SONIC FOUNDRY INC, SB-2/A, 1998-04-03

SONIC FOUNDRY INC
SB-2/A, 1998-04-03
PREPACKAGED SOFTWARE

Previous: IAT MULTIMEDIA INC, 8-K/A, 1998-04-03

Next: TIAA CREF MUTUAL FUND, 497, 1998-04-03

<PAGE>

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 3, 1998

REGISTRATION NO. 333-46005
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

--------------

AMENDMENT NO. 2 TO
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: [_]

--------------

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.

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+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 APRIL 3, 1998

PROSPECTUS

SONIC FOUNDRY, INC.

2,000,000 SHARES OF COMMON STOCK AND
1,000,000 REDEEMABLE COMMON STOCK PURCHASE WARRANTS (AS UNITS, EACH CONSISTING
OF TWO SHARES OF COMMON STOCK AND ONE REDEEMABLE COMMON STOCK PURCHASE WARRANT)
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"), initially as units, each unit consisting of two
Shares and one Warrant. 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 has applied 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 8,
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.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO PUBLIC DISCOUNTS(1) COMPANY(2)
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Unit (comprised of) $ $ $
- --------------------------------------------------------------------------------
Per Share of Common
Stock................ $ $ $
- --------------------------------------------------------------------------------
Per Warrant........... $ $ $
- --------------------------------------------------------------------------------
Total(3)................ $ $ $
- --------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
(1) Does not include additional compensation payable to Dirks & Company, Inc.
and Security Capital Trading Inc., 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 INC.

The date of this Prospectus is , 1998.
<PAGE>

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.
<PAGE>

(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
368,160 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.
<PAGE>

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 599,050 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 110,000 shares of Common Stock upon the exercise of warrants
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.

4
<PAGE>

Company believes it can achieve long term commitment to its products from its
target customers by obtaining the endorsement of industry opinion leaders, such
as audio professionals and writers of trade magazine articles, and by
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
<PAGE>

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 .......... 468,160 shares
Series B Preferred 6,879,732 shares
Stock .................

Securities Outstanding
After the Offering:(1)
Common Stock .......... 2,468,160 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 certain
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) 599,050 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) 110,000 shares of Common Stock issuable
upon the exercise of warrants currently outstanding. See "Management--
Directors' Compensation," "Management--1995 Stock Option Plan" and
"Description of Securities."

6
<PAGE>

SUMMARY FINANCIAL INFORMATION

<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
------------------- --------------------- -------------------
1995 1996 1996 1997(1) 1996 1997
-------- ---------- ---------- ---------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Software license fees... $757,579 $2,442,047 $1,623,066 $2,242,512 $818,981 $ 931,477
Gross profit............ 675,526 2,069,775 1,423,717 1,835,413 646,058 772,062
-------- ---------- ---------- ---------- -------- ---------
Income (loss) from
operations............. 34,391 214,128 231,357 (818,951) (17,229) (301,417)
Income (loss) before
income taxes........... 33,324 199,094 221,065 (859,091) (21,971) (323,507)
Income tax expense
(benefit).............. 0 20,000 0 (20,000) 20,000 0
-------- ---------- ---------- ---------- -------- ---------
Net income (loss)....... $ 33,324 $ 179,094 $ 221,065 $ (839,091) $(41,971) $(323,507)
======== ========== ========== ========== ======== =========
Pro forma net income
(loss) per common
share(2):
Basic................. $ 25.65 $ 5.82 $ 134.91 $ (5.15) $ (.49) $ (1.36)
======== ========== ========== ========== ======== =========
Diluted............... $ .23 $ .09 $ .49 $ (5.15) $ (.49) $ (1.36)
======== ========== ========== ========== ======== =========
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------
PRO FORMA,
AS
ACTUAL ADJUSTED(3)
---------- -----------
<S> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit).............................. $ (50,323) $11,913,619
Total assets........................................... 2,596,228 14,490,172
Long-term liabilities.................................. 701,656 1,000,000
Stockholders' equity................................... 1,027,907 13,693,507
</TABLE>
- --------
(1) On September 30, 1997, the Company changed its fiscal year end to September
30 of each year.
(2) See Note 1 to the Financial Statements of the Company.
(3) Gives effect on a pro forma basis to (i) the exercise in March 1998 of
100,000 options under the Plan, (ii) the sale of 5,000 shares of Common
Stock in January 1998, and (iii) the issuance in February 1998 of three
unsecured notes payable in the aggregate principal amount of $1,000,000 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,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" and "Management--1995 Stock
Option Plan."

7
<PAGE>

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; Retained 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 December 31,
1997, the Company had a working capital deficit of $50,323 and a retained
deficit of $1,152,088. 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."

8
<PAGE>

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
<PAGE>

("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. In February 1998, the Company issued unsecured
notes payable in the aggregate principal amount of $1,000,000. The notes
mature February 1999 and bear interest at a rate of 12% per annum. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources." 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 signed an agreement with Ingram Micro,
Inc. ("Ingram Micro") on October 16, 1997 to handle sales and distribution to
various computer resellers, value-added resellers ("VARs"), catalog
distributors and smaller retail outlets. Under the distribution agreement, the
Company has

10
<PAGE>

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
<PAGE>

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, the nine months ended September 30, 1997 and the three months ended
December 31, 1997, approximately 18%, 27% and 18%, 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
<PAGE>

Lack Of Experience Of Representatives. Dirks & Company, Inc., one of the
Representatives, commenced operations in July 1997, and Security Capital
Trading Inc., the other Representative, commenced operations in June 1995.
Neither of the Representatives has ever co-managed a public offering of
securities. In addition, Dirks & Company, Inc. has participated as an
underwriter in only two public offerings of securities and Security Capital
Trading Inc. has never participated as an underwriter in any public offering
of securities. Accordingly, neither of the Representatives have any experience
as a co-manager and one of the Representatives has only limited experience as
an underwriter of public offerings of securities. See "Underwriting."

Shares Eligible For Future Sale. 2,368,160 of the 2,468,160 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 (2,668,160 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 100,000 shares of Common Stock
previously acquired upon the exercise of options granted under the Company's
Plan, 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
<PAGE>

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 one year from the date of the Prospectus, at an exercise
price of $ per Share [165% of the public offering price of the Common
Shares] and at an exercise price of $ per Warrant [165% 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 [110% 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 5,839,866 shares of Common Stock for issuance
as follows: (i) 110,000 shares for issuance upon exercise of the outstanding
warrants; (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)
599,050 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
<PAGE>

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
<PAGE>

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 $5.25 per share or 70% 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 December 31, 1997, the amount of dividends in arrears on the Series
B Preferred Stock was $1,695. 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:

<TABLE>
<CAPTION>
NET PROCEEDS PERCENT OF TOTAL
------------ ----------------
<S> <C> <C>
Product development expenses...................... $ 4,500,000 36%
Sales and marketing expenditures.................. 2,600,000 21
Facilities and other capital expenditures......... 1,700,000 13
Expansion of internal operations.................. 750,000 6
Repayment of certain indebtedness................. 750,000 6
Working capital and general corporate purposes.... 2,337,000 18
----------- ---
Total......................................... $12,637,000 100%
=========== ===
</TABLE>

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
<PAGE>

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.

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.

Facilities and Other Capital Expenditures. The Company intends to use
approximately $1,000,000 of the net proceeds of the Offering to close on an
option to acquire and to renovate a building adjacent to its principal
facility for required expansion space. The purchase option was exercised on
March 23, 1998 and requires payment of $340,000 by May 22, 1998. 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."

Repayment of Certain Indebtedness. The Company intends to use approximately
$750,000 of the net proceeds of the Offering to repay certain indebtedness of
the Company. Such indebtedness consists of (i) a $620,000 term loan due
January 3, 2003, bearing interest at 7.71% per annum, and (ii) an equipment
loan due February 2002, bearing interest at 9.75% per annum, of which $129,000
was outstanding on February 28, 1998. 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
<PAGE>

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 December 31, 1997, the amount of dividends in arrears on
the Series B Preferred Stock was $1,695.

CAPITALIZATION

The following table sets forth the capitalization of the Company as of
December 31, 1997, (a) on an actual basis and (b) on a pro forma as adjusted
basis giving effect to (i) the sale of 5,000 shares of Common Stock in
January, 1998, (ii) the exercise in March 1998 of 100,000 options under the
Plan, (iii) the issuance in February 1998 of three unsecured notes payable in
the aggregate principal amount of $1,000,000, and (iv) 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.

<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------
PRO FORMA,
ACTUAL AS ADJUSTED
----------- -----------
<S> <C> <C>
Long-Term Debt....................................... $ 701,656 $ 1,000,000
----------- -----------
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 363,160 shares,
actual and 2,468,160 shares pro forma, as
adjusted.......................................... 3,632 24,682
Common stock warrant............................... 78,000 78,000
Additional paid-in capital......................... 2,029,566 14,674,116
Retained earnings.................................. (1,152,088) (1,152,088)
----------- -----------
Total stockholders' equity......................... $ 1,027,907 $13,693,507
----------- -----------
Total capitalization............................. $ 1,729,563 $14,693,507
=========== ===========
</TABLE>
- --------
(1) Does not include: (i) 599,050 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) 110,000 shares of Common Stock issuable
upon the exercise of warrants currently outstanding. See "Management--1995
Stock Option Plan," "Management--Directors' Compensation" and "Description
of Securities."

