Preferred Stock (the "Series B Preferred Stock"), and of which 5,000,000 shares have not been designated ("Preference Stock"). 3. The par value of the shares of capital stock has not been changed. B. COMMON STOCK Subject to the prior rights of preference stock, such as holders of shares of Series B Preferred Stock, holders of Common Stock have the right to dividends from funds legally available, when, as and if declared by the Board of Directors. Subject to the prior rights, if any, of holders of any shares of preference stock (such as shares of Series B Preferred Stock) shares of Common Stock are entitled to share ratably in all assets of the Company available for distribution to holders of shares of Common Stock upon liquidation, dissolution, or winding up of the affairs of the Company. Holders of Common Stock shall not have pre-emptive subscription or conversion rights. Holders of Common Stock shall not have cumulative voting rights. C. PREFERENCE STOCK Preference Stock may be issued in series, and shares of each series will have such rights and preference as are fixed by the Board in the resolutions authorizing the issuance of the particular series. In designating any series of preference stock, the Board may, without further action by the holders of either Common Stock or preference stock, unless specifically provided by the Articles of Incorporation for a particular series, fix the number of shares constituting any series and fix the dividend rights, dividend rate, conversion rights, voting rights (which may be greater or less than the voting rights of the Common Stock or any outstanding series of preference stock), rights and terms of redemption (including sinking fund provisions) and the liquidation preferences of the series of preference stock. Any series of preference stock, when and if issued, may have priority, greater or equal claims to dividends, distributions upon liquidation of the Company or voting rights over the holders of Common Stock. D. SERIES B PREFERRED STOCK A series of preferred stock of the Company, be and it hereby is created, such series to be classified as its Series B 5% Cumulative Convertible Preferred Stock (the "Preferred Shares"), to consist of 10,000,000 shares of the par value of $.01 each, of which the preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, shall be as follows: 1. RANKING The Series B 5% Cumulative Convertible Preferred Shares will, with respect to dividend rights and rights of liquidation, dissolution and winding up, rank senior to the common stock of the Company. 2. DIVIDENDS a. Dividend Rate. Holders of the Preferred Shares will be entitled to receive when, as and if declared by the Company, out of funds legally available therefor (the "Legally Available Funds"), dividends at the annual rate of 5% per Preferred Share, based upon the amount of $.01 per share (the "Liquidation Value"). Such dividends will be payable semi-annually on the last day of December and June in each year commencing December 31, 1996 or if any such day is not a business day in the state of Wisconsin, then the next succeeding business day in such State (the "Dividend Payment Dates"). Such dividends will be paid to the holders of record at the close of business on the date specified by the Board of Directors at the time such dividends are declared; provided, however, that such record date will not be more than sixty (60) days prior to the Dividend Payment Date upon which such dividends will be paid. Each of such semi-annual dividends will be fully cumulative, to the extent not paid, and shall 2 accrue (whether or not declared) on a daily basis from the date of original issuance of such Preferred Shares, with additional cumulative dividends on any accrued but unpaid dividend accruing daily (whether or not declared) and compounding semi-annually at the rate of 5% per annum (the "Dividend Rate"), from the first day of the semi-annual dividend period in which such accrued but unpaid dividend first became payable. b. Dividends Payable in Kind. Except as provided below, the Company may, at its option, pay all or part of the dividends on the Preferred Shares by issuing and delivering additional Preferred Shares to the holders hereof at the Dividend Rate (valuing such additional Preferred Shares at the Liquidation Value) provided, however, that if a holder of Preferred Shares notifies the Secretary of the Company, not more than 60 days nor less than 30 days of a Dividend Payment Date, of his election to receive either Preferred Shares or cash in lieu of Preferred Shares, the Company will pay to such holder, at such Dividend Payment Date, dividends in either Preferred Shares or cash in lieu of additional Preferred Shares, at the holder's election. In computing the amount of dividends accrued in respect of a fractional year, such amount shall be computed on the basis of a 360-day year of twelve 30-day months and actual number of days elapsed. c. Reservation of Preferred Shares. Until the date upon which no Preferred Shares are outstanding, the Company shall reserve and keep available out of its authorized and unissued Preferred Shares, solely for the purpose of paying dividends thereon pursuant to the preceding paragraph, such number of Preferred Shares as shall form time to time be sufficient for such purpose. The Board of Directors shall, from time to time, if necessary, propose to the stockholders of the Company amendments to the Articles of Incorporation to increase its authorized capital stock and take such other actions as may be necessary to permit the issuance from time to time of Preferred Shares upon the declaration of any dividend payable in additional Preferred Shares. d. Fractional Preferred Shares. Fractional Preferred Shares shall be issued to the extent necessary to make dividend payments in Preferred Shares. Each fractional Preferred Share outstanding shall be entitled to a ratably proportionate amount of all dividends accruing with respect to each outstanding preferred Share and all of such dividends with respect to such outstanding fractional shares shall be fully cumulative and shall accrue (whether or not declared) and shall be payable in the same manner and at such times as provided for in this paragraph B with respect to dividends on each outstanding Preferred Share. e. Insufficient Funds for Payment of Preferred Shares. All dividends paid in respect of the Preferred Shares pursuant to this paragraph d shall be paid pro rata to the holders entitled thereto. In the event that the Legally Available Funds available for the payment of dividends shall be insufficient for the payment of the entire amount of dividends payable at any Dividend Payment Date, the amount of any available surplus shall be allocated for the payment of dividends with respect to the Preferred Shares pro rata based upon the Liquidation Value of the outstanding shares. 3 f. Restrictions on Payment of Dividends. So long as any Preferred Shares are outstanding and the Company is in arrears in the payment of any dividends thereon, no dividend will be paid or other distribution made on the Common Shares (other than dividends paid or distributions made solely in additional Common Shares), nor will the Company redeem, purchase or otherwise acquire, or permit any subsidiary of the Company to purchase or otherwise acquire (or declare, pay or set aside for payment money for a sinking fund or other similar fund for such redemption, purchase, acquisition or retirement), any Common Shares (including any warrants, rights, calls or options exercisable for or convertible into any of such shares). 3. LIQUIDATION a. General. In the event of any liquidation, dissolution or winding up of the Company, then out of the assets of the Company before any distribution or payment to the holders of the Common Shares, the holders of the Preferred Shares will be entitled to be paid the Liquidation Value per share (or a pro rata portion thereof with respect to fractional shares). In the event of any liquidation, dissolution or winding up of the Company, the Company by resolution of the Board of Directors will, to the extent of any Legally Available Funds therefor, declare a dividend payable in cash on the Preferred Shares payable before any distribution is made to any holders of Common Shares, in an amount equal to the accrued and unpaid dividends, calculated at the Dividend Rate, on the Preferred Shares up to and including the date of such liquidation, dissolution or winding up and, if the Company does not have sufficient Legally Available Funds to declare and pay all dividends in cash so accrued, an amount payable in cash equal to any remaining accrued and unpaid dividends, calculated at the Dividend Rate, will be added to the amount to be received by the holders of the Preferred Shares for such Preferred Shares upon such liquidation, dissolution or winding up. The holders of the Preferred Shares shall be entitled to no other or further distribution in connection with such liquidation, dissolution or winding up. b. Insufficient Funds for Payment of Preferred Shares. If, upon any liquidation, dissolution or winding up of the Corporation, the assets of the Corporation available for distribution to the holders of Preferred Shares shall be insufficient to permit payment in full to such holders the sums which such holders are entitled to receive in such case, then all of the assets available for distribution to the holders of the Preferred Shares shall be distributed among and paid to such holders, ratably in proportion to the respective amounts that would be payable to such holders if such assets were sufficient to permit payment in full. The holders of the Preferred Shares shall be entitled to no other or further distribution in connection with such liquidation, dissolution or winding up. 4. CONVERSION RIGHTS. a. General. Subject to and in compliance with the provisions of this Section 4, any Preferred Shares may, at the option of the holder be converted, into fully-paid and non-assessable Common Shares. The number of Common Shares to which a holder of Preferred Shares shall be entitled upon conversion shall be the product obtained by multiplying the 4 Applicable Conversion Rate (determined as provided in Paragraph 4b) by the number of Preferred Shares being converted at any time. b. Applicable Conversion Rate. The conversion rate in effect at any time for the Preferred Shares (the "Applicable Conversion Rate"), except as adjusted pursuant to Paragraph 4b, shall be .5. c. Applicable Conversion Value. The applicable conversion value in effect at any time for the Preferred Shares (the "Applicable Conversion Value") shall be the liquidation value divided by the Applicable Conversion Rate. The Applicable Conversion Value shall initially be $0.02 (i.e., the Liquidation Value of $0.01 divided by the Applicable Conversion Rate of .5). d. Adjustments to Applicable Conversion Rate. (1) (a) Upon Extraordinary Common Stock Event. Upon the happening of an Extraordinary Common Stock Event (as hereinafter defined), the Applicable Conversion Value shall, simultaneously with the happening of such Extraordinary Common Stock Event, be adjusted by multiplying the then effective Applicable Conversion Rate by a fraction, the denominator of which shall be the number of Common Shares outstanding immediately prior to such Extraordinary Common Stock Event and the numerator of which shall be the number of Common Shares outstanding immediately after such Extraordinary Common Stock Event, and the product so obtained shall thereafter be the Applicable Conversion Value. The applicable Conversion Value, as so adjusted, shall be readjusted in the same manner upon the happening of any successive Extraordinary Common Stock Event or Events. "Extraordinary Common Stock Event" shall mean (i) the issue of additional Common Shares as a dividend or other distribution on outstanding Common Shares, (ii) a subdivision of outstanding Common Shares into a greater number of Common Shares, or (iii) a combination of outstanding Common Shares into a smaller number of Common Shares. (1) (b) Definition of Current Market Price. "Current Market Price" per Common Share means the closing price for the Common Shares on the date specified herein as the determination date for purposes of such valuation. The closing price on any given date shall be (i) the last sale price of Common Shares, regular way, on such date or, if no such sale takes place on such date, the average of the closing bid and asked prices thereof on such date, in each case as officially reported on the principal national securities exchange on which the same are then listed or admitted to trading, or (ii) if Common Shares are not then listed or admitted to trading on any national securities exchange, the last sale price for the Common Shares, regular way, on such date or, if no such sale takes place on such date, or sales of such shares are not reported, the average of the 5 closing bid and asked prices thereof on such date in the over-the-counter market as shown on the National Association of Securities Dealers automated quotation system, or, if Common Shares are not then quoted in such system, as published by the National Quotation Bureau, Incorporated or any similar successor organization, and in either case as reported by any member firm of the New York Stock Exchange selected by the Company, or (iii) if no Common Shares are then listed or admitted to trading on any national securities exchange and if no sales prices or closing bid and asked prices thereof are then so quoted or published in the over-the-counter market, the Current Market Price of such shares on the date in question as determined by more than two-thirds of the directors of the Corporation in good faith. e. Dividends. In the event the Company shall make or issue, or shall fix a record date for the determination of holders of Common Shares entitled to receive a dividend or other distribution (other than a distribution in liquidation or other distribution otherwise provided for herein) with respect to the Common Shares payable in (i) securities of the Company other than Common Shares or (ii) assets (excluding cash dividends or distributions), then and in each such event provision shall be made so that the holders of Preferred Shares shall thereupon receive the number of securities or such other assets of the Company which they would have received had their Preferred Shares been converted into Common Shares as the case may be, on the date of such event. f. Capital Reorganization or Reclassification. If the Common Shares issuable upon the conversion of the Preferred Shares shall be changed into the same or different number of shares of any class or classes of stock, whether by capital reorganization, recapitalization, reclassification or otherwise (other than a subdivision or combination of shares or stock dividend provided for elsewhere in this Section 4 or the sale of all or substantially all of the Company's assets to any other person), then and in each such event the holder of each Preferred Share shall have the right thereafter to convert such share into the kind and amount of shares of stock and other securities and property receivable upon such reorganization, recapitalization, reclassification or other change by holders of the number of Common Shares into which such Preferred Shares might have been converted immediately prior to such reorganization, recapitalization, reclassification or change, all subject to further adjustment as provided herein. g. Capital Reorganization, Merger or Sale of Assets. If at any time or from time to time there shall be a capital reorganization of the Common Shares (other than a subdivision, combination, recapitalization, reclassification or exchange or shares provided for elsewhere in this Section 4) or a merger or consolidation of the Company with or into another company, or the sale of all or substantially all of the Company's assets to any other person, then, as a part of such reorganization, merger, or consolidation or sale, provision shall be made so that the holders of Preferred Shares shall thereafter be entitled to receive upon conversion of the Preferred Shares, the number of shares of stock or other securities or property of the Company, or of the successor company resulting from such merger, consolidation or sale, to which such holder would have been entitled if such holder had converted its Preferred Shares immediately 6 prior to such capital reorganization, merger, consolidation, or sale. In any such case, appropriate adjustment shall be made in the application of the provisions of this Section 4 with respect to the rights of the holders of the Preferred Shares after the reorganization, merger, consolidation or sale to the end that the provisions of this Section 4 (including adjustment of the Applicable Conversion Rate then in effect and the number of shares issuable upon conversion of the Preferred Shares) shall be applicable after that event in as nearly equivalent a manner as may be practicable. Each holder of Preferred Shares upon the occurrence of a capital reorganization, merger or consolidation of the Company, or the sale of all or substantially all its assets and properties, as such events are more fully set forth in the first paragraph of this Section 4(g), shall have the option of electing treatment of his Preferred Shares under either this Section 4(g) or Section 3 hereof, notice of which election shall be submitted in writing to the Company at its principal officers no later than fifteen (15) days before the effective date of such event. h. Accountant's Certificate as to Adjustments; Notice by Company. In each case of an adjustment or readjustment of the Applicable Conversion Rate, the Company at its expense will furnish each holder of Preferred Shares with a certificate, prepared by (1) the Treasurer or chief financial officer of the Company, or (2) if requested by the holders of at least a majority of the then outstanding Preferred Shares, independent public accountants of recognized national standing, in either case, showing such adjustment or readjustment, and stating in detail the facts upon which such adjustment or readjustment is based. i. Exercise of Conversion Privilege. To exercise its conversion privilege, a holder of Preferred Shares shall surrender the certificate or certificates representing the shares being converted to the Company at its principal office, and shall give written notice to the Company at that office that such holder elects to convert such shares. Such notice shall also state the name or names (with address or addresses) in which the certificate or certificates for shares of Common Shares issuable upon such conversion shall be issued. The certificate or certificates for Preferred Shares surrendered for conversion shall be accompanied by proper assignment thereof to the Company or in blank. The date when such written notice is received by the Company, together with the certificate or certificates representing the Preferred Shares being converted, shall be the "Conversion Date." As promptly as practicable after the Conversion Date, the Company shall issue and shall deliver to the holder of the shares of Preferred Shares being converted, or on its written order, such certificate or certificates as it may request for the number of whole Common Shares issuable upon the conversion of such Preferred Shares in accordance with the provisions of this Section 4, cash in the amount of all declared and unpaid dividends on such Preferred Shares, up to and including the Conversion Date, and cash, as provided in Section 4(j), in respect of any fraction of a Common Share issuable upon such conversion. Such conversion shall be deemed to have been effected immediately prior to the close of business on the Conversion Date, and at such time the rights of the holder as holder of the converted Preferred Shares shall cease and the person or persons in whose name or names any certificate or certificates for Common Shares shall be issuable upon such conversion shall 7 be deemed to have become the holder or holders of record of the Common Shares represented thereby. j. Cash in Lieu of Fractional Shares. No fractional Common Shares or scrip representing fractional shares shall be issued upon the conversion of Preferred Shares. Instead of any fractional Common Shares which would otherwise be issuable upon conversion of Preferred Shares, the Company shall pay to the holder of the Preferred Shares which were converted a cash adjustment in respect of such fractional shares in an amount equal to the same fraction of the Current Market Price per Common Share at the close of business on the Conversion Date. The determination as to whether or not any fractional shares are issuable shall be based upon the aggregate number of Preferred Shares being converted at any one time by any holder thereof, not upon each Preferred Share being converted. k. Partial Conversion. In the event some but not all of the Preferred Shares represented by a certificate or certificates surrendered by a holder are converted, the Company shall execute and deliver to or on the order of the holder, at the expense of the Company, a new certificate representing the number of Preferred Shares which were not converted. l. Reservation of Common Shares. The Company shall at all times reserve and keep available out of its authorized but unissued Common Shares, solely for the purpose of effecting the conversion of the Preferred Shares, such number of Common Shares as shall from time to time be sufficient to effect the conversion of all outstanding Preferred Shares (including any Preferred Shares represented by any warrants, options, subscription or purchase rights for preferred Shares), and if at any time the number of authorized but unissued Common Shares shall not be sufficient to effect the conversion of all then outstanding Preferred Shares (including any Preferred Shares represented by any warrants, options, subscriptions or purchase rights for Preferred Shares), the Company shall take such corporate action as may be necessary to increase its authorized but unissued Common Shares to such number of shares as shall be sufficient for such purpose. m. No Reissuance of Preferred Shares. No Preferred Shares acquired by the Company by reason of redemption, purchase, conversion or otherwise shall be reissued, and all such shares shall be cancelled, retired and eliminated from the shares which the Company shall be authorized to issue. The Company shall from time to time take such appropriate corporate action as may be necessary to reduce the authorized number of Preferred Shares accordingly. 5. VOTING RIGHTS. a. General. Holders of Preferred Shares are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders. Holders are not entitled to cumulative votes in the election of directors and, except as hereinafter provided, holders of Preferred Shares and holders of Common Shares will vote together as a single class on all matters submitted to stockholders for a vote. 8 b. Corporate Action. Except as expressly provided herein or as required by law, so long as any of the Preferred Shares remain outstanding, the Company shall not and shall not permit any of its Subsidiaries to, without the prior written consent by the holders of at least sixty-six and two-thirds percent (66-2/3%) of the then outstanding Preferred Shares, voting as a separate class, each Preferred Share to be entitled to one vote in each instance, create, incur, assume or permit to exist any Debt, or create, authorize or issue any class or series of preferred stock that ranks senior or pari passu to the Preferred Shares as to dividends or upon liquidation, dissolution or winding up; provided, however, that the prohibitions of this Section 5b shall not apply (i) to any Debt, or any refinancing thereof (so long as refinancing does not materially increase the obligation of the Company), or preferred stock issued or existing as of the date of the filing of these Articles, (ii) so long as all or substantially all of the proceeds of such new Debt or preferred stock shall be invested in the working capital of, or otherwise used for the benefit of, the Company or any of its Subsidiaries, or (iii) so long as all or substantially all of the proceeds of such Debt or preferred stock are used to acquire any stock or assets of, or in connection with a merger or consolidation with, any Designated Person. Nothing in this Section 5b shall prohibit or limit the Company in creating or organizing an Affiliate for any purpose, including, without limitation, the acquisition of any Person not engaged in a business similar to any business conducted by the Company or its Subsidiaries, so long as neither the Company, nor any of its Subsidiaries shall be liable for the Debt or other obligations of such Affiliate. For purposes of this Section 5b, the terms set forth below shall have the following meanings: "Affiliate" shall have the meaning set forth in Rule 12b-2 of the General Rules and Regulations promulgated under the Securities Exchange Act of 1934, as amended. "Debt", with respect to the Company, means (a) all obligations for borrowed money, (b) all obligations evidenced by bonds, debentures, notes or other similar instruments, (c) all indebtedness of any Person secured by a lien or encumbrance on all or substantially all of the assets or properties of the Company, whether or not such indebtedness is assumed by the Company, and (d) all indebtedness of any person guaranteed by the Company. "Designated Person" shall mean any Person conducting, as one of its primary businesses, any business similar to any business conducted by the Company or any of its Subsidiaries (other than the Company or any Affiliate). "Person" shall mean an individual, a partnership, a joint venture, a corporation, a trust, an unincorporated organization or a governmental entity or any department or agency thereof. 9 "Subsidiary," when used in reference to any other Person, shall mean any corporation of which outstanding securities having ordinary voting power to elect a majority of the Board of Directors of such corporation are owned directly or indirectly by such other Person. c. Amendments to Charter. The Company shall not amend its Articles of Incorporation without the approval, by vote or written consent, of the holders of at least sixty-six and two-thirds percent 66-2/3% of the then outstanding Preferred Shares, each Preferred Share to be entitled to one vote in each instance, if such amendment would change any of the rights, preferences, privileges of or limitations provided for herein for the benefit of any Preferred Shares or materially adversely affect the rights of the holders of the Preferred Shares. Without limiting the generality of the preceding sentence, the Company will not amend its Articles of Incorporation without the approval by the holders of at least sixty-six and two-thirds percent (66-2/3%) of the then outstanding Preferred Shares, voting separately as a class, if such amendment would: (1) Reduce the amount payable to the holders of Preferred Shares upon the voluntary or involuntary liquidation, dissolution or winding up of the Company or adversely affect the dividend rights or redemption rights of the holders of Preferred Shares; or (2) Cancel or modify the conversion rights of the holders of Preferred Shares, provided for herein. 6. NO DILUTION OR IMPAIRMENT. The Company will not, by amendment of its Articles of Incorporation or through any reorganization, transfer of assets, consolidation, merger, dissolution, issue or sale of securities or any other voluntary action, avoid or seek to avoid the observance or performance of any of the terms of the Preferred Shares set forth herein, but will at all times in good faith assist in the carrying out of all such terms and in the taking of all such action as may be necessary or appropriate in order to protect the rights of the holders of the Preferred Shares against dilution or other impairment. Without limiting the generality of the foregoing, the Company (a) will not increase the par value of any shares of stock receivable on the conversion of the Preferred Shares above the amount payable therefor on such conversion, (b) will take all such action as may be necessary or appropriate in order that the Company may validly and legally issue fully paid and nonassessable shares of stock on the conversion of all Preferred Shares from time to time outstanding; (c) will not transfer all or substantially all of its properties and assets to any other person (corporate or otherwise), or consolidate with or merge into any other person or permit any such person to consolidate with or merge into the Company (if the Company is not the surviving person), unless such other person shall expressly assume in writing and will be bound by all the terms of the Preferred Shares set forth herein. 10 7. NOTICES OF RECORD DATE. In the event of 1. any taking by the Company of a record of the holders of any class of securities for the purpose of determining the holders thereof who are entitled to receive any dividend or other distribution, or any right to subscribe for, purchase or otherwise acquire any shares of stock of any class or any other securities or property, or to receive any other right, or 2. any capital reorganization of the Company, any reclassification or recapitalization of the capital stock of the Company, any merger or consolidation of the Company, or any transfer of all or substantially all of the assets of the Company to any other Company, or any other entity or person, or 3. any voluntary or involuntary dissolution, liquidation or winding up of the Company, then and in each such event the Company shall mail or cause to be mailed to each holder of Preferred Shares, a notice specifying (a) the date on which any such record is to be taken for the purpose of such dividend, distribution or right, (b) the date on which any such reorganization, reclassification, recapitalization, transfer, consolidation, merger, dissolution, liquidation or winding up is expected to become effective and (c) the time, if any, that is to be fixed, as to when the holders of record of Common Shares (or other securities) shall be entitled to exchange their Common Shares (or other securities) for securities or other property deliverable upon such reorganization, reclassification, recapitalization, transfer, consolidation, merger, dissolution, liquidation or winding up. Such notice shall be mailed at least twenty (20) days prior to the date specified in such notice on which such action is to be taken. FIFTH. The number of directors of the corporation shall hereinafter be six (6) which may be changed from time to time by or pursuant to a resolution passed by the Board. The Board of Directors shall be divided into five classes, each as nearly equal in number as the then total member of directors constituting the entire Board of Directors permits and with the term of office of one class expiring each year. One class of directors shall be initially elected for a term expiring at the annual meeting of stockholders to be held in 1998, another class shall be initially elected for a term expiring at the annual meeting of stockholders to be held in 1999, another class shall be initially elected for a term expiring at the annual meeting of stockholders to be held in 2000, another class shall be initially elected for a term expiring at the annual meeting of stockholders to be held in 2001, and another class shall be initially elected for a term expiring at the annual meeting of stockholders to be held in 2002. Any vacancy in the Board of Directors for any reason, shall be filled by only the Board of Directors acting by a majority of the directors then in office, although less than a quorum, and any directors so chosen shall hold office until the next election of the class for which such directors have been chosen and until their successors have been elected and qualified. No decrease in the number of directors shall shorten the term of any incumbent director. Subject to the foregoing, at each annual 11 meeting of stockholders, the successors to the class of directors whose term shall then expire shall be elected to hold office for a term expiring at the fifth succeeding annual meeting of stockholders. Notwithstanding the foregoing, any director may be removed from office during any term by the affirmative vote of the holders of shares constituting 66-2/3% of the voting power of the outstanding shares of stock entitled to vote upon the election of directors of the Corporation. SIXTH. The following provisions are hereby adopted for the purpose of defining, limiting and regulating the powers of the Corporation and of the directors and stockholders. The board of directors of the corporation is hereby empowered to authorize the issuance from time to time of shares of its stock of any class, whether now or hereafter authorized, or securities convertible into shares of its stock of any class or classes, whether now or hereafter authorized. No holder of shares of stock of any class shall be entitled as a matter of right to subscribe for or purchase or receive any part of any new or additional issue of shares of stock of any class or of securities convertible into shares of stock of any class, whether now or hereafter authorized or whether issued for money, for a consideration other than money or by way of dividend. SEVENTH. a. APPROVAL OF CERTAIN ACTIONS. The affirmative vote of the holders of shares constituting 66-2/3% of the voting power of the Corporation given in person or by proxy at a meeting called for such purpose, shall be necessary to approve the following actions: 1. any business combination (as defined in the General Corporation Law of the State of Maryland) of the Corporation or any Subsidiary (as hereinafter defined) (a) with any Interested Stockholder (as hereinafter defined), (b) with any other corporation (whether or not itself an Interested Stockholder) which is, or after such business combination would be, an affiliate (as hereinafter defined) of an Interested Stockholder or (c) in which in Interested Stockholder has an interest (except proportionately as a stockholder of the Corporation); 2. any sale, lease, exchange, mortgage, pledge, transfer or any other disposition (in one transaction or in a series of transactions) to or with any Interested Stockholder or any Affiliate of any Interested Stockholder, or in which an Interested Stockholder has an interest (except proportionately as a stockholder of the Corporation) of all or substantially all of the assets of the Corporation or any Subsidiary; 12 3. any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or in a series of transactions) of all or substantially all of the assets of an Interested Stockholder, an Affiliate thereof, or an entity in which the Interested Stockholder has an interest, to the Corporation or any Subsidiary; 4. the issuance, sale, exchange, disposition or other transfer by the Corporation or any Subsidiary (in one transaction or in a series of transactions) of any securities of the Corporation or any Subsidiary to any Interested Stockholder or any Affiliate of any Interested Stockholder (and other than by way of a pro rata distribution to all stockholders or a reclassification, dividend or subdivision of such securities and other than in connection with the exercise or conversion of securities exercisable for or convertible into securities of the Corporation or a Subsidiary that have been distributed pro rata to stockholders) in exchange for cash, securities or other property (or a combination thereof) having an aggregate Fair Market Value (as hereinafter defined) of one million dollars or more; 5. any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any other transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class of equity or convertible securities of, or otherwise increasing the voting power over, the Corporation or any Subsidiary which is directly or indirectly owned by any Interested Stockholder or any Affiliate of any Interested Stockholder. 6. any spinoff, splitoff or splitup of the Corporation in which the Interested Stockholder has an interest (other than proportionately as a stockholder); or 7. any agreement, contract, or other arrangement with an Interested Stockholder (or in which the Interested Stockholder has an interest other than proportionately as a stockholder) providing for any of the transactions described in subsections 1 through 6 of this Article Seventh, Section a; The approval required in this Article Seventh, Section a, shall be required unless all of the conditions in either subsection 1 or 2 of Section b of this Article Seventh have been fulfilled. Such affirmative vote shall be required notwithstanding the fact that no vote may be required by law or that a lesser percentage may be specified by law or in any arrangement with any national securities exchange or otherwise. For purposes of this Section a "substantially all the assets" shall mean assets having a book value of more than (i) 10% of the book value of the assets of the entity in question, in the case of the Corporation or a Subsidiary and (ii) 90% of the book value of the assets of the entity in question in the case of any other entity. 13 b. EXCEPTIONS. The provisions of Section a of this Article Seventh requiring a two-thirds vote of holders of the Corporation's outstanding voting stock shall not be applicable to any particular Business Transaction (as hereinafter defined) and such Business Transaction shall require only the affirmative vote of the stockholders, if any, as is otherwise required by law if all of the conditions specified in either of the following subsections 1 or 2 are met: 1. The Business Transaction shall have been approved expressly be more than two-thirds of the directors of the Corporation; or 2. All of the following conditions have been met: (a) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Transaction of consideration other than cash (including stock of the Corporation in the case of a merger in which the Corporation is the survivor, or the stock of a wholly owned subsidiary of the corporation pursuant to a reincorporation of the Corporation in another domicile) to be received per share by holders of Common Equity (other than the Interested Stockholder) in such Business Transaction is at least equal to such Interested Stockholder's Highest Purchase Price. (b) "Highest Purchase Price" shall mean the highest amount of consideration paid by the Interested Stockholder for a share of Common Equity of the Corporation (including any brokerage commissions, transfer taxes and soliciting dealers' fees) at any time within two years prior to the date such Interested Stockholder became an Interested Stockholder and during any time while such Interested Stockholder was an Interested Stockholder; provided, however, that the Highest Purchase Price shall be appropriately adjusted to reflect the occurrence of any reclassification, recapitalization, stock split, reverse stock split or other readjustment to the number of outstanding shares of capital stock of the Corporation, or the payment of a stock dividend thereon, between the last date upon which such Interested Stockholder paid the Highest Purchase Price and the effective date of the Business Transaction (or, in the case of a Business Transaction in which a distribution is to be made to the stockholders of the Corporation, the date of such distribution). (c) The consideration to be received by holders of a particular class of outstanding voting stock (including Common Stock) shall be in cash or in the same form as the Interested Stockholder has previously paid for shares of such class of voting stock. If the Interested Stockholder has paid for shares of any class of voting stock with varying forms of consideration, the form of consideration for such class of voting stock shall be either cash or the form used to acquire the largest number of shares of such class of voting stock previously acquired by it. 14 (d) After such Interested Stockholder has become an Interested Stockholder and prior to the consummation of such Business Transaction: (i) except as approved by more than two-thirds of the directors of the Corporation, there shall have been no failure to declare and pay at the regular rate thereof any full semi-annual dividends, whether or not cumulative, on any outstanding class of preference stock; (ii) there shall have been (y) no reduction in the annual rate of dividends paid on Common Equity (other than as necessary to reflect any subdivision of the common Equity), except as approved by more than two-thirds of the directors of the Corporation, and (z) an increase in such annual rate of dividends as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or similar transaction which has the effect of reducing the number of outstanding Common Equity, unless the failure so to increase such annual rate is approved by more than two-thirds of the directors of the Corporation; and (iii) such Interested Stockholder shall not have become the beneficial owner of any additional shares of voting stock of the Corporation (A) except as part of the transaction which results in such Interested Stockholder becoming an Interested Stockholder or (B) as a result of a pro rata stock dividend or stock split. (e) After such Interested Stockholder has become an Interested Stockholder, such Interested Stockholder shall not have directly or indirectly (i) received the benefit, directly or indirectly (except proportionately as a stockholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credit or other tax advantages provided by the Corporation or any Subsidiary, or otherwise have engaged in a transaction with the Corporation outside the ordinary course of business or (ii) caused any material change in the Corporation's business or capital structure (including without limitation the issuance of shares of capital stock of the Corporation to any third party) in any case whether in anticipation of, or in connection with, such Business Transaction or otherwise, unless approved by more than two-thirds of the directors of the Corporation; and (f) If the Corporation is at the time a reporting company, as defined in the Securities Exchange Act of 1934 (the "Exchange Act"), a proxy or information statement describing the proposed Business Transaction and complying with the requirements of the Exchange Act, and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) shall be mailed to the public stockholders of the Corporation at least thirty (30) days prior to the consummation of such Business Transaction (whether or not such proxy or information statement is required to be mailed pursuant to such act or subsequent provision). 15 c. DEFINITIONS. For the purposes of this Article Seventh: A "Person" shall mean any individual, group, partnership, association, firm, corporation or other entity. "Interested Stockholder" shall mean any Person (other than the Corporation, any Subsidiary (as defined below), any employee stock ownership or other employee benefit plan of the Corporation or any Subsidiary, or any trustee of, or fiduciary with respect to, any such plan when acting in such capacity) who or which (a) is the Beneficial Owner, directly or indirectly, of more than ten percent (10%) of the voting power of the outstanding voting stock of the Corporation; (b) is an Affiliate of the Corporation and at any time within the two-year period immediately prior to the date in question was the Beneficial Owner, directly or indirectly, of more than ten percent (10%) of the voting power of the outstanding voting stock of the Corporation; or (c) is an Affiliate of the Corporation and at any time within the two-year period immediately prior to the date in question was the Beneficial Owner, directly or indirectly, of ten percent (10%) or more of the voting power of the then outstanding voting stock of the Corporation which was at any time within the two-year period immediately prior to the date in question beneficially owned by any Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933, as amended. The calculation of the percentage of beneficial ownership shall be made at the following three times, any of which will suffice for purposes of determining that a Beneficial Owner is an Interested Stockholder: (f) at the time the definitive agreement providing for the Business Transaction (including any amendment thereof) was entered into, (ii) at the time a resolution approving the Business Transaction was adopted by the Board of Directors of the Corporation, or (iii) as of the record date of the Corporation for the determination of stockholders entitled to notice of and to vote on, or to consent to, the Business Transaction. Notwithstanding the foregoing, a person shall not be deemed an "Interested Stockholder" if such person would have been deemed an "Interested Stockholder", under clause (a) set forth above, at any time prior to December 31, 1996. A Person shall be a "Beneficial Owner" of any voting stock of the Corporation (a) which such Person or any of its Affiliates or Associates (as hereinafter defined) beneficially owns, directly or indirectly; (b) which such Person or any of its Affiliates or Associates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding; or upon the exercise of conversion rights, exchange rights, warrants or other options, or otherwise, or (ii) the right to vote pursuant to any agreement, arrangement or understanding; or (c) which are beneficially owned, directly or indirectly, by an Person with which such Person or any of its Affiliates has any agreement, arrangement or understanding for the purpose of holding, voting or disposing of any shares of such stock. 16 For the purpose of determining whether a Person is an "Interested Stockholder", the number of shares of voting stock of the Corporation deemed to be outstanding shall include shares deemed owned through application of such definition but shall not include any other shares of voting stock of the Corporation which may be issuable pursuant to any agreement, arrangement or understanding, or upon exercise of conversion rights, warrants or options, or otherwise. "Affiliates" or "Associates" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Exchange Act, as in effect from time to time. The term "Associate," used to indicate a relationship with a specified person, shall also mean any person who is a director or officer of such specified person or any of its parents or subsidiaries (other than the Corporation or any Subsidiary). "Subsidiary" shall mean any corporation of which at least a majority of any class of equity security is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of "Interested Stockholder" set forth above, the term "Subsidiary" shall mean only a corporation of which at least a majority of each class of equity securities is owned, directly or indirectly, by the Corporation. "Fair Market Value" shall mean; in the case of stock, the highest closing sale price during the thirty (30) day period immediately preceding the date in question of a share of such stock on the National Association of Securities dealers Automated Quotation System ("Nasdaq") or the Nasdaq National Market System, or, if such stock is not quoted on Nasdaq, on the New York Stock Exchange,or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934, as amended, on which such stock is listed, or if such stock is not listed on any such exchange, the highest closing bid quotation with respect to a share of such stock during the thirty (30) day period immediately preceding the date in question on the Nasdaq, or any system then in use, or if no such quotations are available, the Fair Market Value of such property on the date in question as determined by more than two-thirds of the directors of the Corporation in good faith. In the event of any Business Transaction in which the Corporation survives, the phrase "consideration other than cash to be received" as used in subsections (2)(a) and (b) of Section b shall include the Common Equity and/or the shares of any other class of outstanding voting stock retained by the holder of such shares. "Business Transaction" shall mean any transaction which is referred to in Section a. "Voting power" shall be calculated by multiplying the number of voting shares or other voting securities of the Corporation or the Subsidiary, as the case may be, times the number of votes (or fractional votes) per such share or security to which the holders of such shares or securities are entitled. 17 d. DETERMINATIONS BY DIRECTORS. More than two-thirds of the directors of the Corporation shall have the power and duty to determine, for the purpose of this Article, on the basis of information known to them after reasonable inquiry, (1) whether a person is an Interested Stockholder; (2) the number of shares of voting stock of the Corporation of which any Person is the Beneficial Owner; (3) whether a Person is an Affiliate or an Associate of another; (4) whether a Person has an agreement, arrangement or understanding with another as to matters referred to herein; (5) whether the assets in a Business Transaction are "substantially all the assets" of an entity; (6) whether any Business Transaction is one in which an Interested Stockholder has an interest; (7) whether an Interested Stockholder has received the benefits or caused the changes referred to in Section b(2)(e); (8) whether the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Transaction has an aggregate Fair Market Value of one million dollars or more; and (9) such other matters with respect to which determination is required under this Article Sixth. e. FIDUCIARY DUTIES. Nothing contained in this Article Seventh shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law. f. AMENDMENTS. To amend or repeal or adopt any provisions inconsistent with Sections a through e of this Article Seventh, there shall be required the affirmative vote of (i) the holders of not less than two-thirds of the voting power of the Corporation or (ii) the stockholders of the Corporation as required by law, if the amendment is approved by more than two-thirds of the directors of the Corporation. EIGHT. The Corporation is to have perpetual existence. NINTH. In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to adopt, alter, repeal or amend from time to time any or all of the Bylaws of the Corporation. Without limiting the power of the directors granted in this Article Ninth, the Bylaws of the Corporation may be adopted, altered, repealed or amended by the affirmative vote of holders of not less than two-thirds of the voting power of the outstanding shares of stock entitled to vote on the election of directors. TENTH. To the fullest extent permitted by the General Corporation Law of Maryland, a director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. Notwithstanding the foregoing, in the event that the General Corporation Law of the State of Maryland is subsequently amended to authorize corporate action further eliminating or limiting the personal liability of the Corporation's directors to the Corporation or its stockholders, then the liability of a director of the Corporation will be eliminated or limited to the full extent permitted by the General Corporation Law of the State of Maryland, as so amended. 