18
<PAGE>

DILUTION

As of December 31, 1997, the pro forma net tangible book value of the Common
Stock was $660,407, or approximately $0.17 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 5,000 shares of Common Stock in January
1998 and (b) the exercise in March 1998 of 100,000 options granted under the
Plan. 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 December 31, 1997 would have been
$13,297,407, or approximately $2.25 per share of Common Stock. This represents
an immediate increase in net tangible book value of $2.08 per share of Common
Stock to existing stockholders and an immediate dilution in net tangible book
value of $5.25 per share of Common Stock or 70% to new investors. The
following table illustrates this per share dilution:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per Share.................... $7.50
Pro forma net tangible book value per share prior to this
Offering ................................................... $0.17
Increase per share attributable to this Offering ............ 2.08
-----
Pro forma net tangible book value per share after this Offering ... 2.25
-----
Dilution per share to new investors ............................... $5.25
=====
</TABLE>

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 December 31, 1997 would have been
$15,267,957 or $2.46 per share of Common Stock, resulting in dilution to new
investors of $5.04 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.

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
----------------- ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders....... 3,908,026 66% $ 2,027,422 12% $0.52
New investors(1)............ 2,000,000 34% 15,000,000 88% $7.50
--------- ---- ----------- ----
Total................... 5,908,026 100% $17,027,422 100%
========= ==== =========== ====
</TABLE>
- --------
(1)Attributes no value to the Warrants.

19
<PAGE>

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 and the three month periods ended
December 31, 1996 and 1997 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.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER NINE MONTHS ENDED THREE MONTHS ENDED
31, SEPTEMBER 30, DECEMBER 31,
-------------------- ---------------------- --------------------
1995 1996 1996 1997(1) 1996 1997
-------- ---------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Software license fees... $757,579 $2,442,047 $1,623,066 $2,242,512 $818,981 $ 931,477
Cost of software license
fees................... 82,053 372,272 199,349 407,099 172,923 159,415
-------- ---------- ---------- ---------- -------- ----------
Gross profit............ 675,526 2,069,775 1,423,717 1,835,413 646,058 772,062
-------- ---------- ---------- ---------- -------- ----------
Selling and marketing
expenses............... 234,636 954,243 627,349 1,445,302 326,894 649,320
General and
administrative
expenses............... 256,417 717,664 467,940 834,934 249,724 317,275
Product development
expenses............... 150,082 183,740 97,071 374,128 86,669 106,884
-------- ---------- ---------- ---------- -------- ----------
Total operating
expenses............... 641,135 1,855,647 1,192,360 2,654,364 663,287 1,073,479
-------- ---------- ---------- ---------- -------- ----------
Income (loss) from
operations............. 34,391 214,128 231,357 (818,951) (17,229) (301,417)
Other income (expense).. (1,067) (15,034) (10,292) (40,140) (4,742) (22,090)
-------- ---------- ---------- ---------- -------- ----------
Income (loss) before
income taxes........... 33,324 199,094 221,065 (859,091) (21,971) (323,507)
Income tax expense
(benefit).............. 0 20,000 0 (20,000) 20,000 0
-------- ---------- ---------- ---------- -------- ----------
Net income (loss)....... $ 33,324 $ 179,094 $ 221,065 $ (839,091) $(41,971) $ (323,507)
======== ========== ========== ========== ======== ==========
Pro forma net income
(loss) per common
share(2):
Basic................. $ 25.65 $ 5.82 $ 134.91 $ (5.15) $ (.49) $ (1.36)
======== ========== ========== ========== ======== ==========
Diluted............... $ .23 $ .09 $ .49 $ (5.15) $ (.49) $ (1.36)
======== ========== ========== ========== ======== ==========
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
------------------- SEPTEMBER 30, DECEMBER 31,
1995 1996 1997(1) 1997
-------- ---------- ------------- ------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)........ $ 52,904 $ 515,385 $ (264,853) $ (50,323)
Total assets..................... 238,086 1,627,122 2,332,963 2,596,228
Long-term liabilities............ 0 20,000 702,443 701,656
Stockholders' equity............. 175,316 1,076,705 684,414 1,027,907
</TABLE>
- --------
(1) On September 30, 1997, the Company changed its fiscal year end to
September 30 of each year.
(2) See Note 1 to the Financial Statements of the Company.

20
<PAGE>

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 and the three-month period ended December 31, 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
<PAGE>

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, the nine months ended September 30,
1997 and the three months ended December 31, 1997, approximately 18%, 27% and
18%, respectively, of the Company's total revenues were generated from sources
outside the U.S., including 4%, 6% and 4%, 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.

<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS THREE MONTHS
DECEMBER ENDED ENDED
31, SEPTEMBER 30, DECEMBER 31,
------------ -------------- ---------------
1995 1996 1996 1997 1996 1997
----- ----- ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Software license fees..... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of software license
fees..................... 10.8 15.2 12.3 18.2 21.1 17.1
----- ----- ------ ------ ------ ------
Gross profit.............. 89.2 84.8 87.7 81.8 78.9 82.9
Operating expenses:
Selling and marketing... 31.0 39.1 38.7 64.4 39.9 69.7
General and
administrative......... 33.8 29.4 28.8 37.2 30.5 34.1
Product development..... 19.8 7.5 6.0 16.7 10.6 11.5
----- ----- ------ ------ ------ ------
Total operating expenses.. 84.6 76.0 73.5 118.3 81.0 115.3
----- ----- ------ ------ ------ ------
Income (loss) from
operations............... 4.6 8.8 14.2 (36.5) (2.1) (32.4)
Interest expense.......... 0.0 0.9 0.8 1.9 1.0 2.3
Other income (expense).... (0.2) 0.3 0.2 0.1 .4 0
----- ----- ------ ------ ------ ------
Income before income
taxes.................... 4.4 8.2 13.6 (38.3) (2.7) (34.7)
Income tax expense
(benefit)................ 0.0 0.9 0.0 (0.9) 2.4 0
----- ----- ------ ------ ------ ------
Net income (loss)......... 4.4% 7.3% 13.6% (37.4)% (5.1)% (34.7)%
===== ===== ====== ====== ====== ======
</TABLE>

RESULTS OF OPERATIONS

Three Months Ended December 31, 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
<PAGE>

Software license fees increased by $112,000 to $931,000 for the three-month
period ended December 31, 1997 from the $819,000 recorded in the three-month
period ended December 31, 1996. The increase was largely attributable to the
expanding suite of products offered by the Company and the increased emphasis
in 1997 on advertising and other product marketing activities. In mid-1997,
the Company released its acoustics modeler and CD Architect products.

Software license fees to international customers accounted for 18% and 20%
of software license fees for the three-month periods ended December 31, 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 decreased by $14,000 to $159,000 for the three-month period
ended December 31, 1997 from $173,000 during the three month period ended
December 31, 1996 and were 21.1% and 17.1% as a percentage of software license
fees during the 1996 and 1997 periods, respectively. The decrease resulted
primarily from reduced costs of materials associated with improved purchasing
and inventory management during the quarter ended December 31, 1997 over the
comparable 1996 period.

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
$322,000 to $649,000 during the three-month period ended December 31, 1997
from $327,000 during the three-month period ended December 31, 1996, as the
number of employees in sales, marketing and technical support increased from 9
on December 31, 1996 to 21 on December 31, 1997. Selling and marketing
expenses as a percentage of software license fees were 39.9% and 69.7% 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 expenses as a percentage of software license fees was
primarily due to the Company's decision to hire additional sales, marketing
and technical support personnel and incur other advertising and marketing
costs in advance of the introduction of new products.

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
$67,000 to $317,000 during the three-month period ended December 31, 1997 from
$250,000 during the three-month period ended December 31, 1996. General and
administrative expenses as a percentage of software license fees were 30.5%
and 34.1% during the 1996 and 1997 periods, respectively. The increase was
primarily attributable to increases in salaries, benefits, rent, utilities,
depreciation and other expenses required to build an infrastructure to support
the increased suite of 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 capitalized
pursuant to SFAS No. 86, "Accounting for the Cost of Computer Software to be
Sold, Leased, or Otherwise Marketed." Product development expenses increased
by $20,000 to $107,000 during the three-month period ended December 31, 1997
from $87,000 during the three-month period ended December 31, 1996. Product
development expenses as a percentage of software license fees were 10.6% and
11.5% for the 1996 and 1997 periods, respectively. The level of development
effort expended on software products that had reached the level of
technological feasibility but were not ready for general release had increased
significantly during the three-month period ended December 31, 1997 over the
comparable period in 1996. The Company's ACID

23
<PAGE>

product fell into this category during the entire three-month period ended
December 31, 1997 while no products met this definition during the 1996
period. The Company capitalized $125,000 of software development costs
pursuant to SFAS Number 86 relating primarily to the ACID product during the
three-month period ended December 31, 1997. The combined increase in product
development costs incurred during the 1997 period over the comparable 1996
period was due to an increase in the number of software engineers needed to
accelerate development of the Company's expanding line of software products.

INCOME TAX EXPENSE (BENEFIT)

In October 1996 the Company elected to terminate its election to be treated
as a sub-chapter S Corporation for Federal and State income tax purposes.
Prior to that, the income tax impact of earnings and losses flowed through to
the individual returns of the owners of the Company. The tax impact of the
two-month period ended December 31, 1996 resulted in a charge of $20,000 to
record deferred income taxes. The deferred nature of the charge resulted
primarily from book and tax differences associated with the treatment of
capitalized software development and depreciation costs.

Nine Months Ended September 30, 1996 and 1997

SOFTWARE LICENSE FEES

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 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 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

24
<PAGE>

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 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 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

25
<PAGE>

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.

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

26
<PAGE>

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 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 operating
activities of $104,000 and $317,000 for the three-month periods ended December
31, 1996 and 1997, respectively, were largely affected by net losses of
$42,000 and $324,000, respectively. Also affecting cash used in operating
activities were additional investments in accounts receivable, inventory and
other assets of $204,000 and $181,000 for the three-month periods ended
December 31, 1996 and 1997, respectively, partially offset by additional
credit obtained from creditors of $80,000 and $116,000 and $62,000 and
$72,000, respectively, representing the add-back of non-cash depreciation,
amortization and deferred tax charges.

27
<PAGE>

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 used in investing activities of $198,000 and
$200,000 for the three-month periods ended December 31, 1996 and 1997,
respectively, related primarily to purchases of computers, furniture and other
equipment of $198,000 and $75,000, respectively, and from the capitalization
of software development costs of $125,000 in the 1997 quarter.

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. Cash provided by financing activities of $620,000
and $471,000 for the three-month periods ended December 31, 1996 and 1997
related primarily to issuances of shares of common stock which were partially
offset by repayments under the line of credit of $150,000 in 1997.

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 360,160 shares
were sold as of January 31, 1998 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, 125,400 shares ($627,000), was sold
during the quarter ended December 31, 1997, and 5,000 shares ($25,000) was
sold in January, 1998.

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. The Company intends to repay the construction
loan with a portion of the net proceeds of this Offering. See "Use of
Proceeds."

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, which was repaid in February,
1998.

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 February 28, 1998, $129,000 was outstanding under such loan. The
Company intends to repay the equipment loan with a portion of the net proceeds
of this Offering. See "Use of Proceeds."

In February 1998, the Company issued unsecured notes payable in the
aggregate principal amount of $1,000,000. The notes mature February 1999 and
bear interest at a rate of 12% per annum. In connection with the issuance of
the notes, the Company also issued a total of 50,000 common stock purchase
warrants, each exercisable for one share of Common Stock at an exercise price
of $5.00 per share. Such warrants are exercisable for a period of four years
beginning in February 1999. See "Description of Securities--Outstanding
Warrants."

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

28
<PAGE>

$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 12 months following the date
of this Prospectus consistent with its anticipated growth in operations and
infrastructure. The Company has exercised a purchase option on approximately
8,000 square feet of partially heated storage space in a building adjacent to
its principal facility, which it currently leases. The Company expects to
expend approximately $1,000,000 to close on the purchase option 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 December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $1,295,000 and $1,302,000, 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 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.

29
<PAGE>

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 such as
audio professionals and writers of trade magazine articles, and by 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 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

30
<PAGE>

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:

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."

31
<PAGE>

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 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)

32
<PAGE>

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:

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

33
<PAGE>

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.

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.

34
<PAGE>

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.

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.

35
<PAGE>

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.

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, the nine months ended September 30, 1997
and the three months ended December 31, 1997, the Company expended
approximately $360,000, $488,000 and $232,000, or 14.7%, 21.8% and 24.9%,
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 December 31, 1997, the Company had 15 employees, or
approximately 35% of its workforce, engaged in product development activities.

36
<PAGE>

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, the nine months ended September 30, 1997 and the three
months ended December 31, 1997, 18%, 27% and 18% 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.

Computer Distributor. The Company entered into an agreement on October 16,
1997 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."

37
<PAGE>

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 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

38
<PAGE>

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. 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."

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 signing of the

39
<PAGE>

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.

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.

40
<PAGE>

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 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.

41
<PAGE>

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 technical 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 has exercised an option to purchase an 8,000
square foot building directly adjacent to its principal facility, which it
currently leases. This space is currently used for storage, however, the
Company intends to renovate the space and use it for future expansion. 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" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."

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.

<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Rimas P. Buinevicius.... 35 Chief Executive Officer and Chairman
Monty R. Schmidt........ 34 President and Director
Curtis J. Palmer........ 28 Chief Technology Officer and Director
Kenneth A. Minor........ 36 Chief Financial Officer and Assistant Secretary
Roy Elkins.............. 38 Vice President, Sales and Marketing
Frederick H. Kopko, Jr.. 42 Secretary and Director
Arnold Pollard.......... 55 Director
David C. Kleinman....... 62 Director
</TABLE>

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

42
<PAGE>

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 and Assistant Secretary since December 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.

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

43
<PAGE>

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.

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.

44
<PAGE>

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.

<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($)
--------------------------- ---- ---------- ---------
<S> <C> <C> <C>
Rimas Buinevicius (1)...................... 1997(3) 54,808 0
Chairman and Chief Executive Officer 1996 64,616 37,149
Monty Schmidt (2).......................... 1997(3) 54,808 0
President and Director 1996 64,616 6,462
</TABLE>
- --------
(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.

(3) Represents nine months ended September 30, 1997.

None of the Named Executive Officers exercised options to purchase Common
Stock during the fiscal year ended September 30, 1997, and no Named Executive
Officer had exercised or unexercised stock options as of September 30, 1997.

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. Options to purchase 100,000
shares were exercised in March 1998. 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.

45
<PAGE>

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.
Such non-compete clauses may not be enforceable, or may only be partially
enforceable, in state courts of relevant jurisdictions.

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 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 twelve month periods ended December 31, 1997 and 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.

46
<PAGE>

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."

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 March 18, 1998, 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.

47
<PAGE>

<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF CLASS
OF CLASS BENEFICIALLY OWNED
BENEFICIALLY ------------------------------
NAME OF BENEFICIAL OWNER(1) OWNED BEFORE OFFERING AFTER OFFERING
- --------------------------- ---------------- --------------- --------------
<S> <C> <C> <C>
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
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)......................
</TABLE>
- --------
*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."

48
<PAGE>

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 368,160 shares of Common Stock. The Selling
Stockholders Shares are not being underwritten by the Representatives 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.

49
<PAGE>

<TABLE>
<CAPTION>
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)
- ------------------ ------------------- ---------------- -------------------
<S> <C> <C> <C>
Interbac................ 10,000 10,000 0
Algimantas L. and
Cleopatra A.
Buinevicius Living
Trust Dated 2/19/98.... 8,000 8,000 0
Eric Ebacher............ 8,000 8,000 0
Mark and Virginia
Ebacher................ 8,000 8,000 0
Todd Rizzo.............. 6,500 6,500 0
Harrison Trust.......... 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
</TABLE>

50
<PAGE>

51
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have 2,468,160 shares of
Common Stock and 6,879,732 shares of Series B Preferred Stock outstanding.
After the Offering, 2,368,160 of the 2,468,160 shares of Common Stock 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 (24,681 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 100,000 shares of Common
Stock previously acquired upon the exercise of options granted under the
Company's Plan, 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
2,468,160 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

52
<PAGE>

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

53
<PAGE>

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 WARRANTS

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.

In connection with the issuance in February 1998 of unsecured notes in the
aggregate principal amount of $1,000,000, the Company issued 50,000 common
stock purchase warrants. The warrants give the holders the right from February
1999 to February 2003 to purchase 50,000 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. Effective February 1999, the
holders will have piggyback registration rights with respect to the Common
Stock issuable upon exercise of the warrants for the term of the warrants.

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

54
<PAGE>

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. 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.

55
<PAGE>

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
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

56
<PAGE>

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.

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 Inc. 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:

<TABLE>
<CAPTION>
NUMBER OF NUMBER OF
UNDERWRITER SHARES WARRANTS
----------- --------- ---------
<S> <C> <C>
Dirks & Company, Inc..................................
Security Capital Trading Inc..........................
--------- ---------
Total............................................. 2,000,000 1,000,000
========= =========
</TABLE>

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

57
<PAGE>

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 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. 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 been
advised that, in the opinion of the Commission, such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.

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, 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.
There are no current or future plans, proposals, arrangements or
understandings known to the Underwriters with respect to engaging in any
transactions with the Selling Stockholders.

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
one year from the date of the Prospectus at a price of $ [165% of the
public offering price of the Common Stock] per share of Common Stock and $
[165% of the public offering price of the Warrants] per Warrant. The Warrants
issuable upon exercise of the Representatives' Warrants are initially
exercisable at a price of $ [110% 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. In addition, the Representatives'
Warrants may not be sold, transferred, assigned, hypothecated or otherwise
disposed of, in whole or in part, for a period of one year from the date of
the prospectus, except to officers of the Representative.

58
<PAGE>

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 Inc., the other Representative,
commenced operations in June 1995. Neither of the Representatives has ever co-
managed a public offering of securities. In addition, Dirks & Company Inc. has
participated as an underwriter in only two public offerings of securities and
Security Capital Trading Inc. has never participated as an underwriter in any
public offering of securities. Accordingly, neither of the Representatives has
experience as a co-manager and one of the Representatives has only limited
experience as an 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."

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.