18 ELEVENTH. A. Each person who was or is made a party or is threatened to be made a party to any threatened, pending or completed action, rule or proceeding, whether civil, criminal, administrative or investigative by reason of the fact that he, or a person of whom he is the legal representative, is or was a director, officer, employee or agent of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to employee benefit plans, whether the basis of such proceeding is alleged action in an official capacity as a director, officer, employee or agent or in any other capacity while serving as a director, officer, employee or agent shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the General Corporation Law of the State of Maryland. B. The Corporation may purchase and maintain insurance, at its expense, on behalf of any person who is or was a director, officer, employee or agent of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against him and incurred by him in such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify such person against such liability under the General Corporation Law of the State of Maryland. TWELFTH. A special meeting of the stockholders of the Corporation may be called at any time by the Board of Directors, or by the chairman of the board, or by the vice chairman, or by the chief executive officer of the president of the Corporation, or by the holders of not less than twenty-five percent (25%) of the outstanding shares of stock entitled to vote on the election of directors. THIRTEENTH. Except as otherwise provided for or fixed pursuant to the provisions of Article 4 of these Articles of Incorporation relating to the rights of holders of any series of Preferred Stock, no action that is required or permitted to be taken by the stockholders of the Corporation at any annual or special meeting of stockholders may be effected by written consent of stockholders in lieu of a meeting of stockholders, unless the action to be effected by written consent of stockholders and the taking of such action by such written consent have expressly been approved in advance by the Board of Directors of the Corporation. FOURTEENTH. The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Amended and Restated Articles of Incorporation in the manner now or hereafter prescribed by statute; provided, however, that any amendment, alteration, repeal or change of Articles 5, 6, 9, 12, 13 and 14 of this Amended and Restated Article of Incorporation, in addition to any vote required therein, shall require the approval of the affirmative vote of holders of not less than two-thirds of the voting power of the outstanding shares of stock entitled to vote upon the election of directors; provided, however, that if at the time of such vote any Interested Stockholder (as defined in Article 7 above) exists, then such 19 alteration, amendment, change or repeal shall also require the affirmative vote of at least a majority of the voting power of the outstanding shares of stock entitled to vote upon the election of directors beneficially owned by persons other than the Interested Stockholder or any Affiliate or Associate thereof (each as defined in Article 7 above). IN WITNESS WHEREOF, Sonic Foundry, Inc. has caused these Amended and Restated Articles of Incorporation to be signed and acknowledged in its name and on its behalf by its ________________ and witnessed by its _____________ on this 26th day of January, 1998, and they acknowledge the same to be the act of said Company, and that to the best of their knowledge, information and belief, all matters and facts stated herein are true in all material respects, and that this statement is made under the penalties of perjury. ATTEST: SONIC FOUNDRY, INC. ______________________________ By: _______________________________ 20 EX-3.2 4 AMENDED & RESTATED BY-LAWS EXHIBIT 3.2 SONIC FOUNDRY AMENDED AND RESTATED BYLAWS Article I OFFICES The registered office of SONIC FOUNDRY, INC. (the "Corporation") in the State of Maryland shall be in the City of Baltimore, State of Maryland. The Corporation shall have offices at such other places as the Board of Directors, in its discretion, may from time to time determine. Article II STOCKHOLDERS Section 1. Annual Meetings. The annual meeting of the stockholders for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held on such date as the Board of Directors shall each year fix. Each such annual meeting shall be held at such place, within or without the State of Maryland, and hour as shall be determined by the Board of Directors. The day, place and hour of each annual meeting shall be specified in the notice of such annual meeting. Any annual meeting of stockholders may be adjourned from time to time and place to place until its business is completed. Section 2. Business Conducted at Meetings. At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (b) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (c) otherwise properly brought before the meeting by a stockholder. For business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the secretary of the Corporation. To be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the Corporation, not less than thirty days nor more than fifty days prior to the meeting; provided, however, that in the event that less than forty days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the tenth day following the date on which such notice of the date of the annual meeting was mailed or such public disclosure was made. A stockholder's notice to the secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting, (b) the name and address, as they appear on the Corporation's books, of the stockholder proposing such business, (c) the class and number of shares of the Corporation which are beneficially owned by the stockholder, and (d) any material interest of the stockholder in such business. Notwithstanding anything in the bylaws to the contrary, no business shall be conducted at an annual meeting except in accordance with the procedures set forth in this Section 2. The presiding officer of an annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of this Section 2, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. Section 3. Special Meetings. (a) Except as otherwise required by law or by the Articles of Incorporation and subject to the rights of the holders of any class or series of stock having a preference over the common stock as to dividends or on liquidation, special meetings of the stockholders may be called only be the chairman of the board, the vice chairman and chief executive officer, the president, the board of directors pursuant to a resolution approved by a majority of the entire board of directors or by one or more stockholders holding shares in the aggregate representing not less than twenty-five percent (25%) of the votes at that meeting. The term "entire board of directors", as used in these bylaws, means the total number of directors which the Corporation would have if there were no vacancies. (b) If a special meeting is called by any person or persons other than the board of directors, the request shall be in writing, specifying the time of such meeting and the general purpose or purposes for which the meeting is called, and shall be delivered personally or sent by registered mail or by telegraphic or other facsimile transmission to the chairman of the board of directors, the president, any vice president, or the secretary of the Corporation. The officer receiving the request shall cause notice to be promptly given to the stockholders entitled to vote, in accordance with the provisions of Sections 4 and 5 of this Article II, that a meeting will be held at the time requested by the person or person calling the meeting, not less than thirty-five (35) nor more than sixty (60) days after the receipt of the request. If the notice is not given within twenty (20) days after receipt of the request, the person or persons requesting the meeting may give the notice. Nothing contained in this subparagraph (b) of this Section 3 shall be construed as limiting, fixing of affecting the time when a meeting of stockholders called by action of the board of directors may be held. Section 4. Stockholder Action; How Taken. Any action required or permitted to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of such stockholders and may not be effected by any consent in writing by such stockholders; provided, however, that any action required or permitted to be taken at any annual or special meeting of stockholders of the Corporation may be taken without a meeting, without prior notice, and without a vote, if (i) a 2 consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than a majority of the votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote were present and voted and (ii) such written consent has been approved in advance by the Corporation's board of directors. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. Any such consent may be in counterparts and shall hear the date of signature of each stockholder who signs the consent. No such consent shall be effective to take any action unless, within sixty days following the date of the earliest signature thereon, the consent or counterparts thereof, hearing the signatures of holders of stock having not less than a majority of the votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote were present and voted to take such action, are delivered to the Corporation by delivery to its principal place of business or to the secretary of the Corporation. Any action taken pursuant to such consent shall be effective as of the date of the last signature thereon needed to make it effective unless otherwise provided in the consent. All counterparts of such consent necessary to make it effective shall be filed with the minutes of proceedings of the stockholders. If the action that is consented to is such as would have required the filing of a certificate under any provisions of the Maryland General Corporation Law if such action had been voted upon by stockholders at a meeting, the certificate filed shall state, in lieu of nay statement concerning a vote of stockholders, that written consent has been given in accordance with the provisions of Maryland General Corporation Law, and that written notice has been given as provided in that section. Section 5. Notice of Meeting. Written notice stating the place, date and hour of the meeting and, in case of a special meeting, the purpose or purposes for which the meeting is called, except as set forth in subparagraph (b) of Section 3, shall be given not less than ten nor more than sixty days before the date of the meeting, except as otherwise required by statute or the articles of incorporation, either personally or by mail, prepaid telegram, telex, cablegram, or radiogram, to each stockholder or record entitled to vote at such meeting. If mailed, such notice shall be deemed to be given when deposited in the United States mail, postage prepaid, addressed to the stockholder at his address as it appears on the stock records of the Corporation. If given personally or otherwise than by mail, such notice shall be deemed to be given when either handed to the stockholder or delivered to the stockholder's address as it appears on the stock records of the Corporation. Section 6. Waiver. Attendance of a stockholder of the Corporation, either in person or by proxy, at any meeting, whether annual or special, shall constitute a waiver of notice of such meeting, except where a stockholder attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business became the meeting is not lawfully called or convened. A written waiver of notice of any such meeting signed by a stockholder or 3 stockholders entitled to such notice, whether before, at or after the time for notice or the time of the meeting, shall be equivalent to notice. Neither the business to be transacted at, nor the purposes of, any meeting need be specified in any written waiver of notice. Section 7. Voting List. The secretary shall prepare and make available, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order and showing the address and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall be produced and kept at the place of the meeting during the whole time thereof and may be inspected by an stockholder who is present. Section 8. Quorum. Except as otherwise required by law, the articles of incorporation or these bylaws, the holders of not less than one-third of the shares entitled to vote at any meeting of the stockholders, present in person or by proxy, shall consider a quorum, and the act of the majority of such quorum shall be deemed the act of the stockholders. If a quorum shall fail to attend any meeting, the chairman of the meeting may adjourn the meeting from time to time, without notice if the time and place are announced at the meeting, until a quorum shall be present. At such adjourned meeting at which a quorum is present, any business may be transacted which might have been transacted at the original meeting. If the adjournment is for more than thirty days or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. If a notice of any adjourned special meeting of stockholders is sent to all stockholders entitled to vote thereat, stating that it will be held with those present constituting a quorum, then, except as otherwise required by law, those present at such adjourned meeting shall constitute a quorum, and all matters shall be determined by a majority of votes cast at such meeting. Section 9. Record Date. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting, or at any adjournment of a meeting, of stockholders; or entitled to express consent to corporate action in writing without a meeting; or entitled to receive payment of any dividend or other distribution or allotment of any rights; or entitled to exercise any rights in respect of any change, conversion, or exchange of stock; or for the purpose of any other lawful action; the board of directors may fix, in advance, a record date, which record date shall not proceed the date upon which the resolution fixing the record date is adopted by the 4 board of directors. The record date for determining the stockholders entitled to notice of or to vote at any meeting of the stockholders or any adjournment thereof shall not be more than sixty nor less than ten days before the date of such meeting. The record date for determining the stockholders entitled to consent to corporate action in writing without a meeting shall not be more than ten days after the date upon which the resolution fixing the record date is adopted by the board of directors. The record date for any other action shall not be more than sixty days prior to such action. If no record date is fixed, (i) the record date for determining stockholders entitled to notice of or to vote at any meeting shall be at the close of business on the day next preceding the day on which notice is given or, if notice is waived by all stockholders, at the close of business on the day next preceding the day on which the meeting is held; (ii) the record date for determining stockholders entitled to express consent to corporate action in writing without a meeting, when no prior action by the board of directors is required, shall be the first date on which a signed written consent setting forth the action taken or to be taken is delivered to the Corporation and, when prior action by the board of directors is required, shall be at the close of business on the day on which the board of directors adopts the resolution taking such prior action; and (iii) the record date for determining stockholders for any other purpose shall be at the close of business ont he day on which the board of directors adopts the resolution relating to such other purpose. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the board of directors may fix a new record date for the adjourned meeting. Section 10. Procedure. The order of business and all other matters of procedure at every meeting of the stockholders may be determined by the presiding officer. Article II DIRECTORS Section 1. Number, Election, and Terms. The number of directors shall be fixed from time to time exclusively by resolutions adopted by the board of directors; provided, however, that the number of directors shall at no time be less than three nor greater than twelve and further provided that no decrease in the number of directors constituting the board of directors shall shorten the term of any incumbent director. The directors, other than those who may be elected by the holders of any class or series of stock having a preference over the common stock as to dividends or upon liquidation, shall be classified with respect to the time for which they severally hold office, into five classes, as nearly equal in number as possible, as determined by the board of directors, Class I to hold office initially for a term expiring at the annual meeting of stockholders to be held during the fiscal year ending in 1998, Class II to hold office initially for a term expiring at the annual meeting of stockholders to be held during the fiscal year ending in 1999, Class III to hold office initially for a term expiring at the annual meeting of stockholders to be held during 5 the fiscal year ending in 2000, Class IV to hold office initially for a term expiring at the annual meeting of stockholders to be held during the fiscal year ending in 2001, and Class V to hold office initially for a term expiring at the annual meeting of stockholders to be held during the fiscal year ending in 2002, with the members of each class to hold office until their successors are elected and qualified. At each annual meeting of stockholders, the successors of the class of directors whose term expires at that meeting shall be elected to hold office for a term expiring at the annual meeting of stockholders held in the fifth year following the year of their election. Subject to the rights of holders of any class or series of stock having a preference over the common stock as to dividends or upon liquidation, nominations for the election of directors may be made by the board of directors or a committee appointed by the board of directors or by any stockholder entitled to vote in the election of directors generally. However, any stockholder entitled to vote in the election of directors generally may nominate one or more persons for election as directors at a meeting only if written notice of such stockholder's intent to make such nomination or nominations has been given, either by personal delivery or by United States mail, postage prepaid, to the secretary of the Corporation no later than (i) with respect to an election to be held at an annual meeting of stockholders, ninety days prior to the anniversary date of the immediately preceding annual meeting, and (ii) with respect to an election to be held at a special meeting of stockholders for the election of directors, the close of business on the tenth day following the date on which notice of such meeting is first given to stockholders. Each such notice shall set forth: (a) the name and address of the stockholder who intends to make the nomination and of the person or person to be nominated; (b) representation that the stockholder is a holder of record of stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (c) a description of all arrangements or understandings between the stockholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the stockholder; (d) such other information regarding each nominee proposed by such stockholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission; and (e) the consent of each nominee to serve as a director of the Corporation if so elected. The presiding officer of the meeting may refuse to acknowledge nomination of any person not made in compliance with the foregoing procedure. Section 2. Newly Created Directorships and Vacancies. Except as otherwise fixed pursuant to the provisions of the Corporation's articles of incorporation, newly created directorships resulting from any increase in the number of directors and any vacancies on the board of directors resulting from death, resignation, disqualification, removal or other cause shall be filled solely by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum of the board 6 of directors. Any director elected in accordance with the preceding sentence shall hold office for the remainder of the full term of the class of directors in which the new directorship was created or the vacancy occurred and until such director's successor shall have been elected and qualified. Section 3. Regular Meetings. The first meeting of each newly elected board of directors elected at the annual meeting of stockholders shall be held immediately after and at the same place as, the annual meeting of the stockholders, provided a quorum is present, and no notice of such meeting shall be necessary in order to legally constitute the meeting. Regular meetings of the board of directors shall be held at such times and places as the board of directors may from time to time determine. Section 4. Special Meetings. Special meetings of the board of directors may be called at any time, at any place and for any purpose by the chairman of the executive committee, the chairman of the board, or the vice chairman and chief executive officer, or by any officer of the Corporation upon the request of a majority of the entire board of directors. Section 5. Notice of Meetings. Notice of regular meetings of the board of directors need not be given. Notice of every special meeting of the board of directors shall be given to each directors at his usual place of business or at such other address as shall have been furnished by him for such purpose. Such notice shall be properly and timely given if it is (a) deposited in the United States mail not later than the seventh calendar day preceding the date of the meeting, or (b) personally delivered, telecopied, telegraphed, or communicated by telephone at least twenty-four hours before the time of the meeting. Such notice need not include a statement of the business to be transacted at, or the purpose of, any such meeting. Section 6. Waiver. Attendance of a director at a meeting of the board of directors shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. A written waiver of notice signed by a director or directors entitled to such notice, whether before, at, or after the time for notice or the time of the meeting, shall be equivalent to the giving of such notice. 7 Section 7. Quorum. Except as may be otherwise provided by law, in the Articles of Incorporation, or in these bylaws, the presence of a majority of the entire board of directors shall be necessary and sufficient to constitute a quorum for the transaction of business at any meeting of the board of directors, and the act of a majority of such quorum shall be deemed the act of the board of directors. Less than a quorum may adjourn any meeting of the board of directors from time to time without notice. Section 8. Chairman of the Board. The chairman of the board shall be appointed by the board of directors and shall have such general powers and duties of supervision and management as are usually vested in the office of chairman of the board. He shall preside at all meetings of the stockholders and directors at which he may be present and shall have such other duties, powers and authority as may be prescribed elsewhere in these bylaws. The board of directors may delegate such other authority and assign such additional duties to the chairman of the board, other than those conferred by law exclusively upon the vice chairman and chief executive officer or the president, as it may from time to time determine. The chairman of the board shall hold his position at the pleasure of the board of directors and may be removed at any time by the board of directors with or without cause. Section 9. Participation in Meetings By Telephone. Members of the board of directors, or of any committee thereof, may participate in a meeting of such board or committee by means of conference telephone or similar communications equipment by means of which all person participating in the meeting can hear each other and such participation shall constitute presence in person at such meeting. Section 10. Powers The business, property and affairs of the Corporation shall be managed by or under the direction of its board of directors, which shall have and may exercise all the powers of the Corporation to do all such lawful acts and things as are not be law, by the certificate of incorporation, or by these bylaws, directed or required to be exercised or done by the stockholders. Section 11. Compensation of Directors. Directors shall receive such compensation for their services as shall be determined by a majority of the entire board of directors, provided that directors who are serving the Corporation as officers or employees and who receive compensation for their services as such officers or employees shall not receive any salary or other compensation for their services as directors. 8 Section 12. Action Without a Meeting. Unless otherwise restricted by the articles of incorporation or these bylaws, any action required or permitted to be taken at any meeting of the board of directors or any committee thereof may be taken without a meeting if written consent thereto is signed by all members of the board of directors or of such committee, as the case may be, and such written consent is filed with the minutes of proceedings of the board or committee. Any such consent may be in counterparts and shall be effective on the date of the last signature thereon unless otherwise provided therein. Article IV COMMITTEES Section 1. Designation of Committees. The board of directors may establish committees for the performance of delegated or designated functions to the extent permitted by law, each committee to consist of one or more directors of the Corporation. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of such absent or disqualified member. Section 2. Committee Powers and Authority. The board of directors may provide, by resolution or by amendment to these bylaws, that a committee may exercise all the power and authority of the board of directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; provided, however, that a committee may not exercise the power or authority of the board of directors in reference to amending the certificate of incorporation (except that a committee may, to the extent authorized in the resolution or resolutions providing for the issuance of shares of stock adopted by the board of directors, pursuant to Article IV of the certificate of incorporation, fix the designations and any of the preferences or rights of shares of preferred stock relating to dividends, redemption, dissolution, any distribution of property or assets of the Corporation, or the conversation into, or the exchange of shares for, shares of any other class or classes or any other series of the same or any other class or classes of stock of the Corporation or fix the number of shares of any series of stock or authorize the increase or decrease of the shares of any series), adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease, or exchange of all or substantially all of the Corporation's property and assets, recommending to the stockholders a dissolution of the Corporation or a revocation of a dissolution, or amending these bylaws; and, unless the resolution expressly so provides, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock. 9 Section 3. Committee Procedures. To the extent the board of directors or the committee does not establish other procedures for the committee, each committee shall be governed by the procedures established in Article II, Section 3 (except as they relate to an annual meeting of the board of directors) and Article III, Sections 4, 5, 6, 7, 9, and 12 of these bylaws, as if the committee were the board of directors. Article V OFFICERS Section 1. Number. The officers of the Corporation shall be appointed or elected by the board of directors. The officers shall be a chairman of the board of directors, a vice chairman of the board of directors and chief executive officer, a president, such number of vice presidents as the board of directors may form time to time determine, a secretary, and a treasurer. Any person may hold two or more offices, other than the secretary who may not serve as either president, chief executive officer or chairman of the board of directors, at the same time. Section 2. Additional Officers. The board of directors may appoint such other officers as it shall deem appropriate. Section 3. Term of Office, Resignation. All officers, agents and employees of the Corporation shall hold their respective offices or positions at the pleasure of the board of directors and may be removed at any time by the board of directors with or without cause. Any officer may resign at any time by giving written notice of his resignation to the chief executive officer, the president or to the secretary, and acceptance of such resignation shall not be necessary to make it effective unless the notice so provides. Any vacancy occurring in any office shall be filed by the board of directors. Section 4. Duties. The officers of the Corporation shall perform the duties and exercise the powers as may be assigned to them from time to time by the board of directors, the chairman of the board of directors, the chief executive officer, or the president. In the absence of such assignment, the officers shall have the duties and powers described in Sections 5 through 9 or this Article V. 10 Section 5. Chairman of the Board. The chairman of the board of directors (who may also hold other offices) shall have such duties as the board of directors shall prescribe. In the chairman's absence, such duties shall be attended by the vice chairman of the board of directors and chief executive officer. Section 6. Vice Chairman of the Board. The vice chairman of the board of directors shall in the absence of the chairman, if present, preside at meetings, of the board of directors and exercise and perform such other powers and duties as may be from time to time assigned to him by the board of directors or prescribed by the bylaws. Section 7. Chief Executive Officer. Subject to the direction and control of the board of directors, the chief executive officer shall manage the business of the Corporation, and such other matters as from time to time assigned to him by the board of directors or prescribed by the bylaws. The chief executive officer may execute contracts, deeds and other instruments on behalf of the corporation. The chief executive officer shall have full authority on behalf of the corporation to attend any meeting, give any waiver, cast any vote, grant any discretionary or directed proxy to any person, and exercise any other rights of ownership with respect to any shares of capital stock or other securities held by the Corporation and issued by any other corporation or with respect to any partnership, trust or similar interest held by the corporation. Section 8. President. Subject to such supervisory powers as may be given by the board of directors to the chairman of the board of directors, the vice chairman of the board of directors and the chief executive officer, if any, the president shall have general supervision, direction, and control of the business and the officers of the corporation, subject to the discretion of the board of directors. He shall have the general powers and duties of management usually vested in the office of president of a corporation, and shall have such other powers and duties as may be prescribed by the board of directors, the chairman of the board of directors, the vice chairman of the board of directors and the chief executive officer of the bylaws. Section 9. Chief Operating Officer. Subject to such supervisory powers, if any, as may be given by the board of directors to the chairman of the board of directors, the vice chairman of the board of directors, the chief executive officer of the president, if there be such officers, the chief operating officer of the corporation shall be the general manager of the corporation and shall, subject to the control of the board of directors, the chairman of the board of directors, the vice chairman of 11 the board of directors, chief executive officer and the president, have general supervision, direction, and control of the business and the officers of the corporation. In the absence of the chief executive officer or president, or in the event of their disability, inability or refusal to act, the chief operating officer shall perform the duties and exercise the power of the chief executive officer or the president. He shall have the general powers and duties of management usually vested in the office of chief operating officer of a corporation, and shall have such other powers and duties as may be prescribed by the board of directors, the chairman of the board of directors, the vice chairman of the board of directors, the chief executive officer and the president or the bylaws. Section 10. Vice President. Each vice president, if any, shall perform such functions as may be prescribed by the board of directors, the chief executive officer or the president. Upon the death, disability or absence of the president or the chief operating officer, the vice president named as executive vice president shall perform the duties and exercise the powers of the president. Each vice president shall perform such other duties as the board, the chief executive officer, or the president may from time to time prescribe or delegate to him. Section 11. Secretary. The secretary shall give, or cause to be given, notice of all meetings of the stockholders and, upon the request of a person entitled to call a special meeting of the board of directors, he shall give notice of any such special meeting. He shall keep the minutes of all meetings of the stockholders, the board of directors, or any committee established by the board of directors. The secretary shall be responsible for the maintenance of all records of the Corporation and may attest documents on behalf of the Corporation. The secretary shall perform such other duties as the board, the vice chairman of the board and chief executive officer or the president may from time to time prescribe or delegate to him. Section 12. Treasurer. The treasurer shall be responsible for the control of the funds of the Corporation and the custody of all securities owned by the Corporation. The treasurer shall perform such other duties as the board, the chief executive officer or the president may from time to time prescribe or delegate to him. Section 13. Compensation. Officers shall receive such compensation, if any, for their services as may be authorized or ratified by the board of directors. Election or appointment as an officer shall not of itself create a right to compensation for services performed as such officer. 12 Article VI INDEMNIFICATION OF DIRECTORS, OFFICERS AND EMPLOYEES Section 1. Directors and Officers. The Corporation shall indemnify to the full extent permitted by, and in the manner permissible under, the laws of the State of Maryland, any person who was or is a party or is threatened to be made, a party to any threatened, pending or completed action, suit, or proceeding, whether criminal, civil, administrative, or investigative, by reason of the fact that he, is or was a director or officer of the Corporation, or, while a director or officer of the Corporation, is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, association, or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding. The Corporation may advance expenses (including attorneys' fees) to any such person incurred in defending any such action, suit or proceeding upon terms and conditions, if any, deemed appropriate by the board of directors upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as authorized by the laws of the State of Maryland. Section 2. Contract. The foregoing provisions of this Article VI shall be deemed to be a contract between the Corporation and each director and officer who serves in such capacity at any time while this bylaw is in effect, and any repeal or modification thereof shall not affect any rights or obligations then existing with respect to any state of facts then or theretofore existing or any action, suit or proceeding theretofore or thereafter brought based in whole in part upon any such state of facts. The foregoing rights of indemnification shall not be deemed exclusive of any other rights to which any director or officer may be entitled apart from the provisions of this Article VI. Section 3. Surviving Corporation. The board of directors may provide by resolution that references to "the Corporation" in this Article VI shall include, in addition to this Corporation, all constituent corporations absorbed in a merger with this Corporation so that any person who was a director or officer of such a constituent corporation or is or was serving at the request of such constituent corporation as a director, employee, or agent of another corporation, partnership, joint venture, trust, association, or other entity shall stand in the same position under the provisions of this Article VI with respect to this Corporation as he would if he had served this Corporation in the same capacity or is or was so serving such other entity at the request of this Corporation, as the case may be. 13 Section 4. Inurement. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article VI shall continue as to a person who has ceased to be a director or officer and shall insure to the benefit of the heirs, executors, and administrators of such person. Section 5. Employees and Agents. To the same extent as it may do for a director or officer, the Corporation may indemnify and advance expenses to a person who is not and was not a director or officer of the Corporation but who is or was an employee or agent of the Corporation or who is or was serving at the request of the Corporation as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, association, or other enterprise. Article VII CAPITAL STOCK Section 1. Certificates. Each stockholder of the Corporation shall be entitled to a certificate or certificates signed by or in the name of the Corporation by any one of the chairman, the chief executive officer, the president, the chief operating officer or a vice president, and by any one of the treasurer, an assistant treasurer, the secretary or an assistant secretary, certifying the number of shares of stock of the Corporation owned by such stockholder. Section 2. Facsimile Signatures. In case any officer, transfer agent or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the Corporation with the same effect as if he, she or it was such officer, transfer agent or registrar at the date of issue. Section 3. Registered Stockholders. The Corporation shall be entitled to treat the holder of record of any share or shares of stock of the Corporation as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it has actual or other notice thereof, except as provided by law. 14 Section 4. Cancellation of Certificates. All certificates surrendered to the Corporation shall be cancelled and, except in the case of lost, stolen or destroyed certificates, no new certificates shall be issued until the former certificate or certificates for the same number of shares of the same class of stock have been surrendered and cancelled. Section 5. Lost, Stolen or Destroyed Certificates. The board of directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate or certificates to be lost, stolen or destroyed. In its discretion, and as a condition precedent to the issuance of any such new certificate or certificates, the board of directors may require that the owner of such lost, stolen or destroyed certificate or certificates, or such person's legal representative, give the Corporation and its transfer agent or agents, registrar or registrars a bond in such form and amount as the board of directors may direct as indemnity against any claim that may be made against the Corporation and the transfer agent or agents, registrar or registrars on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new certificate. Section 6. Transfer of Shares. Shares of stock shall be transferable on the books of the Corporation by the holder thereof, in person or by duly authorized attorney, upon the surrender of the certificate or certificates representing the shares to be transferred, properly endorsed, with such proof or guarantee of the authenticity of the signature as the Corporation or its agents may reasonably require. Section 7. Transfer Agents and Registrars. The Corporation may have one or more transfer agents and one or more registrars of its stock, whose respective duties the board of directors may, form time to time, define. No certificate of stock shall be valid until countersigned by a transfer agent, if the Corporation shall have a transfer agent, or until registered by the registrar, if the Corporation shall have a registrar. The duties of transfer agent and registrar may be combined. Article VIII SEAL The board of directors may adopt and provide a seal which shall be circular in form and shall bear the name of the Corporation and the words "Seal" and "Maryland," and which, when adopted shall constitute the corporate seal of the Corporation. 15 Article IX FISCAL YEAR The board of directors, by resolution, may adopt a fiscal year for the Corporation. Article X AMENDMENTS Subject to the provisions of the articles of incorporation, these bylaws may be altered, amended or repealed at any regular meeting of the stockholders (or at any special meeting thereof duly called for that purpose) by the holders of two-thirds of the voting power of the outstanding shares of stock entitled to vote at such meeting on the election of directors; provided that in the notice of such special meeting, notice of such purpose shall be given. Subject to the laws of the State of Maryland, the articles of incorporation and these bylaws, the board of directors may, by majority vote of those present at any meeting at which a quorum is present, amend these bylaws, or enact such other bylaws as in their judgment may be advisable for the regulation of the conduct of the affairs of the Corporation. _____________________________________ Secretary 16 EX-4.2 5 FORM OF WARRANT AGREEMENT EXHIBIT 4.2 ================================================================================ SONIC FOUNDRY, INC. AND CONTINENTAL STOCK TRANSFER AND TRUST COMPANY ____________ WARRANT AGREEMENT Dated as of _________, 1998 ================================================================================ AGREEMENT, dated this ___ day of _________, 1998, by and between SONIC FOUNDRY, INC., a Maryland corporation (the "Company") and CONTINENTAL STOCK TRANSFER AND TRUST COMPANY, as Warrant Agent (the "Warrant Agent"). W I T N E S S E T H: WHEREAS, in connection with (i) the offering to the public of up to 2,000,000 shares of Common Stock (as defined in Section 1) and 1,000,000 redeemable common stock purchase warrants (the "Warrants"), each warrant entitling the holder thereof to purchase one additional share of Common Stock, (ii) the over-allotment option to purchase up to an additional 300,000 shares of Common Stock and/or 150,000 Warrants (the "Over-allotment Option"), and (iii) the sale to Dirks & Company, Inc. and Security Capital Trading Corp., the representatives of the several underwriters (the "Representatives"), of warrants (the "Representatives' Warrants") to purchase up to 200,000 shares of Common Stock and/or 100,000 Warrants, the Company will issue up to 1,250,000 Warrants (subject to increase as provided in the Representatives' Warrant Agreement); and WHEREAS, the Company desires to provide for the issuance of certificates representing the Warrants; and WHEREAS, the Company desires the Warrant Agent to act on behalf of the Company, and the Warrant Agent is willing to so act, in connection with the issuance, registration, transfer, exchange and redemption of the Warrants, the issuance of certificates representing the Warrants, the exercise of the Warrants and the rights of the holders thereof. NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter set forth and for the purpose of defining the terms and provisions of the Warrants and the certificates representing the Warrants and the respective rights and obligations thereunder of the Company, the holders of certificates representing the Warrants and the Warrant Agent, the parties hereto agree as follows: SECTION 1. Definitions. As used herein, the following terms shall have the following meanings, unless the context shall otherwise require: (a) "Act" shall mean the Securities Act of 1933, as amended. (b) "Common Stock" shall mean the authorized stock of the Company of any class, whether now or hereafter authorized, which has the right to participate in the voting and in the distribution of earnings and assets of the Company without limit as to amount or percentage. (c) "Commission" shall mean the Securities and Exchange Commission. (d) "Corporate Office shall mean the office of the Warrant Agent (or its successor) at which at any particular time its business in New York, New York, shall be administered, which office is located on the date hereof at 2 Broadway. (e) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (f) "Exercise Date" shall mean, subject to the provisions of Section 5(b) hereof, as to any Warrant, the date on which the Warrant Agent shall have received both (i) the Warrant Certificate representing such Warrant, with the exercise form thereon duly executed by the Registered Holder thereof or his attorney duly authorized in writing, and (ii) payment in cash or by official bank or certified check made payable to the Warrant Agent for the account of the Company, of the amount in lawful money of the United States of America equal to the applicable Purchase Price (as hereinafter defined) in good funds. (g) "Initial Public Offering Price" shall mean $______ per share of Common Stock. 2 (h) "Initial Warrant Exercise Date" shall mean _________, 1998 [six months after date of Prospectus]. (i) "Initial Warrant Redemption Date" shall mean ________, 1999 [18 months after date of Prospectus]. (j) "NASD" shall mean the National Association of Securities Dealers, Inc. (k) "Nasdaq" shall mean the Nasdaq Stock Market. (l) "Purchase Price" shall mean, subject to modification and adjustment as provided in Section 8, $______ [150% of initial public offering price per share of Common Stock] and further subject to the Company's right, in its sole discretion, to decrease the Purchase Price for a period of not less than 30 days on not less than 30 days' prior written notice to the Registered Holders. (m) "Redemption Date" shall mean the date (which may not occur before the Initial Warrant Redemption Date) fixed for the redemption of the Warrants in accordance with the terms hereof. (n) "Redemption Price" shall mean the price at which the Company may, at its option, redeem the Warrants, in accordance with the terms hereof, which price shall be $0.10 per Warrant, subject to adjustment from time to time pursuant to the provisions of Section 9 hereof. (o) "Registered Holder" shall mean the person in whose name any certificate representing the Warrants shall be registered on the books maintained by the Warrant Agent pursuant to Section 6. (p) "Transfer Agent" shall mean Continental Stock Transfer and Trust Company, or its authorized successor. (q) "Underwriting Agreement" shall mean the underwriting agreement dated __________, 1998 [date of Prospectus] between the Company and the several underwriters 3 listed therein relating to the purchase for resale to the public of the Common Stock and the Warrants. (r) "Representatives' Warrant Agreement" shall mean the agreement dated as of _________, 1998 [date of Prospectus] between the Company and the Representatives relating to and governing the terms and provisions of the Representatives' Warrants. (s) "Warrant Certificate" shall mean a certificate representing each of the Warrants substantially in the form annexed hereto as Exhibit A. (t) "Warrant Expiration Date" shall mean, unless the Warrants are redeemed as provided in Section 9 hereof prior to such date, 5:30 p.m. (New York time), on ________, 2003 [five years after date of Prospectus], or the Redemption Date as defined herein, whichever date is earlier; provided that if such date shall in the State of New York be a holiday or a day on which banks are authorized to close, then 5:30 p.m. (New York time) on the next following day which, in the State of New York, is not a holiday or a day on which banks are authorized to close. Upon five business days' prior written notice to the Registered Holders, the Company shall have the right to extend the Warrant Expiration Date. SECTION 2. Warrants and Issuance of Warrant Certificates. (a) Each Warrant shall initially entitle the Registered Holder of the Warrant Certificate representing such Warrant to purchase at the Purchase Price therefor from the Initial Warrant Exercise Date until the Warrant Expiration Date one share of Common Stock upon the exercise thereof in accordance with the terms hereof, subject to modification and adjustment as provided in Section 8. (b) Upon execution of this Agreement, Warrant Certificates representing the number of Warrants sold pursuant to the Underwriting Agreement (subject to modification and 4 adjustment as provided in Section 8) shall be executed by the Company and delivered to the Warrant Agent. (c) Upon exercise of the Representatives' Warrants as provided therein, Warrant Certificates representing all or a portion of 100,000 Warrants to purchase up to an aggregate of 100,000 shares of Common Stock (subject to modification and adjustment as provided in Section 8 hereof and in the Representatives' Warrant Agreement), shall be countersigned, issued and delivered by the Warrant Agent upon written order of the Company signed by its Chairman of the Board, Chief Executive Officer, President or a Vice President and by its Treasurer or an Assistant Treasurer or its Secretary or an Assistant Secretary. (d) From time to time, up to the Warrant Expiration Date or the Redemption Date, whichever date is earlier, the Warrant Agent shall countersign and deliver Warrant Certificates in required denominations of one or whole number multiples thereof to the person entitled thereto in connection with any transfer or exchange permitted under this Agreement. Except as provided herein, no Warrant Certificates shall be issued except (i) Warrant Certificates initially issued hereunder and those issued on or after the Initial Warrant Exercise Date, upon the exercise of fewer than all Warrants held by the exercising Registered Holder, (ii) Warrant Certificates issued upon any transfer or exchange of Warrants, (iii) Warrant Certificates issued in replacement of lost, stolen, destroyed or mutilated Warrant Certificates pursuant to Section 7, (iv) Warrant Certificates issued pursuant to the Representatives' Warrant Agreement, and (v) at the option of the Company, Warrant Certificates in such form as may be approved by its Board of Directors, to reflect any adjustment or change in the Purchase Price, the number of shares of Common Stock purchasable upon exercise of the Warrants or the Redemption Price therefor made pursuant to Section 8 hereof. SECTION 3. Form and Execution of Warrant Certificates. 