The decision to change accountants was made mutually by the Company and
Williams, Young & Associates, LLC and was effective as of September 30, 1997.
The Company's decision was recommended by the Company's board of directors.
The report on the financial statements by Williams, Young & Associates, LLC
for each of the two years ended December 31, 1996, did not contain an adverse
opinion or disclaimer of opinion, and was not modified as to uncertainty,
audit scope, or accounting principles. The Company had no disagreement with
Williams, Young & Associates, LLC, on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope or procedure,
which, if not resolved to the satisfaction of Williams, Young & Associates,
LLC, would have caused it to make reference to the subject matter of the
disagreement in connection with its report.

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

59
<PAGE>

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.

60
<PAGE>

SONIC FOUNDRY, INC.

INDEX TO HISTORICAL FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................... F-2
Report of Williams, Young & Associates LLC, Independent Auditors........... F-3
Balance Sheets as of September 30, 1997 and December 31, 1997 (unaudited).. F-4
Statements of Operations for the years ended December 31, 1995 and 1996,
for the nine months ended September 30, 1996 (unaudited) and 1997 and for
the three months ended December 31, 1996 (unaudited) and 1997 (unaudited). 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,
for the nine months ended September 30, 1996 (unaudited) and 1997, and for
the three months ended December 31, 1996 (unaudited) and 1997 (unaudited). F-8
Notes to Financial Statements.............................................. F-9
</TABLE>
<PAGE>

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
<PAGE>

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
<PAGE>

SONIC FOUNDRY, INC.

BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1997 1997
------------ -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................... $ 114,737 $ 68,338
Accounts receivable, net of allowance, of $20,090
and $68,028 at September 30, 1997 and December 31,
1997, respectively................................. 428,484 464,885
Inventories......................................... 56,662 149,368
Prepaid expenses and other current assets........... 81,370 133,751
---------- ----------
Total current assets.............................. 681,253 816,342
Property and equipment:
Land................................................ 95,000 95,000
Buildings and improvements.......................... 734,575 768,657
Equipment........................................... 674,695 704,043
Furniture and fixtures.............................. 36,877 48,551
---------- ----------
1,541,147 1,616,251
Less accumulated depreciation....................... 190,193 232,465
---------- ----------
Net property and equipment.......................... 1,350,954 1,383,786
Capitalized software development costs, net........... 300,078 395,485
Other assets.......................................... 678 615
---------- ----------
Total assets...................................... $2,332,963 $2,596,228
========== ==========
</TABLE>

F-4
<PAGE>

SONIC FOUNDRY, INC.

BALANCE SHEETS

<TABLE>
<CAPTION>
SEPTEMBER 30 DECEMBER 31
1997 1997
------------ -----------
(UNAUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit...................................... $ 220,000 $ 70,000
Note payable to related party....................... 40,000 --
Accounts payable.................................... 570,650 737,479
Accrued liabilities................................. 84,282 33,553
Current portion of long-term obligations............ 31,174 25,633
---------- ----------
Total current liabilities............................. 946,106 866,665
Long-term obligations................................. 702,443 701,656
Deferred income taxes................................. -- --
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 6,879,732 shares at September 30, 1997
and December 31, 1997, respectively................ 68,797 68,797
Common stock, $.01 par value, authorized 20,000,000
shares; issued and outstanding 229,760 and 363,160
shares at September 30, 1997 and December 31, 1997,
respectively....................................... 2,298 3,632
Common stock warrant................................ 78,000 78,000
Additional paid-in capital.......................... 1,363,900 2,029,566
Retained deficit.................................... (828,581) (1,152,088)
---------- ----------
684,414 1,027,907
---------- ----------
Total liabilities and stockholders' equity............ $2,332,963 $2,596,228
========== ==========
</TABLE>

See accompanying notes.

F-5
<PAGE>

SONIC FOUNDRY, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31 SEPTEMBER 30 DECEMBER 31
-------------------- ----------------------- -----------------------
1995 1996 1996 1997 1996 1997
-------- ---------- ----------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Software license fees... $757,579 $2,442,047 $1,623,066 $2,242,512 $818,981 $ 931,477
Cost of software license
fees................... 82,053 372,272 199,349 407,099 172,923 159,415
-------- ---------- ---------- ---------- -------- ---------
675,526 2,069,775 1,423,717 1,835,413 646,058 772,062
Selling and marketing
expenses............... 234,636 954,243 627,349 1,445,302 326,894 649,320
General and
administrative
expenses............... 256,417 717,664 467,940 834,934 249,724 317,275
Product development
expenses............... 150,082 183,740 97,071 374,128 86,669 106,884
-------- ---------- ---------- ---------- -------- ---------
641,135 1,855,647 1,192,360 2,654,364 663,287 1,073,479
-------- ---------- ---------- ---------- -------- ---------
Income (loss) from
operations............. 34,391 214,128 231,357 (818,951) (17,229) (301,417)
Other income (expense):
Interest expense...... (159) (21,928) (13,445) (42,771) (8,483) (22,090)
Other income (ex-
pense)............... (908) 6,894 3,153 2,631 3,741 --
-------- ---------- ---------- ---------- -------- ---------
(1,067) (15,034) (10,292) (40,140) (4,742) (22,090)
-------- ---------- ---------- ---------- -------- ---------
Income (loss) before
income taxes........... 33,324 199,094 221,065 (859,091) (21,971) $(323,507)
Income tax expense
(benefit).............. -- 20,000 -- (20,000) 20,000 --
-------- ---------- ---------- ---------- -------- ---------
Net income (loss)....... $ 33,324 $ 179,094 $ 221,065 $ (839,091) $(41,971) $(323,507)
======== ========== ========== ========== ======== =========
Pro forma data
(unaudited):
Income (loss) before
income taxes......... $ 33,324 $ 199,094 $ 221,065 $ (859,091) $(21,971) $(323,507)
Income tax expense
(benefit)............ 7,000 70,000 79,000 (20,000) 20,000 --
-------- ---------- ---------- ---------- -------- ---------
Net income (loss)..... $ 26,324 $ 129,094 $ 142,065 $ (839,091) $(41,971) $(323,507)
======== ========== ========== ========== ======== =========
Net income (loss) per
common share:
Basic............... $ 25.65 $ 5.82 $ 134.91 $ (5.15) $ (.49) $ (1.36)
======== ========== ========== ========== ======== =========
Diluted............. $ .23 $ .09 $ .49 $ (5.15) $ (.49) $ (1.36)
======== ========== ========== ========== ======== =========
</TABLE>

See accompanying notes.

F-6
<PAGE>

SONIC FOUNDRY, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 1995 AND 1996 AND THE
NINE MONTHS ENDED SEPTEMBER 30, 1997

<TABLE>
<CAPTION>
PREFERRED STOCK-SERIES B COMMON STOCK COMMON ADDITIONAL RETAINED
------------------------------------------ STOCK PAID-IN EARNINGS
SHARES DOLLARS SHARES DOLLARS WARRANT CAPITAL (DEFICIT) TOTAL
------------- ------------------- ------- ------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
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
Issuance of common
stock, net
(unaudited).......... -- -- 133,400 1,334 -- 665,666 -- 667,000
Net loss (unaudited).. -- -- -- -- -- -- (323,507) (323,507)
------------- ----------- ------- ------ ------- ---------- ----------- ----------
Balance, December 31,
1997 (unaudited)....... 6,879,732 $ 68,797 363,160 $3,632 $78,000 $2,029,566 $(1,152,088) $1,027,907
============= =========== ======= ====== ======= ========== =========== ==========
</TABLE>

See accompanying notes.

F-7
<PAGE>

SONIC FOUNDRY, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED NINE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31 SEPTEMBER 30 DECEMBER 31
----------------- ---------------------- -----------------------
1995 1996 1996 1997 1996 1997
------- -------- ----------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)....... $33,324 $179,094 $221,065 $ (839,091) $(41,971) $(323,507)
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 17,343 42,335
Amortization of
capitalized software
development costs.... 12,000 41,345 16,336 85,718 25,009 29,434
Deferred income taxes. -- 20,000 -- (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 (182,684) (36,401)
Inventories......... (107) (26,692) (62,929) (11,435) 36,237 (92,706)
Prepaid expenses and
other current
assets............. -- (76,976) (19,190) (4,394) (57,786) (52,381)
Accounts payable and
accrued
liabilities........ 32,269 282,647 202,937 324,515 79,710 116,100
------- -------- -------- ---------- -------- ---------
Total adjustments....... 12,154 5,652 67,823 514,575 (62,171) 6,381
------- -------- -------- ---------- -------- ---------
Net cash provided by
(used in) operating
activities............. 45,478 184,746 288,888 (324,516) (104,142) (317,126)
INVESTING ACTIVITIES
Purchases of property
and equipment.......... (72,654) (383,556) (185,518) (1,042,665) (198,038) (75,104)
Proceeds from sale of
equipment.............. 350 -- -- -- -- --
Capitalized software
development costs...... -- (176,068) (176,068) (212,073) -- (124,841)
Other................... 4,076 -- -- -- -- --
------- -------- -------- ---------- -------- ---------
Net cash used in
investing activities... (68,228) (559,624) (361,586) (1,254,738) (198,038) (199,945)
FINANCING ACTIVITIES
Proceeds from sale of
common stock, net of
issuance costs......... -- 620,494 -- 509,800 620,494 627,000
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 -- (150,000)
Proceeds from long-term
debt................... -- -- -- 747,800 -- (6,328)
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 1,240,417 620,494 470,672
------- -------- -------- ---------- -------- ---------
Net increase (decrease)
in cash................ (23,750) 430,616 112,302 (338,837) 318,314 (46,399)
Cash and cash
equivalents at
beginning of year...... 46,708 22,958 22,958 453,574 135,260 114,737
------- -------- -------- ---------- -------- ---------
Cash and cash
equivalents at end of
year................... $22,958 $453,574 $135,260 $ 114,737 $453,574 $ 68,338
======= ======== ======== ========== ======== =========
Supplemental cash flow
information:
Interest paid......... $ 159 $ 21,928 $ 13,445 $ 41,451 $ 8,483 $ 23,410
Noncash transactions:
Exchange of common
stock for preferred
stock.............. -- 183,023 -- -- 183,023 --
Conversion of notes
payable into common
stock.............. -- -- -- -- -- 40,000
Stock issued for
services........... 7,222 23,801 23,801 -- -- --
Warrant issued for
services........... -- 78,000 78,000 -- -- --
Preferred stock
dividend........... -- -- -- 1,997 -- --
</TABLE>

See accompanying notes.

F-8
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 1997 AND DECEMBER 31, 1997 (UNAUDITED)

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 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

F-9
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

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 balance sheet as of December 31, 1997 and the unaudited
statements of operations and cash flows for the nine-month period ended
September 30, 1996 and the three-month period ended December 31, 1996 and 1997
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. Operating results for the
three month period ended December 31, 1997 are not necessarily indicative of
the results that might be expected for the year ended September 30, 1998.

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:

<TABLE>
<CAPTION>
YEARS
-------------
<S> <C>
Building and improvements................................... 5 to 40 years
Equipment................................................... 3 to 5 years
Furniture and fixtures...................................... 7 years
</TABLE>

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.

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.

F-10
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

Pro Forma Net Income (Loss) Per Share

In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS
No. 128 replaced the calculation of primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Earnings per share amounts for all
periods have been presented and, where appropriate, restated to conform to
SFAS No. 128 requirements.

The following table sets forth the computation of basic and diluted earnings
per share.

<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED THREE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30, DECEMBER 31,
------------------- ------------------ --------------------
1995 1996 1996 1997 1996 1997
-------- ---------- -------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
NUMERATOR
Pro forma net income
(loss) used in
computing basic
earnings per share..... $ 26,324 $ 129,094 $142,065 $(839,091) $ (41,971) $(323,507)
Preferred stock
dividends declared..... -- -- -- (1,997) -- --
Interest on convertible
debt................... -- -- -- 718 -- --
-------- ---------- -------- --------- --------- ---------
Adjusted pro forma net
income (loss) used in
computing diluted
earnings per share..... $ 26,324 $ 129,094 $142,065 $(840,370) $ (41,971) $(323,507)
======== ========== ======== ========= ========= =========
DENOMINATOR
Denominator for basic
earnings per share--
weighted average common
shares................. 1,026 22,178 1,053 163,231 85,551 237,427
Effect of dilutive
securities--stock
options and warrants... 111,330 297,398 286,080 -- -- --
Effect of weighted
average shares issuable
upon conversion of
Series B Preferred
Stock.................. -- 1,113,333 -- -- -- --
-------- ---------- -------- --------- --------- ---------
Denominator for diluted
earnings per share--
adjusted weighted
average common shares.. 112,356 1,432,909 287,133 163,231 85,551 237,427
======== ========== ======== ========= ========= =========
Securities that could
potentially dilute
basic earnings per
share in the future
that are not included
in the computation of
diluted earnings per
share as their impact
is antidilutive
(treasury stock method)
Options and warrants... -- -- -- 348,962 337,696 365,839
Convertible debt....... -- -- -- 8,000 -- --
Convertible Series B
Preferred Stock....... -- -- -- 3,439,866 3,340,000 3,439,866
</TABLE>

F-11
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)

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

Reclassifications

Certain reclassifications have been made to the 1995 and 1996 financial
statements to conform to the 1997 presentation.

F-12
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

2. LONG-TERM DEBT AND NOTES PAYABLE

Long-term obligations consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
1996 1997
----------- ------------
<S> <C> <C>
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
======== ========
</TABLE>

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.

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.

F-13
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

2. LONG-TERM DEBT AND NOTES PAYABLE--(CONTINUED)

Maturities of long-term debt at September 30, 1997 are as follows:

<TABLE>
<S> <C>
1998............................................................. $291,174
1999............................................................. 41,353
2000............................................................. 45,396
2001............................................................. 49,834
2002............................................................. 32,241
Thereafter....................................................... 533,619
--------
Total.......................................................... $993,617
========
</TABLE>

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.

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.

F-14
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

5. COMMON STOCK WARRANT--(CONTINUED)

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.

<TABLE>
<CAPTION>
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
------- -------- ------- -------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
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
</TABLE>

The options outstanding at September 30, 1997 have been segregated into
three ranges for additional disclosure as follows:

<TABLE>
<CAPTION>
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
- -------- -------------- ---------------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$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
</TABLE>

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
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)

F-15
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
6. STOCK OPTIONS--(CONTINUED)

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):

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31 NINE MONTHS ENDED
---------------- SEPTEMBER 30
1995 1996 1997
------- -------- -----------------
<S> <C> <C> <C>
Pro forma net income (loss).................. $32,824 $177,574 $(845,370)
Pro forma net income (loss) per share........ .08 .10 (1.11)
</TABLE>

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:

<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31 SEPTEMBER 30
1996 1997
----------- -----------------
<S> <C> <C>
Deferred....................................... $20,000 $(337,000)
Change in valuation reserve.................... -- 317,000
------- ---------
$20,000 $ (20,000)
======= =========
</TABLE>

The reconciliation of income tax expense computed at the U.S. federal
statutory rate to income tax expense is:

<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31 SEPTEMBER 30
1996 1997
----------- ------------
<S> <C> <C>
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)
======== =========
</TABLE>

F-16
<PAGE>

SONIC FOUNDRY, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

7. INCOME TAXES--(CONTINUED)

The significant components of the deferred tax accounts recognized for
financial reporting purposes were as follows:

<TABLE>
<CAPTION>
DECEMBER 31 SEPTEMBER 30
1996 1997
----------- ------------
<S> <C> <C>
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 $ --
======= =======
</TABLE>

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.

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:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31 NINE MONTHS ENDED
------------------- SEPTEMBER 30
1995 1996 1997
-------- ---------- -----------------
<S> <C> <C> <C>
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
======== ========== ==========
</TABLE>

F-17
<PAGE>

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------

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

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
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.................................................................. 30
Management................................................................ 42
Certain Transactions...................................................... 46
Principal Stockholders.................................................... 47
Selling Stockholders...................................................... 49
Shares Eligible for Future Sale........................................... 52
Description of Securities................................................. 52
Underwriting.............................................................. 57
Legal Matters............................................................. 59
Experts................................................................... 59
Additional Information.................................................... 59
Index to Financial Statements............................................. F-1
</TABLE>

---------------

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
(AS UNITS, EACH CONSISTING OF TWO SHARES OF COMMON STOCK AND ONE REDEEMABLE
COMMON STOCK PURCHASE WARRANT)

---------------

PROSPECTUS

---------------

DIRKS & COMPANY, INC.

SECURITY CAPITAL TRADING INC.

, 1998

- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>

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*

<TABLE>
<S> <C>
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
========
</TABLE>
- --------

*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 unregistered
securities as follows:

(1) An aggregate of 360,160 shares of Common Stock issued from October 1996
through January 1998 were sold to the 40 accredited and 23 non-
accredited investors (including 130,400 shares of Common Stock issued
from October 1997 through January 1998) listed under "Selling
Stockholders" in the Prospectus (excluding Algimantas L. and Cleopatra
A. Buinevicius Living Trust Dated 2/19/98, which

II-1
<PAGE>

shares are listed in paragraph (2) hereof). These sales were made in
reliance upon, among other provisions, Rule 505 of Regulation D. The
aggregate consideration received for such shares was $1,800,800.

(2) The conversion of a promissory note in the original principal amount of
$40,000 into 8,000 shares of Common Stock on October 17, 1997.
Individuals acquiring the Common Stock, Algimantas L. and Cleopatra A.
Buinevicius, the parents of the Chief Executive Officer, were
accredited and sophisticated investors. This issuance of Common Stock
was 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. By virtue of their relation to the Chief
Executive Officer, these individuals had access to information on the
Registrant necessary to make an informed investment decision.
Consideration received by the Registrant consisted of the promissory
note.

(3) The conversion of Common Stock of the Registrant into 6,680,000 shares
of Series B Preferred Stock on November 25, 1996. Participants in the
conversion were Rimas Buinevicius, Monty Schmidt, Curtis Palmer and
Frederick H. Kopko, Jr. These issuances of Common Stock were made in
reliance upon the exemption from registration set forth in Section 4(2)
of the Securities Act, relating to sales by an issuer not involving a
public offering. Individuals acquiring the Common Stock were all
accredited and sophisticated investors. By virtue of their relation to
the Registrant, these individuals all had access to information on the
Registrant necessary to make an informed investment decision.
Consideration received by the Registrant consisted of shares of Common
Stock.