5 (a) The Warrant Certificates shall be substantially in the form annexed hereto as Exhibit A (the provisions of which are hereby incorporated herein) and may have such letters, numbers or other marks of identification or designation and such legends, summaries or endorsements printed, lithographed or engraved thereon as the Company may deem appropriate and as are not inconsistent with the provisions of this Agreement, or as may be required to comply with any law or with any rule or regulation made pursuant thereto or with any rule or regulation of any stock exchange on which the Warrants may be listed, or to conform to usage. The Warrant Certificates shall be dated the date of issuance thereof (whether upon initial issuance, transfer, exchange or in lieu of mutilated, lost, stolen or destroyed Warrant Certificates) and issued in registered form. Warrants shall be numbered serially with the letter W on the Warrants. (b) Warrant Certificates shall be executed on behalf of the Company by its Chairman of the Board, Chief Executive Officer, President or any Vice President and by its Treasurer or an Assistant Treasurer or its Secretary or an Assistant Secretary, by manual signatures or by facsimile signatures printed thereon, and shall have imprinted thereon a facsimile of the Company's seal. Warrant Certificates shall be manually countersigned by the Warrant Agent and shall not be valid for any purpose unless so countersigned. In case any officer of the Company who shall have signed any of the Warrant Certificates shall cease to be such officer of the Company before the date of issuance of the Warrant Certificates or before countersignature by the Warrant Agent and issue and delivery thereof, such Warrant Certificates, nevertheless, may be countersigned by the Warrant Agent, issued and delivered with the same force and effect as though the person who signed such Warrant Certificates had not ceased to be such officer of the Company. After countersignature by the Warrant Agent, Warrant Certificates shall be delivered by the Warrant Agent to the Registered Holder promptly and without further action by the Company, except as otherwise provided by Section 4(a) hereof. 6 SECTION 4. Exercise. (a) Warrants in denominations of one or whole number multiples thereof may be exercised by the Registered Holder thereof commencing at any time on or after the Initial Warrant Exercise Date, but not after the Warrant Expiration Date, upon the terms and subject to the conditions set forth herein and in the applicable Warrant Certificate. A Warrant shall be deemed to have been exercised immediately prior to the close of business on the Exercise Date and the person entitled to receive the securities deliverable upon such exercise shall be treated for all purposes as the holder, upon exercise thereof, as of the close of business on the Exercise Date. If Warrants in denominations other than whole number multiples thereof shall be exercised at one time by the same Registered Holder, the number of full shares of Common Stock which shall be issuable upon exercise thereof shall be computed on the basis of the aggregate number of full shares of Common Stock issuable upon such exercise. As soon as practicable on or after the Exercise Date and in any event within five business days after such date, if one or more Warrants have been exercised, the Warrant Agent on behalf of the Company shall cause to be issued to the person or persons entitled to receive the same a Common Stock certificate or certificates for the shares of Common Stock deliverable upon such exercise, and the Warrant Agent shall deliver the same to the person or persons entitled thereto. Upon the exercise of any one or more Warrants, the Warrant Agent shall promptly notify the Company in writing of such fact and of the number of securities delivered upon such exercise and, subject to subsection (b) below, shall cause all payments of an amount in cash or by check made payable to the order of the Company, equal to the Purchase Price, to be deposited promptly in the Company's bank account. (b) The Company shall not be required to issue fractional shares on the exercise of Warrants. Warrants may only be exercised in such multiples as are required to permit the issuance by the Company of one or more whole shares. If one or more Warrants shall be 7 presented for exercise in full at the same time by the same Registered Holder, the number of whole shares which shall be issuable upon such exercise thereof shall be computed on the basis of the aggregate number of shares purchasable on exercise of the Warrants so presented. If any fraction of a share would, except for the provisions provided herein, be issuable on the exercise of any Warrant (or specified portion thereof), the Company shall pay an amount in cash equal to such fraction multiplied by the then current market value of a share of Common Stock, determined as follows: (1) If the Common Stock is listed, or admitted to unlisted trading privileges on a national securities exchange, or is traded on Nasdaq, the current market value of a share of Common Stock shall be the closing sale price of the Common Stock at the end of the regular trading session on the last business day prior to the date of exercise of the Warrants on whichever of such exchanges or Nasdaq had the highest average daily trading volume for the Common Stock on such day; or (2) If the Common Stock is not listed or admitted to unlisted trading privileges on any national securities exchange, or listed, quoted or reported for trading on Nasdaq, but is traded in the over-the-counter market, the current market value of a share of Common Stock shall be the average of the last reported bid and asked prices of the Common Stock reported by the National Quotation Bureau, Inc. on the last business day prior to the date of exercise of the Warrants; or (3) If the Common Stock is not listed, admitted to unlisted trading privileges on any national securities exchange, or listed, quoted or reported for trading on Nasdaq, and bid and asked prices of the Common Stock are not reported by the National Quotation Bureau, Inc., the current market value of a share of Common Stock shall be an amount, not less than the book value thereof as of the end of the most recently completed fiscal quarter of the Company ending prior to the date of exercise, determined by the members of the Board of Directors of the Company exercising good faith and using customary valuation methods. 8 SECTION 5. Reservation of Shares; Listing; Payment of Taxes; etc. (a) The Company covenants that it will at all times reserve and keep available out of its authorized Common Stock, solely for the purpose of issue upon exercise of Warrants, such number of shares of Common Stock as shall then be issuable upon the exercise of all outstanding Warrants. The Company covenants that all shares of Common Stock which shall be issuable upon exercise of the Warrants shall, at the time of delivery thereof, be duly and validly issued and fully paid and nonassessable and free from all preemptive or similar rights, taxes, liens and charges with respect to the issue thereof, and that upon issuance such shares shall be listed on each securities exchange, if any, on which the other shares of outstanding Common Stock of the Company are then listed. (b) The Company covenants that if any securities to be reserved for the purpose of exercise of Warrants hereunder require registration with, or approval of, any governmental authority under any federal securities law before such securities may be validly issued or delivered upon such exercise, then the Company will file a registration statement under the federal securities laws or a post-effective amendment, use its best efforts to cause the same to become effective and to keep such registration statement current while any of the Warrants are outstanding and deliver a prospectus which complies with Section 10(a)(3) of the Act, to the Registered Holder exercising the Warrant (except, if in the opinion of counsel to the Company, such registration is not required under the federal securities law or if the Company receives a letter from the staff of the Commission stating that it would not take any enforcement action if such registration is not effected). The Company will use its best efforts to obtain appropriate approvals or registrations under state "blue sky" securities laws with respect to any such securities. However, Warrants may not be exercised by, or shares of Common Stock issued to, any Registered Holder in any state in which such exercise would be unlawful. 9 (c) The Company shall pay all documentary, stamp or similar taxes and other governmental charges that may be imposed with respect to the issuance of Warrants, or the issuance or delivery of any shares of Common Stock upon exercise of the Warrants; provided, however, that if shares of Common Stock are to be delivered in a name other than the name of the Registered Holder of the Warrant Certificate representing any Warrant being exercised, then no such delivery shall be made unless the person requesting the same has paid to the Warrant Agent the amount of transfer taxes or charges incident thereto, if any. (d) The Warrant Agent is hereby irrevocably authorized as the Transfer Agent to requisition from time to time certificates representing shares of Common Stock or other securities required upon exercise of the Warrants, and the Company will comply with all such requisitions. SECTION 6. Exchange and Registration of Transfer. (a) Warrant Certificates may be exchanged for other Warrant Certificates representing an equal aggregate number of Warrants of the same class or may be transferred in whole or in part. Warrant Certificates to be exchanged shall be surrendered to the Warrant Agent at its Corporate Office, and, upon satisfaction of the terms and provisions hereof, the Company shall execute and the Warrant Agent shall countersign, issue and deliver in exchange therefor the Warrant Certificate or Certificates which the Registered Holder making the exchange shall be entitled to receive. (b) The Warrant Agent shall keep, at its office, books in which, subject to such reasonable regulations as it may prescribe, it shall register Warrant Certificates and the transfer thereof in accordance with customary practice. Upon due presentment for registration of transfer of any Warrant Certificate at such office, the Company shall execute and the Warrant Agent shall issue 10 and deliver to the transferee or transferees a new Warrant Certificate or Certificates representing an equal aggregate number of Warrants of the same class. (c) With respect to all Warrant Certificates presented for registration of transfer, or for exchange or exercise, the subscription or exercise form, as the case may be, on the reverse thereof shall be duly endorsed or be accompanied by a written instrument or instruments of transfer and subscription, in form satisfactory to the Company and the Warrant Agent, duly executed by the Registered Holder thereof or his attorney-in-fact duly authorized in writing. (d) A service charge may be imposed by the Warrant Agent for any exchange or registration of transfer of Warrant Certificates. In addition, the Company may require payment by such Holder of a sum sufficient to cover any tax or other governmental charge that may be imposed in connection therewith. (e) All Warrant Certificates surrendered for exercise or for exchange in case of mutilated Warrant Certificates shall be promptly canceled by the Warrant Agent and thereafter retained by the Warrant Agent until termination of this Agreement. (f) Prior to due presentment for registration of transfer thereof, the Company and the Warrant Agent may deem and treat the Registered Holder of any Warrant Certificate as the absolute owner thereof and of each Warrant represented thereby (notwithstanding any notations of ownership or writing thereon made by anyone other than a duly authorized officer of the Company or the Warrant Agent) for all purposes and shall not be affected by any notice to the contrary. SECTION 7. Loss or Mutilation. Upon receipt by the Company and the Warrant Agent of evidence satisfactory to them of the ownership of and the loss, theft, destruction or mutilation of any Warrant Certificate and (in the case of loss, theft or destruction) of indemnity satisfactory to them, and (in case of mutilation) upon surrender and cancellation thereof, the Company shall execute and the Warrant Agent shall (in the absence of notice to the Company 11 and/or the Warrant Agent that a new Warrant Certificate has been acquired by a bona fide purchaser) countersign and deliver to the Registered Holder in lieu thereof a new Warrant Certificate of like tenor representing an equal aggregate number of Warrants. Applicants for a substitute Warrant Certificate shall also comply with such other reasonable regulations and pay such other reasonable charges as the Warrant Agent may prescribe. SECTION 8. Adjustment of Purchase Price and Number of Shares of Common Stock Deliverable. (a) Except as hereinafter provided, in the event the Company shall, issue or sell any shares of Common Stock for a consideration per share less than the Initial Public Offering Price of the shares of Common Stock or issue any shares of Common Stock as a stock dividend to the holders of Common Stock, or subdivide or combine the outstanding shares of Common Stock into a greater or lesser number of shares (any such issuance, subdivision or combination being herein called a "Change of Shares"), then, and thereafter upon each further Change of Shares, the Purchase Price for the Warrants (whether or not the same shall be issued and outstanding) in effect immediately prior to such Change of Shares shall be changed to a price (including any applicable fraction of a cent to the nearest cent) determined by dividing (i) the sum of (a) the total number of shares of Common Stock outstanding immediately prior to such Change of Shares, multiplied by the Purchase Price in effect immediately prior to such Change of Shares and (b) the consideration, if any, received by the Company upon such sale, issuance, subdivision or combination, by (ii) the total number of shares of Common Stock outstanding immediately after such Change of Shares; provided, however, that in no event shall the Purchase Price be adjusted pursuant to this computation to an amount in excess of the Purchase Price in effect immediately prior to such computation, except in the case of a combination of outstanding shares of Common Stock. 12 For the purposes of any adjustment to be made in accordance with this Section 8(a), the following provisions shall be applicable: (A) In case of the issuance or sale of shares of Common Stock (or of other securities deemed hereunder to involve the issuance or sale of shares of Common Stock) for a consideration part or all of which shall be cash, the amount of the cash portion of the consideration therefor deemed to have been received by the Company shall be (i) the subscription price, if shares of Common Stock are offered by the Company for subscription, or (ii) the public offering price (before deducting therefrom any compensation paid or discount allowed in the sale, underwriting or purchase thereof by underwriters or dealers or others performing similar services, or any expenses incurred in connection therewith), if such securities are sold to underwriters or dealers for public offering without a subscription offering, or (iii) the gross amount of cash actually received by the Company for such securities, in any other case. (B) In case of the issuance or sale (otherwise than as a dividend or other distribution on any stock of the Company, and otherwise than on the exercise of options, rights or warrants or the conversion or exchange of convertible or exchangeable securities) of shares of Common Stock (or of other securities deemed hereunder to involve the issuance or sale of shares of Common Stock) for a consideration part or all of which shall be other than cash, the amount of the consideration therefor other than cash deemed to have been received by the Company shall be the value of such consideration as determined in good faith by the Board of Directors of the Company, using customary valuation methods and on the basis of prevailing market values for similar property or services. (C) Shares of Common Stock issuable by way of dividend or other distribution on any stock of the Company shall be deemed to have been issued immediately after the opening of business on the day following the record date for the determination of shareholders 13 entitled to receive such dividend or other distribution and shall be deemed to have been issued without consideration. (D) The reclassification of securities of the Company other than shares of Common Stock into securities including shares of Common Stock shall be deemed to involve the issuance of such shares of Common Stock for a consideration other than cash immediately prior to the close of business on the date fixed for the determination of security holders entitled to receive such shares, and the value of the consideration allocable to such shares of Common Stock shall be determined as provided in subsection (B) of this Section 8(a). (E) The number of shares of Common Stock at any one time outstanding shall be deemed to include the aggregate maximum number of shares issuable (subject to readjustment upon the actual issuance thereof) upon the exercise of options, rights or warrants and upon the conversion or exchange of convertible or exchangeable securities. (b) Upon each adjustment of the Purchase Price pursuant to this Section 8, the number of shares of Common Stock purchasable upon the exercise of each Warrant shall be the number derived by multiplying the number of shares of Common Stock purchasable immediately prior to such adjustment by the Purchase Price in effect prior to such adjustment and dividing the product so obtained by the applicable adjusted Purchase Price. (c) In case the Company shall at any time after the date hereof issue options, rights or warrants to subscribe for shares of Common Stock, or issue any securities convertible into or exchangeable for shares of Common Stock, for a consideration per share (determined as provided in Sections 8(a) and 8(b) and as provided below) less than the Initial Public Offering Price of the Common Stock, or without consideration (including the issuance of any such securities by way of dividend or other distribution), the Purchase Price for the Warrants (whether or not the same shall be issued and outstanding) in effect immediately prior to the issuance of such 14 options, rights or warrants, or such convertible or exchangeable securities, as the case may be, shall be reduced to a price determined by making the computation in accordance with the provisions of Sections 8(a) and 8(b) hereof, provided that: (A) The aggregate maximum number of shares of Common Stock, as the case may be, issuable or that may become issuable under such options, rights or warrants (assuming exercise in full even if not then currently exercisable or currently exercisable in full) shall be deemed to be issued and outstanding at the time such options, rights or warrants were issued, for a consideration equal to the minimum purchase price per share provided for in such options, rights or warrants at the time of issuance, plus the consideration, if any, received by the Company for such options, rights or warrants; provided, however, that upon the expiration or other termination of such options, rights or warrants, if any thereof shall not have been exercised, the number of shares of Common Stock deemed to be issued and outstanding pursuant to this subsection (A) (and for the purposes of subsection (E) of Section 8(a) hereof) shall be reduced by the number of shares as to which options, warrants and/or rights shall have expired, and such number of shares shall no longer be deemed to be issued and outstanding, and the Purchase Price then in effect shall forthwith be readjusted and thereafter be the price that it would have been had adjustment been made on the basis of the issuance only of the shares actually issued plus the shares remaining issuable upon the exercise of those options, rights or warrants as to which the exercise rights shall not have expired or terminated unexercised. (B) The aggregate maximum number of shares of Common Stock issuable or that may become issuable upon conversion or exchange of any convertible or exchangeable securities (assuming conversion or exchange in full even if not then currently convertible or exchangeable in full) shall be deemed to be issued and outstanding at the time of issuance of such securities, for a consideration equal to the consideration received by the Company for such 15 securities, plus the minimum consideration, if any, receivable by the Company upon the conversion or exchange thereof; provided, however, that upon the termination of the right to convert or exchange such convertible or exchangeable securities (whether by reason of redemption or otherwise), the number of shares of Common Stock deemed to be issued and outstanding pursuant to this subsection (B) (and for the purposes of subsection (E) of Section 8(a) hereof) shall be reduced by the number of shares as to which the conversion or exchange rights shall have expired or terminated unexercised, and such number of shares shall no longer be deemed to be issued and outstanding, and the Purchase Price then in effect shall forthwith be readjusted and thereafter be the price that it would have been had adjustment been made on the basis of the issuance only of the shares actually issued plus the shares remaining issuable upon conversion or exchange of those convertible or exchangeable securities as to which the conversion or exchange rights shall not have expired or terminated unexercised. (C) If any change shall occur in the price per share provided for in any of the options, rights or warrants referred to in subsection (A) of this Section 8(c), or in the price per share or ratio at which the securities referred to in subsection (B) of this Section 8(c) are convertible or exchangeable, such options, rights or warrants or conversion or exchange rights, as the case may be, to the extent not theretofore exercised, shall be deemed to have expired or terminated on the date when such price change became effective in respect of shares not theretofore issued pursuant to the exercise or conversion or exchange thereof, and the Company shall be deemed to have issued upon such date new options, rights or warrants or convertible or exchangeable securities. (d) In case of any reclassification or change of outstanding shares of Common Stock issuable upon exercise of the Warrants (other than a change in par value, or from par value to no par value, or from no par value to par value or as a result of a subdivision or combination), or in case of any consolidation or merger of the Company with or into another corporation (other than (1) a merger with a subsidiary of the Company in which merger the Company is the continuing corporation or (2) any consolidation or merger of the Company with or into another 16 corporation which, in either instance, does not result in any reclassification or change of the then outstanding shares of Common Stock or other capital stock issuable upon exercise of the Warrants (other than a change in par value, or from par value to no par value, or from no par value to par value or as a result of subdivision or combination)) or in case of any sale or conveyance to another corporation of the property of the Company as an entirety or substantially as an entirety, then, as a condition of such reclassification, change, consolidation, merger, sale or conveyance, the Company, or such successor or purchasing corporation, as the case may be, shall make lawful and adequate provision whereby the Registered Holder of each Warrant then outstanding shall have the right thereafter to receive on exercise of such Warrant the kind and amount of securities and property receivable upon such reclassification, change, consolidation, merger, sale or conveyance by a holder of the number of securities issuable upon exercise of such Warrant immediately prior to such reclassification, change, consolidation, merger, sale or conveyance and shall forthwith file at the Corporate Office of the Warrant Agent a statement signed by its Chief Executive Officer, President or a Vice President and by its Treasurer or an Assistant Treasurer or its Secretary or an Assistant Secretary evidencing such provision. Such provisions shall include provision for adjustments which shall be as nearly equivalent as may be practicable to the adjustments provided for in Sections 8(a), (b) and (c). The above provisions of this Section 8(d) shall similarly apply to successive reclassifications and changes of shares of Common Stock and to successive consolidations, mergers, sales or conveyances. (e) Irrespective of any adjustments or changes in the Purchase Price or the number of shares of Common Stock purchasable upon exercise of the Warrants, the Warrant Certificates theretofore and thereafter issued shall, unless the Company shall exercise its option to 17 issue new Warrant Certificates pursuant to Section 2(e) hereof, continue to express the Purchase Price per share and the number of shares purchasable thereunder as the Purchase Price per share and the number of shares purchasable thereunder were expressed in the Warrant Certificates when the same were originally issued. (f) After each adjustment of the Purchase Price pursuant to this Section 8, the Company will promptly prepare a certificate signed by the Chairman, Chief Executive Officer or President, and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary, of the Company setting forth: (i) the Purchase Price as so adjusted, (ii) the number of shares of Common Stock purchasable upon exercise of each Warrant, after such adjustment, and (iii) a brief statement of the facts accounting for such adjustment. The Company will promptly file such certificate with the Warrant Agent and cause a brief summary thereof to be sent by ordinary first class mail to each Registered Holder at his last address as it shall appear on the registry books of the Warrant Agent. No failure to mail such notice nor any defect therein or in the mailing thereof shall affect the validity thereof except as to the holder to whom the Company failed to mail such notice, or except as to the holder whose notice was defective. The affidavit of an officer of the Warrant Agent or the Secretary or an Assistant Secretary of the Company that such notice has been mailed shall, in the absence of fraud, be prima facie evidence of the facts stated therein. (g) No adjustment of the Purchase Price shall be made as a result of or in connection with (A) the issuance or sale of shares of Common Stock pursuant to options, warrants, stock purchase agreements and convertible or exchangeable securities outstanding or in effect on the date hereof and on the terms described in the final prospectus relating to the public offering contemplated by the Underwriting Agreement; (B) stock options to be granted under the Company's 1995 Stock Option Plan to employees, consultants and directors; or (C) the issuance or sale of shares of Common Stock if the amount of said adjustment shall be less than $.10, provided, 18 however, that in such case, any adjustment that would otherwise be required then to be made shall be carried forward and shall be made at the time of and together with the next subsequent adjustment that shall amount, together with any adjustment so carried forward, to at least $.10. In addition, Registered Holders shall not be entitled to cash dividends paid by the Company prior to the exercise of any Warrant or Warrants held by them. SECTION 9. Redemption. (a) Commencing on the Initial Warrant Redemption Date, the Company may, on 30 days' prior written notice, redeem all the Warrants at ten cents ($.10) per Warrant, provided, however, that before any such call for redemption of Warrants can take place, the average closing bid price for the Common Stock as reported by Nasdaq, if the Common Stock is then traded on Nasdaq, (or the average closing sale price, if the Common Stock is then traded on a national exchange) shall have equalled or exceeded $20.00 per share, for any twenty (20) trading days within a period of thirty (30) consecutive trading days ending on the fifth trading day prior to the date on which the notice contemplated by (b) and (c) below is given (subject to adjustment in the event of any stock splits or other similar events as provided in Section 8 hereof). (b) In case the Company shall exercise its right to redeem all of the Warrants, it shall give or cause to be given notice to the Registered Holders of the Warrants, by mailing to such Registered Holders a notice of redemption, first class, postage prepaid, at their last address as shall appear on the records of the Warrant Agent. Any notice mailed in the manner provided herein shall be conclusively presumed to have been duly given whether or not the Registered Holder receives such notice. Not less than four (4) trading days prior to the mailing to the Registered Holders of the Warrants of the notice of redemption, the Company shall deliver or cause to be delivered to National a similar notice telephonically and confirmed in writing together 19 with a list of the Registered Holders (including their respective addresses and number of Warrants beneficially owned) to whom such notice of redemption has been or will be given. (c) The notice of redemption shall specify (i) the redemption price, (ii) the Redemption Date, which shall in no event be less than thirty (30) days after the date of mailing of such notice, (iii) the place where the Warrant Certificate shall be delivered and the redemption price shall be paid, and (iv) that the right to exercise the Warrant shall terminate at 5:30 p.m. (New York time) on the business day immediately preceding the date fixed for redemption. No failure to mail such notice nor any defect therein or in the mailing thereof shall affect the validity of the proceedings for such redemption except as to a holder (a) to whom notice was not mailed or (b) whose notice was defective. An affidavit of the Warrant Agent or the Secretary or Assistant Secretary of the Company that notice of redemption has been mailed shall, in the absence of fraud, be prima facie evidence of the facts stated therein. (d) Any right to exercise a Warrant shall terminate at 5:30 p.m. (New York time) on the business day immediately preceding the Redemption Date. The redemption price payable to the Registered Holders shall be mailed to such persons at their addresses of record. SECTION 10. Concerning the Warrant Agent. (a) The Warrant Agent acts hereunder as agent and in a ministerial capacity for the Company, and its duties shall be determined solely by the provisions hereof. The Warrant Agent shall not, by issuing and delivering Warrant Certificates or by any other act hereunder, be deemed to make any representations as to the validity or value or authorization of the Warrant Certificates or the Warrants represented thereby or of any securities or other property delivered upon exercise of any Warrant or whether any stock issued upon exercise of any Warrant is fully paid and nonassessable. 20 (b) The Warrant Agent shall not at any time be under any duty or responsibility to any holder of Warrant Certificates to make or cause to be made any adjustment of the Purchase Price or the Redemption Price provided in this Agreement, or to determine whether any fact exists which may require any such adjustments, or with respect to the nature or extent of any such adjustments, when made, or with respect to the method employed in making the same. It shall not (i) be liable for any recital or statement of fact contained herein or for any action taken, suffered or omitted by it in reliance on any Warrant Certificate or other document or instrument believed by it in good faith to be genuine and to have been signed or presented by the proper party or parties, (ii) be responsible for any failure on the part of the Company to comply with any of its covenants and obligations contained in this Agreement or in any Warrant Certificate, or (iii) be liable for any act or omission in connection with this Agreement except for its own negligence, bad faith or willful misconduct. (c) The Warrant Agent may at any time consult with counsel satisfactory to it (who may be counsel for the Company or for Dirks) and shall incur no liability or responsibility for any action taken, suffered or omitted by it in good faith in accordance with the opinion or advice of such counsel. (d) Any notice, statement, instruction, request, direction, order or demand of the Company shall be sufficiently evidenced by an instrument signed by the Chairman of the Board of Directors, Chief Executive Officer, President or any Vice President (unless other evidence in respect thereof is herein specifically prescribed). The Warrant Agent shall not be liable for any action taken, suffered or omitted by it in accordance with such notice, statement, instruction, request, direction, order or demand reasonably believed by it to be genuine. (e) The Company agrees to pay the Warrant Agent reasonable compensation for its services hereunder and to reimburse it for its reasonable expenses hereunder; 21 the Company further agrees to indemnify the Warrant Agent and save it harmless from and against any and all losses, expenses and liabilities, including judgments, costs and counsel fees, for anything done or omitted by the Warrant Agent in the execution of its duties and powers hereunder except losses, expenses and liabilities arising as a result of the Warrant Agent's negligence, bad faith or willful misconduct. (f) The Warrant Agent may resign its duties and be discharged from all further duties and liabilities hereunder (except liabilities arising as a result of the Warrant Agent's own gross negligence or willful misconduct), after giving 30 days' prior written notice to the Company. At least 15 days prior to the date such resignation is to become effective, the Warrant Agent shall cause a copy of such notice of resignation to be mailed to the Registered Holder of each Warrant Certificate at the Company's expense. Upon such resignation, or any inability of the Warrant Agent to act as such hereunder, the Company shall appoint in writing a new warrant agent. If the Company shall fail to make such appointment within a period of 15 days after it has been notified in writing of such resignation by the resigning Warrant Agent, then the Registered Holder of any Warrant Certificate may apply to any court of competent jurisdiction for the appointment of a new warrant agent. Any new warrant agent, whether appointed by the Company or by such a court, shall be a bank or trust company having a capital and surplus, as shown by its last published report to its stockholders, of not less than $10,000,000 or a stock transfer company. After acceptance in writing of such appointment by the new warrant agent is received by the Company, such new warrant agent shall be vested with the same powers, rights, duties and responsibilities as if it had been originally named herein as the Warrant Agent, without any further assurance, conveyance, act or deed; but if for any reason it shall be necessary or expedient to execute and deliver any further assurance, conveyance, act or deed, the same shall be done at the expense of the Company and shall be legally and validly executed and delivered by the resigning Warrant Agent. Not later than the 22 effective date of any such appointment the Company shall file notice thereof with the resigning Warrant Agent and shall forthwith cause a copy of such notice to be mailed to the Registered Holder of each Warrant Certificate. (g) Any corporation into which the Warrant Agent or any new warrant agent may be converted or merged, any corporation resulting from any consolidation to which the Warrant Agent or any new warrant agent shall be a party, or any corporation succeeding to the corporate trust business of the Warrant Agent or any new warrant agent shall be a successor warrant agent under this Agreement without any further act, provided that such corporation is eligible for appointment as successor to the Warrant Agent under the provisions of the preceding paragraph. Any such successor warrant agent shall promptly cause notice of its succession as warrant agent to be mailed to the Company and to the Registered Holders of each Warrant Certificate. (h) The Warrant Agent, its subsidiaries and affiliates, and any of its or their officers or directors, may buy and hold or sell Warrants or other securities of the Company and otherwise deal with the Company in the same manner and to the same extent and with like effect as though it were not Warrant Agent. Nothing herein shall preclude the Warrant Agent from acting in any other capacity for the Company or for any other legal entity. (i) The Warrant Agent shall retain for a period of two years from the date of exercise any Warrant Certificate received by it upon such exercise. SECTION 11. Modification of Agreement. The Warrant Agent and the Company may by supplemental agreement make any changes or corrections in this Agreement (i) that they shall deem appropriate to cure any ambiguity or to correct any defective or inconsistent provision or manifest mistake or error herein contained; or (ii) that they may deem necessary or desirable and which shall not adversely affect the interests of the holders of Warrant Certificates; provided, however, that no change in the number or nature of 23 the securities purchasable upon the exercise of any Warrant, or to increase the Purchase Price therefor or to accelerate the Warrant Expiration Date, shall be made without the consent in writing of the Registered Holders representing not less than 66-2/3% of the Warrants then outstanding, other than such changes as are presently specifically prescribed by this Agreement as originally executed. In addition, this Agreement may not be modified, amended or supplemented without the prior written consent of the Representatives, other than to cure any ambiguity or to correct any provision which is inconsistent with any other provision of this Agreement or to make any such change that is necessary or desirable and which shall not adversely affect the interests of the Representatives and except as may be required by law. SECTION 12. Notices. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been made when delivered or mailed first-class registered or certified mail, postage prepaid, as follows: if to the Registered Holder of a Warrant Certificate, at the address of such holder as shown on the registry books maintained by the Warrant Agent; if to the Company at 754 Williams Street, Madison, Wisconsin 53703, Attention: Rimas P. Buinevicius, Chief Executive Officer, or at such other address as may have been furnished to the Warrant Agent in writing by the Company; and if to the Warrant Agent, at its Corporate Office. Copies of any notice delivered pursuant to this Agreement shall also be delivered to the Representatives c/o Dirks & Company, Inc., 520 Madison Avenue, 10th Floor, New York, New York 10022, Attention: General Counsel, or at such other address as may have been furnished to the Company and the Warrant Agent in writing. SECTION 13. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York without giving effect to conflicts of laws. 24 SECTION 14. Binding Effect. This Agreement shall be binding upon and inure to the benefit of the Company, the Warrant Agent and their respective successors and assigns and the holders from time to time of Warrant Certificates or any of them. Nothing in this Agreement is intended or shall be construed to confer upon any other person any right, remedy or claim, in equity or at law, or to impose upon any other person any duty, liability or obligation. SECTION 15. Termination. This Agreement shall terminate at the close of business on the Expiration Date of all of the Warrants or such earlier date upon which all Warrants have been exercised or redeemed, except that the Warrant Agent shall account to the Company for cash held by it and the provisions of Section 10 hereof shall survive such termination. SECTION 16. Counterparts. This Agreement may be executed in several counterparts, which taken together shall constitute a single document. 25 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. [SEAL] SONIC FOUNDRY, INC. By: ____________________________________ Name: Title Attest: By: _______________________________ Name: Title: CONTINENTAL STOCK TRANSFER AND TRUST COMPANY, As Warrant Agent By: ____________________________________ Name: Title 26 EXHIBIT A --------- No. W______ VOID AFTER ________, 2003 WARRANTS REDEEMABLE WARRANT CERTIFICATE TO PURCHASE ONE SHARE OF COMMON STOCK SONIC FOUNDRY, INC. CUSIP_____ THIS CERTIFIES THAT, FOR VALUE RECEIVED or registered assigns (the "Registered Holder") is the owner of the number of Redeemable Warrants (the "Warrants") specified above. Each Warrant initially entitles the Registered Holder to purchase, subject to the terms and conditions set forth in this Certificate and the Warrant Agreement (as hereinafter defined), one fully paid and nonassessable share of Common Stock, $0.01 par value, of Sonic Foundry, Inc., a Maryland corporation (the "Company"), at any time between _______, 1999 (the "Initial Warrant Exercise Date"), and the Expiration Date (as hereinafter defined) upon the presentation and surrender of this Warrant Certificate with the Subscription Form on the reverse hereof duly executed, at the corporate office of Continental Stock Transfer and Trust Company, as Warrant Agent, or its successor (the "Warrant Agent"), accompanied by payment of $_____ subject to adjustment (the "Purchase Price"), in lawful money of the United States of America in cash or by check made payable to the Warrant Agent for the account of the Company. This Warrant Certificate and each Warrant represented hereby are issued pursuant to and are subject in all respects to the terms and conditions set forth in the Warrant Agreement (the "Warrant Agreement"), dated _________, 1998, between the Company and the Warrant Agent. In the event of certain contingencies provided for in the Warrant Agreement, the Purchase Price and the number of shares of Common Stock subject to purchase upon the exercise of each Warrant represented hereby are subject to modification or adjustment. Each Warrant represented hereby is exercisable at the option of the Registered Holder, but no fractional interests will be issued. In the case of the exercise of less than all the Warrants represented hereby, the Company shall cancel this Warrant Certificate upon the surrender hereof and shall execute and deliver a new Warrant Certificate or Warrant Certificates of like tenor, which the Warrant Agent shall countersign, for the balance of such Warrants. The term "Expiration Date" shall mean 5:30 p.m. (New York time) on the date which is forty-eight (48) months after the Initial Warrant Exercise Date. If each such date shall in the State of New York be a holiday or a day on which the banks are authorized to close, then the Expiration Date shall mean 5:30 p.m. (New York time) on the next following day which in the State of New York is not a holiday or a day on which banks are authorized to close. 1 The Company shall not be obligated to deliver any securities pursuant to the exercise of this Warrant unless a registration statement under the Securities Act of 1933, as amended (the "Act"), with respect to such securities is effective or an exemption thereunder is available. The Company has covenanted and agreed that it will file a registration statement under the Federal securities laws, use its best efforts to cause the same to become effective, use its best efforts to keep such registration statement current, if required under the Act, while any of the Warrants are outstanding, and deliver a prospectus which complies with Section 10(a)(3) of the Act to the Registered Holder exercising this Warrant. This Warrant shall not be exercisable by a Registered Holder in any state where such exercise would be unlawful. This Warrant Certificate is exchangeable, upon the surrender hereof by the Registered Holder at the corporate office of the Warrant Agent, for a new Warrant Certificate or Warrant Certificates of like tenor representing an equal aggregate number of Warrants, each of such new Warrant Certificates to represent such number of Warrants as shall be designated by such Registered Holder at the time of such surrender. Upon due presentment and payment of any tax or other charge imposed in connection therewith or incident thereto, for registration of transfer of this Warrant Certificate at such office, a new Warrant Certificate or Warrant Certificates representing an equal aggregate number of Warrants will be issued to the transferee in exchange therefor, subject to the limitations provided in the Warrant Agreement. Prior to the exercise of any Warrant represented hereby, the Registered Holder shall not be entitled to any rights of a stockholder of the Company, including, without limitation, the right to vote or to receive dividends or other distributions, and shall not be entitled to receive any notice of any proceedings of the Company, except as provided in the Warrant Agreement. Subject to the provisions of the Warrant Agreement, this Warrant may be redeemed at the option of the Company, at a redemption price of $0.10 per Warrant, at any time commencing after ________, 1999, provided that the average closing bid price for the Common Stock as reported by Nasdaq (or the closing sale price, if the Common Stock is then traded on a national exchange), shall have equaled or exceeded $20.00 per share for any twenty (20) trading days within a period of thirty (30) consecutive trading days ending on the fifth trading day prior to the Notice of Redemption, as defined below (subject to adjustment in the event of any stock splits or other similar events). Notice of redemption (the "Notice of Redemption") shall be given not later than the thirtieth day before the date fixed for redemption, all as provided in the Warrant Agreement. On and after the date fixed for redemption, the Registered Holder shall have no rights with respect to the Warrants except to receive the $.10 per Warrant upon surrender of this Warrant Certificate. Prior to due presentment for registration of transfer hereof, the Company and the Warrant Agent may deem and treat the Registered Holder as the absolute owner hereof and of each Warrant represented hereby (notwithstanding any notations of ownership or writing hereon made by anyone other than a duly authorized officer of the Company or the Warrant Agent) for all purposes and shall not be affected by any notice to the contrary, except as provided in the Warrant Agreement. This Warrant Certificate shall be governed by and construed in accordance with the laws of the State of New York without giving effect to conflicts of laws. This Warrant Certificate is not valid unless countersigned by the Warrant Agent. 2 IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to be duly executed, manually or in facsimile by two of its officers thereunto duly authorized and a facsimile of its corporate seal to be imprinted hereon. Dated: SONIC FOUNDRY, INC. [SEAL] By: ____________________________________ Name: Title COUNTERSIGNED: CONTINENTAL STOCK TRANSFER AND TRUST COMPANY, as Warrant Agent By: _______________________________ Authorized Officer 3 SUBSCRIPTION FORM To Be Executed by the Registered Holder in Order to Exercise Warrants The undersigned Registered Holder hereby irrevocably elects to exercise Warrants represented by this Warrant Certificate, and to purchase the securities issuable upon the exercise of such Warrants, and requests that certificates for such securities shall be issued in the name of PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER __________________________________________ __________________________________________ __________________________________________ (please print or type name and address) and be delivered to __________________________________________ __________________________________________ __________________________________________ (please print or type name and address) 4 and if such number of Warrants shall not be all the Warrants evidenced by this Warrant Certificate, that a new Warrant Certificate for the balance of such Warrants be registered in the name of, and delivered to, the Registered Holder at the address stated below. Dated: ____________________ X ______________________________________ ________________________________________ ________________________________________ Address ________________________________________ Social Security or Taxpayer Identification Number ________________________________________ Signature Guaranteed 5 ASSIGNMENT To Be Executed by the Registered Holder in Order to Assign Warrants FOR VALUE RECEIVED,_______________________, hereby sells, assigns and transfers unto PLEASE INSERT SOCIAL SECURITY OR OTHER IDENTIFYING NUMBER ________________________________________ ________________________________________ ________________________________________ ________________________________________ (please print or type name and address) ___________________ of the Warrants represented by this Warrant Certificate, and hereby irrevocably constitutes and appoints _____________________ Attorney to transfer this Warrant Certificate on the books of the Company, with full power of substitution in the premises. Dated: ____________________ X ______________________________________ Signature Guaranteed THE SIGNATURE TO THE ASSIGNMENT OR THE SUBSCRIPTION FORM MUST CORRESPOND TO THE NAME AS WRITTEN UPON THE FACE OF THIS WARRANT CERTIFICATE IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT OR ANY CHANGE WHATSOEVER AND MUST BE GUARANTEED BY AN ELIGIBLE GUARANTOR INSTITUTION (BANKS, STOCKBROKERS, SAVINGS AND LOAN ASSOCIATIONS AND CREDIT UNIONS WITH MEMBERSHIP IN AN APPROVED SIGNATURE GUARANTEE MEDALLION PROGRAM), PURSUANT TO S.E.C. RULE 17Ad-15. 