(4) The issuance of a warrant to Vencap, Inc. the Company's stockholder
relations consultant, on July 24, 1996, to purchase 60,000 shares of
Common Stock. This issuance of a warrant was made in reliance upon the
exemption from registration set forth in Section 4(2) of the Securities
Act, relating to sales by an issuer not involving a public offering.
Based on discussions with such stockholder relations consultant, the
Registrant reasonably believes that such stockholder relations
consultant was an accredited and sophisticated investor. By virtue of
his relation to the Registrant, the investor relations consultant had
access to information on the Registrant necessary to make an informed
investment decision. Consideration received by the Registrant consisted
of services performed by the stockholder relations consultant.

(5) The issuance of options to Messrs. Kopko, Pollard, and Kleinman on
December 1, 1997, pursuant to the Directors' Option Plan, to purchase
an aggregate 30,000 shares of Common Stock. Messrs. Kopko, Pollard and
Kleinman are accredited and sophisticated investors. These issuances of
options were made in reliance upon the exemption from registration set
forth in Section 4(2) of the Securities Act, relating to sales by an
issuer not involving a public offering. By virtue of their relation to
the Registrant, these directors had access to information on the
Registrant necessary to make an informed investment decision.
Consideration received by the Registrant consisted of services
performed by the directors.

(6) The issuance of a series of options granted to employees for the years
ended December 31, 1995, 1996 and the nine months ended September 30,
1997, as described in Note 6 to the Financial Statements. These
issuances of options were made in reliance upon the exemption from
registration set forth in Section 4(2) of the Securities Act, relating
to sales by an issuer not involving a public offering. Based on a close
working relationship with such optionees, along with various
discussions with such optionees, the Registrant reasonably believes
that such optionees were accredited and/or sophisticated investors. By
virtue of their relation to the Registrant, these employees had access
to information on the Registrant necessary to make an informed
investment decision.

(7) The issuance of warrants to John Knoeller, John Feith and Frank
Shibilski in February 1998 to purchase a total of 50,000 shares of
Common Stock. These issuances of warrants were made in reliance upon
the exemption from registration set forth in Section 4(2) of the
Securities Act, relating to sales by an issuer not involving a public
offering. Based on discussion with such investors, the Registrant
reasonably believes that such investors were accredited and
sophisticated investors. By virtue of their relation to the Registrant,
these investors had access to information on the Registrant necessary
to make

II-2
<PAGE>

an informed investment decision. Consideration received by the
Registrant consisted of a loan in the amount of $1,000,000.

(8) The exercise of two options to purchase an aggregate of 100,000 shares
of Common Stock by two employees, John Feith and Shawn Pourchot, in
March 1998. Mr. Feith exercised options to purchase 80,000 shares and
Mr. Pourchot exercised options to purchase 20,000 shares. These sales
were made in reliance upon the exemption from registration set forth in
Rule 701. Consideration received by the Registrant consisted of the
option exercise price of $3,600.

No underwriters were engaged in connection with these issuances and sales.

II-3
<PAGE>

ITEM 27. EXHIBITS

<TABLE>
<CAPTION>
NUMBER DESCRIPTION
------ ----------- ---
<C> <S> <C>
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.
10.10* Form of Lock-up Agreement between Registrant and all
directors, officers, and non-selling stockhholders.
10.11* Form of Lock-up Agreement between Registrant and all selling
stockholders.
11.1* Statement re: Computation of Net Profit (Loss) Per Share
16.1* Letter on Change in Certifying Accountant.
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
</TABLE>
- --------
* Previously filed.

II-4
<PAGE>

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.

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.

The Registrant hereby undertakes that if the underwriter(s) in the offering
covered by this Registration Statement enter into transactions with any of the
selling securityholders named herein, or waive lock-ups applicable to such
selling securities holders, then:

(1) if such transaction or waiver of lock-up relates to not less than
five percent nor more than ten percent of the registered selling security
holders securities, the Registrant will file a "sticker" supplement
pursuant to Rule 424(c) under the Act relating thereto; and

(2) if such transaction or waiver of lock-up relates to more than ten
percent of the registered selling security holders securities, the
Registrant will file a post-effective amendment to the registration
statement relating thereto.

II-5
<PAGE>

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 AMENDMENT NO. 2 TO 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 APRIL 2, 1998.

Sonic Foundry, Inc.

/s/ Rimas P. Buinevicius
By: _________________________________
Rimas P. Buinevicius
Chief Executive Officer

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.

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----

<S> <C> <C>
/s/ Rimas P. Buinevicius Chairman of the Board and April 2, 1998
____________________________________ Chief Executive Officer
Rimas P. Buinevicius (Principal Executive
Officer)

/s/ Monty R. Schmidt President and Director April 2, 1998
____________________________________
Monty R. Schmidt

/s/ Curtis J. Palmer Chief Technology Officer April 2, 1998
____________________________________ and Director
Curtis J. Palmer

/s/ Kenneth A. Minor Chief Financial Officer April 2, 1998
____________________________________ (Principal Financial and
Kenneth A. Minor Accounting Officer)

/s/ Frederick H. Kopko, Jr. Director April 2, 1998
____________________________________
Frederick H. Kopko, Jr.

/s/ Arnold Pollard* Director April 2, 1998
____________________________________
Arnold Pollard

/s/ David C. Kleinman* Director April 2, 1998
____________________________________
David C. Kleinman
</TABLE>

/s/ Rimas Buinevicius
*By: __________________________
Rimas Buinevicius
Attorney-in-Fact

II-6

<PAGE>

SONIC

NUMBER LOGO SHARES
SEE REVERSE FOR
CERTAIN DEFINITIONS

FOUNDRY

SONIC FOUNDRY, INC. CUSIP 83545R 10 8

INCORPORATED UNDER THE LAWS OF THE STATE OF MARYLAND

This Certifies that

is the record holder of

FULLY PAID AND NON-ASSESSABLE SHARES OF $.01 PAR VALUE EACH OF THE COMMON
STOCK OF

Sonic Foundry, Inc., transferable on the books of the Corporation by the holder
hereof in person or by duly authorized attorney upon the surrender of this
Certificate properly endorsed. This Certificate is not valid unless
countersigned by the Transfer Agent.

Witness the facsimile seal and signatures of its duly authorized officers.

Dated:

SONIC FOUNDRY, INC. /s/ Kenneth A. Minor /s/
CORPORATE ------------------------ ------------------------
SEAL Kenneth A. Minor CHAIRMAN AND
MARYLAND ASSISTANT SECRETARY CHIEF EXECUTIVE OFFICER

COUNTERSIGNED:
CONTINENTAL STOCK TRANSFER & TRUST COMPANY
BY TRANSFER AGENT

AUTHORIZED OFFICER

AMERICAN BANK NOTE COMPANY MAR 27, 1998 fm
3504 ATLANTIC AVENUE
SUITE 12
LONG BEACH, CA 90807 055905FC-A
(562)989-2333
(FAX) (562) 426-7450 METRO Proof _________REV 2
(c) Jeffries Banknote Company

<PAGE>

SONIC FOUNDRY, INC.

If the Corporation is authorized to issue different classes of shares or
different series within a class, the Corporation will furnish in writing and
without charge to each shareholder who so requests, a summary of the
designations, relative rights, preferences and limitations applicable to each
class, and the variations in rights, preferences and limitations determined for
each series and the authority of the Board of Directors to determine variations
for future series. Such requests may be made to the Secretary of the
Corporation.

The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
accourding to applicable laws or regulations:

TEN COM--as tenants in common
TEN ENT--as tenants by the entireties
JT TEN--as joint tenants with right of
survivorship and not as tenants
in common

UNIF GIFT MIN ACT--...........Custodian...........
(Cust) (Minor)
under Uniform gifts to Minors
Act..............................
(State)
UNIF TRAN MIN ACT--...........Custodian...........
(Cust) (Minor)
under Uniform Transfers to Minors
Act..............................
(State)

Additional abbreviations may also be used though not in the above list.

For value received, ______________________________ hereby sell, assign and
transfer unto

PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------

- --------------------------------------------------------------------------------
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS INCLUDING ZIP CODE OF ASSIGNEE)
________________________________________________________________________________
________________________________________________________________________________
__________________________________________________________________________Shares
of the Common Stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint______________________________________________
________________________________________________________________________Attorney
to transfer the said stock on the books of the within-named Corporation with
full power of substitution in the premises.

Dated, ____________________________________

AFFIX MEDALLION SIGNATURE
GUARANTEE IMPRINT BELOW

----------------------------------------

----------------------------------------
ABOVE SIGNATURE(S) TO THIS ASSIGNMENT
MUST CORRESPOND WITH THE NAME AS WRITTEN
UPON THE FACE OF THE CERTIFICATE IN
EVERY PARTICULAR, WITHOUT ALTERATION OR
ENLARGEMENT, OR ANY CHANGE WHATEVER.

THE SIGNATURE(S) MUST BE GUARANTEED BY
AND ELIGIBLE GUARANTOR INSTITUTION SUCH
AS A SECURITIES BROKER/DEALER,
COMMERCIAL BANK & TRUST COMPANY, SAVINGS
AND LOAN ASSOCIATION OR A CREDIT UNION
PARTICIPATING IN A MEDALLION PROGRAM
APPROVED BY THE SECURITIES TRANSFER
ASSOCIATION, INC.