6 EX-4.3 6 FORM OF REPRESENTATIVES WARRANT AGREEMENT EXHIBIT 4.3 ================================================================================ SONIC FOUNDRY, INC. AND DIRKS & COMPANY, INC. AND SECURITY CAPITAL TRADING CORP. REPRESENTATIVES' WARRANT AGREEMENT Dated as of _________, 1998 =============================================================================== REPRESENTATIVES' WARRANT AGREEMENT dated as of _________, 1998 between SONIC FOUNDRY, INC., a Maryland corporation (the "Company"), and DIRKS & COMPANY, INC. and SECURITY CAPITAL TRADING CORP. (hereinafter referred to variously as the "Holder" or "Holders" or the "Representatives"). W I T N E S S E T H: - - - - - - - - - - WHEREAS, the Company proposes to issue to the Representatives warrants ("Warrants") to purchase up to an aggregate 200,000 shares of Common Stock, $0.01 par value, of the Company and/or 100,000 redeemable Common Stock purchase warrants of the Company ("Redeemable Warrants"), each Redeemable Warrant to purchase one additional share of Common Stock; and WHEREAS, the Representatives have agreed pursuant to the underwriting agreement (the "Underwriting Agreement") dated as of the date hereof between the Company and the several Underwriters listed therein to act as the Representatives in connection with the Company's proposed public offering of up to 2,000,000 shares of Common Stock and 100,000 Redeemable Warrants (the "Public Warrants") at a public offering price of $______ per share of Common Stock and $_____ per Redeemable Warrant (the "Public Offering"); and WHEREAS, the Warrants to be issued pursuant to this Agreement will be issued on the Closing Date (as such term is defined in the Underwriting Agreement) by the Company to the Representatives in consideration for, and as part of the Representatives' compensation in connection with, the Representatives acting as the Representatives pursuant to the Underwriting Agreement; NOW, THEREFORE, in consideration of the premises, the payment by the Representatives to the Company of an aggregate twenty dollars ($20.00), the agreements herein set forth and other good and valuable consideration, hereby acknowledged, the parties hereto agree as follows: 1. Grant. The Representatives (or its designees) are hereby granted the right to purchase, at any time from _____________, 1999 [six months after date of this Agreement], until 5:30 P.M., New York time, on ___________, 2003 [five years after date of this Agreement], up to an aggregate of 200,000 shares of Common Stock and/or 100,000 Redeemable Warrants at an initial exercise price (subject to adjustment as provided in Section 8 hereof) of $_____ per share of Common Stock [120% of initial public offering price per share of Common Stock], and $______ per Redeemable Warrant [120% of initial public offering price per Redeemable Warrant], subject to the terms and conditions of this Agreement. One Redeemable Warrant is exercisable to purchase one additional share of Common Stock at an initial exercise price of $______ [150% of initial public offering price per share of the Common Stock] from ________, 1999 [one year after date of this Agreement] until 5:30 p.m. New York time on ________, 2003[5 years after date of this Agreement], at which time the Redeemable Warrants shall expire. Except as set forth herein, the shares of Common Stock and the Redeemable Warrants issuable upon exercise of the Warrants are in all respects identical to the shares of Common Stock and the Public Warrants being purchased by the Underwriters for resale to the public pursuant to the terms and provisions of the Underwriting Agreement. The shares of Common Stock and the Redeemable Warrants issuable upon exercise of the Warrants are sometimes hereinafter referred to collectively as the "Securities." 2. Warrant Certificates. The warrant certificates (the "Warrant Certificates") delivered and to be delivered pursuant to this Agreement shall be in the form set forth in Exhibit A, attached hereto and made a part hereof, with such appropriate insertions, omissions, substitutions, and other variations as required or permitted by this Agreement. 2 3. Exercise of Warrant. (S)3.1 Method of Exercise. The Warrants initially are exercisable at an aggregate initial exercise price (subject to adjustment as provided in Section 8 hereof) per share of Common Stock and per Redeemable Warrant set forth in Section 6 hereof payable by certified or official bank check in New York Clearing House funds, subject to adjustment as provided in Section 8 hereof. Upon surrender of a Warrant Certificate with the annexed Form of Election to Purchase duly executed, together with payment of the Exercise Price (as hereinafter defined) for the shares of Common Stock and/or the Redeemable Warrants purchased at the Company's principal executive offices in New York (presently located at 754 Williams Street, Madison, Wisconsin 53703) the registered holder of a Warrant Certificate ("Holder" or "Holders") shall be entitled to receive a certificate or certificates for the shares of Common Stock so purchased and a certificate or certificates for the Redeemable Warrants so purchased. The purchase rights represented by each Warrant Certificate are exercisable at the option of the Holder thereof, in whole or in part (but not as to fractional shares of the Common Stock and Redeemable Warrants underlying the Warrants). In the event the Company redeems all of the Public Warrants (other than the Redeemable Warrants underlying the Warrants), then the Warrants may only be exercised if such exercise is accompanied by the simultaneous exercise of the Redeemable Warrant(s) underlying the Warrants being so exercised. Warrants may be exercised to purchase all or part of the shares of Common Stock together with an equal or unequal number of the Redeemable Warrants represented thereby. In the case of the purchase of less than all the shares of Common Stock and/or the Redeemable Warrants purchasable under any Warrant Certificate, the Company shall cancel said Warrant Certificate upon the surrender thereof and shall execute and deliver a new Warrant Certificate of like tenor for the balance of the shares of Common Stock and Redeemable Warrants purchasable thereunder. 3 (S)3.2 Exercise by Surrender of Warrant. In addition to the method of payment set forth in Section 3.1 and in lieu of any cash payment required thereunder, the Holder(s) of the Warrants shall have the right at any time and from time to time to exercise the Warrants in full or in part by surrendering the Warrant Certificate in the manner specified in Section 3.1 hereof. The number of shares of Common Stock to be issued pursuant to this Section 3.2 shall be equal to the difference between (a) the number of shares of Common Stock in respect of which the Warrants are exercised and (b) a fraction, the numerator of which shall be the number of shares of Common Stock in respect of which the Warrants are exercised multiplied by the Exercise Price and the denominator of which shall be the Market Price (as defined in Section 3.3 hereof) of the shares of Common Stock. The number of Redeemable Warrants to be issued pursuant to this Section 3.2 shall be equal to the difference between (a) the number of Redeemable Warrants in respect of which the Warrants are exercised and (b) a fraction, the numerator of which shall be the number of Redeemable Warrants in respect of which the Warrants are exercised multiplied by the Exercise Price and the denominator of which shall be the Market Price (as defined in Section 3.3 hereof) of the Redeemable Warrants. Solely for the purposes of this paragraph, Market Price shall be calculated either (i) on the date on which the form of election attached hereto is deemed to have been sent to the Company pursuant to Section 14 hereof ("Notice Date") or (ii) as the average of the Market Prices for each of the five trading days preceding the Notice Date, whichever of (i) or (ii) is greater. (S)3.3 Definition of Market Price. As used herein, the phrase "Market Price" at any date shall be deemed to be (i) when referring to the Common Stock, the last reported sale price, or, in case no such reported sale takes place on such day, the average of the last reported sale prices for the last three (3) trading days, in either case as officially reported by the principal securities exchange on which the Common Stock is listed or admitted to trading or by the 4 Nasdaq SmallCap Market ("Nasdaq SmallCap") or by the National Association of Securities Dealers Automated Quotation System ("Nasdaq"), or, if the Common Stock is not listed or admitted to trading on any national securities exchange or quoted by Nasdaq, the average closing bid price as furnished by the National Association of Securities Dealers, Inc. ("NASD") through Nasdaq or similar organization if Nasdaq is no longer reporting such information, or if the Common Stock is not quoted on Nasdaq, as determined in good faith (using customary valuation methods) by resolution of the members of the Board of Directors of the Company, based on the best information available to it or (ii) when referring to a Redeemable Warrant, the last reported sales price, or, in the case no such reported sale takes place on such day, the average of the last reported sale prices for the last three (3) trading days, in either case as officially reported by the principal securities exchange on which the Redeemable Warrants are listed or admitted to trading or by Nasdaq, or, if the Redeemable Warrants are not listed or admitted to trading on any national securities exchange or quoted by Nasdaq, the average closing bid price as furnished by the NASD through Nasdaq or similar organization if Nasdaq is no longer reporting such information, or if the Redeemable Warrants are not quoted on Nasdaq or are no longer outstanding, the Market Price of a Redeemable Warrant shall equal the difference between the Market Price of the Common Stock and the Exercise Price of the Redeemable Warrant. 4. Issuance of Certificates. Upon the exercise of the Warrants, the issuance of certificates for shares of Common Stock and Redeemable Warrants and/or other securities, properties or rights underlying such Warrants and, upon the exercise of the Redeemable Warrants, the issuance of certificates for shares of Common Stock and/or other securities, properties or rights underlying such Redeemable Warrants shall be made forthwith (and in any event within five (5) business days thereafter) without charge to the Holder thereof including, without limitation, any tax which may be payable in respect of the issuance thereof, and such 5 certificates shall (subject to the provisions of Sections 5 and 7 hereof) be issued in the name of, or in such names as may be directed by, the Holder thereof; provided, however, that the Company shall not be required to pay any tax which may be payable in respect of any transfer involved in the issuance and delivery of any such certificates in a name other than that of the Holder, and the Company shall not be required to issue or deliver such certificates unless or until the person or persons requesting the issuance thereof shall have paid to the Company the amount of such tax or shall have established to the satisfaction of the Company that such tax has been paid. The Warrant Certificates and the certificates representing the shares of Common Stock and the Redeemable Warrants underlying the Warrants and the shares of Common Stock underlying the Redeemable Warrants (and/or other securities, property or rights issuable upon the exercise of the Warrants or the Redeemable Warrants) shall be executed on behalf of the Company by the manual or facsimile signature of the then Chairman or Vice Chairman of the Board of Directors or President or Vice President of the Company. Warrant Certificates shall be dated the date of execution by the Company upon initial issuance, division, exchange, substitution or transfer. Certificates representing the shares of Common Stock and Redeemable Warrants, and the shares of Common Stock underlying each Redeemable Warrant (and/or other securities, property or rights issuable upon exercise of the Warrants) shall be dated as of the Notice Date (regardless of when executed or delivered) and dividend bearing securities so issued shall accrue dividends from the Notice Date. 5. Restriction On Transfer of Warrants. The Holder of a Warrant Certificate, by its acceptance thereof, covenants and agrees that the Warrants are being acquired as an investment and not with a view to the distribution thereof; that the Warrants may not be sold, 6 transferred, assigned, hypothecated or otherwise disposed of, in whole or in part, for a period of one (1) year from the date hereof, except to officers of the Representatives. 6. Exercise Price. (S)6.1 Initial and Adjusted Exercise Price. Except as otherwise provided in Section 8 hereof, the initial exercise price of each Warrant shall be $_____ per share of Common Stock [120% of the initial public offering price of the Common Stock] and $______ per Redeemable Warrant [120% of the initial public offering price of the Redeemable Warrants]. The adjusted exercise price shall be the price which shall result from time to time from any and all adjustments of the initial exercise price in accordance with the provisions of Section 8 hereof. Any transfer of a Warrant shall constitute an automatic transfer and assignment of the registration rights set forth in Section 7 hereof with respect to the Securities or other securities, properties or rights underlying the Warrants. (S)6.2 Exercise Price. The term "Exercise Price" herein shall mean the initial exercise price or the adjusted exercise price, depending upon the context or unless otherwise specified. 7. Registration Rights. (S)7.1 Registration Under the Securities Act of 1933. The Warrants, the shares of Common Stock and Redeemable Warrants, or other securities issuable upon exercise of the Warrants, and the shares of Common Stock or other securities issuable upon exercise of the Redeemable Warrants (collectively, the "Warrant Securities") have been registered under the Securities Act of 1933, as amended (the "Act") pursuant to the Company's Registration Statement on Form SB-2 (Registration No. 333-_______) (the "Registration Statement"). All of the Representatives and warranties of the Company contained in the Underwriting Agreement relating to the Registration Statement, the Preliminary Prospectus and Prospectus (as such terms 7 are defined in the Underwriting Agreement) and made as of the dates provided therein, are incorporated by reference herein. The Company agrees and covenants promptly to file post-effective amendments to such Registration Statement as may be necessary in order to maintain its effectiveness and otherwise to take such action as may be necessary to maintain the effectiveness of the Registration Statement as long as any Warrants are outstanding. In the event that, for any reason, whatsoever, the Company shall fail to maintain the effectiveness of the Registration Statement, the certificates representing the Warrant Securities shall bear the following legend: The securities represented by this certificate have not been registered under the Securities Act of 1933, as amended ("Act"), and may not be offered or sold except pursuant to (i) an effective registration statement under the Act, (ii) to the extent applicable, Rule 144 under the Act (or any similar rule under such Act relating to the disposition of securities), or (iii) an opinion of counsel, if such opinion shall be reasonably satisfactory to counsel to the issuer, that an exemption from registration under such Act is available. (S)7.2 Piggyback Registration. If, at any time commencing after the date hereof and expiring seven (7) years thereafter, the Company proposes to register any of its securities under the Act (other than pursuant to Form S-4, Form S-8 or a comparable registration statement) it will give written notice by registered mail, at least thirty (30) days prior to the filing of each such registration statement, to the Representatives and to all other Holders of the Warrants and/or the Warrant Securities of its intention to do so. If the Representatives or other Holders of the Warrants and/or Warrant Securities notify the Company within twenty (20) business days after receipt of any such notice of its or their desire to include any such securities in such proposed registration statement, the Company shall afford the Representatives and such Holders of the Warrants and/or Warrant Securities the opportunity to have any such Warrant Securities registered under such registration statement. 8 Notwithstanding the provisions of this Section 7.2, the Company shall have the right at any time after it shall have given written notice pursuant to this Section 7.2 (irrespective of whether a written request for inclusion of any such securities shall have been made) to elect not to file any such proposed registration statement, or to withdraw the same after the filing but prior to the effective date thereof. (S)7.3 Demand Registration. (a) At any time commencing after the date hereof and expiring five (5) years thereafter, the Holders of the Warrants and/or Warrant Securities representing a "Majority" (as hereinafter defined) of such securities (assuming the exercise of all of the Warrants) shall have the right (which right is in addition to the registration rights under Section 7.2 hereof), exercisable by written notice to the Company, to have the Company prepare and file with the Securities and Exchange Commission (the "Commission"), on one occasion, a registration statement and such other documents, including a prospectus, as may be necessary in the opinion of both counsel for the Company and counsel for the Representatives and Holders, in order to comply with the provisions of the Act, so as to permit a public offering and sale of their respective Warrant Securities for six (6) consecutive months by such Holders and any other Holders of the Warrants and/or Warrant Securities who notify the Company within ten (10) days after receiving notice from the Company of such request. (b) The Company covenants and agrees to give written notice of any registration request under this Section 7.3 by any Holder or Holders to all other registered Holders of the Warrants and the Warrant Securities within ten (10) days from the date of the receipt of any such registration request. (c) Notwithstanding anything to the contrary contained herein, if the Company shall not have filed a registration statement for the Warrant Securities within the time period 9 specified in Section 7.4(a) hereof pursuant to the written notice specified in Section 7.3(a) of a Majority of the Holders of the Warrants and/or Warrant Securities, the Company may, at its option, upon the written notice of election of a Majority of the Holders of the Warrants and/or Warrant Securities requesting such registration, repurchase (i) any and all Warrant Securities of such Holders at the higher of the Market Price per share of Common Stock and per Redeemable Warrant, determined as of (x) the date of the notice sent pursuant to Section 7.3(a) or (y) the expiration of the period specified in Section 7.4(a) and (ii) any and all Warrants of such Holders at such Market Price less the Exercise Price of such Warrant. Such repurchase shall be in immediately available funds and shall close within two (2) days after the later of (i) the expiration of the period specified in Section 7.4(a) or (ii) the delivery of the written notice of election specified in this Section 7.3(c). (S)7.4 Covenants of the Company With Respect to Registration. In connection with any registration under Section 7.2 or 7.3 hereof, the Company covenants and agrees as follows: (a) The Company shall use its best efforts to file a registration statement within thirty (30) days of receipt of any demand therefor, shall use its best efforts to have any registration statements declared effective at the earliest possible time, and shall furnish each Holder desiring to sell Warrant Securities such number of prospectuses as shall reasonably be requested. (b) The Company shall pay all costs (excluding fees and expenses of Holder(s)' counsel and any underwriting or selling commissions), fees and expenses in connection with all registration statements filed pursuant to Sections 7.2 and 7.3(a) hereof including, without limitation, the Company's legal and accounting fees, printing expenses, blue sky fees and expenses. 10 (c) The Company will take all necessary action which may be required in qualifying or registering the Warrant Securities included in a registration statement for offering and sale under the securities or blue sky laws of such states as reasonably are requested by the Holder(s), provided that the Company shall not be obligated to execute or file any general consent to service of process or to qualify as a foreign corporation to do business under the laws of any such jurisdiction. (d) The Company shall indemnify the Holder(s) of the Warrant Securities to be sold pursuant to any registration statement and each person, if any, who controls such Holders within the meaning of Section 15 of the Act or Section 20(a) of the Securities Exchange Act of 1934, as amended ("Exchange Act"), against all loss, claim, damage, expense or liability (including all expenses reasonably incurred in investigating, preparing or defending against any claim whatsoever) to which any of them may become subject under the Act, the Exchange Act or otherwise, arising from such registration statement but only to the same extent and with the same effect as the provisions pursuant to which the Company has agreed to indemnify each of the Underwriters contained in Section 7 of the Underwriting Agreement. (e) The Holder(s) of the Warrant Securities to be sold pursuant to a registration statement, and their successors and assigns, shall severally, and not jointly, indemnify the Company, its officers and directors and each person, if any, who controls the Company within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, against all loss, claim, damage, expense or liability (including all expenses reasonably incurred in investigating, preparing or defending against any claim whatsoever) to which they may become subject under the Act, the Exchange Act or otherwise, arising from information furnished by or on behalf of such Holders, or their successors or assigns, for specific inclusion in such registration statement to the same extent and with the same effect as the provisions contained in Section 7 of the 11 Underwriting Agreement pursuant to which the Underwriters have agreed to indemnify the Company. (f) Nothing contained in this Agreement shall be construed as requiring the Holder(s) to exercise their Warrants prior to the initial filing of any registration statement or the effectiveness thereof. (g) The Company shall not permit the inclusion of any securities other than the Warrant Securities to be included in any registration statement filed pursuant to Section 7.3 hereof, or permit any other registration statement to be or remain effective during the effectiveness of a registration statement filed pursuant to Section 7.3 hereof (other than (i) shelf registrations effective prior thereto and (ii) registrations on Form S-4 or S-8), without the prior written consent of the Holders of the Warrants and Warrant Securities representing a Majority of such securities. (h) The Company shall furnish to each Holder participating in the offering and to each underwriter, if any, a signed counterpart, addressed to such Holder or underwriter, of (i) an opinion of counsel to the Company, dated the effective date of such registration statement (and, if such registration includes an underwritten public offering, an opinion dated the date of the closing under the underwriting agreement) relating to the due incorporation of the Company, the validity of the shares being issued, the due execution and delivery of the underwriting agreement and Rule 10b-5, and (ii) a "cold comfort" letter dated the effective date of such registration statement (and, if such registration includes an underwritten public offering, a letter dated the date of the closing under the underwriting agreement) signed by the independent public accountants who have issued a report on the Company's financial statements included in such registration statement, covering substantially the same matters with respect to such registration statement (and the prospectus included therein) and, with respect to events subsequent to the date 12 of such financial statements, as are customarily covered in accountants' letters delivered to underwriters in underwritten public offerings of securities. (i) The Company shall as soon as practicable after the effective date of the registration statement, and in any event within 15 months thereafter, make "generally available to its security holders" (within the meaning of Rule 158 under the Act) an earnings statement (which need not be audited) complying with Section 11(a) of the Act and covering a period of at least 12 consecutive months beginning after the effective date of the registration statement. (j) The Company shall deliver promptly to each Holder participating in the offering requesting the correspondence and memoranda described below and to the managing underwriters, copies of all correspondence between the Commission and the Company, its counsel or auditors and all memoranda relating to discussions with the Commission or its staff with respect to the registration statement and permit each Holder and underwriter to do such investigation, upon reasonable advance notice, with respect to information contained in or omitted from the registration statement as it deems reasonably necessary to comply with applicable securities laws or rules of the NASD. Such investigation shall include access to books, records and properties and opportunities to discuss the business of the Company with its officers and independent auditors, all to such reasonable extent and at such reasonable times and as often as any such Holder or underwriter shall reasonably request. (k) The Company shall enter into an underwriting agreement with the managing underwriters selected for such underwriting by Holders holding a Majority of the Warrant Securities requested pursuant to Section 7.3(a) to be included in such underwriting, which may be the Representatives. Such agreement shall be satisfactory in form and substance to the Company, each Holder and such managing underwriter(s), and shall contain such representations, warranties and covenants by the Company and such other terms as are 13 customarily contained in agreements of that type used by the managing underwriter(s). The Holders shall be parties to any underwriting agreement relating to an underwritten sale of their Warrant Securities whether pursuant to Section 7.2 or Section 7.3(a) and may, at their option, require that any or all of the representations, warranties and covenants of the Company to or for the benefit of such underwriter(s) shall also be made to and for the benefit of such Holders. Such Holders shall not be required to make any representations or warranties to or agreements with the Company or the underwriter(s) except as they may relate to such Holders and their intended methods of distribution. (l) For purposes of this Agreement, the term "Majority" in reference to the Holders of Warrants or Warrant Securities, shall mean in excess of fifty percent (50%) of the then outstanding Warrants or Warrant Securities that (i) are not held by the Company, an affiliate, officer, creditor, employee or agent thereof or any of their respective affiliates, members of their family, persons acting as nominees or in conjunction therewith and (ii) have not been resold to the public pursuant to a registration statement filed with the Commission under the Act. 8. Adjustments to Exercise Price and Number of Securities. (S)8.1 Subdivision and Combination. In case the Company shall at any time subdivide or combine the outstanding shares of Common Stock, the Exercise Price shall forthwith be proportionately decreased in the case of subdivision or increased in the case of combination. (S)8.2 Stock Dividends and Distributions. In case the Company shall pay a dividend in, or make a distribution of, shares of Common Stock or of the Company's capital stock convertible into Common Stock, the Exercise Price shall forthwith be proportionately 14 decreased. An adjustment made pursuant to this Section 8.2 shall be made as of the record date for the subject stock dividend or distribution. (S)8.3 Adjustment in Number of Securities. Upon each adjustment of the Exercise Price pursuant to the provisions of this Section 8, the number of Warrant Securities issuable upon the exercise at the adjusted exercise price of each Warrant shall be adjusted to the nearest full amount by multiplying a number equal to the Exercise Price in effect immediately prior to such adjustment by the number of Warrant Securities issuable upon exercise of the Warrants immediately prior to such adjustment and dividing the product so obtained by the adjusted Exercise Price. (S)8.4 Definition of Common Stock. For the purpose of this Agreement, the term "Common Stock" shall mean (i) the class of stock designated as Common Stock in the Certificate of Incorporation of the Company as may be amended as of the date hereof, or (ii) any other class of stock resulting from successive changes or reclassifications of such Common Stock consisting solely of changes in par value, or from par value to no par value, or from no par value to par value. (S)8.5 Merger or Consolidation. In case of any consolidation of the Company with, or merger of the Company with, or merger of the Company into, another corporation (other than a consolidation or merger which does not result in any reclassification or change of the outstanding Common Stock), the corporation formed by such consolidation or merger shall execute and deliver to the Holder a supplemental warrant agreement providing that the holder of each Warrant then outstanding or to be outstanding shall have the right thereafter (until the expiration of such Warrant) to receive, upon exercise of such Warrant, the kind and amount of shares of stock and other securities and property receivable upon such consolidation or merger, by a holder of the number of securities of the Company for which such Warrant might have been 15 exercised immediately prior to such consolidation, merger, sale or transfer. Such supplemental warrant agreement shall provide for adjustments which shall be identical to the adjustments provided in Section 8. The above provision of this subsection shall similarly apply to successive consolidations or mergers. (S)8.6 No Adjustment of Exercise Price in Certain Cases. No adjustment of the Exercise Price shall be made if the amount of said adjustment shall be less than two cents (24) per Warrant Security, provided, however, that in such case any adjustment that would otherwise be required then to be made shall be carried forward and shall be made at the time of and together with the next subsequent adjustment which, together with any adjustment so carried forward, shall amount to at least two cents (24) per Warrant Security. 9. Exchange and Replacement of Warrant Certificates. Each Warrant Certificate is exchangeable without expense, upon the surrender thereof by the registered Holder at the principal executive office of the Company, for a new Warrant Certificate of like tenor and date representing in the aggregate the right to purchase the same number of Warrant Securities in such denominations as shall be designated by the Holder thereof at the time of such surrender. Upon receipt by the Company of evidence reasonably satisfactory to it of the loss, theft, destruction or mutilation of any Warrant Certificate, and, in case of loss, theft or destruction, of indemnity or security reasonably satisfactory to it, and reimbursement to the Company of all reasonable expenses incidental thereto, and upon surrender and cancellation of the Warrants, if mutilated, the Company will make and deliver a new Warrant Certificate of like tenor, in lieu thereof. 10. Elimination of Fractional Interests. The Company shall not be required to issue certificates representing fractions of shares of Common Stock or Redeemable Warrants upon the exercise of the Warrants, nor shall it be required to issue scrip or pay cash in lieu of 16 fractional interests, it being the intent of the parties that all fractional interests shall be eliminated by rounding any fraction up to the nearest whole number of shares of Common Stock or Redeemable Warrants or other securities, properties or rights. 11. Reservation and Listing of Securities. The Company shall at all times reserve and keep available out of its authorized shares of Common Stock, solely for the purpose of issuance upon the exercise of the Warrants and the Redeemable Warrants, such number of shares of Common Stock or other securities, properties or rights as shall be issuable upon the exercise thereof. The Company covenants and agrees that, upon exercise of the Warrants and payment of the Exercise Price therefor, all shares of Common Stock, Redeemable Warrants and other securities issuable upon such exercise shall be duly and validly issued, fully paid, non-assessable and not subject to the preemptive rights of any stockholder. The Company further covenants and agrees that upon exercise of the Redeemable Warrants underlying the Warrants and payment of the respective Redeemable Warrant exercise price therefor, all shares of Common Stock and other securities issuable upon such exercises shall be duly and validly issued, fully paid, non-assessable and not subject to the preemptive rights of any stockholder. As long as the Warrants shall be outstanding, the Company shall use its best efforts to cause all shares of Common Stock issuable upon the exercise of the Warrants and Redeemable Warrants and all Redeemable Warrants underlying the Warrants to be listed (subject to official notice of issuance) on all securities exchanges on which the Common Stock or the Public Warrants issued to the public in connection herewith may then be listed and/or quoted on Nasdaq SmallCap or Nasdaq. 12. Notices to Warrant Holders. Nothing contained in this Agreement shall be construed as conferring upon the Holders the right to vote or to consent or to receive notice as a stockholder in respect of any meetings of stockholders for the election of directors or any other matter, or as having any rights whatsoever as a stockholder of the Company. If, however, at any 17 time prior to the expiration of the Warrants and their exercise, any of the following events shall occur: (a) the Company shall take a record of the holders of its shares of Common Stock for the purpose of entitling them to receive a dividend or distribution payable otherwise than in cash, or a cash dividend or distribution payable otherwise than out of current or retained earnings or capital surplus (in accordance with applicable law), as indicated by the accounting treatment of such dividend or distribution on the books of the Company; or (b) the Company shall offer to all the holders of its Common Stock any additional shares of capital stock of the Company or securities convertible into or exchangeable for shares of capital stock of the Company, or any option, right or warrant to subscribe therefor; or (c) a dissolution, liquidation or winding up of the Company (other than in connection with a consolidation or merger) or a sale of all or substantially all of its property, assets and business as an entirety shall be proposed; then, in any one or more of said events, the Company shall give written notice of such event at least thirty (30) days prior to the date fixed as a record date or the date of closing the transfer books for the determination of the stockholders entitled to such dividend, distribution, convertible or exchangeable securities or subscription rights, or entitled to vote on such proposed dissolution, liquidation, winding up or sale. Such notice shall specify such record date or the date of closing the transfer books, as the case may be. Failure to give such notice or any defect therein shall not affect the validity of any action taken in connection with the declaration or payment of any such dividend, or the issuance of any convertible or exchangeable securities, or subscription rights, options or warrants, or any proposed dissolution, liquidation, winding up or sale. 18 13. Redeemable Warrants. The form of the certificate representing Redeemable Warrants (and the form of election to purchase shares of Common Stock upon the exercise of Redeemable Warrants and the form of assignment printed on the reverse thereof) shall be substantially as set forth in Exhibit "A" to the Warrant Agreement dated as of the date hereof by and between the Company and Continental Stock Transfer and Trust Company (the "Redeemable Warrant Agreement"). Each Redeemable Warrant issuable upon exercise of the Warrants shall evidence the right to initially purchase a fully paid and non-assessable share of Common Stock at an initial purchase price of $____ per share [150% of the initial public offering price per share of Common Stock] from _________, 1999 [one year after date of Prospectus] until 5:30 p.m. New York time on _________, 2003 [five years after date of Prospectus] at which time the Redeemable Warrants, unless the exercise period has been extended, shall expire. The exercise price of the Redeemable Warrants and the number of shares of Common Stock issuable upon the exercise of the Redeemable Warrants are subject to adjustment, whether or not the Warrants have been exercised and the Redeemable Warrants have been issued, in the manner and upon the occurrence of the events set forth in Section 8 of the Redeemable Warrant Agreement, which is hereby incorporated herein by reference and made a part hereof as if set forth in its entirety herein. Subject to the provisions of this Agreement and upon issuance of the Redeemable Warrants underlying the Warrants, each registered holder of such Redeemable Warrant shall have the right to purchase from the Company (and the Company shall issue to such registered holders) up to the number of fully paid and non-assessable shares of Common Stock (subject to adjustment as provided herein and in the Redeemable Warrant Agreement), free and clear of all preemptive rights of stockholders, provided that such registered holder complies with the terms governing exercise of the Redeemable Warrant set forth in the Redeemable Warrant Agreement, and pays the applicable exercise price, determined in 19 accordance with the terms of the Redeemable Warrant Agreement. Upon exercise of the Redeemable Warrants, the Company shall forthwith issue to the registered holder of any such Redeemable Warrant in his name or in such name as may be directed by him, certificates for the number of shares of Common Stock so purchased. Except as otherwise provided in this Agreement, the Redeemable Warrants underlying the Warrants shall be governed in all respects by the terms of the Redeemable Warrant Agreement. The Redeemable Warrants shall be transferable in the manner provided in the Redeemable Warrant Agreement, and upon any such transfer, a new Redeemable Warrant Certificate shall be issued promptly to the transferee. The Company covenants to, and agrees with, the Holder(s) that without the prior written consent of the Holder(s), which will not be unreasonably withheld, the Redeemable Warrant Agreement will not be modified, amended, canceled, altered or superseded, and that the Company will send to each Holder, irrespective of whether or not the Warrants have been exercised, any and all notices required by the Redeemable Warrant Agreement to be sent to holders of Redeemable Warrants. 14. Notices. All notices, requests, consents and other communications hereunder shall be in writing and shall be deemed to have been duly made and sent when delivered, or mailed by registered or certified mail, return receipt requested: (a) If to the registered Holder of the Warrants, to the address of such Holder as shown on the books of the Company; or (b) If to the Company, to the address set forth in Section 3 hereof or to such other address as the Company may designate by notice to the Holders. 15. Supplements and Amendments. The Company and the Representatives may from time to time supplement or amend this Agreement without the approval of any Holders of 20 Warrant Certificates (other than the Representatives) in order to cure any ambiguity, to correct or supplement any provision contained herein which may be defective or inconsistent with any provisions herein, or to make any other provisions in regard to matters or questions arising hereunder which the Company and the Representatives may deem necessary or desirable and which the Company and the Representatives deem shall not adversely affect the interests of the Holders of Warrant Certificates. 16. Successors. All the covenants and provisions of this Agreement shall be binding upon and inure to the benefit of the Company, the Holders and their respective successors and assigns hereunder. 17. Termination. This Agreement shall terminate at the close of business on __________, 2005. Notwithstanding the foregoing, the indemnification provisions of Section 7 shall survive such termination until the close of business on _________, 2011. 18. Governing Law; Submission to Jurisdiction. This Agreement and each Warrant Certificate issued hereunder shall be deemed to be a contract made under the laws of the State of New York and for all purposes shall be construed in accordance with the laws of said State without giving effect to the rules of said State governing the conflicts of laws. The Company, the Representatives and the Holders hereby agree that any action, proceeding or claim against it arising out of, or relating in any way to, this Agreement shall be brought and enforced in the courts of the State of New York or of the United States of America for the Southern District of New York, and irrevocably submits to such jurisdiction, which jurisdiction shall be exclusive. The Company, the Representatives and the Holders hereby irrevocably waive any objection to such exclusive jurisdiction or inconvenient forum. Any such process or summons to be served upon any of the Company, the Representatives and the Holders (at the option of the party bringing such action, proceeding or claim) may be served by 21 transmitting a copy thereof, by registered or certified mail, return receipt requested, postage prepaid, addressed to it at the address set forth in Section 14 hereof. Such mailing shall be deemed personal service and shall be legal and binding upon the party so served in any action, proceeding or claim. The Company, the Representatives and the Holders agree that the prevailing party(ies) in any such action or proceeding shall be entitled to recover from the other party(ies) all of its/their reasonable legal costs and expenses relating to such action or proceeding and/or incurred in connection with the preparation therefore. 19. Entire Agreement; Modification. This Agreement (including the Underwriting Agreement and the Redeemable Warrant Agreement to the extent portions thereof are referred to herein) contains the entire understanding between the parties hereto with respect to the subject matter hereof and may not be modified or amended except by a writing duly signed by the party against whom enforcement of the modification or amendment is sought. 20. Severability. If any provision of this Agreement shall be held to be invalid or unenforceable, such invalidity or unenforceability shall not affect any other provision of this Agreement. 21. Captions. The caption headings of the Sections of this Agreement are for convenience of reference only and are not intended, nor should they be construed as, a part of this Agreement and shall be given no substantive effect. 22. Benefits of this Agreement. Nothing in this Agreement shall be construed to give to any person or corporation other than the Company and the Representatives and any other registered Holder(s) of the Warrant Certificates or Warrant Securities any legal or equitable right, remedy or claim under this Agreement; and this Agreement shall be for the sole benefit of the Company and the Representatives and any other registered Holders of Warrant Certificates or Warrant Securities. 22 23. Counterparts. This Agreement may be executed in any number of counterparts and each of such counterparts shall for all purposes be deemed to be an original, and such counterparts shall together constitute but one and the same instrument. 23 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed, as of the day and year first above written. SONIC FOUNDRY, INC. By:____________________________________ Name: Title: Attest: _________________________________ Secretary DIRKS & COMPANY, INC. By:____________________________________ Name: Title: SECURITY CAPITAL TRADING CORP. By:____________________________________ Name: Title: 24 EXHIBIT A [FORM OF WARRANT CERTIFICATE] THE WARRANTS REPRESENTED BY THIS CERTIFICATE AND THE OTHER SECURITIES ISSUABLE UPON EXERCISE THEREOF MAY NOT BE OFFERED OR SOLD EXCEPT PURSUANT TO (i) AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933, (ii) TO THE EXTENT APPLICABLE, RULE 144 UNDER SUCH ACT (OR ANY SIMILAR RULE UNDER SUCH ACT RELATING TO THE DISPOSITION OF SECURITIES), OR (iii) AN OPINION OF COUNSEL, IF SUCH OPINION SHALL BE REASONABLY SATISFACTORY TO COUNSEL FOR THE ISSUER, THAT AN EXEMPTION FROM REGISTRATION UNDER SUCH ACT IS AVAILABLE. THE TRANSFER OR EXCHANGE OF THE WARRANTS REPRESENTED BY THIS CERTIFICATE IS RESTRICTED IN ACCORDANCE WITH THE WARRANT AGREEMENT REFERRED TO HEREIN. EXERCISABLE ON OR BEFORE 5:30 P.M., NEW YORK TIME, ___________, 2003 No. W- Warrants to Purchase ____ shares of Common Stock and/or _____ Redeemable Warrants WARRANT CERTIFICATE This Warrant Certificate certifies that __________, or registered assigns, is the registered holder of _____________ Warrants to purchase initially, at any time from _________, 1999 until 5:30 p.m. New York time on __________, 2003 ("Expiration Date"), up to __________ fully-paid and non- assessable shares of common stock, $0.01 par value ("Common Stock"), of SONIC FOUNDRY, INC., a Maryland corporation (the "Company"), and ___ Redeemable Warrants of the Company (one Redeemable Warrant entitling the owner to purchase one fully-paid and non-assessable share of Common Stock) at the initial exercise price, subject to adjustment in certain events (the "Exercise Price"), of $_____ per share of Common Stock and $_____ per Redeemable Warrant upon surrender of this Warrant Certificate and payment of the Exercise Price at an office or agency of the Company, but subject to the conditions set forth herein and in the warrant agreement dated as of _________, 1998 between the Company and DIRKS & COMPANY, INC. and SECURITY CAPITAL TRADING CORP. (the "Warrant Agreement"). Payment of the Exercise Price shall be made by certified or official bank check in New York Clearing House funds payable to the order of the Company or by surrender of this Warrant Certificate. A-1 No Warrant may be exercised after 5:30 p.m., New York time, on the Expiration Date, at which time all Warrants evidenced hereby, unless exercised prior thereto, hereby shall thereafter be void. The Warrants evidenced by this Warrant Certificate are part of a duly authorized issue of Warrants issued pursuant to the Warrant Agreement, which Warrant Agreement is hereby incorporated by reference in and made a part of this instrument and is hereby referred to for a description of the rights, limitation of rights, obligations, duties and immunities thereunder of the Company and the holders (the words "holders" or "holder" meaning the registered holders or registered holder) of the Warrants. The Warrant Agreement provides that upon the occurrence of certain events the Exercise Price and the type and/or number of the Company's securities issuable thereupon may, subject to certain conditions, be adjusted. In such event, the Company will, at the request of the holder, issue a new Warrant Certificate evidencing the adjustment in the Exercise Price and the number and/or type of securities issuable upon the exercise of the Warrants; provided, however, that the failure of the Company to issue such new Warrant Certificates shall not in any way change, alter, or otherwise impair, the rights of the holder as set forth in the Warrant Agreement. Upon due presentment for registration of transfer of this Warrant Certificate at an office or agency of the Company, a new Warrant Certificate or Warrant Certificates of like tenor and evidencing in the aggregate a like number of Warrants shall be issued to the transferee(s) in exchange for this Warrant Certificate, subject to the limitations provided herein and in the Warrant Agreement, without any charge except for any tax or other governmental charge imposed in connection with such transfer. Upon the exercise of less than all of the Warrants evidenced by this Certificate, the Company shall forthwith issue to the holder hereof a new Warrant Certificate representing such number of unexercised Warrants. The Company may deem and treat the registered holder(s) hereof as the absolute owner(s) of this Warrant Certificate (notwithstanding any notation of ownership or other writing hereon made by anyone), for the purpose of any exercise hereof, and of any distribution to the holder(s) hereof, and for all other purposes, and the Company shall not be affected by any notice to the contrary. All terms used in this Warrant Certificate which are defined in the Warrant Agreement shall have the meanings assigned to them in the Warrant Agreement. A-2 IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to be duly executed under its corporate seal. Dated as of _____________, 1998 SONIC FOUNDRY, INC. By:____________________________________ Name: Title: A-3 [FORM OF ELECTION TO PURCHASE PURSUANT TO SECTION 3.1] The undersigned hereby irrevocably elects to exercise the right, represented by this Warrant Certificate, to purchase: [_] _____________ shares of Common Stock; [_] _____________ Redeemable Warrants; [_] _____________ shares of Common Stock together with an equal number of Redeemable Warrants; or [_] _____________ shares of Common Stock together with _____________ Redeemable Warrants. and herewith tenders in payment for such securities a certified or official bank check payable in New York Clearing House Funds to the order of Sonic Foundry, Inc. in the amount of $_______________________, all in accordance with the terms of Section 3.1 of the Representatives' Warrant Agreement dated as of _________, 1998 between Sonic Foundry, Inc. and Dirks & Company, Inc. and Security Capital Trading Corp. The undersigned requests that a certificate for such securities be registered in the name of _________________________________ whose address is ______________________________________ and that such Certificate be delivered to ______________________________________ whose address is _______________________. Dated: Signature ______________________________ (Signature must conform in all respects to name of holder as specified on the face of the Warrant Certificate.) ________________________________________ (Insert Social Security or Other Identifying Number of Holder) A-4 [FORM OF ELECTION TO PURCHASE PURSUANT TO SECTION 3.2] The undersigned hereby irrevocably elects to exercise the right, represented by this Warrant Certificate, to purchase: [_] _____________ shares of Common Stock; [_] _____________ Redeemable Warrants; [_] _____________ shares of Common Stock together with an equal number of Redeemable Warrants; or [_] _____________ shares of Common Stock together with _____________ Redeemable Warrants. and herewith tenders in payment for such securities ________ Warrants all in accordance with the terms of Section 3.2 of the Representatives' Warrant Agreement dated as of ________, 1998 between Sonic Foundry, Inc. and Dirks & Company, Inc. and Security Capital Trading Corp. The undersigned requests that a certificate for such securities be registered in the name of __________________ whose address is ____________________ and that such Certificate be delivered to ___________________________________ whose address is ___________________. Dated: Signature ______________________________ (Signature must conform in all respects to name of holder as specified on the face of the Warrant Certificate.) ________________________________________ (Insert Social Security or Other Identifying Number of Holder) A-5 [FORM OF ASSIGNMENT] (To be executed by the registered holder if such holder desires to transfer the Warrant Certificate.) FOR VALUE RECEIVED ____________________________________ hereby sells, assigns and transfers unto ________________________________________________________________________________ (Please print name and address of transferee) this Warrant Certificate, together with all right, title and interest therein, and does hereby irrevocably constitute and appoint _______________ Attorney, to transfer the within Warrant Certificate on the books of the within-named Company, with full power of substitution. Dated:_________________ Signature:______________________________ (Signature must conform in all respects to name of holder as specified on the face of the Warrant Certificate.) ________________________________________ Insert Social Security or Other Identifying Number of Assignee) A-6 EX-10.3 7 COMMERCIAL LEASE COMMERCIAL LEASE THIS AGREEMENT, made this 20th day of JANUARY, 1998, by and between The --- Williamson Center LLC, of Madison, Wisconsin, as Landlord, and Sonic Foundry, - ---------------------- -------------- Inc., of Madison, Wisconsin, as Tenant: - ----- WITNESSETH. That the said Landlord does hereby demise and lease to Tenant and Tenant does hereby hire from Landlord approximately 5,238 square feet on the 2nd floor of 740 & 744 Williamson Street and 2,780 square feet located in the lower level at 744 Williamson Street, Madison, Wisconsin, (as shown on the attached Exhibit "A") together with all appurtenances thereto, for the term of five years, running from and including the first day of May, 1998, up to and including the 30th day of April, 2003, subject to the terms and conditions of this lease. AMOUNT OF RENTAL ---------------- 1. Tenant covenants to pay to Landlord at Landlord's office, c/o Mike Kohn, --------- 1014 Williamson Street, Madison, Wisconsin 53703, or such other place as - ------------------------------------------------ Landlord shall designate in writing, as base rent for the first year of this lease for payment on said premises, the sum of: Year one: $13.50 per square foot for 5,238 square feet on the 2/nd/ floor, and $11.00 per square foot for 2,780 square feet in the lower level, payable in monthly installments of $8,441.08 commencing on the 1/st/ of May, 1998. Year two; $14.50 per square foot for 5,238 on the 2/nd/ floor, and $11.33 per square feet for 2,780 in the lower level, payable in monthly installments of $8,954.03 commencing on the 1/st/ day of May, 1999, without deduction or offset. The term lease year shall be defined as a period of 12 consecutive calendar months beginning with the commencement date. Rent for the third year through fifth lease years shall be calculated by adding to the preceding years rent amount in increase in the amount of 3%. OPTION TO EXEND --------------- Landlord hereby grants Tenant the option to extend this lease for one additional 5 year term under the following conditions: 1. Tenant has met all obligations under the initial lease term, 2. Tenant serves Landlord with written notice of intent to extend the lease no less than 180 days prior to the end of the current lease. Base rent shall increase 4% annually during the option term. USE --- 2. Tenant shall have the right to use the premises as general office space. -------------------- Tenant shall operate its business under the name of Sonic Foundry. Tenant will ------------- not use or permit upon the premises any activity or thing which will invalidate any policies of insurance now or hereafter carried on the premises, or any activity or thing which may be dangerous to life or limb, and will do nothing and suffer nothing to be done upon the premises in any way tending to create a nuisance or to disturb, annoy or interfere with the right of any other tenant in said building or occupants of the neighboring property, or to injure the reputation of the premises, or tend to do any of these things, and will comply with all legal or health and police regulations respecting Tenant's use of the premises and will not use the premises for cooking, or for lodging or sleeping purposes, or for any immoral or illegal purposes. Tenant agrees to take the premises after the Landlord improvements are in place as itemized in Exhibit "B", and make all necessary additions and improvements at Tenant expense to create professional office space. Page 1 SERVICES BY LANDLORD -------------------- 3. Throughout the term of this lease, Landlord shall furnish: a. 24 hours every day, elevator service, water and sewer service for normal office and sanitary uses and provision for access by Tenant to the building. b. Electricity shall be furnished in the common areas of the building complex daily. Both parties agree to use off-hour setbacks in die interest of energy conservation, but the Tenant shall be provided building standard controls to override such setbacks as might be necessary to conduct Tenant's business during off-hours. c. Base year real estate taxes and building structural insurance shall be expenses of the Landlord. d. Access to the space in the building for all such equipment and facilities as the telephone company providing service to Tenant shall require from time to time in order to establish, provide and maintain such service as Tenant shall be determine to obtain. e. Lobby display panels showing names and office numbers of Tenant, Tenant's affiliated corporations and any permitted subleases. f. Two keys to the leased premises. g. Janitorial services for the common areas of the building complex shall be performed at the Landlord's own expense. LANDLORD'S REPAIRS AND MAINTENANCE ---------------------------------- 4. a. Landlord shall maintain the roof, all structural walls and the foundation of the premises. Landlord shall be responsible for replacement of the heating and air conditioning systems (not including tenant supplied mechanicals). Landlord shall perform all maintenance to elevators and elevator equipment and the common areas located in the building and the grounds, walks, landscaping and other site improvements appurtenant thereto, as well as, of the glass and windows in the exterior walls for the common areas of the building, as shall be necessary in order to keep all the foregoing in good order and repair and operating condition. Landlord may also make all such necessary repairs to the non-structural parts of the interior of the premises, if any, as may be made necessary by failure of Tenant to fully and promptly perform its obligations under Paragraph 5. b. Landlord shall at all reasonable times have the right, and be authorized to give license, to enter and occupy the premises for the purpose of making such repairs or alterations therein as shall be necessary or proper for the maintenance, repair, replacement, safety, protection, preservation, renovation or improvement of the premises, or any part thereof, or the building containing the same, or any part thereof provided that except in case of actual emergency Landlord shall give to Tenant reasonable advance notice of its intention so to enter or occupy the premises and shall perform all such work in such manner as shall minimize disturbance of Tenant's use of the premises. If Tenant shall be deprived of the use of a material part of the premises for more than 1 day due to Landlord's repair of the premises, where the damage to premises being repaired was Page 2 not caused by Tenant's fault, an equitable adjustment of rent shall be made. e. Tenant will give to Landlord, or its agents, prompt notice of any accident to or defect in the water pipes, gas pipes, electrical conduits, connections, switches of which Tenant is aware. TENANTS MAINTENANCE AND REPAIR OF BUILDING ------------------------------------------ 5. The Tenant will, at the Tenant's own cost and expense, repair or replace any damage or injury done to the non-structural leased premises, including broken glass or any part thereof, caused by the Tenant or the Tenant's agents, employees, invitees, or visitors. Tenant shall be responsible interior maintenance including, but not limited to, mechanical and non- structural repairs and maintenance. If the Tenant fails to make such repairs or replacements promptly, or within 15 days of occurrence, the Landlord may, at its option, make such repairs or replacements, and the Tenant shall repay the cost thereof to the Landlord on demand. The Tenant will not commit or allow any waste or damage to be committed on any portion of the building and shall, at the termination of this lease, by lapse of time or otherwise, deliver up the premises to the Landlord broom clean and in as good condition as at the commencement of the lease term, ordinary wear and tear excepted, and upon such termination of lease, except as otherwise provided, then the Tenant shall immediately remove all of its property and the Landlord shall have the right to re-enter and resume possession of the premises. Tenant shall be responsible for lighting tube and bulb replacement and janitorial services within the leased premises. Tenant shall be responsible for its prorata share of increases only in real estate taxes over the base amount. The base amount shall be the tax amount payable in 1999. TENANT'S ALTERATIONS, ADDITIONS, -------------------------------- INSTALLATIONS, AND REMOVAL THEREOF ---------------------------------- 6. Tenant shall be given occupancy of the premises on March 15, 1998 for the purpose of conducting their improvements. Prior to this date, Landlord shall have the Landlord improvements that effect the premises completed, as shown on the attached Exhibit B. If Tenant cannot begin their work on March 15, 1998 due to Landlord's fault, base rent shall not be due until after May 1, 1998 for the number of days of the Landlord-caused delay. It is agreed that Tenant will be able to begin their work before March 15, 1998, and that Landlord may be doing work in the premises after March 15, 1998, but this work will not prevent Tenant from doing their improvements. a. Tenant may, upon first receiving written approval of Landlord, which approval will not be unreasonably withheld, at its own expense, either at the commencement of or during the term of this lease, make such alterations in and/or additions to the leased premises as may be necessary to fit the same for its business. Tenant may also, with Landlord's permission, at its own expense, install such counters, racks, shelving, fixtures, fittings, machinery and equipment upon or within the leased premises as Tenant may consider necessary to the conduct of its business. At any time prior to the expiration or earlier termination of the lease, Tenant may remove any or all such alterations, additions or installations in such a manner as will not substantially injure the leased premises. In the event Tenant shall elect to make any such removal, Tenant shall restore the premises, or the portion or portions affected by such removal, to the same condition as existed prior to the making of such alteration, addition or installation, ordinary wear and tear, excepted. All alterations, additions or installations not so removed by Tenant shall become the property of Page 3 Landlord without liability on Landlord's part to pay for the same. All alterations, additions or installations shall be constructed or installed by the Landlord's general contractor, or by another contractor for which Tenant has obtained Landlord's prior written approval. In making said alterations, additions or installations, or generally in its use and occupancy of the premises, it is Tenant's responsibility to meet all applicable federal, state or local building and safety and health regulations and laws. UTILITIES --------- 7. Tenant shall pay the costs of all gas and electric used by Tenant and any service ordered by Tenant. OBSERVANCE OF LAWS ------------------ 8. Tenant shall keep and maintain the premises in a clean and healthful condition and shall duly obey and comply with all public laws, ordinances, and Building Rules and Regulations (as shown on the attached Exhibit C) relating to the use of the leased premises. DAMAGE BY FIRE OR OTHER PERIL, ETC. ----------------------------------- 9. If during the term of this lease: a. The building or the premises shall be damaged or destroyed by fire or other casualty to such extent that in the judgment of Landlord such damage or destruction cannot be restored or repaired with reasonable diligence within 90 days from the happening of such damage -- or destruction, then either party may elect by written notice given to the other within 60 days from the happening of such damage or destruction to terminate this lease, and if the premises shall have been rendered wholly untenantable by such fire or other casualty, such termination shall be effective as of the date of such notice; but if the premises shall not have been rendered wholly untenantable, Tenant shall retain such portions of the premises for such periods not exceeding 90 days after such notice of termination shall have been given and in that event the date of termination of this lease shall be the date upon which Tenant shall vacate the last portion of the premises. b. If the building or the premises shall be damaged by fire or other casualty, but not to such extent that Landlord determines that such damage cannot be repaired with reasonable diligence within 90 days, or -- if the building or the premises shall be damaged to a greater extent, but neither party shall elect to terminate this lease in accordance with the preceding subparagraph hereof, then Landlord shall proceed diligently to fully restore and repair all such damage to the building and the premises. c. If the utility of the premises to Tenant shall be materially diminished by reason of the existence of damage to the building or the premises by reason of fire or other casualty, regardless of whether the premises shall have been rendered wholly or partially untenantable by reason of the existence of such damage, both the basic rent and additional rent otherwise becoming due hereunder shall be abated in proportion to the diminution of the amount of floor space available to Tenant. Upon termination of this lease by reason of a fire or other casualty, any rent which shall at such time have been paid but not earned shall be refunded to Tenant. Page 4 SIGNS ----- 10. All signage will be subject to prior written approval by Landlord, the City of Madison and the Landmarks Commission (if applicable). Factors to be considered include, for illustration only and without limitation, size, design, color, placement, copy. All signage and signage-related costs shall be the expense of Tenant TERMINATION BY REASON OF DEFAULT -------------------------------- 11. In the event Tenant shall fail to perform any covenant required to be performed by this lease including a default by Tenant in payment of the rent as herein specified, or any part thereof, the Landlord shall have the right to re-enter said premises, to remove the Tenant and all persons holding under the lease therefrom, and to terminate this lease and repossess the premises; provided, however, that such repossession shall not constitute a waiver by the Landlord of any other rights which Landlord might have to enforce collection of rents for the balance of the term or to recover damages from the Tenant for default in payment of rents. CONDEMNATION ------------ 12. In the event that the leased premises shall be taken for public use by the city, state, federal government, public authority or other corporation having the power of eminent domain, then this lease shall terminate as of the date on which possession thereof shall be taken for such public use, or, at the option of Tenant, as of the date on which the premises shall become unsuitable for Tenant's regular business by reason of such taking; provided, however, that if only a part of the leased premises shall be so taken, such termination shall be at the option of Tenant only. If such a taking of only a part of the leased premises occurs, and Tenant elects not to terminate the lease, there shall be a proportionate reduction of the rent to be paid under this lease from and after the date such possession is taken for public use. Tenant shall have no claim against the Landlord for the value of any unexpired term under this lease, or the value of improvements, except for whatever separate third party claim the Tenant may have in accordance with law. SUBLEASING OR ASSIGNMENT ------------------------ 13. The Tenant may not sublease, sell, assign, license or transfer the whole or any part of its interest in this lease or the leased premises without the prior written consent of the Landlord which shall not be unreasonably withheld or unduly delayed. In the event a subtenant pays more rent than is called for in this lease, the Landlord and Tenant shall share equally in the excess rent, after Tenant recoups its subleasing costs, including but not limited to: broker's fees, attorneys' fees, reasonable improvements required for the subtenant and other reasonable and necessary out-of-pocket costs. Tenant shall be able to assign or sublease part of all of the premises without Landlord's consent to any affiliates by serving Landlord 60 day advance written notice of its intention to do so. Affiliates would include any corporation, partnership or other entity that controls, is controlled by, or is under common control with Tenant; or any corporation or other entity resulting from the merger or consolidations with Tenant or to any entity that acquires all of Tenant's assets as a going concern of the business that is being conducted on the premises, as long as the assignee or Subtenant is a bona fide entity and assumes the obligations of the Tenant. Page 5 INSURANCE --------- a. Tenant shall obtain and keep in full force and effect such comprehensive public liability insurance by insurance companies approved by Landlord insuring the Landlord, Tenant and any other parties designated by the Landlord, and any manager or managing agent, against injury to property, persons or loss of life arising out of the use and occupancy of the premises (in an amount of not less than $1,000,000.00 combined single limit per occurrence/aggregate) covering all claims for bodily injury, personal injury, death or property damage arising out of one occurrence. Said insurance shall be written on an occurrence basis and not on a claims made basis. If at any time during the term of this lease, Tenant owns or rents more than one location, its liability policy shall contain an endorsement to the effect that the aggregate limit in the policy shall apply separately to each location owned or rented by Tenant. The Tenant shall furnish a certificate or duplicate policy of such coverage to the Landlord, and such insurance shall contain provisions preventing cancellations, discontinuance or alteration without at least 10 days prior notice to the Landlord. Tenant's public liability and any casualty insurance on its property shall also contain a provision that the Tenant's waiver of subrogation rights against the Landlord and any other co-insured, which subrogation rights the Tenant hereby waives, shall not invalidate such coverage. Landlord shall also waive any subrogation rights which Landlord or Landlord's insurers may have against the Tenant if such waivers arc permitted by such insurers, and any and all public liability insurance insuring the Landlord shall also contain a provision that the Landlord waives subrogation rights against the Tenant should such provisions be obtainable from the insurer. The Tenant waives and releases all claims against the Landlord or Landlord's agents, employees and servants, in respect of, and they shall not be liable for injury to person or damage to property sustained by the Tenant or by any occupant of the premises or the building, or any other person occurring in or about the building or the premises resulting directly, or indirectly from any existing or future condition, defect, matter or thing in the premises, the building or part of it or from equipment or appurtenance becoming out of repair or from accident, or from any occurrence, act, or from negligence or omission of any tenant or occupant of the building, or of any other person. This paragraph shall apply especially, but not exclusively, to damage caused as aforesaid or by the flooding of lower floors or other sub-surface areas or by refrigerators, sprinkling devices, air-conditioning apparatus, water, snow, frost, steam, excessive heat or cold, falling plaster, broken glass, sewage, gas, odors or noise, or the bursting or leaking of pipes or plumbing fixtures, and shall apply equally whether any such damage be caused or result from any thing or circumstance above mentioned, or any other thing or circumstance whether of a like or wholly different nature. If any such damage to the premises or to the building, or to tenants thereof, results from any act or omission of negligence of the Tenant or Tenant's agents, employees or invitees, the Landlord may, at the Landlord's option, repair such damage and the Tenant shall, upon demand by the Landlord, reimburse the Landlord forthwith for all costs of such repairs and damages both to the building and to die tenants thereof, in excess of the amounts, if any, paid to Landlord under insurance covering such damages. All property entrusted to the Landlord or any of its agents or employees, and all property in the building or in the premises belonging to the Tenant, its agents, employees or invitees, or to any occupant of the premises shall be there at the risk of the Tenant or other person only, and the Landlord shall not be liable for damage thereto or theft, misappropriation or loss thereof. The Tenant agrees to hold Landlord harmless and indemnified against claims and liability for injuries to all persons and for the damage to, or the theft, misappropriation or loss of all property occurring in the premises, or due to act or omission of Tenant or Tenant's agents or employees. The Landlord agrees to hold the Tenant harmless and indemnified against claims and liabilities for injuries to all persons and for damage to, or the theft, misappropriation or loss of all property occurring in or on the premises, or caused by the act or omission of Landlord or Landlord's agents or employees Page 6 b. Tenant shall keep leasehold improvements insured against loss or damage occasioned by fire, extended coverage perils and such other hazards as Landlord requires. Said insurance to be an initial amount of not less than $200,000 and policy limits shall increase from time to time or upon the reasonable request of Landlord as necessary to provide full coverage. Tenant shall name Landlord as co-insured on said insurance, and shall have its insurance provider provide Landlord with an annual Certificate of Insurance evidencing said co-insurance. LANDLORD'S RIGHT TO ENTER PREMISES ---------------------------------- 14. Tenant shall permit Landlord and Landlord's agents to enter at all reasonable times to view the state and condition of the premises or to make such alterations or repairs therein as may be necessary for the safety and preservation thereof, or for any other reasonable purposes. Tenant shall also permit Landlord or Landlord's agents, on or after 180 days preceding the expiration of the term of this lease, to show the premises to prospective tenants at reasonable times, and to place notices on the front of said premises, or on any part thereof, offering the premises for lease. If the Tenant shall abandon or vacate said premises before the end of the term of this lease, or shall suffer the rent to be in arrears, the Landlord may, at its option, forthwith cancel this lease or it may enter said premises as the agent of the Tenant, by force or otherwise, without being liable in any way therefor, and re-let the premises with or without any furniture that may be therein, as the agent of the Tenant, at such price and upon such terms and for such duration of time as the Landlord may determine, and receive the rent therefor, applying the same to the payment of the rent due by these presents, and if the full rental herein provided shall not be realized by Landlord over and above the expenses to Landlord in such reletting, the said Tenant shall pay any deficiency, and if more than the full rental is realized, Landlord will pay over to said Tenant the excess of demand. CONSTRUCTION LIENS ------------------ 15. The Tenant shall promptly pay for any work done in or about the premises contracted by it, and will not permit or suffer any construction liens to attach to the premises as a result thereof, furnishing Landlord with lien waivers, and shall promptly cause any claim for any such lien to be released, or to secure the Landlord to Landlord's satisfaction in the event the Tenant desires to contest any such claim. DEFAULT AND REMEDIES -------------------- 16. a. Acts of Default: Each of the following shall be deemed a default by the Tenant and a breach of this lease: 1. Failure to pay any of the rent or additional rent herein reserved, or any part thereof, for a period of 15 days after written notice; or 2. Failure to do, observe, keep and perform any term, covenant, condition, agreement or provision in this lease to be done, observed, kept and performed by the Tenant (except concerning the payment of rent or additional rent) for a period of 30 days after written notice; or 3. The abandonment of the leased premises by the Tenant; or 4. Use or permit to be used the premises or any part thereof for any purpose other than Page 7 above specified without the written consent of the Landlord; or 5. Suffer or permit the entry in any involuntary proceedings brought against Tenant in any court or tribunal under any section of any bankruptcy act of any order adjudicating Tenant to be insolvent or unable to pay Tenant's debts unless such order is vacated within 30 days after its entry; or 6. File any voluntary petition or similar proceedings in any court or tribunal under any section of any bankruptcy act to delay or reduce or modify Tenant's debts or obligations; or 7. Be declared insolvent according to law, or make, suffer or permit any assignment of Tenant's property for the benefit of creditors or the appointment of any receiver or trustee for Tenant or Tenant's property. b. Remedies: Upon the happening of any of the acts of default set forth above, which acts remain uncured after expiration of the time periods provided for above, the Landlord shall have the right to elect any one or more of such remedies as may be allowed by applicable law. c. In the event of default, Landlord may, but shall not be obligated to, remedy such default and in connection therewith pay the costs and expenses occasioned by such default and employ counsel with respect thereto. All reasonable sums expended or reasonable obligations incurred by Landlord in connection with the cure of any such default shall be paid by Tenant upon demand. d. The respective rights of the Landlord and Tenant pursuant hereto shall be in addition to such as they might otherwise have pursuant to law and cumulative; and the exercise by either party of any particular right or remedy in relation to any such breach shall not be deemed to be a waiver of any other rights or remedies. A waiver by either party of any breach or breaches by the other of any one or more of the terms, covenants or conditions contained in this lease shall not constitute a waiver of any rights or remedies of such party for any other or subsequent breach. e. Unless the same be expressed in writing signed by the Landlord, the Landlord shall not be deemed to have accepted any surrender of the premises, nor to have prejudiced any right of the Landlord under this lease by any action in reference to the same or to the premises or the possession thereof, nor to have terminated, continued or extended this lease by advertising the premises for rent or by caring for the same or submitting the same to inspection of any person or by receiving from the Tenant any money or keys or by any other action. ATTORNEY FEES ------------- 17. In case the Tenant makes default in the performance of any of the terms, covenants, agreements or conditions contained in this lease and the Landlord therefore places the enforcement of this lease, or any part thereof, or the collection of any rent due, or to become due hereunder, or recovery of possession of the premises in the hands of an attorney, or files suit upon the same, the Tenant agrees to pay the Landlord the reasonable attorney fees and court costs thereby incurred by the Landlord, together with interest at the legal rate for all unpaid sums from the date of default. Page 8 AMENDMENT OF LEASE ------------------ 18. This agreement may not be altered, changed, or amended, except by an instrument in writing, signed by both parties hereto. TRANSFER OF LANDLORD'S RIGHTS ----------------------------- 19. The Landlord shall have the right to transfer and assign, in whole or in part, all and every feature of Landlord's right and obligations hereunder and in the leased premises, the building and land parcel. Such transfers or assignments may be made either to a corporation, trust company, individual or group of individuals, and howsoever made, shall in all things be respected and recognized by the Tenant, and in the event of any such transfer or assignment, whether by absolute conveyance, lease or otherwise, the Landlord shall be relieved of any and all obligations, covenants and duties provided that: a. The new owner is able to and expressly agrees in writing to assume Landlord's obligations under the Lease; and b. The Tenant's funds that the landlord is holding, such as the Security Deposit, are given to the new owner. ESTOPPEL CERTIFICATE -------------------- 20. Within ten days after request therefor by Landlord, the Tenant agrees to deliver in recordable form a certificate to any proposed mortgagee, purchaser or Landlord, certifying (if such be the case) that this lease is in full force and effect and that there are no defenses or offsets thereto, or stating those claimed by Tenant. If Tenant fails to deliver such certificate within such time from written request, then Tenant appoints Landlord Tenant's attorney-in-fact to execute same, or Landlord may exercise all remedies applicable to Tenant's default. WAIVER ------ 21. Failure of the Landlord to declare any default immediately upon occurrence thereof or delay in taking any action in connection therewith shall not waive such default, but the Landlord shall have the right to declare any such default at any time and take such action as might be lawful or authorized hereunder, either in law or in equity. MORTGAGE AND SUBORDINATION --------------------------- 22. This lease is hereby made expressly subject and subordinate at all times to any and all mortgages, ground or underlying leases affecting the premises which have been executed and delivered, or which may at any time hereafter be executed and delivered and any and all extensions and renewals thereof and substitutions therefor, and to any and all advances made or to be made under or upon said mortgages, ground or underlying leases. Tenant agrees, to execute any instrument or instruments which the Landlord may deem necessary or desirable to effect the subordination of this lease to any or all such mortgages, ground or underlying leases. Notwithstanding the foregoing, any successor in interest to the Landlord agrees to recognize the Tenant's rights under the Lease provided that: a. The Tenant's quiet possession shall not be disturbed if the Tenant is not in default under the terms and conditions of this Lease; and b. Tenant will attorn and recognize any successor in interest to the Landlord for the remaining Page 9 term or extension or option term of this Lease. MISCELLANEOUS PROVISIONS ------------------------ 23. a. Light and Air: This lease does not grant any right to light and air over adjoining property except public street and alleys adjoining the land on which the building is situated. b. Notices: Unless otherwise required by law, all written notices may be hand delivered to the leased premises or to Landlord or may be given by certified mail. Notices to the Landlord shall be addressed to the Landlord at the address at which rent has been last paid. Notices to the Tenant shall be addressed to the Tenant at the leased premises. The Landlord and the Tenant may, from time to time, change these addresses by notifying each other of any change in writing. c. Binding Effect: The terms, conditions and covenants contained in this lease and any riders and plans attached hereto shall bind and inure to the benefit of the Landlord and the Tenant and their respective successors, heirs, and assigns. d. Governing Law: This lease shall be governed by and construed under the laws of the State of Wisconsin. e. Severability: In the event that any provision of this lease shall be held invalid or unenforceable, no other provision of this lease shall be affected by such holding, and all of the remaining provisions of this lease shall continue in full force and effect pursuant to the terms hereof. f. Paragraph Captions: The paragraph captions are inserted only for convenience and reference, and are not intended, in any way, to define, limit, or describe the scope, intent and language of this lease or its provisions. g. Entire Agreement: This lease contains the entire agreement between the parties and shall not be modified in any manner except by an instrument in writing executed by the parties or their respective successors in interest. h. Counterparts: This lease may be executed in any number of counterparts with the same effect as if all parties executed a single instrument. i. Late charge: Tenant agrees to pay Landlord a late charge of $150.00 on ------ each monthly rental postmarked or hand delivered after the 5th day of the --- month. j. Authority: The individuals executing this lease warrant and represent that they have full authority to bind their respective parties hereon. k. Security Deposit: Tenant's security deposit shall be in the amount of $8,441.08, and shall be held by Landlord for the term of the lease. This and the first month's rent are payable as follows: $3,000 at the time the lease is signed, and the balance ($13,882.16) at the time tenant receives access to the premises, to be on or before 3-15-98. l. Interest: Any amount due from either party to the other hereunder which is not paid when due shall bear interest at the rate of 18% per annum from the due date until paid, unless otherwise specifically provided herein, but the payment of such interest shall not excuse or cure any default under this lease. Page 10 m. Reservation: The submission of this lease for examination does not constitute a reservation of or option for the leased premises, and this lease shall become effective as a lease only upon execution and delivery thereof by Landlord and Tenant. n. Parking: There shall be no reserved stalls except for Tenant's stalls that are as a result of the 754 Williamson Street building purchase. All building occupants agree that preserving parking for customers and visitors is important. Tenant agrees to not Park in the "visitor" stalls that will be close to the entry. In the event there is an occupant in the building with a greater than proportionate parking requirement, they will be expected to pay for off-site parking for the additional stalls. RULES ----- 24. Landlord may make such reasonable rules governing the premises and the buildings of which they are a part as Landlord deems necessary. Tenant agrees to observe and comply with all such rules and any violations of the rules shall be deemed a breach of this lease. Landlord may make changes in the rules and shall give written notice of changes to Tenant at least 10 days before the new rules become effective. DISPUTES BETWEEN TENANTS ------------------------ 25. Landlord shall be final arbiter in any matter or dispute between Tenant and other tenants in the building. 26. Landlord reserves the right to change the size or layout of the common areas or parking areas serving the premises. Landlord agrees to notify Tenant prior to such a change. 27. Any consents by any party shall not be unreasonably withheld or unduly delayed. 28. Landlord agrees to notify Tenant in writing each time the third floor space in the 744 building becomes available. AND IT IS MUTUALLY UNDERSTOOD AND AGREED that the covenants and agreements herein contained shall inure to the benefit of and be equally binding upon the respective executors, administrators, heirs, successors and assigns of the parties hereto. IN WITNESS WHEREOF, the parties hereto have executed this lease the day and year first above written. LANDLORD: TENANT: By: /s/ Mike Kohn /s/ Rimantas P. Buinevicius -------------------------- ----------------------------- Williamson Center, LLC Sonic Foundry, Inc. By: [SIGNATURE ILLEGIBLE] --------------------------- Williamson Center, LLC Page 11 It is agreed that this guarantee shall be in effect until Tenant provides Landlord with written evidence that they have had a successful ****** ****** offering of stock with a minimum amount raised of $5,000,000. GUARANTY -------- FOR VALUE RECEIVED, AND AS A MATERIAL INDUCEMENT TO AND IN CONSIDERATION OF THE LESSOR MAKING THE FOREGOING LEASE AND IN RELIANCE UPON THIS GUARANTY, THE UNDERSIGNED HEREBY JOINTLY AND SEVERALLY UNCONDITIONALLY GUARANTY THE PAYMENT OF THE RENT AND THE PERFORMANCE OF THE COVENANTS AND AGREEMENTS BY THE LESSEE IN THE FOREGOING LEASE COVENANTED AND AGREED, AND IN THE MANNER AND FORM AS IN SAID LEASE PROVIDED. /s/ Rimantas P. Buinevicius, Individually 1/2O, l998. - ----------------------------- RIMANTAS P. BUINEVICIUS Page 14 EXHIBIT A [FLOOR PLAN OF THE WILLIAMSON CENTER] [FLOOR PLAN OF 740-744 WILLIAMSON ST. THIRD FLOOR] [FLOOR PLAN OF 740-744 WILLIAMSON ST. SECOND FLOOR] [FLOOR PLAN OF 740-744 WILLIAMSON ST. FIRST FLOOR] EXHIBIT A [FLOOR PLAN OF THE WILLIAMSON CENTER] [FLOOR PLAN OF 740-744 WILLIAMSON ST. THIRD FLOOR] [FLOOR PLAN OF 740-744 WILLIAMSON ST. SECOND FLOOR] [FLOOR PLAN OF 740-744 WILLIAMSON ST. FIRST FLOOR] [FLOOR PLAN OF 740-744 WILLIAMSON ST. LOWER LEVEL] EXHIBIT 'B' SONIC FOUNDRY WILLIAMSON CENTER BUILD OUT PACKAGE I. LANDLORD IMPROVEMENTS a. Common Areas ------------ 1. First floor lobby, restrooms, etc. fully finished. 2. New passenger elevator installed to serve 740 and 744. 3. Security locked exterior doors with after hours paging system. b. Floors ready for finish ----------------------- 1. Existing wood - ready for sanding and finish or other floor coverings (patching at areas walls were removed by Tenant at 740-2 if desired). 2. Existing concrete - leveled, ready for floor coverings (744-B). c. Demising Walls (with standard entry doors) ----------------------------------------- 1. Exterior (all) and interior plaster or drywall - taped, finished, ready for paint (exterior walls and walls between Tenants insulated). 2. Interior brick "bump-outs" - cleaned and/or sandblasted (see page A-10 in plans). d. Ceilings -------- 1. Existing heavy joist and beam - all obsolete mechanical items removed. e. HVAC ---- 1. Standard heating and cooling units and controls with supply and return ducts brought into each rental unit. f. Electrical ---------- 1. Lighting and outlets provided complete at common area. 2. Meters and standard distribution panels provided for each rental space. g. Plumbing -------- 1. 2nd floor: Restrooms and drinking fountains provided to minimum or better of State of Wisconsin Building Code standard for office/retail use. 2. Lower level: no plumbing is provided. h. Exterior -------- 1. Buildings complete, finished and weathertight. 2. New energy efficient Low-E, double insulated window units in all areas except 740-2 where existing multi pane aluminum units will remain. 3. Parking lot paved, striped and lighted. 4. Landscaping completed. SONIC FOUNDRY, EXHIBIT 'B' Build Out Package Page 2 II. Tenant Improvements a. Floors ------ 1. Wood - sand and finish or (with landlord approval) apply other floor covering. 2. Concrete - apply floor covering. Note: Tenant should consider sound transmission from the floor below when choosing floor finishes. The Landlord will not be responsible for sound transmission from other floors. b. Walls ----- 1. Install all interior walls, doors and trim. 2. Install all interior wall coverings or paint. c. Ceiling ------- 1. Paint, sandblast or (with landlord approval) install suspended or other system. 2. Any new mechanicals either neatly installed or covered with soffits. 3. Install rated drywall to ceiling to meet fire code requirements in the lower level space. Note: Tenant should consider sound transmission from the floor above when choosing ceiling systems. The Landlord will not be responsible for sound transmission from other floors. d. HVAC ---- 1. Install HVAC distribution runs and diffusers. 2. Install any specialty ventilation, make-up air, additional heating or cooling capacity if required, etc. e. Electrical ---------- 1. Install all outlets, switches, lights, etc. from provided panels. f. Plumbing -------- 1. Install break room plumbing or private restrooms if desired. g. Phone System, Security System and Computer Wiring ------------------------------------------------- 1. Install to meet Tenant's needs. h. Signage ------- 1. Install all Tenant specific signage. i. Any wall or structural member (joists, beams, columns, etc.) penetrations or alterations larger than 1/4 required for mechanical or other systems must be approved by Landlord in writing. EXHIBIT C BUILDING RULES AND REGULATIONS ------------------------------ 1. In these Rules and Regulations "Tenant" includes the Tenant, Tenant's Agent, servant, clerk, employee and other representative, and Tenant's visitor, customer, invitee, client, patient and common carrier. "Premises" and "Building" have the meanings given them in the lease. The masculine gender includes the feminine, singular and plural, and vise versa. 2. No advertising or identification signs shall be permitted on the Premises or in any part of the Building of which the Premises are a part without the Landlord's prior written approval as to the form, location and content. 3. Tenant shall not advertise the business, profession or activities of Tenant conducted in the Building in any manner which violates the letter or spirit of any code of ethics adopted by any recognized association or organization pertaining to such business, profession or activities. Prior to using the name of the Building for any purpose other than that of the business address or Tenant, or using any picture or likeness of the Building in any circulars, notices, advertisements or correspondence, the prior express consent in writing from the Landlord must be procured. 4. Tenant shall not obstruct, use for storage, or for any purpose other than ingress and egress the sidewalks, entrances, passages, courts, corridors, vestibules, halls, elevators and stairways of the Building, nor shall Tenant place objects against glass partitions, doors or windows which would be unsightly from the Building corridor or from the exterior of the Building. 5. No animals or pets shall be brought or permitted to be in the Building or any part thereof without written permission from Landlord. 6. Tenant shall not operate any musical instrument or any similar devices inside or outside of the Leased Premises at a volume level that disturbs other building occupants. 7. Tenant shall not make any room-to-room canvass to solicit business from other Tenants in the Building, and shall not exhibit, sell or offer to sell, use, rent or exchange any item or service in or from the Premises unless, ordinarily embraced within Tenant's use of the Premises specified herein. 8. Tenant shall not waste electricity, water or air conditioning, and shall cooperate fully with Landlord to assure the most effective operation of the Building's heating and air conditioning, and shall not adjust any controls other than room thermostats installed for Tenant's use. Tenant shall keep corridor doors closed. Tenant shall not tie, wedge or otherwise fasten open any water faucet or outlet. 9. No additional locks or similar devices shall be attached to any door or locks changed without providing Landlord with key copies. 10. Tenant assumes full responsibility for protecting its space from theft, robbery and pilferage, which includes keeping doors locked and other means of entry to the Premises closed and secured. The Landlord assumes no responsibility for loss for theft. 11. No sign, film or other material shall be attached to any window, whether inside or out, at any time or for any purpose without 1st obtaining landlord written approval. Page 12 12. Tenant shall not overload any floor and, must receive Landlord's prior written consent as to size, maximum weight, routing and location of business machines, safes and other heavy objects. Safes, furniture and all large articles shall be brought through the Building and into the Premises at such times and in such manner as the Landlord shall direct and at Tenant's sole risk and responsibility. 13. Unless Landlord gives advance written consent in each and every instance, Tenant shall not install or operate any machinery, carry on any mechanical business therein, or use the Premises for housing accommodations or lodging or sleeping purposes, or use any illumination other than electrical light, or use or permit to be brought into the Building any inflammable oils or fluids such as gasoline, kerosene, naphtha and benzine, or any explosive or other articles hazardous to person or property. Tenant may have a fireplace on the premises as long as it is approved in advance by Landlord. 14. Tenant shall advise Landlord in advance in writing of its intention to add electric equipment that may exceed the capacity of any wiring circuit provided Landlord, or of electrical equipment that exceeds standard utility use, as described in the Lease. Landlord shall not be required to provide capacity for any Tenant's temporary or intermittent use that may be substantially in excess of that required for the Tenant's regular use. 15. Landlord is not responsible to Tenant for the violation of these Rules and Regulations by other Tenants or occupants. 16. In the case of a maintenance problem during business hours, call Mike Kohn --------- at 255-1239. If you experience an after hours emergency, call Mike Kohn -------- --------- at 251-1664. The backup contact will be John Martens at 221-2828. -------- 17. All employee parking is to be in the stalls that are farthest away from the entries. (see attached layout). The close in stalls are reserved for client and visitor parking only. 18. Every effort should be made to have your company name on any incoming mail to assist the post office in mail delivery. 19. All vending machine locations, product selections and choice of vending supplier shall be Landlord's sole discretion. All income from vending shall be the property of the Landlord. 20. Landlord reserves the right to change or add to these rules and regulations and will notify Tenant in writing of any changes. /s/ Mike Kohn /s/ Rimantas P. Buinevicius - ------------------------- ------------------------------- LANDLORD TENANT [SIGNATURE ILLEGIBLE] FOR SONIC FOUNDRY, INC. Page 13 [PLAN OF BUILDING EXTERIOR] EX-10.4 8 EMPLOYMENT AGREEMENT WITH RIMAS BUINEVICIOUS EXHIBIT 10.4 EMPLOYMENT AGREEMENT -------------------- THIS IS AN EMPLOYMENT AGREEMENT made as of the ___ day of November, 1997 and effective as of January 1, 1997, by and between SONIC FOUNDRY, INC. ("Sonic Foundry") and RIMAS BUINEVICIUS ("Employee"), who resides at ____________________________________. WHEREAS, Employee has been serving as Chief Executive Officer of Sonic Foundry since January, 1997; and WHEREAS, Sonic Foundry desires to continue to employ Employee, and Employee desires to continue to be employed by Sonic Foundry; and WHEREAS, Sonic Foundry and Employee desire to enter into an employment agreement which will confirm and set forth the terms and conditions of Employee's employment with Sonic Foundry. NOW THEREFORE, in consideration of the premises to this Agreement and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Sonic Foundry and Employee agree as follows: 1. Sonic Foundry hereby hires and employs the Employee, and the Employee agrees to continue to work for Sonic Foundry under the following terms hereby agreed upon. 2. The Employee is hereby engaged to work in the executive capacity of Chief Executive Officer of Sonic Foundry, or any other capacity so designated by Sonic Foundry, generally consistent with Employee's present duties and responsibilities. 3. The Employee shall enter into service and commence work hereunder as of the date hereof and the employment shall continue, unless sooner terminated pursuant to the terms hereof, until January 1, 2001 (the "Contract Term"). 4. The Employee agrees that he shall devote sufficient skill, labor and attention to said employment during the Contract Term in order to promptly and faithfully do and perform all services pertaining to said position that are or may hereafter be required of him by Sonic Foundry during the Contract Term. 5. Sonic Foundry agrees as follows: (a) Sonic Foundry shall pay the Employee a base salary at the rate of $125,000 per year during each year of the Contract Term, payable bi-weekly. The Board of Directors of Sonic Foundry (or a duly constituted and empowered committee thereof) may further increase Employee's salary effective on each anniversary date of this Agreement, at its discretion. In addition, the Employee shall receive annual bonuses as may be declared by the Board of Directors of Sonic Foundry (or a duly constituted and empowered committee thereof). (b) Employee shall receive such other incidental benefits of employment, such as insurance, pension plan and ESOP participation, and vacation, as are provided generally to Sonic Foundry's other salaried employees on the same terms as are applicable to such other employees. For purposes of such incidental benefits of employment which are based upon income, including but not limited to insurance, pension plan and ESOP participation, income shall be deemed to include all amounts payable pursuant to paragraph 5(a) hereof. (c) Employee shall also be reimbursed for all reasonable 2 business expenses incurred in connection with his employment. (d) Prior to the beginning of any calendar year, Employee may defer any portion of his compensation otherwise payable in said following calendar year, by providing written notification to the Board of Directors of Sonic Foundry. Said aggregate deferrals may be payable in installments or in lump sum and shall be subject to the provisions of paragraph six (6) hereof. 