AMERICAN BANK NOTE COMPANY MAR 27, 1998 fm
3504 ATLANTIC AVENUE
SUITE 12
LONG BEACH, CA 90807 055905bk-A
(562) 989-2333
(FAX) (562) 426-7450 Proof_______REV 2

<PAGE>

EXHIBIT 5.1

[Letterhead of McBreen, McBreen & Kopko]

March 31, 1998

Sonic Foundry, Inc.
754 Williamson Street
Madison, Wisconsin 53703

Re: Registration Statement on Form SB-2 (No. 333-46005)

Gentlemen:

You have requested our opinion with respect to certain matters in
connection with the above-referenced registration statement, as amended (the
"Registration Statement"). Such Registration Statement relates to the following
securities:

A. 2,300,000 shares of Common Stock (including 300,000 shares subject
to the underwriters' over-allotment option) and 1,150,000 Redeemable Common
Stock Purchases Warrants (including 150,000 warrants subject to the
underwriters' over-allotment option) that the Registration Statement
contemplates will be sold in an underwritten public offering (the foregoing
shares and warrants being referred to as the "Offered Shares" and "Offered
Warrants", respectively);

B. Warrants (the "Representatives' Warrants") to be sold to Dirks &
Company, Inc. and Security Capital Trading Inc. in connection with the
aforementioned public offering; and

C. (i) 1,150,000 shares of Common Stock issuable upon exercise of
the Offered Warrants; (ii) 368,160 shares of Common Stock registered on
behalf of certain selling stockholders; (iii) 200,000 shares of Common
Stock and 100,000 Redeemable Common Stock Purchase Warrants issuable upon
exercise of the Representatives' Warrants; and (iv) 100,000 shares of
Common Stock issuable upon exercise of the Redeemable Common Stock Purchase
Warrants issuable upon exercise of the Representatives' Warrants (the
shares and warrants described in this subparagraph C being referred to
collectively as the "Warrant Securities").

We have reviewed copies of the Amended and Restated Article of
Incorporation of the Company, the Amended and Restated By-laws of the Company,
the Registration Statement and exhibits thereto and have examined such corporate
documents and records and other certificates, and have made such investigations
of law, as we have deemed necessary in order to render the opinion hereinafter
set forth.
<PAGE>

Based upon and subject to the foregoing, we are of the opinion that (i) the
Offered Shares and Offered Warrants will, when sold and paid for as contemplated
by the Registration Statement and the Underwriting Agreement filed as an exhibit
thereto, be duly authorized, validly issued, fully paid and non-assessable and
(ii) the Warrant Securities will, when issued and paid for in accordance with
the terms of the applicable warrant, be duly authorized, validly issued, fully
paid and non-assessable.

We hereby consent to the reference to us under the caption "Legal Matters"
in the Registration Statement and to the use of this opinion as an exhibit to
the Registration Statement. In giving this consent, we do not hereby admit that
we come within the category of persons whose consent is required under Section 7
of the Securities Act of 1933, as amended, or the rules and regulations of the
Securities and Exchange Commission thereunder.

Very truly yours,

McBreen, McBreen & Kopko

<PAGE>

SONIC FOUNDRY, INC.

1995 STOCK OPTION PLAN

<PAGE>

TABLE OF CONTENTS

Page

SECTION 1
BACKGROUND, PURPOSE AND DURATION
<TABLE>
<CAPTION>

<C> <S> <C>
1.1 Effective Date and Purpose....................................... 1

SECTION 2
DEFINITIONS

2.1 "1934 Act"....................................................... 1
2.2 "Affiliate"...................................................... 1
2.3 "Board".......................................................... 1
2.4 "Code"........................................................... 1
2.5 "Committee"...................................................... 1
2.6 "Company"........................................................ 1
2.7 "Director"....................................................... 2
2.8 "Disability"..................................................... 2
2.9 "Employee"....................................................... 2
2.10 "Exercise Price"................................................ 2
2.11 "Fair Market Value"............................................. 2
2.12 "Fiscal Year"................................................... 2
2.13 "Grant Date".................................................... 2
2.14 "Incentive Stock Option"........................................ 2
2.15 "Nonqualified Stock Option"..................................... 2
2.16 "Option"........................................................ 2
2.17 "Option Agreement".............................................. 2
2.18 "Participant"................................................... 2
2.19 "Plan".......................................................... 3
2.20 "Rule 16b-3".................................................... 3
2.21 "Section 16 Person"............................................. 3
2.22 "Shares"........................................................ 3
2.23 "Subsidiary".................................................... 3
2.24 "Termination of Service"........................................ 3

SECTION 3
ADMINISTRATION

3.1 The Committee................................................... 3
3.2 Authority of the Committee...................................... 3
3.3 Delegation by the Committee..................................... 4
3.4 Decisions Binding............................................... 4
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
PAGE

SECTION 4
SHARES SUBJECT TO THE PLAN

<C> <S> <C>
4.1 Number of Shares............................................ 4
4.2 Lapsed Options.............................................. 4
4.3 Adjustments in Options and Authorized Shares................ 4

SECTION 5
STOCK OPTIONS

5.1 Grant of Options............................................ 4
5.2 Option Agreement............................................ 4
5.3 Exercise Price.............................................. 5
5.3.1 Nonqualified Stock Options........................... 5
5.3.2 Incentive Stock Options.............................. 5
5.3.3 Substitute Options................................... 5
5.4 Expiration of Options....................................... 5
5.4.1 Expiration Dates..................................... 5
5.4.2 Death of Participant................................. 6
5.4.3 Committee Discretion................................. 6
5.5 Exercisability of Options................................... 6
5.6 Payment..................................................... 6
5.7 Restrictions on Share Transferability....................... 6
5.8 Certain Additional Provisions for Incentive Stock Options... 6
5.8.1 Exercisability....................................... 6
5.8.2 Termination of Service............................... 7
5.8.3 Company and Subsidiaries Only........................ 7
5.8.4 Expiration........................................... 7
5.9 Grant of Reload Options..................................... 7

SECTION 6
MISCELLANEOUS

6.1 No Effect on Employment or Service.......................... 9
6.2 Participation............................................... 9
6.3 Indemnification............................................. 9
6.4 Successors.................................................. 9
6.5 Beneficiary Designations.................................... 9
6.6 Nontransferability of Options............................... 10
6.7 No Rights as Shareholder.................................... 10
6.8 Withholding Requirements.................................... 10
6.9 Withholding Arrangements.................................... 10
</TABLE>

<PAGE>

<TABLE>
<CAPTION>
Page

SECTION 7
AMENDMENT, TERMINATION, AND DURATION

<S> <C> <C>
7.1 Amendment, Suspension, or Termination................................ 10
7.2 Duration of the Plan................................................. 10

SECTION 8
LEGAL CONSTRUCTION

8.1 Gender and Number.................................................... 11
8.2 Severability......................................................... 11
8.3 Requirements of Law.................................................. 11
8.4 Compliance with Rule 16b-3........................................... 11
8.5 Governing Law........................................................ 11
8.6 Captions............................................................. 11
</TABLE>
<PAGE>

EXHIBIT 10.1

SONIC FOUNDRY, INC.
1995 STOCK OPTION PLAN

SONIC FOUNDRY, INC., hereby adopts Sonic Foundry, Inc. 1995 Stock
Option Plan, as follows:

SECTION 1
BACKGROUND, PURPOSE AND DURATION

1.1 Effective Date and Purpose. The Plan is effective as of January
1, 1995. The Plan is intended to increase incentive and to encourage Share
ownership on the part of (1) employees of the Company and its Affiliates, and
(2) consultants who provide significant services to the Company and its
Affiliates. The Plan also is intended to further the growth and profitability of
the Company.

SECTION 2
DEFINITIONS

The following words and phrases shall have the following meanings
unless a different meaning is plainly required by the context:

2.1 "1934 Act" means the Securities Exchange Act of 1934, as amended.
Reference to a specific section of the 1934 Act or regulation thereunder shall
include such section or regulation, any valid regulation promulgated under such
section, and any comparable provision of any future legislation or regulation
amending, supplementing or superseding such section or regulation.

2.2 "Affiliate" means any corporation or any other entity (including,
but not limited to, partnerships and joint ventures) controlling, controlled by,
or under common control with the Company.

2.3 "Board" means the Board of Directors of the Company.

2.4 "Code" means the Internal Revenue Code of 1986, as amended.
Reference to a specific section of the Code or regulation thereunder shall
include such section or regulation, any valid regulation promulgated under such
section, and any comparable provision of any future legislation or regulation
amending, supplementing or superseding such section or regulation.

2.5 "Committee" means the executive compensation committee appointed
by the Board (pursuant to Section 3.1) to administer the Plan.

2.6 "Company" means Sonic Foundry, Inc., a Maryland corporation, or
any successor thereto.
<PAGE>

2.7 "Director" means any individual who is a member of the Board.

2.8 "Disability" means a permanent and total disability within the
meaning of Code section 22(e)(3), provided that in the case of Options other
than Incentive Stock Options, the Committee in its discretion may determine
whether a permanent and total disability exists in accordance with uniform and
non-discriminatory standards adopted by the Committee from time to time.