6. (a) This Agreement and the employment of Employee hereunder shall terminate on the first to occur of: (i) the expiration of the term specified in Paragraph 3 hereof; (ii) the death or Physical or Mental Disability of Employee as described in Paragraph (g) hereof; (iii) Employee's voluntary departure from employment other than for those reasons described herein in Paragraph 6(c); (iv) Employee's termination pursuant to Paragraphs (b) or (c) hereof. (b) The Board of Directors of Sonic Foundry may terminate or shall be deemed to have terminated the employment of Employee at any time: (i) "with cause" upon the conviction of the Employee for a malfeasance (i.e. theft, embezzlement, fraud or a dishonest act) against Sonic Foundry; or (ii) "without cause" if they shall determine that it is in the best interests of Sonic Foundry to terminate this 3 Agreement for any reason other than the reason described in subparagraph (i) of this paragraph 6(b). (c) In the event, whether prior to or subsequent to a "Change in Control", as hereinafter defined in paragraph 6(e), Employee and Sonic Foundry shall hereafter jointly determine (i) that Employee's status or responsibilities with Sonic Foundry has or have been reduced, including but not limited to the assignment to Employee of any duties, positions, responsibilities or tasks inconsistent with those immediately prior to said reduction, or (ii) that Sonic Foundry has failed to perform its obligations hereunder or in the event, subsequent to a "Change in Control", Employee and Sonic Foundry shall jointly determine that the financial prospects of Sonic Foundry have significantly declined to a level where the future operations of Sonic Foundry would be impaired, Employee shall have the right to terminate his employment with Sonic Foundry by written notice thereof and shall be treated as having terminated his employment pursuant to paragraph 6(f) hereof. In the event that Employee and Sonic Foundry are unable to agree upon any determination pursuant to this paragraph 6(c), an arbitrator, jointly selected by the parties, shall resolve the dispute. In the event the parties are unable to agree upon an arbitrator, the arbitrator shall be selected by two additional arbitrators, one of which shall be an arbitrator selected by Sonic Foundry and the other of which shall be an arbitrator selected by the Employee. (d) In the event Employee's termination is for any 4 reason set out in Paragraphs 6(a)(iii) above prior to a Change in Control or Paragraphs 6(a)(i) or 6(b)(i) above at any time, Employee shall not be entitled to any termination payments or benefits other than (i) salary and other accrued benefits earned up to the date of termination; and (ii) amounts deferred pursuant to Paragraph 5(d) hereof. In the event Employee's termination is for any reason set out in paragraph 6(a)(ii) above prior to a Change in Control, Employee shall be entitled to (i) salary and other accrued benefits earned up to the last day of the month of the date of death or Date of Disability (as defined in paragraph (g) hereof); (ii) all amounts deferred pursuant to paragraph 5(d) hereof and, (iii) a lump sum termination payment equal to the highest yearly salary and bonus paid to Employee pursuant to paragraph 5(a) in any year during the 3 years immediately subsequent to the year in which the death or disability occurs, and, if termination is due to disability, Employee shall also be entitled to the medical, health and insurance-related benefits as set forth in paragraph 5(b) hereof prior to and for one year following the date of disability. (e) For purposes of determining whether a "Change in Control" has occurred, a "Change in Control" shall be defined as the occurrence at any time during the Contract Term of any of the following events: (1) A change in control of a nature that would have had to have been reported in Sonic Foundry's proxy statement, if Sonic Foundry were required to have filed proxy statements under the Securities Exchange Act of 1934 (the "Exchange 5 Act"). (2) Sonic Foundry is merged or consolidated or reorganized into or with another corporation or other legal person and as a result of such merger, consolidation or reorganization less than 75% of the outstanding voting securities or other capital interests of the surviving, resulting or acquiring corporation or other legal person are owned in the aggregate by the stockholders of Sonic Foundry immediately prior to such merger, consolidation or reorganization; (3) Sonic Foundry sells all or substantially all of its business and/or assets to any other corporation or other legal person, less than 75% of the outstanding voting securities or other capital interests of which are owned in the aggregate by the stockholders of Sonic Foundry, directly or indirectly, immediately prior to or after such sale; (4) Any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) of 25% or more of the issued and outstanding shares of voting securities of Sonic Foundry. (5) During any period of two consecutive years, individuals who at the beginning of any such period constitute the Directors of Sonic Foundry cease for any reason to 6 constitute at least a majority thereof unless the election, or the nomination or election by Sonic Foundry's stockholders, of each new Director of Sonic Foundry was approved by a vote of at least two-thirds of such Directors of Sonic Foundry then still in office who were Directors of Sonic Foundry at the beginning of any such period. (f) Upon a termination of Employee's employment for any reason set out in Paragraphs 6(a)(ii) or 6(a)(iii) subsequent to a Change in Control or upon a termination pursuant to the provisions of Paragraph 6(b)(ii) or Paragraph 6(c) above at any time, Employee shall be entitled to (i) salary and other accrued benefits earned up to the last day of the month in which employment was terminated; (ii) all amounts deferred pursuant to Paragraph 5(d) hereof, and (iii) a lump sum termination payment equal to three (3) times the highest yearly salary and bonus paid to Employee pursuant to Paragraph 5(a) in any year during the last three (3) years immediately prior to termination. Employee shall also be entitled to the medical, health and insurance-related benefits as set forth in Paragraph 5(b) hereof prior to and for three years following the date of termination. (g) As used herein, "Physical or Mental Disability" shall mean a serious illness, accident or any other physical or mental incapacity which prevents Employee from substantially performing his duties hereunder for a continuous period of twelve months. The last day of any such twelve (12) month period shall be Employee's "Date of Disability". 7 (h) All payments to be made in the event of the death of the Employee shall be made to the Employee's surviving spouse, or in the event the Employee dies without leaving a surviving spouse, then to such beneficiary as the Employee may designate in writing to Sonic Foundry for that purpose, or if the Employee has not so designated, then to the personal representative of the estate of the Employee. (i) This Section 6 shall not be deemed a limitation of the Employee's benefits under any death or disability plan currently in effect. (j) If litigation shall be brought to enforce or interpret any provision contained in this Agreement, Sonic Foundry agrees to indemnify the Employee for his reasonable attorneys' fees and disbursements incurred in such litigation, and hereby agrees to pay prejudgment interest on any money judgment obtained by the Employee calculated at the prime rate of First National Bank of Chicago, in effect from time to time from the date that payment(s) to him should have been made under this Agreement; provided that the Employee shall not have been found by the court to have acted in bad faith, which finding must be final with the time to appeal therefrom having expired and no appeal having been taken. 7. The Employer will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Employer, by agreement in form and substance satisfactory to the Employee, to expressly assume and agree to perform this Agreement 8 in the same manner and to the same extend that the Employer would be required to perform it if no such succession had taken place. As used in this paragraph, "Employer" shall mean Sonic Foundry, Inc. and any successor to its business and/or assets as aforesaid which executed and delivers the agreement provided for this paragraph 7, or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 8. Employee understands that in the course of his employment with Sonic Foundry, he shall or may be making use of, acquiring, or adding to confidential information of a special and unique nature and value relating to such matters as Sonic Foundry's trade secrets, systems, inventions, programs (including, without limitation, Sonic Foundry's computer software programs), procedures, manuals, confidential reports and communications, and lists of customers and clients. Employee also understands that any information, data and materials received by Sonic Foundry from third-parties in confidence (or subject to nondisclosure or similar covenants), including but not limited to customers, prospective customers, joint ventures, parties to cooperative agreements or partners, shall be deemed to be and shall be confidential information. Employee hereby confirms that he has not and shall not, except with the express, prior written consent of Sonic Foundry, or except if he is acting as an employee of Sonic Foundry solely for the benefit of Sonic Foundry in connection with Sonic Foundry's business and in accordance with Sonic Foundry's business practices and employee policies, at any time during or following 9 the term of his employment by Sonic Foundry, directly or indirectly, disclose, divulge, reveal, report, publish, transfer or use, for any purpose whatsoever, any of such information which has been obtained by or disclosed to him as a result of his employment by Sonic Foundry. Further, Employee agrees to be bound by all nondisclosure or similar covenants between Sonic Foundry and any third- party. 9. Employee further understands that all of the following information and materials are "Protected Information" belonging to Sonic Foundry and shall be kept strictly confidential, even if not physically marked as such: a. Applications, operating system, database, communication and other computer software, whether now or hereafter existing, developed for use on any operating system, all modifications, enhancements and versions and all options available with respect thereto, and all future products developed or derived therefrom; b. Source and object codes, flowcharts, algorithms, coding sheets, routines, sub-routines, compilers, assemblers, design concepts, and related documentation and manuals; c. Products, inventions, production processes, marketing techniques and arrangements, mailing lists, purchasing information, pricing policies, quoting procedures, financial information, customer 10 and prospect names and requirements, employee, customer supplier and distributor data, and other materials and information relating to Sonic Foundry's business and activities and the manner in which Sonic Foundry does business; d. Discoveries, concepts and ideas including, without limitation, the nature and results of research and development activities, processes formulas, inventions, computer-related equipment or technology, techniques, "know-how", designs, drawings, and specifications; e. Any other materials or information related to the business or activities of Sonic Foundry which are not generally known to others engaged in similar businesses or activities; f. All ideas which are derived from or relate to Employee's access to or knowledge of any of the above enumerated materials and information; and g. All information, data and materials received by Sonic Foundry from third-parties in confidence ( or subject to nondisclosure or similar covenants), including but not limited to information, data and materials received by Sonic Foundry from customers, prospective customers, joint ventures, parties to cooperative agreements or partners. 10. At Sonic Foundry's request, or, in the absence of such a 11 request, upon termination of Employee's employment with Sonic Foundry, Employee agrees to turn over to Sonic Foundry all notes, data tapes, lists, reference items, sketches, drawings, memoranda, records, and other materials in any way relating to any financial data, Protected Information and Inventions, and other documents that are in his possession or control belonging to Sonic Foundry or relating to its business. 11. Employee represents and warrants that his employment with Sonic Foundry does not and will not breach any agreement or duty which he has to any other party to keep in confidence any confidential information belonging to others. Employee will not disclose to Sonic Foundry or use in its behalf any confidential information belonging to others. Except as set forth on any exhibit that is attached hereto and signed by both parties hereof, Employee does not claim an ownership interest in any inventions. 12. Employee acknowledges that if he were to compete with Sonic Foundry in the audio and multimedia software development business, it could cause serious harm to Sonic Foundry. In the event that the Employee terminates this Agreement or Sonic Foundry terminates this Agreement, the Employee agrees that he will not engage in the audio software business for a period of two (2) years from the time of Employee's termination of employment within the Continental United States. This covenant shall survive the termination of this Agreement and shall apply to any renewal or extension of employment. The restrictive covenant contained herein shall be given the broadest lawful and enforceable scope 12 permissible for the protection of Sonic Foundry. Employee has carefully considered his obligations as stated herein and agrees that the restrictions contained herein are fair and reasonable and are reasonably required for the protection of Sonic Foundry. 13. Employee understands that a breach of this Agreement including, but not limited to, unauthorized copying, assignment, transfer or distribution of Protected Information and Inventions will result in irreparable or immeasurable damage to Sonic Foundry and that Sonic Foundry is authorized to seek injunctive relief against Employee. Employee also consents to the exclusive jurisdiction of the Dane County Circuit Courts or the Federal District Court for the Western District of Wisconsin, both located in Madison, Wisconsin, as the appropriate forums for resolution of any dispute arising from this Agreement, including issuance of an injunction. Employee understands that this provision regarding the issuance of an injunction does not limit any remedies at law or equity otherwise available to Sonic Foundry. 14. No oral arrangements have been made between the parties hereto and this Agreement may be amended only in writing signed by both parties. 15. The rights and obligations of Sonic Foundry under this Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of Sonic Foundry. Employee may not assign his obligations under this Agreement. 16. If any provision of this Agreement shall be declared 13 invalid or unenforceable by a court of competent jurisdiction, the remainder of this Agreement shall not be affected thereby and shall continue in full force and effect. 17. This Agreement shall be construed in accordance with the laws of the State of Wisconsin. IN WITNESS WHEREOF, the parties hereto have set their hands and seals as of the day and year first above written. EMPLOYEE: SONIC FOUNDRY, INC. ____________________________ By: ________________________ Rimas Buinevicius Title:______________________ ____________________________ Witness 14 EX-10.5 9 EMPLOYMENT AGREEMENT WITH MONTY R. SCHMIDT EXHIBIT 10.5 EMPLOYMENT AGREEMENT -------------------- THIS IS AN EMPLOYMENT AGREEMENT made as of the ___ day of November, 1997 and effective as of January 1, 1997, by and between SONIC FOUNDRY, INC. ("Sonic Foundry") and MONTY R. SCHMIDT ("Employee"), who resides at ____________________________________. WHEREAS, Employee has been serving as President of Sonic Foundry since prior to January, 1997; and WHEREAS, Sonic Foundry desires to continue to employ Employee, and Employee desires to continue to be employed by Sonic Foundry; and WHEREAS, Sonic Foundry and Employee desire to enter into an employment agreement which will confirm and set forth the terms and conditions of Employee's employment with Sonic Foundry. NOW THEREFORE, in consideration of the premises to this Agreement and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Sonic Foundry and Employee agree as follows: 1. Sonic Foundry hereby hires and employs the Employee, and the Employee agrees to continue to work for Sonic Foundry under the following terms hereby agreed upon. 2. The Employee is hereby engaged to work in the executive capacity of President of Sonic Foundry, or any other capacity so designated by Sonic Foundry, generally consistent with Employee's present duties and responsibilities. 3. The Employee shall enter into service and commence work hereunder as of the date hereof and the employment shall continue, unless sooner terminated pursuant to the terms hereof, until January 1, 2001 (the "Contract Term"). 4. The Employee agrees that he shall devote sufficient skill, labor and attention to said employment during the Contract Term in order to promptly and faithfully do and perform all services pertaining to said position that are or may hereafter be required of him by Sonic Foundry during the Contract Term. 5. Sonic Foundry agrees as follows: (a) Sonic Foundry shall pay the Employee a base salary at the rate of $125,000 per year during each year of the Contract Term, payable bi-weekly. The Board of Directors of Sonic Foundry (or a duly constituted and empowered committee thereof) may further increase Employee's salary effective on each anniversary date of this Agreement, at its discretion. In addition, the Employee shall receive annual bonuses as may be declared by the Board of Directors of Sonic Foundry (or a duly constituted and empowered committee thereof). (b) Employee shall receive such other incidental benefits of employment, such as insurance, pension plan and ESOP participation, and vacation, as are provided generally to Sonic Foundry's other salaried employees on the same terms as are applicable to such other employees. For purposes of such incidental benefits of employment which are based upon income, including but not limited to insurance, pension plan and ESOP participation, income shall be deemed to include all amounts payable pursuant to paragraph 5(a) hereof. (c) Employee shall also be reimbursed for all reasonable 2 business expenses incurred in connection with his employment. (d) Prior to the beginning of any calendar year, Employee may defer any portion of his compensation otherwise payable in said following calendar year, by providing written notification to the Board of Directors of Sonic Foundry. Said aggregate deferrals may be payable in installments or in lump sum and shall be subject to the provisions of paragraph six (6) hereof. 6. (a) This Agreement and the employment of Employee hereunder shall terminate on the first to occur of: (i) the expiration of the term specified in Paragraph 3 hereof; (ii) the death or Physical or Mental Disability of Employee as described in Paragraph (g) hereof; (iii) Employee's voluntary departure from employment other than for those reasons described herein in Paragraph 6(c); (iv) Employee's termination pursuant to Paragraphs (b) or (c) hereof. (b) The Board of Directors of Sonic Foundry may terminate or shall be deemed to have terminated the employment of Employee at any time: (i) "with cause" upon the conviction of the Employee for a malfeasance (i.e. theft, embezzlement, fraud or a dishonest act) against Sonic Foundry; or (ii) "without cause" if they shall determine that it is in the best interests of Sonic Foundry to terminate this 3 Agreement for any reason other than the reason described in subparagraph (i) of this paragraph 6(b). (c) In the event, whether prior to or subsequent to a "Change in Control", as hereinafter defined in paragraph 6(e), Employee and Sonic Foundry shall hereafter jointly determine (i) that Employee's status or responsibilities with Sonic Foundry has or have been reduced, including but not limited to the assignment to Employee of any duties, positions, responsibilities or tasks inconsistent with those immediately prior to said reduction, or (ii) that Sonic Foundry has failed to perform its obligations hereunder or in the event, subsequent to a "Change in Control", Employee and Sonic Foundry shall jointly determine that the financial prospects of Sonic Foundry have significantly declined to a level where the future operations of Sonic Foundry would be impaired, Employee shall have the right to terminate his employment with Sonic Foundry by written notice thereof and shall be treated as having terminated his employment pursuant to paragraph 6(f) hereof. In the event that Employee and Sonic Foundry are unable to agree upon any determination pursuant to this paragraph 6(c), an arbitrator, jointly selected by the parties, shall resolve the dispute. In the event the parties are unable to agree upon an arbitrator, the arbitrator shall be selected by two additional arbitrators, one of which shall be an arbitrator selected by Sonic Foundry and the other of which shall be an arbitrator selected by the Employee. (d) In the event Employee's termination is for any 4 reason set out in Paragraphs 6(a)(iii) above prior to a Change in Control or Paragraphs 6(a)(i) or 6(b)(i) above at any time, Employee shall not be entitled to any termination payments or benefits other than (i) salary and other accrued benefits earned up to the date of termination; and (ii) amounts deferred pursuant to Paragraph 5(d) hereof. In the event Employee's termination is for any reason set out in paragraph 6(a)(ii) above prior to a Change in Control, Employee shall be entitled to (i) salary and other accrued benefits earned up to the last day of the month of the date of death or Date of Disability (as defined in paragraph (g) hereof); (ii) all amounts deferred pursuant to paragraph 5(d) hereof and, (iii) a lump sum termination payment equal to the highest yearly salary and bonus paid to Employee pursuant to paragraph 5(a) in any year during the 3 years immediately subsequent to the year in which the death or disability occurs, and, if termination is due to disability, Employee shall also be entitled to the medical, health and insurance-related benefits as set forth in paragraph 5(b) hereof prior to and for one year following the date of disability. (e) For purposes of determining whether a "Change in Control" has occurred, a "Change in Control" shall be defined as the occurrence at any time during the Contract Term of any of the following events: (1) A change in control of a nature that would have had to have been reported in Sonic Foundry's proxy statement, if Sonic Foundry were required to have filed proxy statements under the Securities Exchange Act of 1934 (the "Exchange 5 Act"). (2) Sonic Foundry is merged or consolidated or reorganized into or with another corporation or other legal person and as a result of such merger, consolidation or reorganization less than 75% of the outstanding voting securities or other capital interests of the surviving, resulting or acquiring corporation or other legal person are owned in the aggregate by the stockholders of Sonic Foundry immediately prior to such merger, consolidation or reorganization; (3) Sonic Foundry sells all or substantially all of its business and/or assets to any other corporation or other legal person, less than 75% of the outstanding voting securities or other capital interests of which are owned in the aggregate by the stockholders of Sonic Foundry, directly or indirectly, immediately prior to or after such sale; (4) Any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) of 25% or more of the issued and outstanding shares of voting securities of Sonic Foundry. (5) During any period of two consecutive years, individuals who at the beginning of any such period constitute the Directors of Sonic Foundry cease for any reason to 6 constitute at least a majority thereof unless the election, or the nomination or election by Sonic Foundry's stockholders, of each new Director of Sonic Foundry was approved by a vote of at least two-thirds of such Directors of Sonic Foundry then still in office who were Directors of Sonic Foundry at the beginning of any such period. (f) Upon a termination of Employee's employment for any reason set out in Paragraphs 6(a)(ii) or 6(a)(iii) subsequent to a Change in Control or upon a termination pursuant to the provisions of Paragraph 6(b)(ii) or Paragraph 6(c) above at any time, Employee shall be entitled to (i) salary and other accrued benefits earned up to the last day of the month in which employment was terminated; (ii) all amounts deferred pursuant to Paragraph 5(d) hereof, and (iii) a lump sum termination payment equal to three (3) times the highest yearly salary and bonus paid to Employee pursuant to Paragraph 5(a) in any year during the last three (3) years immediately prior to termination. Employee shall also be entitled to the medical, health and insurance-related benefits as set forth in Paragraph 5(b) hereof prior to and for three years following the date of termination. (g) As used herein, "Physical or Mental Disability" shall mean a serious illness, accident or any other physical or mental incapacity which prevents Employee from substantially performing his duties hereunder for a continuous period of twelve months. The last day of any such twelve (12) month period shall be Employee's "Date of Disability". 7 (h) All payments to be made in the event of the death of the Employee shall be made to the Employee's surviving spouse, or in the event the Employee dies without leaving a surviving spouse, then to such beneficiary as the Employee may designate in writing to Sonic Foundry for that purpose, or if the Employee has not so designated, then to the personal representative of the estate of the Employee. (i) This Section 6 shall not be deemed a limitation of the Employee's benefits under any death or disability plan currently in effect. (j) If litigation shall be brought to enforce or interpret any provision contained in this Agreement, Sonic Foundry agrees to indemnify the Employee for his reasonable attorneys' fees and disbursements incurred in such litigation, and hereby agrees to pay prejudgment interest on any money judgment obtained by the Employee calculated at the prime rate of First National Bank of Chicago, in effect from time to time from the date that payment(s) to him should have been made under this Agreement; provided that the Employee shall not have been found by the court to have acted in bad faith, which finding must be final with the time to appeal therefrom having expired and no appeal having been taken. 7. The Employer will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Employer, by agreement in form and substance satisfactory to the Employee, to expressly assume and agree to perform this Agreement 8 in the same manner and to the same extend that the Employer would be required to perform it if no such succession had taken place. As used in this paragraph, "Employer" shall mean Sonic Foundry, Inc. and any successor to its business and/or assets as aforesaid which executed and delivers the agreement provided for this paragraph 7, or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 8. Employee understands that in the course of his employment with Sonic Foundry, he shall or may be making use of, acquiring, or adding to confidential information of a special and unique nature and value relating to such matters as Sonic Foundry's trade secrets, systems, inventions, programs (including, without limitation, Sonic Foundry's computer software programs), procedures, manuals, confidential reports and communications, and lists of customers and clients. Employee also understands that any information, data and materials received by Sonic Foundry from third-parties in confidence (or subject to nondisclosure or similar covenants), including but not limited to customers, prospective customers, joint ventures, parties to cooperative agreements or partners, shall be deemed to be and shall be confidential information. Employee hereby confirms that he has not and shall not, except with the express, prior written consent of Sonic Foundry, or except if he is acting as an employee of Sonic Foundry solely for the benefit of Sonic Foundry in connection with Sonic Foundry's business and in accordance with Sonic Foundry's business practices and employee policies, at any time during or following 9 the term of his employment by Sonic Foundry, directly or indirectly, disclose, divulge, reveal, report, publish, transfer or use, for any purpose whatsoever, any of such information which has been obtained by or disclosed to him as a result of his employment by Sonic Foundry. Further, Employee agrees to be bound by all nondisclosure or similar covenants between Sonic Foundry and any third- party. 9. Employee further understands that all of the following information and materials are "Protected Information" belonging to Sonic Foundry and shall be kept strictly confidential, even if not physically marked as such: a. Applications, operating system, database, communication and other computer software, whether now or hereafter existing, developed for use on any operating system, all modifications, enhancements and versions and all options available with respect thereto, and all future products developed or derived therefrom; b. Source and object codes, flowcharts, algorithms, coding sheets, routines, sub-routines, compilers, assemblers, design concepts, and related documentation and manuals; c. Products, inventions, production processes, marketing techniques and arrangements, mailing lists, purchasing information, pricing policies, quoting procedures, financial information, customer 10 and prospect names and requirements, employee, customer supplier and distributor data, and other materials and information relating to Sonic Foundry's business and activities and the manner in which Sonic Foundry does business; d. Discoveries, concepts and ideas including, without limitation, the nature and results of research and development activities, processes formulas, inventions, computer-related equipment or technology, techniques, "know-how", designs, drawings, and specifications; e. Any other materials or information related to the business or activities of Sonic Foundry which are not generally known to others engaged in similar businesses or activities; f. All ideas which are derived from or relate to Employee's access to or knowledge of any of the above enumerated materials and information; and g. All information, data and materials received by Sonic Foundry from third-parties in confidence (or subject to nondisclosure or similar covenants), including but not limited to information, data and materials received by Sonic Foundry from customers, prospective customers, joint ventures, parties to cooperative agreements or partners. 10. At Sonic Foundry's request, or, in the absence of such a 11 request, upon termination of Employee's employment with Sonic Foundry, Employee agrees to turn over to Sonic Foundry all notes, data tapes, lists, reference items, sketches, drawings, memoranda, records, and other materials in any way relating to any financial data, Protected Information and Inventions, and other documents that are in his possession or control belonging to Sonic Foundry or relating to its business. 11. Employee represents and warrants that his employment with Sonic Foundry does not and will not breach any agreement or duty which he has to any other party to keep in confidence any confidential information belonging to others. Employee will not disclose to Sonic Foundry or use in its behalf any confidential information belonging to others. Except as set forth on any exhibit that is attached hereto and signed by both parties hereof, Employee does not claim an ownership interest in any inventions. 12. Employee acknowledges that if he were to compete with Sonic Foundry in the audio and multimedia software development business, it could cause serious harm to Sonic Foundry. In the event that the Employee terminates this Agreement or Sonic Foundry terminates this Agreement, the Employee agrees that he will not engage in the audio software business for a period of two (2) years from the time of Employee's termination of employment within the Continental United States. This covenant shall survive the termination of this Agreement and shall apply to any renewal or extension of employment. The restrictive covenant contained herein shall be given the broadest lawful and enforceable scope 12 permissible for the protection of Sonic Foundry. Employee has carefully considered his obligations as stated herein and agrees that the restrictions contained herein are fair and reasonable and are reasonably required for the protection of Sonic Foundry. 13. Employee understands that a breach of this Agreement including, but not limited to, unauthorized copying, assignment, transfer or distribution of Protected Information and Inventions will result in irreparable or immeasurable damage to Sonic Foundry and that Sonic Foundry is authorized to seek injunctive relief against Employee. Employee also consents to the exclusive jurisdiction of the Dane County Circuit Courts or the Federal District Court for the Western District of Wisconsin, both located in Madison, Wisconsin, as the appropriate forums for resolution of any dispute arising from this Agreement, including issuance of an injunction. Employee understands that this provision regarding the issuance of an injunction does not limit any remedies at law or equity otherwise available to Sonic Foundry. 14. No oral arrangements have been made between the parties hereto and this Agreement may be amended only in writing signed by both parties. 15. The rights and obligations of Sonic Foundry under this Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of Sonic Foundry. Employee may not assign his obligations under this Agreement. 16. If any provision of this Agreement shall be declared 13 invalid or unenforceable by a court of competent jurisdiction, the remainder of this Agreement shall not be affected thereby and shall continue in full force and effect. 17. This Agreement shall be construed in accordance with the laws of the State of Wisconsin. IN WITNESS WHEREOF, the parties hereto have set their hands and seals as of the day and year first above written. EMPLOYEE: SONIC FOUNDRY, INC. ____________________________ By: ________________________ Monty R. Schmidt Title:______________________ ____________________________ Witness 14 EX-10.6 10 EMPLOYMENT AGREEMENT WITH CURTIS J. PALMER EXHIBIT 10.6 EMPLOYMENT AGREEMENT -------------------- THIS IS AN EMPLOYMENT AGREEMENT made as of the ___ day of November, 1997 and effective as of January 1, 1997, by and between SONIC FOUNDRY, INC. ("Sonic Foundry") and CURTIS J. PALMER ("Employee"), who resides at ____________________________________. WHEREAS, Employee has been serving as Chief Technology Officer of Sonic Foundry since prior to January, 1997; and WHEREAS, Sonic Foundry desires to continue to employ Employee, and Employee desires to continue to be employed by Sonic Foundry; and WHEREAS, Sonic Foundry and Employee desire to enter into an employment agreement which will confirm and set forth the terms and conditions of Employee's employment with Sonic Foundry. NOW THEREFORE, in consideration of the premises to this Agreement and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, Sonic Foundry and Employee agree as follows: 1. Sonic Foundry hereby hires and employs the Employee, and the Employee agrees to continue to work for Sonic Foundry under the following terms hereby agreed upon. 2. The Employee is hereby engaged to work in the executive capacity of Chief Technology Officer of Sonic Foundry, or any other capacity so designated by Sonic Foundry, generally consistent with Employee's present duties and responsibilities. 3. The Employee shall enter into service and commence work hereunder as of the date hereof and the employment shall continue, unless sooner terminated pursuant to the terms hereof, until January 1, 2001 (the "Contract Term"). 4. The Employee agrees that he shall devote sufficient skill, labor and attention to said employment during the Contract Term in order to promptly and faithfully do and perform all services pertaining to said position that are or may hereafter be required of him by Sonic Foundry during the Contract Term. 5. Sonic Foundry agrees as follows: (a) Sonic Foundry shall pay the Employee a base salary at the rate of $125,000 per year during each year of the Contract Term, payable bi-weekly. The Board of Directors of Sonic Foundry (or a duly constituted and empowered committee thereof) may further increase Employee's salary effective on each anniversary date of this Agreement, at its discretion. In addition, the Employee shall receive annual bonuses as may be declared by the Board of Directors of Sonic Foundry (or a duly constituted and empowered committee thereof). (b) Employee shall receive such other incidental benefits of employment, such as insurance, pension plan and ESOP participation, and vacation, as are provided generally to Sonic Foundry's other salaried employees on the same terms as are applicable to such other employees. For purposes of such incidental benefits of employment which are based upon income, including but not limited to insurance, pension plan and ESOP participation, income shall be deemed to include all amounts payable pursuant to paragraph 5(a) hereof. (c) Employee shall also be reimbursed for all reasonable 2 business expenses incurred in connection with his employment. (d) Prior to the beginning of any calendar year, Employee may defer any portion of his compensation otherwise payable in said following calendar year, by providing written notification to the Board of Directors of Sonic Foundry. Said aggregate deferrals may be payable in installments or in lump sum and shall be subject to the provisions of paragraph six (6) hereof. 6. (a) This Agreement and the employment of Employee hereunder shall terminate on the first to occur of: (i) the expiration of the term specified in Paragraph 3 hereof; (ii) the death or Physical or Mental Disability of Employee as described in Paragraph (g) hereof; (iii) Employee's voluntary departure from employment other than for those reasons described herein in Paragraph 6(c); (iv) Employee's termination pursuant to Paragraphs (b) or (c) hereof. (b) The Board of Directors of Sonic Foundry may terminate or shall be deemed to have terminated the employment of Employee at any time: (i) "with cause" upon the conviction of the Employee for a malfeasance (i.e. theft, embezzlement, fraud or a dishonest act) against Sonic Foundry; or (ii) "without cause" if they shall determine that it is in the best interests of Sonic Foundry to terminate this 3 Agreement for any reason other than the reason described in subparagraph (i) of this paragraph 6(b). (c) In the event, whether prior to or subsequent to a "Change in Control", as hereinafter defined in paragraph 6(e), Employee and Sonic Foundry shall hereafter jointly determine (i) that Employee's status or responsibilities with Sonic Foundry has or have been reduced, including but not limited to the assignment to Employee of any duties, positions, responsibilities or tasks inconsistent with those immediately prior to said reduction, or (ii) that Sonic Foundry has failed to perform its obligations hereunder or in the event, subsequent to a "Change in Control", Employee and Sonic Foundry shall jointly determine that the financial prospects of Sonic Foundry have significantly declined to a level where the future operations of Sonic Foundry would be impaired, Employee shall have the right to terminate his employment with Sonic Foundry by written notice thereof and shall be treated as having terminated his employment pursuant to paragraph 6(f) hereof. In the event that Employee and Sonic Foundry are unable to agree upon any determination pursuant to this paragraph 6(c), an arbitrator, jointly selected by the parties, shall resolve the dispute. In the event the parties are unable to agree upon an arbitrator, the arbitrator shall be selected by two additional arbitrators, one of which shall be an arbitrator selected by Sonic Foundry and the other of which shall be an arbitrator selected by the Employee. (d) In the event Employee's termination is for any 4 reason set out in Paragraphs 6(a)(iii) above prior to a Change in Control or Paragraphs 6(a)(i) or 6(b)(i) above at any time, Employee shall not be entitled to any termination payments or benefits other than (i) salary and other accrued benefits earned up to the date of termination; and (ii) amounts deferred pursuant to Paragraph 5(d) hereof. In the event Employee's termination is for any reason set out in paragraph 6(a)(ii) above prior to a Change in Control, Employee shall be entitled to (i) salary and other accrued benefits earned up to the last day of the month of the date of death or Date of Disability (as defined in paragraph (g) hereof); (ii) all amounts deferred pursuant to paragraph 5(d) hereof and, (iii) a lump sum termination payment equal to the highest yearly salary and bonus paid to Employee pursuant to paragraph 5(a) in any year during the 3 years immediately subsequent to the year in which the death or disability occurs, and, if termination is due to disability, Employee shall also be entitled to the medical, health and insurance-related benefits as set forth in paragraph 5(b) hereof prior to and for one year following the date of disability. (e) For purposes of determining whether a "Change in Control" has occurred, a "Change in Control" shall be defined as the occurrence at any time during the Contract Term of any of the following events: (1) A change in control of a nature that would have had to have been reported in Sonic Foundry's proxy statement, if Sonic Foundry were required to have filed proxy statements under the Securities Exchange Act of 1934 (the "Exchange 5 Act"). (2) Sonic Foundry is merged or consolidated or reorganized into or with another corporation or other legal person and as a result of such merger, consolidation or reorganization less than 75% of the outstanding voting securities or other capital interests of the surviving, resulting or acquiring corporation or other legal person are owned in the aggregate by the stockholders of Sonic Foundry immediately prior to such merger, consolidation or reorganization; (3) Sonic Foundry sells all or substantially all of its business and/or assets to any other corporation or other legal person, less than 75% of the outstanding voting securities or other capital interests of which are owned in the aggregate by the stockholders of Sonic Foundry, directly or indirectly, immediately prior to or after such sale; (4) Any person (as the term "person" is used in Section 13(d)(3) or Section 14(d)(2) of the Exchange Act) has become the beneficial owner (as the term "beneficial owner" is defined under Rule 13d-3 or any successor rule or regulation promulgated under the Exchange Act) of 25% or more of the issued and outstanding shares of voting securities of Sonic Foundry. (5) During any period of two consecutive years, individuals who at the beginning of any such period constitute the Directors of Sonic Foundry cease for any reason to 6 constitute at least a majority thereof unless the election, or the nomination or election by Sonic Foundry's stockholders, of each new Director of Sonic Foundry was approved by a vote of at least two-thirds of such Directors of Sonic Foundry then still in office who were Directors of Sonic Foundry at the beginning of any such period. (f) Upon a termination of Employee's employment for any reason set out in Paragraphs 6(a)(ii) or 6(a)(iii) subsequent to a Change in Control or upon a termination pursuant to the provisions of Paragraph 6(b)(ii) or Paragraph 6(c) above at any time, Employee shall be entitled to (i) salary and other accrued benefits earned up to the last day of the month in which employment was terminated; (ii) all amounts deferred pursuant to Paragraph 5(d) hereof, and (iii) a lump sum termination payment equal to three (3) times the highest yearly salary and bonus paid to Employee pursuant to Paragraph 5(a) in any year during the last three (3) years immediately prior to termination. Employee shall also be entitled to the medical, health and insurance-related benefits as set forth in Paragraph 5(b) hereof prior to and for three years following the date of termination. (g) As used herein, "Physical or Mental Disability" shall mean a serious illness, accident or any other physical or mental incapacity which prevents Employee from substantially performing his duties hereunder for a continuous period of twelve months. The last day of any such twelve (12) month period shall be Employee's "Date of Disability". 7 (h) All payments to be made in the event of the death of the Employee shall be made to the Employee's surviving spouse, or in the event the Employee dies without leaving a surviving spouse, then to such beneficiary as the Employee may designate in writing to Sonic Foundry for that purpose, or if the Employee has not so designated, then to the personal representative of the estate of the Employee. (i) This Section 6 shall not be deemed a limitation of the Employee's benefits under any death or disability plan currently in effect. (j) If litigation shall be brought to enforce or interpret any provision contained in this Agreement, Sonic Foundry agrees to indemnify the Employee for his reasonable attorneys' fees and disbursements incurred in such litigation, and hereby agrees to pay prejudgment interest on any money judgment obtained by the Employee calculated at the prime rate of First National Bank of Chicago, in effect from time to time from the date that payment(s) to him should have been made under this Agreement; provided that the Employee shall not have been found by the court to have acted in bad faith, which finding must be final with the time to appeal therefrom having expired and no appeal having been taken. 7. The Employer will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Employer, by agreement in form and substance satisfactory to the Employee, to expressly assume and agree to perform this Agreement 8 in the same manner and to the same extend that the Employer would be required to perform it if no such succession had taken place. As used in this paragraph, "Employer" shall mean Sonic Foundry, Inc. and any successor to its business and/or assets as aforesaid which executed and delivers the agreement provided for this paragraph 7, or which otherwise becomes bound by all the terms and provisions of this Agreement by operation of law. 8. Employee understands that in the course of his employment with Sonic Foundry, he shall or may be making use of, acquiring, or adding to confidential information of a special and unique nature and value relating to such matters as Sonic Foundry's trade secrets, systems, inventions, programs (including, without limitation, Sonic Foundry's computer software programs), procedures, manuals, confidential reports and communications, and lists of customers and clients. Employee also understands that any information, data and materials received by Sonic Foundry from third-parties in confidence (or subject to nondisclosure or similar covenants), including but not limited to customers, prospective customers, joint ventures, parties to cooperative agreements or partners, shall be deemed to be and shall be confidential information. Employee hereby confirms that he has not and shall not, except with the express, prior written consent of Sonic Foundry, or except if he is acting as an employee of Sonic Foundry solely for the benefit of Sonic Foundry in connection with Sonic Foundry's business and in accordance with Sonic Foundry's business practices and employee policies, at any time during or following 9 the term of his employment by Sonic Foundry, directly or indirectly, disclose, divulge, reveal, report, publish, transfer or use, for any purpose whatsoever, any of such information which has been obtained by or disclosed to him as a result of his employment by Sonic Foundry. Further, Employee agrees to be bound by all nondisclosure or similar covenants between Sonic Foundry and any third- party. 9. Employee further understands that all of the following information and materials are "Protected Information" belonging to Sonic Foundry and shall be kept strictly confidential, even if not physically marked as such: a. Applications, operating system, database, communication and other computer software, whether now or hereafter existing, developed for use on any operating system, all modifications, enhancements and versions and all options available with respect thereto, and all future products developed or derived therefrom; b. Source and object codes, flowcharts, algorithms, coding sheets, routines, sub-routines, compilers, assemblers, design concepts, and related documentation and manuals; c. Products, inventions, production processes, marketing techniques and arrangements, mailing lists, purchasing information, pricing policies, quoting procedures, financial information, customer 10 and prospect names and requirements, employee, customer supplier and distributor data, and other materials and information relating to Sonic Foundry's business and activities and the manner in which Sonic Foundry does business; d. Discoveries, concepts and ideas including, without limitation, the nature and results of research and development activities, processes formulas, inventions, computer-related equipment or technology, techniques, "know-how", designs, drawings, and specifications; e. Any other materials or information related to the business or activities of Sonic Foundry which are not generally known to others engaged in similar businesses or activities; f. All ideas which are derived from or relate to Employee's access to or knowledge of any of the above enumerated materials and information; and g. All information, data and materials received by Sonic Foundry from third-parties in confidence ( or subject to nondisclosure or similar covenants), including but not limited to information, data and materials received by Sonic Foundry from customers, prospective customers, joint ventures, parties to cooperative agreements or partners. 10. At Sonic Foundry's request, or, in the absence of such a 11 request, upon termination of Employee's employment with Sonic Foundry, Employee agrees to turn over to Sonic Foundry all notes, data tapes, lists, reference items, sketches, drawings, memoranda, records, and other materials in any way relating to any financial data, Protected Information and Inventions, and other documents that are in his possession or control belonging to Sonic Foundry or relating to its business. 11. Employee represents and warrants that his employment with Sonic Foundry does not and will not breach any agreement or duty which he has to any other party to keep in confidence any confidential information belonging to others. Employee will not disclose to Sonic Foundry or use in its behalf any confidential information belonging to others. Except as set forth on any exhibit that is attached hereto and signed by both parties hereof, Employee does not claim an ownership interest in any inventions. 12. Employee acknowledges that if he were to compete with Sonic Foundry in the audio and multimedia software development business, it could cause serious harm to Sonic Foundry. In the event that the Employee terminates this Agreement or Sonic Foundry terminates this Agreement, the Employee agrees that he will not engage in the audio software business for a period of two (2) years from the time of Employee's termination of employment within the Continental United States. This covenant shall survive the termination of this Agreement and shall apply to any renewal or extension of employment. The restrictive covenant contained herein shall be given the broadest lawful and enforceable scope 12 permissible for the protection of Sonic Foundry. Employee has carefully considered his obligations as stated herein and agrees that the restrictions contained herein are fair and reasonable and are reasonably required for the protection of Sonic Foundry. 13. Employee understands that a breach of this Agreement including, but not limited to, unauthorized copying, assignment, transfer or distribution of Protected Information and Inventions will result in irreparable or immeasurable damage to Sonic Foundry and that Sonic Foundry is authorized to seek injunctive relief against Employee. Employee also consents to the exclusive jurisdiction of the Dane County Circuit Courts or the Federal District Court for the Western District of Wisconsin, both located in Madison, Wisconsin, as the appropriate forums for resolution of any dispute arising from this Agreement, including issuance of an injunction. Employee understands that this provision regarding the issuance of an injunction does not limit any remedies at law or equity otherwise available to Sonic Foundry. 14. No oral arrangements have been made between the parties hereto and this Agreement may be amended only in writing signed by both parties. 15. The rights and obligations of Sonic Foundry under this Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of Sonic Foundry. Employee may not assign his obligations under this Agreement. 16. If any provision of this Agreement shall be declared 13 invalid or unenforceable by a court of competent jurisdiction, the remainder of this Agreement shall not be affected thereby and shall continue in full force and effect. 17. This Agreement shall be construed in accordance with the laws of the State of Wisconsin. IN WITNESS WHEREOF, the parties hereto have set their hands and seals as of the day and year first above written. EMPLOYEE: SONIC FOUNDRY, INC. ____________________________ By: ________________________ Curtis J. Palmer Title:______________________ ____________________________ Witness 14 EX-10.7 11 DIGITAL AUDIO SYSTEM LICENSE AGREEMENT [LOGO OF DOLBY LABORATORIES LICENSING CORPORATION APPEARS HERE] DIGITAL AUDIO SYSTEM LICENSE AGREEMENT PROFESSIONAL ENCODERS AN AGREEMENT - ------------ BY AND BETWEEN - -------------- Dolby Laboratories Licensing Corporation and Sonic Foundry (hereinafter called "LICENSOR") (hereinafter called "LICENSEE") of 100 Potrero Avenue of 100 South Baldwin Street, San Francisco, CA 94103-4813 Suite 204 Madison, WI 53703 Facsimile telephone number of LICENSOR for transmission of quarterly royalty reports (Section 4.05): (415) 863-1373 LICENSOR's bank and account number for wire transfer of royalty payments (Section 4.05): Bank: Wells Fargo Bank Address: 464 California Street, San Francisco, CA 94104 U.S.A. Account Name: Dolby Laboratories Licensing Corporation Account Number: 4001-191451 ABA Number: 121000248 Identification of bank with respect to whose prime rate interest is calculated on overdue royalties (Section 4.06): Wells Fargo Bank Address of LICENSEE for communications not otherwise specified (Section 8.04):
SIGNATURES: - ----------- On behalf of LICENSOR On behalf of LICENSEE Signature: /s/ Lily S. Cheung Signature: /s/ RIMANTAS P. BUINEVICIUS --------------------------------- --------------------------- Name: Lily S. Cheung Name: RIMANTAS P. BUINEVICIUS --------------------------------- --------------------------- Title: Intellectual Property Manager Title: CEO --------------------------------- --------------------------- Place: San Francisco, California, U.S.A. Place: SONIC FOUNDRY, INC. --------------------------------- --------------------------- Date: July 28, 1997 Date: 6/27/97 --------------------------------- --------------------------- Witnessed By: Witnessed By: /s/ Lara Thompson /s/ Kenneth A. Minor - ---------------------------- -----------------------------
Effective Date of Agreement: July 28, 1997 Initial Payment: $10,000 DIGITAL AUDIO SYSTEM LICENSE AGREEMENT PROFESSIONAL ENCODERS INDEX ----- Preamble I. DEFINITIONS Section 1.01 - "LICENSOR" Section 1.02 - "LICENSEE" Section 1.03 - "Application" Section 1.04 - "Patent" Section 1.05 - "Related Application" Section 1.06 - "Related Patent" Section 1.07 - "Scheduled Patents" Section 1.08 - "Dolby Digital AC-3 Audio System Specifications" Section 1.09 - Section Deleted Section 1.10 - "Licensed Device" Section 1.11 - "Licensed Product" Section 1.12 - "Patent Rights" Section 1.13 - Section Deleted Section 1.14 - "Sensitive Information" Section 1.15 - "Non-Patent Country" Section 1.16 - "LICENSEE's Trade Name and Trademarks" Section 1.17 - Section Deleted Section 1.18 - Section Deleted Section 1.19 - The "Consumer Price Index" Section 1.20 - The "Effective Date" II. LICENSES GRANTED Section 2.01 - Licenses Granted to LICENSEE Section 2.02 - Limitation of Licenses Granted III. OTHER OBLIGATIONS OF LICENSEE AND LICENSOR Section 3.01 - Section Deleted Section 3.02 - Section Deleted Section 3.03 - Section Deleted Section 3.04 - Patent Enforcement Section 3.05 - Section Deleted Section 3.06 - Patent Marking Section 3.07 - Section Deleted Section 3.08 - Section Deleted Section 3.09 - License Notice Section 3.10 - Section Deleted Section 3.11 - Use of Sensitive Information IV. PAYMENTS Section 4.01 - Initial Payment Section 4.02 - Royalties Section 4.03 - Manufacture of Licensed Products by Another Licensee Section 4.04 - Royalty Applicability Section 4.05 - Royalty Payments and Statements Section 4.06 - Royalties in Non-Patent Country Section 4.07 - Books and Records Section 4.08 - Rights of Inspecting Books and Records V. ARTICLE DELETED VI. TERMINATION AND EFFECT OF TERMINATION Section 6.01 - Expiration of Agreement Section 6.02 - Termination for Cause Section 6.03 - Option to Terminate in a Non-Patent Country Section 6.04 - Effect of Termination VII. LIMITATIONS OF RIGHTS AND AUTHORITY Section 7.01 - Limitation of Rights Section 7.02 - Limitation of Authority Section 7.03 - Disclaimer of Warranties and Liability; Hold Harmless Section 7.04 - Limitation of Assignment by LICENSEE Section 7.05 - Compliance with U.S. Export Control Regulations VIII. MISCELLANEOUS PROVISIONS Section 8.01 - Language of Agreement; Language of Notices Section 8.02 - Stability of Agreement Section 8.03 - Public Announcements Section 8.04 - Address of LICENSEE and LICENSOR for all Other Communications Section 8.05 - Applicable Law Section 8.06 - Choice of Forum; Attorneys' Fees Section 8.07 - Construction of Agreement Section 8.08 - Captions Section 8.09 - Singular and Plural Section 8.10 - Complete Agreement Section 8.11 - Severability Section 8.12 - Company Representation and Warranty Section 8.13 - Execution Appendix A - Scheduled Patents Appendix B - Dolby Digital AC-3 Audio System Appendix C - Preliminary Specifications for Dolby Digital AC-3 Encoders Appendix D - Deleted Appendix E - Royalty Schedule 1 DIGITAL AUDIO SYSTEM LICENSE AGREEMENT WHEREAS, LICENSOR is engaged in the field of audio signal processing systems and has developed signal processing systems useful for audio tape recording and playback and for other applications; and WHEREAS, LICENSOR has developed the model Dolby Digital AC-3 audio system which uses a new technique for encoding and decoding of audio frequency data in digital form with a substantially reduced bit-rate while maintaining a high quality decoded audio signal; WHEREAS, LICENSOR's model Dolby Digital AC-3 audio system and its manufacture embody inventive subject matter which are the subject of international patents and patent applications owned or licensable by LICENSOR, WHEREAS, LICENSOR represents and warrants that it has rights to grant licenses under such patents and patent applications; WHEREAS, LICENSEE is engaged in the manufacture of equipment for the encoding of entertainment source material into a variety of digitally compressed formats; WHEREAS, LICENSEE desires a non-exclusive license to manufacture and sell professional encoding equipment using LICENSOR's model Dolby Digital AC-3 audio system under LICENSOR's patents and patent applications; and WHEREAS, LICENSOR is willing to grant such a license under the terms and conditions set forth in this Agreement. NOW, THEREFORE, it is agreed by and between LICENSOR and LICENSEE as follows: 2 ARTICLE I DEFINITIONS Section 1.01 - "LICENSOR" means Dolby Laboratories Licensing Corporation, a ------------------------- corporation of the State of New York, having a place of business as indicated on the title page of this Agreement, and its successors and assigns. Section 1.02 - "LICENSEE" means the corporation identified on the title ------------------------- page of this Agreement and any subsidiary thereof of whose ordinary voting shares more than 50% are controlled directly or indirectly by such corporation, but only so long as such control exists. Section 1.03 - "Application" means an application for the protection of an ---------------------------- invention or an industrial design; references to an "Application" shall be construed as references to applications for patents for inventions, inventors' certificates, utility certificates, utility models, patents or certificates of addition, inventors' certificates of addition, utility certificates of addition, design patents, and industrial design registrations. Section 1.04.- "Patent" means patents for inventions, inventors' ----------------------- certificates, utility certificates, utility models, patents or certificates of addition, inventors' certificates of addition, utility certificates of addition, design patents, and industrial design registrations. Section 1.05 "Related Application" means an Application, whether ---------------------------------- international or in the same or another country or region, which (1) is substantially the same as (e.g., it does not include any new matter in the sense of the United States Patent Law) an Application or Patent listed in Appendix A, entitled "Scheduled Patents and Applications," which is attached hereto and forms an integral part of this Agreement (for example, without limiting the foregoing; a continuation Application, a corresponding Application, an Application to reissue, or a re-filed Application), or (2) is substantially only a portion of (e.g., it contains less than an Application or Patent listed in Appendix A and, it does not include any new matter in the sense of the United States Patent Law) an Application or Patent listed in Appendix A (for example, a divisional Application, or a corresponding or refiled Application in the nature of a divisional Application). 3 Section 1.06 - "Related Patent" means: -------------------------------------- (1) a Patent granted on an Application listed in Appendix A, (2) a Patent granted on a Related Application, (3) a reissue of a Patent of Sections 1.06(1) or 1.06(2), and (4) a reexamination certificate of a Patent of Sections 1.06 (1), 1.06(2), or 1.06(3). Section 1.07 - "Scheduled Patents" means the Applications and Patents ---------------------------------- listed in Appendix A together with Related Applications and Related Patents. Applications and Patents which contain not only common subject matter but also additional subject matter going beyond the disclosure of Applications and Patents of this Section (for example, without limiting the foregoing, a continuation-in-part Application, or a corresponding or re-filed Application in the nature of a continuation-in-part Application) shall be deemed to be Scheduled Patents only with respect to that portion of their subject matter common to the Applications and Patents of this Section. Section 1.08 - "Dolby Digital AC-3 Audio System Specifications" means the --------------------------------------------------------------- specifications for the Dolby Digital AC-3 audio system, comprising the claims and teachings of the Scheduled Patents, the Dolby Digital AC-3 audio system operating parameters as specified in Appendix B entitled "Dolby Digital AC-3 Audio System," and the "Preliminary Specifications for Dolby Digital AC-3 Encoders" as specified in Appendix C. Appendices B and C are attached hereto and form an integral part of this Agreement. Section 1.09 - Section Deleted ------------------------------ Section 1.10 - "Licensed Device" means a digital audio circuit having Dolby -------------------------------- Digital AC-3 Audio System Specifications, whether made in discrete component, integrated circuit, or other forms, for encoding one audio channel into a digital AC-3 bitstream. A circuit counts as one "Licensed Device" for each input audio channel it can simultaneously encode. Section 1.11 - "Licensed Product" means a complete ready-to-use electronic --------------------------------- professional encoder product which: (1) contains one or more Licensed Devices; (2) is sold in conjunction with, or as an encoder product package that has both video and audio encoding capabilities, the video component of which is manufactured by LICENSEE; and (3) is intended to encode one or more audio channels from digital or analog sources into an AC-3 bitstream; 4 (4) may have a built in "confidence" audio decoder for checking the encoded bitstream. Such confidence decoder may not include Dolby Pro Logic decoding capability, a noise sequencer, any bass management or level trims. It may not be sold as a stand-alone unit. A Licensed Product is not a semiconductor chip, a partially assembled product, a product in kit form, or a knocked-down or semi-knocked-down product. Section 1.12 "Patent Rights" means: ----------------------------------- (1) the Scheduled Patents; and (2) such Patents and Applications directed to Licensed Products that LICENSOR may own or gain rights to license during the term of this Agreement and which LICENSOR may agree to include in the Patent Rights without payment of additional compensation by LICENSEE. The Patent Rights do not include such other Applications and Patents as LICENSOR does not agree to include in the Patent Rights without payment of additional compensation by LICENSEE. Section 1.13 - Section Deleted ------------------------------ Section 1.14 - "Sensitive Information" means non-technical proprietary -------------------------------------- information of LICENSOR or L1CENSEE, including, without limiting the foregoing, marketing information, product plans, business plans, royalty, and sales information. Section 1.15 - "Non-Patent Country" means a country in which there do not ----------------------------------- exist, with respect to a Licensed Product, any Scheduled Patents including any pending Application or unexpired Patent, which, but for the licenses herein granted, are (or in the case of an Application, would be if it were an issued Patent) infringed by the manufacture, and/or use, lease or sale of such Licensed Product. Section 1.16 - "LICENSEE's Trade Name and Trademarks" means any trade name ----------------------------------------------------- or trademark used and owned by LICENSEE. Section 1.17 - Section Deleted ------------------------------ Section 1.18 - Section Deleted ------------------------------ Section 1.19 - The "Consumer Price Index" means the U.S. City Average Index ----------------------------------------- (base of 1982-1984=100) of the Consumer Price Index for All Urban Consumers as published by the Department of Labor, Bureau of Labor Statistics of the United States Government. In the event that said Index ceases to be published under its present name or form or ceases to be published by the same government entity, reference shall be made to the most similar index then available. 5 Section 1.20 - The "Effective Date" of this Agreement is the date of ----------------------------------- execution hereof by the last party to execute the Agreement, or, if this Agreement requires validation by any governmental or quasi-governmental body, the "Effective Date" is the date of validation of this Agreement. ARTICLE II LICENSES GRANTED ---------------- Section 2.01 - Licenses Granted to LICENSEE ------------------------------------------- LICENSOR hereby grants to LICENSEE: a personal, non-transferable, indivisible, and non-exclusive license throughout the world under the Patent Rights, subject to the conditions set forth and LICENSEE's performance of its obligations, including paying royalties due, to make Licensed Products, and to use, lease and sell the same. Section 2.02 - Limitation of Licenses Granted --------------------------------------------- Notwithstanding the license granted under Section 2.01: (1) no license is granted to lease, sell, transfer, or otherwise dispose of any part of a Licensed Product, including, without limiting the foregoing, a semiconductor chip specially adapted for use in a Licensed Product, which part (a) is a material part of an invention which is the subject of a Scheduled Patent and which part is not a staple article or commodity of commerce suitable for substantial noninfringing use or (b) is not a spare part solely for the repair of a Licensed Product manufactured by Licensee under this Agreement; (2) no license is granted under this Agreement to lease, sell, transfer, or otherwise dispose of any partially assembled products, products in kit form, and knocked-down or semi-knocked-down products; (3) no license is granted under this Agreement to copy any of LICENSOR's own hardware designs or any of LICENSOR's proprietary software; (4) no license is granted under this Agreement with respect to LICENSOR's A-type, B-type, C-type, SR or S-type noise reduction systems; (5) no license is granted under this Agreement with respect to LICENSOR's Consumer Surround Decoder Systems; 6 (6) no license is granted under this Agreement to use any Licensed Trademark in connection with offering for sale or in advertising and/or informational material relating to any Licensed Product; (7) no right is granted with respect to LICENSOR's trade name "Dolby Laboratories" except with respect to the use of said tradename on and in connection with Licensed Products in the License Notice required by Section 3.09; and (8) no right to grant sublicenses is granted under this Agreement. ARTICLE III OTHER OBLIGATIONS OF THE LICENSOR AND LICENSEE ---------------------------------------------- Section 3.01 - Section Deleted ------------------------------ Section 3.02 - Section Deleted ------------------------------ Section 3.03 - Section Deleted ------------------------------ Section 3.04 - Patent Enforcement --------------------------------- LICENSEE shall immediately inform LICENSOR of all Infringements, potential or actual, which may come to its attention, of the Patent Rights. It shall be the exclusive responsibility of LICENSOR, at its own expense, to terminate, compromise, or otherwise act at its discretion with respect to such infringements. LICENSEE agrees to cooperate with LICENSOR by furnishing, without charge, except out-of-pocket expenses, such evidence, documents and testimony as may be required therein. Section 3.05 - Section Deleted ------------------------------ Section 3.06 - Patent Marking ------------------------------ LICENSEE shall mark each Licensed Product in the form, manner and location specified by LICENSOR, with one or more patent numbers of Patents in such countries under which a license is granted under this Agreement. Section 3.07 - Section Deleted ------------------------------ Section 3.08 - Section Deleted ------------------------------ Section 3.09 - License Notice ----------------------------- On all Licensed Products, LICENSEE shall acknowledge that the Licensed Products are manufactured under license from LICENSOR. The following notice shall be used by LICENSEE on an 7 exposed surface, such as the back or the bottom, of all Licensed Products: "Dolby Digital AC-3 audio system manufactured under license from Dolby Laboratories". Such notice shall also be used in all instruction and servicing manuals unless such acknowledgment is clearly and unambiguously given in the course of any textual descriptions or explanations. Section 3.10 - Section Deleted ------------------------------ Section 3.11 - Use of Sensitive Information ------------------------------------------- 3.11(1) - By LICENSEE --------------------- LICENSEE shall use all Sensitive Information obtained heretofore or hereafter from LICENSOR solely for the purpose of manufacturing and selling Licensed Products under this Agreement, shall not use such Sensitive Information in an unauthorized way, and shall not divulge such Sensitive Information or any portion thereof to third parties, unless such Sensitive Information (a) was known to LICENSEE prior to its obtaining the same from LICENSOR; (b) becomes known to LICENSEE from sources other than either directly or indirectly from LICENSOR; or (c) becomes public knowledge other than by breach of this Agreement by LICENSEE or by another licensee of LICENSOR. The obligations of this subsection 3.11(1) shall cease six (6) years from the date on which such Sensitive Information are acquired by LICENSEE from LICENSOR under this Agreement. 3.11(2) - By LICENSOR --------------------- Except as provided by Article IV of this Agreement, LICENSEE is not obligated to disclose to LICENSOR any information that it deems proprietary or sensitive. Except as provided by Article IV of this Agreement, LICENSOR has no obligation to treat in confidence, nor to restrict, in any way, the use, reproduction, or publication of information obtained from LICENSEE. ARTICLE IV PAYMENTS -------- Section 4.01 - Initial Payment ------------------------------ LICENSEE shall promptly upon the Effective Date of this Agreement pay LICENSOR the sum specified on the title page and shall pay all local fees, taxes, duties, or charges of any kind and shall not deduct them from the payment due. 8 Section 4.02 - Royalties ------------------------- Subject to the provisions of Section 4.05, LICENSEE shall pay to LICENSOR royalties on Licensed Devices manufactured by or for LICENSEE and incorporated in Licensed Products which are used, sold, leased, or otherwise disposed of by LICENSEE, except for Licensed Devices incorporated in Licensed Products returned to LICENSEE by customers of LICENSEE, other than in exchange for an upgraded product, on which a credit has been allowed by LICENSEE to said customers. The royalty payable shall be based on the number of Licensed Devices, hereinbefore defined, contained in Licensed Products, which are used, sold, leased or otherwise disposed of by LICENSEE in successive calendar quarters from the effective date hereof, based on the schedule given in Appendix E of this Agreement. On the Effective Date of this Agreement, and annually thereafter on first day of each calendar year, the rate at which the royalties are calculated shall be adjusted in accordance with the Consumer Price Index. The adjustment shall be made by multiplying the royalties calculated as specified above by the ratio between the Consumer Price Index for the last month of the year preceding the year in which the adjustment takes place and the Consumer Price Index for the month of December 1993. LICENSOR will, during the first quarter of each calendar year, or as soon as such information is known, if later, inform LICENSEE of the adjustment ratio to be applied to royalties due in that year. The first adjustment to royalty rates shall be made in the quarter commencing January 1, 1995. Section 4.03 - Manufacture of Licensed Products by Another Licensee. --------------------------------------------------------------------- If L1CENSEE purchases Licensed Products from or has Licensed Products made for it by another party holding a Licensed Product license then LICENSEE shall have no royalty obligation under this Agreement, but all other rights and obligations of LICENSEE under this Agreement shall be fully effective. Section 4.04 - Royalty Applicability ------------------------------------- A Licensed Product shall be considered sold under Section 4.02 when invoiced, or if not invoiced, delivered to another by LICENSEE or otherwise disposed of or put into use by LICENSEE, except for consignment shipments, which will be considered sold when the payment for such shipments is agreed upon between LICENSEE and customer. Section 4.05 - Royalty Payments and Statements ---------------------------------------------- Unless Licensed Products are manufactured for LICENSEE under the provisions of Section 4.03 of this Agreement, LICENSEE shall render statements and royalty payments as follows: 9 (1) LICENSEE shall deliver to the address shown on the cover sheet of this Agreement or such place as LICENSOR may from time to time designate, quarterly reports certified by LICENSEE's chief financial officer or the officer's designate within 30 days after each calendar quarter ending with the last day of March, June, September and December. Alternatively, such reports may be delivered by facsimile by transmitting them to LICENSOR's facsimile telephone number shown on the cover sheet of this Agreement or such other number as LICENSOR may from time to time designate. Royalty payments are due for each quarter at the same time as each quarterly report and shall be made by wire transfer in United States funds to LICENSOR's bank as identified on the cover sheet of this Agreement or such other bank as LICENSOR may from time to time designate. LICENSEE shall pay all local fees, taxes, duties, or charges of any kind and shall not deduct them from the royalties due unless such deductions may be offset against LICENSOR's own tax liabilities. Each quarterly report shall: (a) state the number of each model type of Licensed Products leased, sold, or otherwise disposed of by LICENSEE during the calendar quarter with respect to which the report is due; (b) state the number of Licensed Devices in each model type of Licensed Product; and (c) contain such other information and be in such form as LICENSOR or its outside auditors may prescribe. If LICENSEE claims less than full product royalty (under Section 4.06) or no royalty due (under Section 6.03), LICENSEE shall specify the country in which such Licensed Products were made, the country in which such Licensed Products were sold, and the identity of the purchasers of such Licensed Products. (2) Any remittance in excess of royalties due with respect to the calendar quarter for which the report is due shall be applied by LICENSOR to the next payment due. (3) LICENSEE's first report shall be for the calendar quarter in which LICENSEE sells its first Licensed Product. (4) LICENSEE shall deliver a final report and payment of royalties to LICENSOR certified by LICENSEE's chief financial officer or the officer's designate within 30 days after termination of this Agreement throughout the world. Such a final report shall include a report of all royalties due with respect to Licensed Products not previously reported to LICENSOR. Such final report shall be supplemented at 10 the end of the next and subsequent quarters, in the same manner as provided for during the Life of the Agreement, in the event that LICENSEE learns of any additional royalties due. (5) LICENSEE shall pay interest to LICENSOR from the due date to the date payment is made of any overdue royalties or fees, including the Initial Payment, at the rate of 2% above the prime rate as is in effect from time to time at the bank identified on the cover page of this Agreement, or another major bank agreed to by the LICENSOR and LICENSEE in the event that the identified bank should cease to exist, provided however, that if the interest rate thus determined is in excess of rates allowable by any applicable law, the maximum interest rate allowable by such law shall apply. Section 4.06 - Royalties in Non-Patent Country ---------------------------------------------- If a Licensed Product is manufactured in a Non-Patent Country and used, sold, leased or otherwise disposed of in a Non-Patent Country, be it the same or a different Non-Patent Country, no royalties for the manufacture, use, sale, lease or other disposal of the Licensed Products in such Non-Patent Country or Countries shall be payable. This provision shall not apply and full royalties shall be payable under Section 4.02: (1) when Licensed Products are manufactured in any country which is not a Non-Patent Country or are used, sold, leased or otherwise disposed of in any country which is not a Non-Patent Country, be it the same country as the country of manufacture or a different country; or (2) when LICENSEE knows or has reason to know that the Licensed Products manufactured in a Non-Patent Country and used, sold, leased or otherwise disposed of in a Non-Patent Country are destined for use or for sale, lease or other disposal in a country which is not a Non-Patent Country and LICENSOR deems such sale to be for the purpose of defeating the royalty provisions of this agreement. Section 4.07 - Books and Records -------------------------------- LICENSEE shall keep complete books and records of all sales, leases, uses, returns, or other disposals by LICENSEE of Licensed Products. Section 4.08 - Rights of Inspecting Books and Records ----------------------------------------------------- LICENSOR shall have the right, through a professionally registered accountant at LICENSOR's expense, to inspect, examine and make abstracts of the said books and records insofar as may be necessary to verify the accuracy of the same and of the statements provided for herein but such inspection and examination shall be made during business hours upon reasonable notice and not more 11 often than once per calendar year. LICENSOR agrees not to divulge to third parties any Sensitive Information obtained from the books and records of LICENSEE as a result of such inspection unless such information (a) was known to LICENSOR prior to its acquisition by LICENSOR as a result of such inspection; (b) becomes known to LICENSOR from sources other than directly or indirectly from LICENSEE; or (c) becomes a matter of public knowledge other than by breach of this Agreement by LICENSOR. ARTICLE V ARTICLE DELETED --------------- ARTICLE VI TERMINATION AND EFFECT OF TERMINATION ------------------------------------- Section 6.01 - Expiration of Agreement -------------------------------------- Unless this Agreement already has been terminated in accordance with the provisions of Section 6.02, this Agreement shall terminate five years from the Effective Date and thereafter is renewable at LICENSEE's request at same terms and conditions as in this Agreement, except that the royalty rates shall be the same as LICENSOR offers to third parties at the time of renewal. Section 6.02 - Termination for Cause ------------------------------------ At the option of LICENSOR, in the event that LICENSEE breaches any of its material obligations under this Agreement, subject to the conditions of Section 6.04, this Agreement shall terminate upon LICENSOR's giving sixty (60) days advance notice in writing, effective on dispatch of such notice, of such termination, giving reasons therefor to LICENSEE, provided however, that, if LICENSEE, within the sixty (60) day period, remedies the failure or default upon which such notice is based, then such notice shall not become effective and this Agreement shall continue in full force and effect. Notwithstanding the sixty day cure period provided under the provisions of this Section 6.02, interest due under Section 4.05 shall remain payable and shall not waive, diminish, or otherwise affect any of LICENSOR's rights pursuant to this Section 6.02. 12 Section 6.03 - Option to Terminate in a Non-Patent Country ---------------------------------------------------------- Subject to the provisions of Section 6.04, unless this Agreement already has been terminated in accordance with the provisions of Section 6.01 or Section 6.02, LICENSEE shall have the option to terminate its license under this Agreement with respect to a Non-Patent Country at any time after three years from the Effective Date of this Agreement. Said option to terminate with respect to such country shall be effective when LICENSOR receives LICENSEE's written notice of its exercise of such option and shall be prospective only and not retroactive. Section 6.04 - Effect of Termination ------------------------------------ Upon termination of the Agreement, as provided in Sections 6.01 or 6.02, or upon termination of the license under this Agreement with respect to a Non- Patent Country in accordance with the option set forth in Section 6.03, with respect to such country only, all licenses granted by LICENSOR to LICENSEE under this Agreement shall terminate, all rights LICENSOR granted to LICENSEE shall revest in LICENSOR, and all other rights and obligations of LICENSOR and LICENSEE under this agreement shall terminate except that the following rights and obligations of LICENSOR and LICENSEE shall survive to the extent necessary to permit their complete fulfillment and discharge, with the exception that subsection (9) shall not apply in case of termination under Section 6.01: (1) LICENSEE's obligation to deliver a final royalty report and supplements thereto as required by Section 4.05; (2) LICENSOR's right to receive and LICENSEE's obligation to pay royalties, under Article IV, including interest on overdue royalties, accrued or accruable for payment at the time of termination and interest on overdue royalties accruing subsequent to termination; (3) LICENSEE's obligation to maintain books and records and LICENSOR's right to examine, audit, and copy as provided in Section 4.07; (4) any cause of action or claim of LICENSOR accrued or to accrue because of any breach or default by LICENSEE; (5) LICENSEE's obligations with respect to Sensitive Information under Section 3.11(1) and LICENSOR's obligations with respect to Sensitive Information under Section 4.08; (6) LICENSEE's obligations to cooperate with LICENSOR with respect to Patent enforcement under Section 3.04, with respect to matters arising before termination; 13 (7) LICENSEE's obligation to return to LICENSOR all documents and things furnished to LICENSEE, and copies thereof, under the provisions of Section 3.11; (8) LICENSEE's and LICENSOR's obligations regarding public announcements under Section 8.03; and (9) LICENSEE shall be entitled to fill orders for Licensed Products already received and to make and sell Licensed Products for which commitments to vendors have been made at the time of such termination, subject to payment of applicable royalties thereon and subject to said Licensed Products meeting LICENSOR's quality standards, provided that LICENSEE promptly advises LICENSOR of such commitments upon termination. The portions of the Agreement specifically identified in the sub-parts of this Section shall be construed and interpreted in connection with such other portions of the Agreement as may be required to make them effective. ARTICLE VII LIMITATIONS OF RIGHTS AND AUTHORITY ----------------------------------- Section 7.01 - Limitation of Rights ----------------------------------- No right or title whatsoever in the Patent Rights, Know-How, Licensed Copyrighted Works, or the Licensed Trademarks is granted by LICENSOR to LICENSEE or shall be taken or assumed by LICENSEE except as is specifically laid down in this Agreement. Section 7.02 - Limitation of Authority -------------------------------------- Neither party shall in any respect whatsoever be taken to be the agent or representative of the other party and neither party shall have any authority to assume any obligation for or to commit the other party in any way. Section 7.03 - Disclaimer of Warranties and Liability; Hold Harmless -------------------------------------------------------------------- LICENSOR has provided LICENSEE the rights and privileges contained in this Agreement in good faith. However, nothing contained in this Agreement shall be construed as (1) a warranty or representation by LICENSOR as to the validity or scope of any Patent included in the Patent Rights, (2) a warranty or representation that the Dolby Digital AC-3 audio system technology, Patent Rights, or any Licensed Device, Licensed Product, or part thereof embodying any of them will be free from infringement of Patents, copyrights, trademarks, service marks, or other proprietary rights of third parties; or (3) an agreement to defend LICENSEE against actions or suits of any nature brought by any third parties. LICENSOR disclaims all liability and responsibility for property damage, personal injury, and consequential damages, whether or not foreseeable, that may result from the manufacture, use, lease, or sale of Licensed Devices, Licensed Products and parts thereof, and LICENSEE agrees to assume all liability and responsibility for all such damage and injury. LICENSEE agrees to indemnify, defend, and hold LICENSOR harmless from and against all claims (including without limitation, product, liability claims), suits, losses and damages, including reasonable attorneys' fees and any other expenses incurred in investigation and defense, arising out of LICENSEE's manufacture, use, lease, or sale of Licensed Devices, Licensed Products, or parts thereof, or out of any allegedly unauthorized use of any trademark, service mark, Patent, copyright, process, idea, method, or device (excepting the Licensed Patent Rights) by LICENSEE or those acting under its apparent or actual authority. Section 7.04 - Limitation of Assignment by LICENSEE --------------------------------------------------- The rights, duties and privileges of LICENSEE hereunder shall not be transferred or assigned by it either in part or in whole without prior written consent of LICENSOR. However, LICENSEE shall have the right to transfer its rights, duties and privileges under this Agreement in connection with its merger and consolidation with another firm or the sale of its entire business to another person or firm, provided that such person or firm shall first have agreed with LICENSOR to perform the transferring party's obligations and duties hereunder. Section 7.05 - Compliance with U.S. Export Control Regulations -------------------------------------------------------------- (1) LICENSEE agrees not to export any technical data acquired from LICENSOR under this Agreement, nor the direct product thereof, either directly or indirectly, to any country in contravention of United States law. (2) Nothing in this Agreement shall be construed as requiring LICENSOR to export from the United States, directly or indirectly, any technical data or any commodities to any country in contravention of United States law. ARTICLE VIII MISCELLANEOUS PROVISIONS ------------------------ Section 8.01 - Language of Agreement; Language of Notices --------------------------------------------------------- The language of this Agreement is English. If translated into another language, this English version of the Agreement shall be controlling. Except as may be agreed by LICENSOR and LICENSEE, all notices, reports, consents, and approvals required or permitted to be given hereunder shall be written in the English language. Section 8.02 - Stability of Agreement ------------------------------------- No provision of this Agreement shall be deemed modified by any acts of LICENSOR, its agents or employees or by failure to object to any acts of LICENSEE which may be inconsistent herewith, or otherwise, except by a subsequent agreement in writing signed by LICENSOR and LICENSEE. No waiver of a breach committed by either party in one instance shall constitute a waiver or a license to commit or continue breaches in other or like instances. Section 8.03 - Public Announcements ----------------------------------- Neither party shall at any time heretofore or hereafter publicly state or imply that the terms specified herein or the relationships between LICENSOR and LICENSEE are in any way different from those specifically laid down in this Agreement. LICENSEE shall not at any time publicly state or imply that any unlicensed products use the Dolby Digital AC-3 Audio System Specifications. If requested by one party, the other party shall promptly supply the first party with copies of all public statements and of all publicity and promotional material relating to this Agreement, the Dolby Digital AC-3 Audio System Specifications, and Licensed Products. Section 8.04 - Address of LICENSOR and LICENSEE for all Other ------------------------------------------------------------- Communications - -------------- Except as otherwise specified in this Agreement, all notices, reports, consents, and approvals required or permitted to be given hereunder shall be in writing, signed by an officer of LICENSEE or LICENSOR, respectively, and sent postage or shipping charges prepaid by certified or registered mail, return receipt requested showing to whom, when and where delivered, or by Express mail, or by a secure overnight or one-day delivery service that provides proof and date of delivery, or by facsimile, properly addressed or transmitted to LICENSEE or LICENSOR, respectively, at the address or facsimile number set forth on the cover page of this Agreement or to such other address or facsimile number as may from time to time be designated by either party to the other in writing. Wire payments from LICENSEE to LICENSOR shall be made to the bank and account of LICENSOR as set forth on the cover page of this agreement or to such other bank and account as LICENSOR may from time to time designate in writing to LICENSEE. Section 8.05 - Applicable Law ----------------------------- This Agreement shall be construed in accordance with the substantive laws, but not the choice of law rules, of the State of California. Section 8.06 - Choice of Forum: Attorneys' Fees ----------------------------------------------- To the full extent permitted by law, LICENSOR and LICENSEE agree that their choice of forum, in the event that any dispute arising under this agreement is not resolved by mutual agreement, shall be the United States Courts in the State of California and the State Courts of the State of California. In the event that any action is brought for any breach or default of any of the terms of this Agreement, or otherwise in connection with this Agreement, the prevailing party shall be entitled to recover from the other party all costs and expenses incurred in that action or any appeal therefrom, including without limitation, all attorneys' fees and costs actually incurred. Section 8.07 - Construction of Agreement ---------------------------------------- This Agreement shall not be construed for or against any party based on any rule of construction concerning who prepared the Agreement or otherwise. Section 8.08 - Captions ----------------------- Titles and captions in this Agreement are for convenient reference only and shall not be considered in construing the intent, meaning, or scope of the Agreement or any portion thereof. Section 8.09 - Singular and Plural ---------------------------------- Throughout this Agreement, words in the singular shall be construed as including the plural and words in the plural shall be construed as including the singular. Section 8.10 - Complete Agreement --------------------------------- This Agreement contains the entire agreement and understanding between LICENSOR and LICENSEE and merges all prior or contemporaneous oral or written communication between them. Neither L1CENSOR nor LICENSEE now is, or shall hereafter be, in any way bound by any prior, contemporaneous or subsequent oral or written communication except insofar as the same is expressly set forth in this Agreement or in a subsequent written agreement duly executed by both LICENSOR and LICENSEE. Section 8.11 - Severability --------------------------- Should any portion of this Agreement be declared null and void by operation of law, or otherwise, the remainder of this Agreement shall remain in full force and effect. Section 8.12 - Company Representation and Warranty -------------------------------------------------- LICENSEE represents and warrants to LICENSOR that it is not a party to any agreement, and is not subject to any statutory or other obligation or restriction, which might prevent or restrict it from performing all of its obligations and undertakings under this License Agreement, and that the execution and delivery of this Agreement and the performance by LICENSEE of its obligations hereunder have been authorized by all necessary action, corporate or otherwise. Section 8.13 - Execution ------------------------ IN WITNESS WHEREOF, the said LICENSOR has caused this Agreement to be executed on the cover page of this Agreement, in the presence of a witness, by an officer duly authorized and the said LICENSEE has caused the same to be executed on the cover page of this Agreement, in the presence of a witness by an officer duly authorized, in duplicate original copies, as of the date set forth on said cover page. APPENDIX A - SCHEDULED PATENTS The Scheduled Patents shall mean the following patents and patent applications:
PATENTS ------- Country Patent Number ------- ------------- Australia 631,404 Australia 644,170 Australia 649,786 Australia 653,582 Australia 655,053 Australia 655,535 Austria 0 524 264 Belgium 0 208 712 Belgium 0 481 374 Belgium 0 524 264 Canada 1,239,701 Canada 1,301,337 Canada 2,026,213 Denmark 0 208 712 Denmark 0 481 374 Denmark 0 524 264 France 0 208 712 France 0 455 738 France 0 481 374 France 0 524 264 Germany 690 060 11.4 Germany 691 078 41.6 Greece 0 524 264 Italy 0 208 712 Italy 0 524 264 Netherlands 0 455 738 Netherlands 0 524 264 Spain 0 524 264 Sweden 0 524 264 Switzerland 0 524 264 Taiwan 52,047 Taiwan 53,726 Taiwan 56,006 Taiwan 60,430 United Kingdom 0 208 712 United Kingdom 0 455 738 United Kingdom 0 524 264 United States of America 4,790,016 United States of America 4,914,701 United States of America 5,109,417 United States of America 5,235,671 United States of America 5,274,740 United States of America 5,291,557 United States of America 5,297,236 United States of America 5,357,594 United States of America 5,394,473 United States of America 5,463,424 United States of America 5,479,562
PATENT APPLICATIONS ------------------- Country Application Number ------- ------------------ Australia 53266/94 Australia 73357/94 Australia 73621/94 Australia 73642/94 Australia 75531/94 Australia 76765/94 Australia 11305/95 Austria 92 904 177.0 Belgium 92 904 177.0 Canada 2,053,064-2 Canada 2,059,141 Canada 2,077,662 Canada 2,077,668 Canada 2,103,051 Canada 2,140,678 Canada 2,142,092 Canada 2,164,964 Canada 2,165,450 Canada 2,166,551 Canada 2,167,523 Canada 2,167,527 China 91 102 167.1 Denmark 92 904 177.0 Europe 92 903 819.8 Europe 94 107 838.8 Europe 93 108 874.4 Europe 92 912 812.2 Europe 93 923 341.7 Europe 94 922 554.4 Europe 94 925 719.0 Europe 94 927 268.6 Europe 94 922 585.8 Europe 94 923 506.3 France 92 904 177.0 Germany 92 904 177.0 Italy 92 904 177.0 Japan 2-503825 Japan 3-508357 Japan 4-504474 Japan 4-503836 Japan 5-500680 Japan 6-510170 Japan 7-504717 Japan 7-506055 Japan 7-508213 Japan 7-504753 Japan 7-504747
PATENT APPLICATIONS (continued) ------------------------------- Country Application Number ------- ------------------ Korea 90-702194 Korea 92-702394 Korea 92-702095 Korea 92-702096 Korea 95-700769 Netherlands 92 904 177.0 Singapore Spain 92 204 177.0 Sweden 92 904 177.0 Switzerland 92 904 177.0 United Kingdom 92 904 177.0 United States of America 07/927,429 United States of America 08/115,513 United States of America 08/145,975 United States of America 08/190,655 United States of America 08/472,231 United States of America 08/478,983 United States of America 08/481,638
APPENDIX B - "DOLBY DIGITAL AC-3 AUDIO SYSTEM" Compliance with the algorithm description and operating parameters as specified in ATSC document A/52, the "Dolby Digital AC-3 Licensee Information Manual", the "Software Interface Protocol" issued by Dolby and any further reasonable specifications and requirements as DOLBY may issue from time to time. APPENDIX C - PRELIMINARY SPECIFICATIONS FOR DOLBY DIGITAL AC-3 ENCODERS Dolby Digital AC-3 audio system encoding equipment shall comply with the following specifications in production (when measured through a standard decoder): Audio data rate for two channels: 192 kb/sec Frequency Response: 20 Hz - 20 kHz +/- 0.2 dB Dynamic Range: Greater than 85 dB Distortion: Less than 0.1% at 1 kHz Less than 0.5%, 20 Hz - 20 kHz Crosstalk: Less than -80 dB Level Stability: Better than 0.2 dB APPENDIX D - Deleted APPENDIX E - ROYALTY SCHEDULE MANUFACTURING PATENT RIGHTS ONLY $ 5.00 per Licensed Device EX-10.8 12 DIGITAL AUDIO SYSTEM LICENSE AGREEMENT [LOGO OF DOLBY LABORATORIES LICENSING CORPORATION APPEARS HERE] L3D-SCE DIGITAL AUDIO SYSTEM LICENSE AGREEMENT PROFESSIONAL ENCODERS HARDWARE, SOURCE CODE, COPYRIGHT, TRADEMARK AND KNOW-HOW LICENSE AN AGREEMENT ------------ BY AND BETWEEN -------------- Dolby Laboratories Licensing Corporation and Sonic Foundry (hereinafter called "LICENSOR") (hereinafter called "LICENSEE") of 100 Potrero Avenue of 100 South Baldwin Street, San Francisco, CA 94103-4813 Suite 204 Madison, WI 53703 Facsimile telephone number of LICENSOR for transmission of quarterly royalty reports (Section 4.05): (415) 863-1373 LICENSOR's bank and account number for wire transfer of royalty payments (Section 4.05): Bank: Wells Fargo Bank Address: 464 California Street, San Francisco, CA 94104 U.S.A. Account Name: Dolby Laboratories Licensing Corporation Account Number: 4001-191451 ABA Number: 121000248 Identification of bank with respect to whose prime rate interest is calculated on overdue royalties (Section 4.06): Wells Fargo Bank Address of LICENSEE for communications not otherwise specified (Section 8.04):
SIGNATURES: - ---------- On behalf of LICENSOR On behalf of LICENSEE Signature: /s/ Lily S. Cheung Signature: /s/ Rimas Buinevicius ................................... ................................... Name: Lily S. Cheung Name: RIMAS BUINEVICIUS ................................... ................................... Title: Intellectual Property Manager Title: CEO ................................... ................................... Place San Francisco, California, U.S.A. Place SONIC FOUNDRY, INC. ................................... ................................... Date July 28, 1997 Date 6/27/97 ................................... ................................... Witnessed By: /s/ Lara Thompson Witnessed By: /s/ Kenneth A. Minor ................................... ...................................
Effective Date of Agreement: July 28, 1997 Initial Payment $40,000 APPENDIX E - ROYALTY SCHEDULE ROYALTY PER LICENSED DEVICE: $ 65.00 DIGITAL AUDIO SYSTEM LICENSE AGREEMENT PROFESSIONAL ENCODERS INDEX ----- Preamble I. DEFINITIONS Section 1.01 - "LICENSOR" Section 1.02 - "LICENSEE" Section 1.03 - "Dolby Digital AC-3 Audio System Specifications" Section 1.04 - "Licensed Trademark" Section 1.05 - "Licensed Device" Section 1.06 - "Licensed Product" Section 1.07 - "Licensed Copyrighted Works" Section 1.08 - "Derivative Works" Section 1.09 - "LICENSOR Deliverables" Section 1.10 - "Know-How" Section 1.11 - "Sensitive Information" Section 1.12 - Section Deleted Section 1.13 - "LICENSEE's Trade Name and Trademarks" Section 1.14 - "Other-Trademark Purchaser" Section 1.15 - The "Consumer Price Index" Section 1.16 - The "Effective Date" II. LICENSES GRANTED Section 2.01 - Licenses Granted to LICENSEE Section 2.02 - Limitation of Licenses Granted III. OTHER OBLIGATIONS OF LICENSEE AND LICENSOR Section 3.01 - Use of Licensed Trademarks SectiOn 3.02 - Ownership of the Licensed Trademarks Section 3.03 - Maintenance of Trademark Rights Section 3.04 - Trademark Enforcement Section 3.05 - Other-Trademark Purchasers Section 3.06 - Section Deleted Section 3.07 - Copyright Notice Section 3.08 - Furnishing of Licensed Copyrighted Works Section 3.09 - License Notice Section 3.10 - Furnishing of Know-How Section 3.11 - Use of Know-How and Sensitive Information Section 3.12 - Confidential Information IV. PAYMENTS Section 4.01 - Initial Payment Section 4.02 - Royalties Section 4.03 - Section Deleted Section 4.04 - Royalty Applicability Section 4.05 - Royalty Payments and Statements Section 4.06 - Section Deleted Section 4.07 - Books and Records Section 4.08 - Rights of Inspecting Books and Records V. STANDARDS OF MANUFACTURE AND QUALITY Section 5.01 - Standardization and Quality Section 5.02 - Right to Inspect Quality VI. TERMINATION AND EFFECT OF TERMINATION Section 6.01 - Expiration of Agreement Section 6.02 - Termination for Cause Section 6.03 - Section Deleted Section 6.04 - Effect of Termination VII. LIMITATIONS OF RIGHTS AND AUTHORITY Section 7.01 - Limitation of Rights Section 7.02 - Limitation of Authority Section 7.03 - Disclaimer of Warranties and Liability; Hold Harmless Section 7.04 - Limitation of Assignment by LICENSEE Section 7.05 - Compliance with U.S. Export Control Regulations VIII. MISCELLANEOUS PROVISIONS Section 8.01 - Language of Agreement; Language of Notices Section 8.02 - Stability of Agreement Section 8.03 - Public Announcements Section 8.04 - Address of LICENSEE and LICENSOR for all Other Communications Section 8.05 - Applicable Law Section 8.06 - Choice of Forum; Attorneys' Fees Section 8.07 - Construction of Agreement Section 8.08 - Captions Section 8.09 - Singular and Plural Section 8.10 - Complete Agreement Section 8.11 - Severability Section 8.12 - Company Representation and Warranty Section 8.13 - Execution Appendix A - Appendix Deleted Appendix B - Dolby Digital AC-3 Audio System Appendix C - Preliminary Specifications for Dolby Digital AC-3 Encoders Appendix D - Dolby Digital Licensee Information Manual Appendix E - Royalty Schedule DIGITAL AUDIO SYSTEM LICENSE AGREEMENT WHEREAS, LICENSOR is engaged in the field of audio signal processing systems and has developed signal processing systems useful for audio tape recording and playback and for other applications; WHEREAS, LICENSOR's signal processing systems have acquired a reputation for excellence and LICENSOR's trademarks have acquired valuable goodwill; WHEREAS, LICENSOR has licensed over 160 companies to make, use and sell consumer audio hardware incorporating LICENSOR's noise reduction systems and marked with LICENSOR's trademarks; and WHEREAS, LICENSOR has developed the model Dolby Digital AC-3 audio system which uses a new technique for encoding and decoding of audio frequency data in digital form with a substantially reduced bit-rate while maintaining a high quality decoded audio signal; WHEREAS, LICENSOR represents and warrants that it has rights to grant licenses under its copyrights, know-how and trademarks; WHEREAS, LICENSEE is engaged in the manufacture of equipment for the encoding of entertainment source material into a variety of digitally compressed formats; WHEREAS, LICENSEE believes it can develop a substantial demand for equipment marked with LICENSOR's trademarks used to encode audio signals using LICENSOR's model Dolby Digital AC-3 audio system; WHEREAS, LICENSEE desires a non-exclusive license to manufacture and sell professional encoding equipment using LICENSOR's model Dolby Digital AC-3 audio system based on LICENSOR's unpublished source code and using LICENSOR's know- how and trade secrets and under LICENSOR's trademarks; and WHEREAS, LICENSOR is willing to grant such a license under the terms and conditions set forth in this Agreement. NOW, THEREFORE, it is agreed by and between LICENSOR and LICENSEE as follows: ARTICLE I DEFINITIONS ----------- Section 1.01 - "LICENSOR" means Dolby Laboratories Licensing Corporation, a ------------------------ corporation of the State of New York, having a place of business as indicated on the title page of this Agreement, and its successors and assigns. Section 1.02 - "LICENSEE" means the corporation identified on the title ------------------------ page of this Agreement and any subsidiary thereof of whose ordinary voting shares more than 50% are controlled directly or indirectly by such corporation, but only so long as such control exists. Section 1.03 - "Dolby Digital AC-3 Audio System Specification" means the -------------------------------------------------------------- specifications for the Dolby Digital AC-3 audio system, comprising the Dolby Digital AC-3 Audio System operating parameters as specified in Appendix B entitled "Dolby Digital AC-3 Audio System," the "Preliminary Specifications for Dolby Digital AC-3 Encoders" as specified in Appendix C, attached hereto and an integral part of this Agreement. Section 1.04 - "Licensed Trademark" means one or more of the following: (a) ---------------------------------- the word mark "Dolby" (b) the device mark [LOGO] which is also referred to as the 'Double-D' symbol and (c) the term "AC-3". Section 1.05 - "Licensed Device" means a digital audio circuit having Dolby ------------------------------- Digital AC-3 Audio System Specifications, whether made in discrete component, integrated circuit, or other forms, for encoding one audio channel into a digital AC-3 bitstream. A circuit counts as one "Licensed Device" for each input audio channel it can simultaneously encode. Section 1.06 - "Licensed Product" means a complete ready-to-use -------------------------------- professional software or hardware package which: (1) contains one or more Licensed Devices; (2) is designed to encode one or more audio channels from digital or analog sources into an AC-3 bitstream when running on a suitable hardware platform; (3) is sold in conjunction with, or as an encoder product package that has both video and audio encoding capabilities, the video component of which is manufactured by LICENSEE; and (4) may have a built in "confidence" audio decoder for checking the encoded bitstream. Such confidence decoder may not include Dolby Pro Logic decoding capability, a noise sequencer, any bass management or level trims. It may not be sold as a stand-alone unit. Processors that execute the AC-3 algorithm in Licensed Products must be certified by LICENSOR as adequate to perform the required function. If the Licensed Product is a stand-alone software package, it must be specifically designated for execution on hardware platforms deemed adequate by LICENSOR. Section 1.07 - "Licensed Copyrighted Works" shall mean all copyrighted ------------------------------------------- works including the AC-3 Source Code, implementing Dolby Digital AC-3 encoder and/or decoder functions both in simulation (C-language) and in real-time (assembly code), owned by DOLBY or owned by others to which DOLBY has the right to sublicense, relating to AC-3 and which are useful for the development, design, manufacture, sale, or use of Licensed Products. Section 1.08 - "Derivative Works" - shall mean any derivative works based -------------------------------- on any of the Licensed Copyrighted Works (including the AC-3 source code), whether in human readable (C-code), machine language (object code), or any other form. Section 1.09 - "LICENSOR Deliverables" shall mean any and all items ------------------------------------- delivered by LICENSOR to LICENSEE which enable LICENSEE to design and test Licensed Products, including: (1) Encoder and decoder "C"-language source code of the latest revision, (2) Documentation accompanying said code, (3) Test documentation and test vectors to verify bitstream compliance. Section 1.10 - "Know-How" means all proprietary information, trade secrets, ------------------------ skills, experience, recorded or unrecorded, accumulated by LICENSOR, from time to time prior to and during the term of this Agreement, or licensable by LICENSOR, relating to the Licensed Products and all designs, drawings, reports, memoranda, blue-prints, specifications and the like, prepared by LICENSOR or by others and licensable by LICENSOR, insofar as LICENSOR deems the same to relate to and be useful for the development, design, manufacture, sale or use of Licensed Products. Know-How does not include Licensed Copyrighted Works, whether or not published. Section 1.11 - "Sensitive Information" means non-technical proprietary ------------------------------------- information of LICENSOR or LICENSEE, including, without limiting the foregoing, marketing information, product plans, business plans, royalty, and sales information. Section 1.12 - Section Deleted ------------------------------ Section 1.13 - "LICENSEE's Trade Name and Trademarks" means any trade ----------------------------------------------------- name or trademark used and owned by L1CENSEE. Section 1.14 - "Other-Trademark Purchaser" means any customer of LICENSEE ----------------------------------------- who, with LICENSEE's knowledge, intends to resell, use or lease the Licensed Products under a trademark other than LICENSEE's Trade Name and Trademarks. Section 1.15 - The "Consumer Price Index" means the U.S. City Average ---------------------------------------- Index (base of 1982-1984 equal 100) of the Consumer Price Index for All Urban Consumers as published by the Department of Labor, Bureau of Labor Statistics of the United States Government. In the event that said Index ceases to be published under its present name or form or ceases to be published by the same government entity, reference shall be made to the most similar index then available. Section 1.16 - The "Effective Date" of this Agreement is the date of ---------------------------------- execution hereof by the last party to execute the Agreement, or, if this Agreement requires validation by any governmental or quasi-governmental body, the "Effective Date" is the date of validation of this Agreement. ARTICLE II LICENSES GRANTED ---------------- Section 2.01 - Licenses Granted to LICENSEE ------------------------------------------- A. Hardware. LICENSOR hereby grants to LICENSEE: a personal, non-transferable, indivisible, and non-exclusive license throughout the world (1) to manufacture, market, sell and import Licensed Products subject to the conditions set forth in this Agreement and LICENSEE's performance of its obligations, including the payment of royalties, (2) to use the Licensed Know-How and the Licensed Trademarks on Licensed Products and in connection with the advertising and offering for sale of Licensed Products bearing one or more of the Licensed Trademarks subject to the conditions set forth in this Agreement and LICENSEE's performance of its obligations; B. Software: LICENSOR hereby grants to LICENSEE: a personal, non-transferable, indivisible, and non-exclusive license throughout the world (1) to use but not to modify the Licensed Copyrighted Works (including the AC-3 source code) in order to prepare (compile) Derivative Works that comprise or can run on Licensed Products, for processors designated as adequate by LICENSOR. (2) to market, sell, distribute, maintain, and support the Derivative Works in object or executable form only, to grant end-user licenses to executable code to use but not to modify executable versions of the Derivative Works in connection with Licensed Products, and to copy the Derivative Works for execution, backup, and archival purposes subject to the conditions set forth in this Agreement and LICENSEE's performance of its obligations, including the payment of royalties. Section 2.02 - Limitation of Licenses Granted --------------------------------------------- Notwithstanding the licenses granted under Section 2.01: (1) no license is granted under this Agreement to lease, sell, transfer, or otherwise dispose of any subset or portion of a Licensed Product, partially assembled products, products in kit form, and knocked-down or semi-knocked-down products; (2) no license is granted under this Agreement to use any Licensed Trademark in connection with offering for sale or in advertising and/or informational material relating to any Licensed Product which is not marked with the mark specified in Section 3.01(1) of this Agreement; (3) no license is granted under this Agreement with respect to the use of any Licensed Trademark on or in connection with products other than Licensed Products; (4) no right is granted with respect to LICENSOR's trade name "Dolby Laboratories" except with respect to the use of said tradename on and in connection with Licensed Products for the acknowledgments and notices required herein; and (5) no license is granted to sell, distribute, lease, rent or otherwise dispose of Licensed Derivative Works that are not linked to the sale of a specific Licensed Product; and (6) no right to grant sublicenses other than end-user licenses specifically allowed under Section 2.01 B. (2) is granted under this Agreement. ARTICLE III OTHER OBLIGATIONS OF THE LICENSOR AND LICENSEE ---------------------------------------------- Section 3.01 - Use of Licensed Trademarks ----------------------------------------- The Licensed Trademarks have acquired a reputation for high quality among professionals and consumers around the world. The performance capability of the Dolby Digital AC-3 audio system is such that LICENSOR is willing, by virtue of this Agreement, to allow the use of the Licensed Trademarks on Licensed Products or on the user interface to Licensed Products and in connection with their advertising and marketing to indicate that the quality of such products conforms with the general reputation for high quality associated with the Licensed Trademarks. LICENSEE's use of the Licensed Trademarks shall be subject to the obligations of this Agreement as well as detailed regulations issued from time to time by LICENSOR. LICENSEE shall comply with the requirements of the body of this Agreement and such additional regulations as LICENSOR may issue and shall ensure that its subsidiaries, agents, distributors, and dealers throughout the world comply with such requirements (in the case of any inconsistencies among the body of this Agreement, the Dolby Digital Licensee Information Manual of Appendix D and any additional regulations, the body of this Agreement shall govern): (1) LICENSEE shall prominently mark the Licensed Product or the user interface to the Licensed Product in the following way: [LOGO] DOLBY D I G I T A L (2) The mark specified in subsection (1) of this Section 3.01, shall also be used at least once in a prominent manner in all advertising and promotions for such Licensed Product; such usages shall be no less prominent and in the same relative size as the most prominent third party other trademark(s) appearing on such Licensed Product or in the advertising and promotion thereof. (3) LICENSEE may not use the Licensed Trademarks in advertising and promotion of a product not marked in accordance with subsection (1) of this Section 3.01. (4) In every use of a Licensed Trademark, except on the main control surface of a Licensed Product, LICENSEE shall give notice to the public that such Licensed Trademark is a trademark by using the superscript letters "TM" after the respective trademark, or by use of the trademark registration symbol "(R)" (the capital letter R enclosed in a circle) as a superscript after the respective trademark. LICENSOR shall inform LICENSEE as to which notice form is to be used. (5) LICENSEE shall use its best efforts to ensure that the appropriate trademark notices, as set forth in subsection (3) above, appear in advertising for such Licensed Products at the retail level. (6) LICENSOR's ownership of Licensed Trademarks shall be indicated whenever used by LICENSEE, whether use is on a product or on descriptive, instructional, advertising, or promotional material, by the most relevant of the following acknowledgments: "'Dolby' is a trademark of Dolby Laboratories", "The 'Double-D' symbol is a trademark of Dolby Laboratories", or "'Dolby' and the 'Double-D' symbol are trademarks of Dolby Laboratories." On Licensed Products such words shall be used on an exposed surface, such as the back or the bottom. LICENSEE shall use its best efforts to ensure that such an acknowledgment appears in advertising at the retail level. (7) Licensed Trademarks shall always be used in accordance with established United States practices for the protection of trademark and service mark rights, unless the requirements in the country or jurisdiction in which the product will be sold are more stringent, in which case the practice of such country or jurisdiction shall be followed. In no event shall any Licensed Trademark be used in any way that suggests or connotes that it is a common, descriptive or generic designation. Whenever the word "Dolby" is used, the letter D shall be upper-case. The word "Dolby" shall be used only as an adjective referring to a digital audio product, never as a noun or in any other usage which may contribute to a generic meaning thereof. ln descriptive, instructional, advertising, or promotional material or media relating to Licensed Products, LICENSEE must use the Licensed Trademarks and expressions which include the Licensed Trademark "Dolby" with an appropriate generic or descriptive term (e.g. "Dolby Digital encoder", "Dolby Digital audio circuit", "Dolby AC-3 transmission" etc.), with reference to Licensed Products and their use. (8) All uses of the Licensed Trademarks are subject to approval by LICENSOR. LICENSOR reserves the right to require LICENSEE to submit proposed uses to LICENSOR for written approval prior to actual use. Upon request of LICENSOR, LICENSEE shall submit to LICENSOR samples of its own usage of the Licensed Trademarks and usage of the Licensed Trademarks by its subsidiaries, agents, distributors, and dealers. (9) Licensed Trademarks shall be used in a manner that distinguishes them from other trademarks, service marks, symbols or trade names, including LICENSEE's Trade Name and Trademarks. (10) LICENSEE may not use the Licensed Trademarks on and in connection with products that do not meet LICENSOR's quality standards. (11) LICENSEE may not use the Licensed Trademarks on and in connection with products other than Licensed Products. Section 3.02 - Ownership of the Licensed Trademarks --------------------------------------------------- LICENSEE acknowledges the validity and exclusive ownership by LICENSOR of the Licensed Trademarks. LICENSEE further acknowledges that it owns no rights in the Licensed Trademarks nor in the tradename "Dolby Laboratories." LICENSEE acknowledges and agrees that all rights that it may accrue in the Licensed Trademarks and in the tradenames "Dolby Laboratories" will inure to the benefit of the owner thereof, LICENSOR or LICENSOR's parent Dolby Laboratories, Inc. LICENSEE further agrees that it will not file any application for registration of the Licensed Trademarks or "Dolby Laboratories" in any country, region, or under any arrangement or treaty. LICENSEE also agrees that it will not use nor will it file any application to register in any country, region, or under any arrangement or treaty any mark, symbol or phrase, in any language, which is confusingly similar to the Licensed Trademarks or "Dolby Laboratories" Section 3.03 - Maintenance of Trademark Rights ---------------------------------------------- The expense of obtaining and maintaining Licensed Trademark registrations shall be borne by LICENSOR. LICENSOR, as it deems necessary, will advise LICENSEE of the grant of registration of such trademarks. As LICENSOR deems necessary, LICENSEE and LICENSOR will comply with applicable laws and practices of the country of registration, including, without limiting the foregoing, the marking with notice of registration and the recording of LICENSEE as a registered or licensed user of such trademarks. The expense of registering or recording LICENSEE as a registered user or otherwise complying with the laws of any country pertaining to such registration or the recording of trademark agreements shall be borne by LICENSEE. LICENSEE shall advise LICENSOR of all countries where Licensed Products are sold, leased or used. Section 3.04 - Trademark Enforcement ------------------------------------ LICENSEE shall immediately inform LICENSOR of all infringements, potential or actual, which may come to its attention, of the Licensed Trademarks. It shall be the exclusive responsibility of LICENSOR, at its own expense, to terminate, compromise, or otherwise act at its discretion with respect to such infringements. LICENSEE agrees to cooperate with LICENSOR by furnishing, without charge, except out-of-pocket expenses, such evidence, documents and testimony as may be required therein. Section 3.05 - Other-Trademark Purchasers ----------------------------------------- To the extent only that technical standardization, equipment or signal source interchangeability, product identification and usage of the Licensed Trademarks are affected, the following conditions shall apply if LICENSEE sells or leases Licensed Products on a mass basis to an Other-Trademark Purchaser who does not hold a license with terms and conditions substantially similar to this Agreement. LICENSEE shall inform LICENSOR of the name, place of business, trademarks, and trade names of the Other-Trademark Purchaser before such Other- Trademark Purchaser sells, leases, or uses Licensed Products. LICENSEE shall obtain agreement from such Other-Trademark Purchaser not to modify, install, use, lease, sell, provide written material for or about, advertise, or promote Licensed Products in any way which is in conflict with any provision of this Agreement. It shall be the responsibility of LICENSEE to inform the Other- Trademark Purchaser of the provisions of this Agreement, to notify such Other- Trademark Purchaser that the provisions of this Agreement shall be applicable, through LICENSEE, in the same way as if the Licensed Products were sold by LICENSEE under LlCENSEE's Trade Names and Trademarks, to ensure by all reasonable means that such provisions are adhered to and, if requested by LICENSOR, to provide to LICENSOR samples on a loan basis of the Other-Trademark Purchaser's embodiment of the Licensed Products, as well as copies of such Other-Trademark Purchaser's advertising, public announcements, literature, instruction manuals, and the like. Section 3.06 - Section Deleted ------------------------------ Section 3.07 - Copyright Notice ------------------------------- 3.07(1) - Where Applied LICENSEE shall apply the copyright notice ----------------------- specified in subsection 3.07(2) of this Section 3.07 to all media in which the program is distributed as permitted by this Agreement, whether as an integral part of a Licensed Product or as a spare part solely for the repair of a Licensed Product. 3.07(2) - Form of Notice LICENSEE shall apply the following copyright ------------------------ notice as required in subsection 3.07(1) of this Section 3.07: "This product contains one or more programs protected under international and U.S. copyright laws as unpublished works. They are confidential and proprietary to Dolby Laboratories. Their reproduction or disclosure, in whole or in part, or the production of derivative works therefrom without the express permission of Dolby Laboratories is prohibited. Copyright 1992-1997 by Dolby Laboratories, Inc. All rights reserved." Section 3.08 - Furnishing of Licensed Copyrighted Works ------------------------------------------------------- Subject to any restrictions under the export control regulations of the United States or any other applicable restrictions, LICENSOR will promptly after the Effective Date, furnish to LICENSEE copies of all programs constituting the Copyrighted Works in the form of executable object code (machine readable code). LICENSEE agrees to use such programs only as specifically laid out in this Agreement. Upon termination of this Agreement, LICENSEE shall promptly return to LICENSOR, at LICENSEE's expense, all documents and things supplied to LICENSEE as Licensed Copyrighted Works, as well as all copies and reproductions thereof. Section 3.09 - License Notice ----------------------------- On all Licensed Products, LICENSEE shall acknowledge that the Licensed Products are manufactured under license from LICENSOR. The following notice shall be used by LICENSEE on an exposed surface, such as the back or the bottom, of all Licensed Products: "Manufactured under license from Dolby Laboratories". Such notice shall also be used in all instruction and servicing manuals. Section 3.10 - Furnishing of Licensor Deliverables and Know-How --------------------------------------------------------------- Subject to any restrictions under the export control regulations of the United States or any other applicable restrictions, LICENSOR will promptly after the Effective Date, furnish to LICENSEE: (1) The Licensor Deliverables, copies of all documents and things comprising the Know-How; and (2) when requested by LICENSEE, provide, as LICENSOR deems reasonable, consulting services regarding design considerations and general advice relating to the Licensed Products and the sale and use thereof, for all of which LICENSEE will reimburse LICENSOR for travel and reasonable per diem expenses. Section 3.11 - Use of Know-How and Sensitive Information -------------------------------------------------------- 3.11(1) - By LICENSEE --------------------- LICENSEE shall use all Know-How and Sensitive Information obtained heretofore or hereafter from LICENSOR solely for the purpose of manufacturing and selling Licensed Products under this Agreement, shall not use such Know-How or Sensitive Information in an unauthorized way, and shall not divulge such Know-How or Sensitive Information or any portion thereof to third parties, unless such Know-How or Sensitive Information (a) was known to LICENSEE prior to its obtaining the same from LICENSOR; (b) becomes known to LICENSEE from sources other than either directly or indirectly from LICENSOR; or (c) becomes public knowledge other than by breach of this Agreement by LICENSEE or by another licensee of LICENSOR. The obligations of this subsection 3.11(1) shall cease six (6) years from the date on which such Know-How or Sensitive Information are acquired by LICENSEE from LICENSOR under this Agreement. Upon termination of this Agreement, with respect to Know-How or Sensitive Information subject to the obligations of this subsection 3.11(1), LICENSEE shall promptly return to LICENSOR, at LICENSEE's expense, all documents and things supplied to LICENSEE as Know-How, as well as all copies and reproductions thereof. 3.11(2) - By LICENSOR --------------------- Except as provided by Article IV of this Agreement, LICENSEE is not obligated to disclose to LICENSOR any information that it deems proprietary or sensitive. Except as provided by Article IV of this Agreement, LICENSOR has no obligation to treat in confidence, nor to restrict, in any way, the use, reproduction, or publication of information obtained from LICENSEE, including, without limiting the foregoing, information obtained by LICENSOR in the course of providing consulting services under Section 3.10(2) of this Agreement and information obtained by LICENSOR in the course of exercising its right to maintain quality control over LICENSEE's Licensed Products under Sections 5.01 and 5.02 of this Agreement. Section 3.12 - Confidential Material ------------------------------------ Parts of the Licensor Deliverables are confidential and will be marked as such. Disclosure of these materials to third parties without the advance written permission of Licensor is prohibited. Licensee may reproduce and/or internally disseminate these materials only on a disciplined "as needed" basis to the extent necessary to facilitate development of the Licensed Product, and only among its employees/consultants who have executed confidentiality agreements establishing a duty to maintain the secrecy of Licensor's confidential material, and in no instance among individuals not maintaining a Work Made for Hire Relationship with Licensee. Licensee shall keep a record of each copy made and shall permit Licensor access to said record at times and places as Licensor may reasonably require. ARTICLE IV PAYMENTS -------- Section 4.01 - Initial Payment ------------------------------ LICENSEE shall pay a premium of One Hundred Thirty Dollars ($130.00) on every Licensed Device used, leased, sold or otherwise disposed of. LICENSEE shall pay all local fees, taxes, duties, or charges of any kind and shall not deduct them from the amount due. The premium is payable each quarter in addition to the normal royalties due on Licensed Devices used, leased, sold, or otherwise disposed of in that quarter, as specified in Section 4.02. The premium is not subject to adjustment according to the change in the U.S. Consumer Price Index. When the total number of Licensed Devices which have been used, leased, sold, or otherwise disposed of by LICENSEE exceeds Three Hundred and Eight (308), the Initial Payment specified on the title page of this agreement shall be paid in full and LICENSEE shall stop paying the premium, but shall continue paying royalties as specified in section 4.02. Section 4.02 - Royalties ------------------------ Subject to the provisions of Section 4.05, LICENSEE shall pay to LICENSOR royalties on Licensed Products which are used, sold, leased, or otherwise disposed of by LICENSEE, except for Licensed Products returned to LICENSEE by customers of LICENSEE, other than in exchange for an upgraded product, on which a credit has been allowed by LiCENSEE to said customers. The royalty payable shall be based on the number of Licensed Products, which are used, sold, leased or otherwise disposed of by LICENSEE in successive calendar quarters from the effective date hereof, as detailed in the schedule given in Appendix E of this Agreement. Subject to the provisions of Section 4.05, LICENSEE shall pay to LICENSOR royalties on Licensed Devices manufactured by or for LICENSEE and incorporated in Licensed Products which are used, sold, leased, or otherwise disposed of by LICENSEE, except for Licensed Devices incorporated in Licensed Products returned to LICENSEE by customers of LICENSEE, other than in exchange for an upgraded product, on which a credit has been allowed by LICENSEE to said customers. The royalty payable shall be based on the number of Licensed Devices, hereinbefore defined, contained in Licensed Products, which are used, sold, leased or otherwise disposed of by LICENSEE in successive calendar quarters from the effective date hereof, based on the schedule given in Appendix E of this Agreement. On the Effective Date of this Agreement, and annually thereafter on first day of each calendar year, the rate at which the royalties are calculated shall be adjusted in accordance with the Consumer Price Index. The adjustment shall be made by multiplying the royalties calculated as specified above by the ratio between the Consumer Price Index for the last month of the year preceding the year in which the adjustment takes place and the Consumer Price Index for the month of December 1993. LICENSOR will, during the first quarter of each calendar year, or as soon as such information is known, if later, inform LICENSEE of the adjustment ratio to be applied to royalties due in that year. The first adjustment to royalty rates shall be made in the quarter commencing January 1, 1995. Section 4.03 - Section Deleted ------------------------------ Section 4.04 - Royalty Applicability ------------------------------------ A Licensed Product shall be considered sold under Section 4.02 when invoiced, or if not invoiced, delivered to another by LICENSEE or otherwise disposed of or put into use by LICENSEE, except for consignment shipments, which will be considered sold when the payment for such shipments is agreed upon between LICENSEE and customer. Section 4.05 - Royalty Payments and Statements ---------------------------------------------- Unless Licensed Products are manufactured for LICENSEE under the provisions of Section 4.03 of this Agreement, LICENSEE shall render statements and royalty payments as follows: (1) LICENSEE shall deliver to the address shown on the cover sheet of this Agreement or such place as LICENSOR may from time to time designate, quarterly reports certified by LICENSEE's chief financial officer or the officer's designate within 30 days after each calendar quarter ending with the last day of March, June, September and December. Alternatively, such reports may be delivered by facsimile by transmitting them to LICENSOR's facsimile telephone number shown on the cover sheet of this Agreement or such other number as LICENSOR may from time to time designate. Royalty payments are due for each quarter at the same time as each quarterly report and shall be made by wire transfer in United States funds to LICENSOR's bank as identified on the cover sheet of this Agreement or such other bank as LICENSOR may from time to time designate. LICENSEE shall pay all local fees, taxes, duties, or charges of any kind and shall not deduct them from the royalties due unless such deductions may be offset against LICENSOR's own tax liabilities. Each quarterly report shall: (a) state the number of each model type of Licensed Products leased, sold, or otherwise disposed of by LICENSEE during the calendar quarter with respect to which the report is due; and (b) state the number of Licensed Devices in each model type of Licensed Product; and (c) contain such other information and be in such form as LICENSOR or its outside auditors may prescribe. (2) Any remittance in excess of royalties due with respect to the calendar quarter for which the report is due shall be applied by LICENSOR to the next payment due. (3) LICENSEE's first report shall be for the calendar quarter in which LICENSEE sells its first Licensed Product. (4) LICENSEE shall deliver a final report and payment of royalties to LICENSOR certified by LICENSEE's chief financial officer or the officer's designate within 30 days after termination of this Agreement throughout the world. Such a final report shall include a report of all royalties due with respect to Licensed Products not previously reported to LICENSOR. Such final report shall be supplemented at the end of the next and subsequent quarters, in the same manner as provided for during the Life of the Agreement, in the event that LICENSEE learns of any additional royalties due. (5) LICENSEE shall pay interest to LICENSOR from the due date to the date payment is made of any overdue royalties or fees, including the Initial Payment, at the rate of 2% above the prime rate as is in effect from time to time at the bank identified on the cover page of this Agreement, or another major bank agreed to by the LICENSOR and LICENSEE in the event that the identified bank should cease to exist, provided however, that if the interest rate thus determined is in excess of rates allowable by any applicable law, the maximum interest rate allowable by such law shall apply. Section 4.06 - Section Deleted ------------------------------ Section 4.07 - Books and Records -------------------------------- LICENSEE shall keep complete books and records of all sales, leases, uses, returns, or other disposals by LICENSEE of Licensed Products. Section 4.08 - Rights of Inspecting Books and Records ----------------------------------------------------- LICENSOR shall have the right, through a professionally registered accountant at LICENSOR's expense, to inspect, examine and make abstracts of the said books and records insofar as may be necessary to verify the accuracy of the same and of the statements provided for herein but such inspection and examination shall be made during business hours upon reasonable notice and not more often than once per calendar year. LICENSOR agrees not to divulge to third parties any Sensitive Information obtained from the books and records of LICENSEE as a result of such inspection unless such information (a) was known to LICENSOR prior to its acquisition by LICENSOR as a result of such inspection; (b) becomes known to LICENSOR from sources other than directly or indirectly from LICENSEE; or (c) becomes a matter of public knowledge other than by breach of this Agreement by LICENSOR. ARTICLE V STANDARDS OF MANUFACTURE AND QUALITY ------------------------------------ Section 5.01 - Standardization and Quality ------------------------------------------ LICENSEE shall abide by the Dolby Digital AC-3 Audio System Specifications, hereto appended in Appendix C and as modified from time to time by LICENSOR. All Licensed Product types are subject to acceptance testing for bitstream compliance by LICENSOR. All licensed products marked with the Licensed Trademarks must additionally comply with all applicable minimum quality standards issued and modified from time to time by LICENSOR. On all Licensed Products marked with the Licensed Trademarks LICENSEE shall abide by reasonable standards of quality and workmanship. Such quality standards shall apply to all aspects of Licensed Products which influence or reflect upon the audio quality or performance of the Licensed Products as perceived by the end user. LICENSEE shall with respect to all Licensed Products conform to any reasonable new quality standards requirements as specified by LICENSOR within a period of ninety (90) days of such specification in writing. Licensed Products shall not be designed, presented or advertised in any way which contributes to confusion of the Dolby Digital AC-3 audio system with any of LICENSOR's other digital audio systems, audio noise reduction or headroom extension systems or LICENSOR's motion picture sound system. Section 5.02 - Right to Inspect Quality --------------------------------------- LICENSEE shall provide LICENSOR with such non-sensitive information concerning Licensed Products as it may reasonably require in performing its right to enforce quality standards under this Agreement. LICENSEE will, upon request, provide on a loan basis to LICENSOR a reasonable number of samples of Licensed Products for testing, together with instruction and service manuals. In the event that LICENSOR shall complain that any Licensed Product does not comply with LICENSOR's quality standards, excepting newly specified standards falling within the ninety (90) day time limit of Section 5.01, it shall promptly so notify LICENSEE by written communication whereupon LICENSEE shall within ninety (90) days suspend the lease, sale or other disposal of the same. ARTICLE VI TERMINATION AND EFFECT OF TERMINATION ------------------------------------- Section 6.01 - Expiration of Agreement -------------------------------------- Unless this Agreement already has been terminated in accordance with the provisions of Section 6.02, this Agreement shall terminate five years from the Effective Date and thereafter is renewable at LICENSEE's request at terms and conditions in force at the time of renewal. Section 6.02 - Termination for Cause ------------------------------------ At the option of LICENSOR, in the event that LICENSEE breaches any of its material obligations under this Agreement, subject to the conditions of Section 6.04, this Agreement shall terminate upon LICENSOR's giving sixty (60) days advance notice in writing, effective on dispatch of such notice, of such termination, giving reasons therefor to LICENSEE, provided however, that, if LICENSEE, within the sixty (60) day period, remedies the failure or default upon which such notice is based, then such notice shall not become effective and this Agreement shall continue in full force and effect. Notwithstanding the sixty day cure period provided under the provisions of this Section 6.02, interest due under Section 4.05 shall remain payable and shall not waive, diminish, or otherwise affect any of LICENSOR's rights pursuant to this Section 6.02. Section 6.03 - Section Deleted ------------------------------ Section 6.04 - Effect of Termination ------------------------------------ Upon termination of the Agreement, as provided in Sections 6.01 or 6.02, all licenses granted by LICENSOR to LICENSEE under this Agreement shall terminate, all rights LICENSOR granted to LICENSEE shall revest in LICENSOR, and all other rights and obligations of LICENSOR and LICENSEE under this agreement shall terminate except that the following rights and obligations of LICENSOR and LICENSEE shall survive to the extent necessary to permit their complete fulfillment and discharge, with the exception that subsection (8) shall not apply in case of termination under Section 6.01: (1) LICENSEE's obligation to deliver a final royalty report and supplements thereto as required by Section 4.05; (2) LICENSOR's right to receive and LICENSEE's obligation to pay royalties, under Article IV, including interest on overdue royalties, accrued or accruable for payment at the time of termination and interest on overdue royalties accruing subsequent to termination; (3) LICENSEE's obligation to maintain books and records and LICENSOR's right to examine, audit, and copy as provided in Section 4.07; (4) any cause of action or claim of LICENSOR accrued or to accrue because of any breach or default by LICENSEE; (5) LICENSEE's obligations with respect to Know-How and Sensitive Information under Section 3.11(1) and LICENSOR's obligations with respect to Sensitive Information under Section 4.08; (6) LICENSEE's obligations to cooperate with LICENSOR with respect to Trademark enforcement under Section 3.04, with respect to matters arising before termination; (7) LICENSEE's and LICENSOR's obligations regarding public announcements under Section 8.03; and (8) LICENSEE shall be entitled to fill orders for Licensed Products already received and to make or have made for it and to sell Licensed Products for which commitments to vendors have been made at the time of such termination, subject to payment of applicable royalties thereon and subject to said Licensed Products meeting LICENSOR's quality standards, provided that LICENSEE promptly advises LICENSOR of such commitment upon termination. The portions of the Agreement specifically identified in the sub-parts of this Section shall be construed and interpreted in connection with such other portions of the Agreement as may be required to make them effective. ARTICLE VII LIMITATIONS OF RIGHTS AND AUTHORITY ----------------------------------- Section 7.01 - Limitation of Rights ----------------------------------- No right or title whatsoever in the Patent Rights, Know-How, Licensed Copyrighted Works, or the Licensed Trademarks is granted by LICENSOR to LICENSEE or shall be taken or assumed by LICENSEE except as is specifically laid down in this Agreement. Section 7.02 - Limitation of Authority -------------------------------------- Neither party shall in any respect whatsoever be taken to be the agent or representative of the other party and neither party shall have any authority to assume any obligation for or to commit the other party in any way. Section 7.03 - Disclaimer of Warranties and Liability: Hold Harmless -------------------------------------------------------------------- LICENSOR has provided LICENSEE the rights and privileges contained in this Agreement in good faith. However, nothing contained in this Agreement shall be construed as (1) a warranty or representation by LICENSOR that the Dolby Digital AC-3 Audio System technology, Know-How, Licensed Copyrighted Works, the Licensed Trademarks, or any Licensed Device, Licensed Product, or part thereof embodying any of them will be free from infringement of patents, copyrights, trademarks, service marks, or other proprietary rights of third parties; or (2) an agreement to defend LICENSEE against actions or suits of any nature brought by any third parties. LICENSOR disclaims all liability and responsibility for property damage, personal injury, and consequential damages, whether or not foreseeable, that may result from the manufacture, use, lease, or sale of Licensed Products and parts thereof, and LICENSEE agrees to assume all liability and responsibility for all such damage and injury. LICENSEE agrees to indemnify, defend, and hold LICENSOR harmless from and against all claims (including, without limitation, product liability claims), suits, losses and damages including reasonable attorneys' fees and any other expenses incurred in investigation and defense, arising out of LICENSEE's manufacture, use, lease, or sale of Licensed Products, or out of any allegedly unauthorized use of any trademark, service mark, patent, copyright, process, idea, method, or device (excepting Licensed Trademarks) by LICENSEE or those acting under its apparent or actual authority. Section 7.04 - Limitation of Assignment by LICENSEE --------------------------------------------------- The rights, duties and privileges of LICENSEE hereunder shall not be transferred or assigned by it either in part or in whole without prior written consent of LICENSOR. However, LICENSEE shall have the right to transfer its rights, duties and privileges under this Agreement in connection with its merger and consolidation with another firm or the sale of its entire business to another person or firm, provided that such person or firm shall first have agreed with LICENSOR to perform the transferring party's obligations and duties hereunder. Section 7.05 - Compliance with U.S. Export Control Regulations -------------------------------------------------------------- (1) LICENSE agrees not to export any technical data acquired from LICENSOR under this Agreement, nor the direct product thereof, either directly or indirectly, to any country in contravention of United States law. (2) Nothing in this Agreement shall be construed as requiring LICENSOR to export from the United States, directly or indirectly, any technical data or any commodities to any country in contravention of United States law. ARTICLE VIII MISCELLANEOUS PROVISIONS ------------------------ Section 8.01 - Language of Agreement: Language of Notices --------------------------------------------------------- The language of this Agreement is English. If translated into another language, this English version of the Agreement shall be controlling. Except as may be agreed by LICENSOR and LICENSEE, all notices, reports, consents, and approvals required or permitted to be given hereunder shall be written in the English language. Section 8.02 - Stability of Agreement ------------------------------------- No provision of this Agreement shall be deemed modified by any acts of LICENSOR, its agents or employees or by failure to object to any acts of LICENSEE which may be inconsistent herewith, or otherwise, except by a subsequent agreement in writing signed by LICENSOR and LICENSEE. No waiver of a breach committed by either party in one instance shall constitute a waiver or a license to commit or continue breaches in other or like instances. Section 8.03 - Public Announcements ----------------------------------- Neither party shall at any time heretofore or hereafter publicly state or imply that the terms specified herein or the relationships between LICENSOR and LICENSEE are in any way different from those specifically laid down in this Agreement. LICENSEE shall not at any time publicly state or imply that any unlicensed products use the Dolby Digital AC-3 Audio System Specifications. If requested by one party, the other party shall promptly supply the first party with copies of all public statements and of all publicity and promotional material relating to this Agreement, the Dolby Digital AC-3 Audio System Specifications, or the Licensed Trademarks. Section 8.04 - Address of LICENSOR and LICENSEE for all Other Communications ---------------------------------------------------------------------------- Except as otherwise specified in this Agreement, all notices, reports, consents, and approvals required or permitted to be given hereunder shall be in writing, signed by an officer of LICENSEE or LICENSOR, respectively, and sent postage or shipping charges prepaid by certified or registered mail, return receipt requested showing to whom, when and where delivered, or by Express mail, or by a secure overnight or one-day delivery service that provides proof and date of delivery, or by facsimile, properly addressed or transmitted to LICENSEE or LICENSOR, respectively, at the address or facsimile number set forth on the cover page of this Agreement or to such other address or facsimile number as may from time to time be designated by either party to the other in writing. Wire payments from LICENSEE to LICENSOR shall be made to the bank and account of LICENSOR as set forth on the cover page of this agreement or to such other bank and account as LICENSOR may from time to time designate in writing to LICENSEE. Section 8.05 - Applicable Law ----------------------------- This Agreement shall be construed in accordance with the substantive laws, but not the choice of law rules, of the State of California. Section 8.06 - Choice of Forum; Attorneys' Fees ----------------------------------------------- To the full extent permitted by law, LICENSOR and LICENSEE agree that their choice of forum, in the event that any dispute arising under this agreement is not resolved by mutual agreement, shall be the United States Courts in the State of California and the State Courts of the State of California. In the event that any action is brought for any breach or default of any of the terms of this Agreement or otherwise in connection with this Agreement, the prevailing party shall be entitled to recover from the other party all costs and expenses incurred in that action or any appeal therefrom, including without limitation, all attorneys' fees and costs actually incurred. Section 8.07 - Construction of Agreement ---------------------------------------- This Agreement shall not be construed for or against any party based on any rule of construction concerning who prepared the Agreement or otherwise. Section 8.08 - Captions ----------------------- Titles and captions in this Agreement are for convenient reference only and shall not be considered in construing the intent, meaning, or scope of the Agreement or any portion thereof. Section 8.09 - Singular and Plural ---------------------------------- Throughout this Agreement, words in the singular shall be construed as including the plural and words in the plural shall be construed as including the singular. Section 8.10 - Complete Agreement --------------------------------- This Agreement contains the entire agreement and understanding between LICENSOR and LICENSEE and merges all prior or contemporaneous oral or written communication between them. Neither LICENSOR nor LICENSEE now is, or shall hereafter be, in any way bound by any prior, contemporaneous or subsequent oral or written communication except insofar as the same is expressly set forth in this Agreement or in a subsequent written agreement duly executed by both LICENSOR and LICENSEE. Section 8.11 - Severability --------------------------- Should any portion of this Agreement be declared null and void by operation of law, or otherwise, the remainder of this Agreement shall remain in full force and effect. Section 8.12 - Company Representation and Warranty -------------------------------------------------- LICENSEE represents and warrants to LICENSOR that it is not a party to any agreement, and is not subject to any statutory or other obligation or restriction, which might prevent or restrict it from performing all of its obligations and undertakings under this License Agreement, and that the execution and delivery of this Agreement and the performance by LICENSEE of its obligations hereunder have been authorized by all necessary action, corporate or otherwise. Section 8.13 - Execution ------------------------ IN WITNESS WHEREOF, the said LICENSOR has caused this Agreement to be executed on the cover page of this Agreement, in the presence of a witness, by an officer duly authorized and the said LICENSEE has caused the same to be executed on the cover page of this Agreement, in the presence of a witness, by an officer duly authorized, in duplicate original copies, as of the date set forth on said cover page. APPENDIX A - APPENDIX DELETED APPENDIX B - "DOLBY DIGITAL AC-3 AUDIO SYSTEM" Compliance with the algorithm description and operating parameters as specified in ATSC document A/52, the "Dolby Digital Licensee Information Manual", the "Software Interface Protocol" issued by Dolby and any further reasonable specifications and requirements as DOLBY may issue from time to time. APPENDIX C - PRELIMINARY SPECIFICATIONS FOR DOLBY DIGITAL AC-3 ENCODERS Dolby Digital AC-3 audio system encoding equipment shall comply with the following audio specifications in production (when measured through a standard decoder); Audio data rate for two channels: 192 kb/sec Frequency Response: 20 Hz - 20 kHz+/-0.2 dB Dynamic Range: Greater than 85 dB Distortion: Less than 0.1% at 1 kHz Less than 0.5%, 20 Hz - 20 kHz Crosstalk: Less than -80 dB Level Stability: Better than 0.2 dB APPENDIX D - DOLBY DIGITAL LICENSEE INFORMATION MANUAL EX-11.1 13 COMPUTATION OF NET PROFIT (LOSS) PER SHARE Exhibit 11 Sonic Foundry, Inc. Earnings Per Share Calculations Earnings per share have been computed based on the weighted average number of common shares outstanding and the common share equivalents of stock options and warrants, assuming an initial public offering price of $7.50 per share and the common shares issuable upon the conversion of the Series B Convertible Preferred Stock and Convertible Debt. The following table reconciles the number of common shares outstanding with the number of common shares used in computing earnings per share.
Year Ended December 31, Nine months ended September 30, ----------------------- ------------------------------- 1995 1996 1996 1997 ---- ---- ---- ---- Common shares outstanding 1,053 127,800 1,177 229,760 Effect of using weighted average common shares outstanding during the period 240,233 134,638 240,136 138,300 Effect of shares issued under stock options and warrants 142,830 328,898 274,130 384,051 Effect of weighted average shares issuable upon conversion of Series B Preferred Stock - 1,113,333 - - Effect of weighted average shares issuable upon conversion of convertible debt 8,000 8,000 8,000 8,000 Common shares and common share equivalents used in computing earnings per ------------------------------------------------------------------ share 392,116 1,712,669 523,443 760,111 ================================================================== Proforma net income (loss) $ 26,324 $ 129,094 $142,065 $(839,091) Preferred stock dividends declared - - - (1,997) Interest on convertible debt - - - 718 ------------------------------------------------------------------ Adjusted proforma net income (loss) $ 26,324 $ 129,094 $142,065 $(840,370) ==================================================================
EX-23.2 14 CONSENT OF ERNST & YOUNG LLP CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the reference to our firm under the captions "Experts" and "Selected Financial and Operating Data" and to the use of our report dated November 7, 1997, except for Note 2 as to which the date is January 8, 1998, in the Registration Statement on Form SB-2 and related Prospectus of Sonic Foundry, Inc. for the registration of 2,000,000 shares of its common stock and 1,000,000 Redeemable Warrants. /s/ ERNST & YOUNG LLP ERNST & YOUNG LLP Milwaukee, Wisconsin February 5, 1998 EX-23.3 15 CONSENT OF WILLIAMS, YOUNG & ASSOCIATES LLC CONSENT OF WILLIAMS, YOUNG & ASSOCIATES, LLC, INDEPENDENT AUDITORS We consent to the reference to our firm under the captions "Experts" and "Selected Financial and Operating Data" and to the use of our report dated May 28, 1997 in the Registration Statement on Form SB-2 and related Prospectus of Sonic Foundry, Inc. for the registration of 2,000,000 shares of its common stock and 1,000,000 Redeemable Warrants. /s/ WILLIAMS, YOUNG & ASSOCIATES, LLC WILLIAMS, YOUNG & ASSOCIATES, LLC Madison, Wisconsin February 5, 1998 EX-27.1 16 FINANCIAL DATA SCHEDULE
5 12-MOS 9-MOS DEC-31-1996 SEP-30-1997 JAN-01-1996 JAN-01-1997 DEC-31-1996 SEP-30-1997 453,574 114,737 0 0 470,025 428,484 0 20,090 45,227 56,662 1,045,802 681,253 406,728 1,350,954 91,753 190,193 1,627,122 2,332,963 530,417 946,106 0 702,443 0 0 66,800 68,797 1,278 2,298 1,008,627 613,319 1,627,122 2,332,963 2,442,047 2,242,512 2,442,047 2,242,512 372,272 407,099 2,069,775 1,835,413 1,855,647 2,654,364 0 0 21,928 42,771 199,094 (859,091) 20,000 (20,000) 179,094 (839,091) 0 0 0 0 0 0 179,094 (839,091) .08 (1.11) .08 (1.11)
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