2.9 "Employee" means any employee of the Company or of an Affiliate,
whether such employee is so employed at the time the Plan is adopted or becomes
so employed subsequent to the adoption of the Plan, and whether or not such
employee is a Director.

2.10 "Exercise Price" means the price at which a Share may be
purchased by a Participant pursuant to the exercise of an Option.

2.11 "Fair Market Value" means the last quoted per share selling
price for Shares on the relevant date, or if there were no sales on such date,
the arithmetic mean of the highest and lowest quoted selling prices on the
nearest day before and the nearest day after the relevant date, as determined by
the Committee. Notwithstanding the preceding, with respect to Options granted on
the date of the initial public offering of Shares, fair market value means the
price at which each Share is sold in such offering, as determined by the
Committee.

2.12 "Fiscal Year" means the fiscal year of the Company.

2.13 "Grant Date" means, with respect to an Option, the date that the
Option was granted.

2.14 "Incentive Stock Option" means an Option to purchase Shares
which is designated as an Incentive Stock Option and is intended to meet the
requirements of section 422 of the Code.

2.15 "Nonqualified Stock Option" means an option to purchase Shares
which is not intended to be an Incentive Stock Option.

2.16 "Option" means an Incentive Stock Option or a Nonqualified Stock
Option.

2.17 "Option Agreement" means the written agreement setting forth the
terms and provisions applicable to each Option granted under the Plan.

2.18 "Participant" means an Employee, Consultant, or Director who has
an outstanding Option.

2.19 "Plan" means Sonic Foundry, Inc. 1995 Stock Option Plan, as set
forth in this instrument and as hereafter amended from time to time.

2.20 "Rule 16b-3" means Rule 16b-3 promulgated under the 1934 Act, as
amended, and any future regulation amending, supplementing or superseding such
regulation.
<PAGE>

2.21 "Section 16 Person" means a person who, with respect to the
Shares, is subject to section 16 of the 1934 Act.

2.22 "Shares" means the shares of the Company's common stock, no par
value.

2.23 "Subsidiary" means any corporation in an unbroken chain of
corporations beginning with the Company if each of the corporations other than
the last corporation in the unbroken chain then owns stock possessing fifty
percent (50%) or more of the total combined voting power of all classes of stock
in one of the other corporations in such chain.

2.24 "Termination of Service" means (a) in the case of an Employee, a
cessation of the employee-employer relationship between an Employee and the
Company or an Affiliate for any reason, including, but not by way of limitation,
a termination by resignation, discharge, death, Disability, retirement, or the
disaffiliation of an Affiliate, but excluding any such termination where there
is a simultaneous reemployment by the Company or an Affiliate.

SECTION 3
ADMINISTRATION

3.1 The Committee. The Plan shall be administered by the Committee.
The members of the Committee shall be appointed from time to time by, and shall
serve at the pleasure of, the Board.

3.2 Authority of the Committee. It shall be the duty of the
Committee to administer the Plan in accordance with the Plan's provisions. The
Committee shall have all powers and discretion necessary or appropriate to
administer the Plan and to control its operation, including, but not limited to,
the power to (a) determine which Employees shall be granted Options, (b)
prescribe the terms and conditions of the Options, (c) interpret the Plan and
the Options, (d) adopt such procedures and subplans as are necessary or
appropriate to permit participation in the Plan by Employees who are foreign
nationals or employed outside of the United States, (e) adopt rules for the
administration, interpretation and application of the Plan as are consistent
therewith, and (f) interpret, amend or revoke any such rules.

3.3 Delegation by the Committee. The Committee, in its sole
discretion and on such terms and conditions as it may provide, may delegate all
or any part of its authority and powers under the Plan to one or more directors
or officers of the Company; provided, however, that unless otherwise determined
by the Board, the Committee may not delegate its authority and powers in any way
which would jeopardize the Plan's qualification under section 162(m) of the Code
or Rule 16b-3.

3.4 Decisions Binding. All determinations and decisions made by the
Committee, the Board, and any delegate of the Committee pursuant to the
provisions of the Plan shall be final, conclusive, and binding on all persons,
and shall be given the maximum deference permitted by law.
<PAGE>

SECTION 4
SHARES SUBJECT TO THE PLAN

4.1 Number of Shares. Subject to adjustment as provided in Section
4.3, the total number of Shares available for grant under the Plan shall not
exceed one million (1,000,000). Shares granted under the Plan may be either
authorized but unissued Shares or treasury Shares.

4.2 Lapsed Options. If an Option terminates, expires, or lapses for
any reason, any Shares subject to such Option again shall be available to be the
subject of an Option.

4.3 Adjustments in Options and Authorized Shares. In the event of any
merger, reorganization, consolidation, recapitalization, separation,
liquidation, stock dividend, split-up, Share combination, or other change in the
corporate structure of the Company affecting the Shares, the Committee shall
adjust the number and class of Shares which may be delivered under the Plan, the
number, class, and price of Shares subject to outstanding Options, and the
numerical limit of Section 4.1 in such manner as the Committee (in its sole
discretion) shall determine to be appropriate to prevent the dilution or
diminution of such Options. Notwithstanding the preceding, the number of Shares
subject to any Option always shall be a whole number.

SECTION 5
STOCK OPTIONS

5.1 Grant of Options. Subject to the terms and provisions of the
Plan, Options may be granted to Employees at any time and from time to time as
determined by the Committee in its sole discretion. The Committee, in its sole
discretion, shall determine the number of Shares subject to each Option. The
Committee may grant Incentive Stock Options, Nonqualified Stock Options, or a
combination thereof.

5.2 Option Agreement. Each Option shall be evidenced by an Option
Agreement that shall specify the Exercise Price, the expiration date of the
Option, the number of Shares to which the Option pertains, any conditions to
exercise of the Option, and such other terms and conditions as the Committee, in
its discretion, shall determine. The Option Agreement shall specify whether the
Option is intended to be an Incentive Stock Option or a Nonqualified Stock
Option.

5.3 Exercise Price. Subject to the provisions of this Section 5.3,
the Exercise Price for each Option shall be determined by the Committee in its
sole discretion.

5.3.1 Nonqualified Stock Options. In the case of a Nonqualified
Stock Option, the Exercise Price shall be not less than one hundred percent
(100%) of the Fair Market Value of a Share on the Grant Date.

5.3.2 Incentive Stock Options. In the case of an Incentive Stock
Option, the Exercise Price shall be not less than one hundred percent (100%) of
the Fair Market Value of a Share on the Grant Date; provided, however, that if
on the Grant Date, the Employee (together with persons whose stock ownership is
attributed to the Employee pursuant to section 424(d) of the Code) owns stock
possessing more than 10% of the total combined voting power of all classes of
<PAGE>

stock of the Company or any of its Subsidiaries, the Exercise Price shall be not
less than one hundred and ten percent (110%) of the Fair Market Value of a Share
on the Grant Date.

5.3.3 Substitute Options. Notwithstanding the provisions of
Sections 5.3.1 and 5.3.2, in the event that the Company or an Affiliate
consummates a transaction described in section 424(a) of the Code (e.g., the
acquisition of property or stock from an unrelated corporation), persons who
become Employees on account of such transaction may be granted Options in
substitution for options granted by their former employer. If such substitute
Options are granted, the Committee, in its sole discretion and consistent with
section 424(a) of the Code, shall determine the exercise price of such
substitute Options.

5.4 Expiration of Options.
---------------------

5.4.1 Expiration Dates. Each Option shall terminate no later
than the first to occur of the following events:

(a) The date for termination of the Option set forth in the
written Option Agreement; or

(b) The expiration of ten (10) years from the Grant Date; or

(c) The expiration of three (3) months from the date of the
Participant's Termination of Service for a reason other than the
Participant's death, Disability or Retirement; or

(d) The expiration of one (1) year from the date of the
Participant's Termination of Service by reason of Disability.

5.4.2 Death of Participant. Notwithstanding Section 5.4.1, if a
Participant dies prior to the expiration of his or her options, the Committee,
in its discretion, may provide that his or her options shall be exercisable for
up to one (1) year after the date of death.

5.4.3 Committee Discretion. The Committee, in its sole
discretion, (a) shall provide in each Option Agreement when each Option expires
and becomes unexercisable, and (b) may, after an Option is granted, extend the
maximum term of the Option (subject to Section 5.4.1(b) (regarding the maximum
term of Options) and Section 5.8.4 (regarding Incentive Stock Options)).

5.5 Exercisability of Options. Options granted under the Plan
shall be exercisable at such times and be subject to such restrictions and
conditions as the Committee shall determine in its sole discretion. After an
Option is granted, the Committee, in its sole discretion, may accelerate the
exercisability of the Option.

5.6 Payment. Options shall be exercised by the Participant's delivery
of a written notice of exercise to the Secretary of the Company (or its
designee), setting forth the number of Shares with respect to which the Option
is to be exercised, accompanied by full payment for the Shares.
<PAGE>

Upon the exercise of any Option, the Exercise Price shall be payable
to the Company in full in cash or its equivalent. The Committee, in its sole
discretion, also may permit exercise (a) by tendering previously acquired Shares
having an aggregate Fair Market Value at the time of exercise equal to the total
Exercise Price, or (b) by any other means which the Committee, in its sole
discretion, determines to both provide legal consideration for the Shares, and
to be consistent with the purposes of the Plan, including by execution and
delivery of a promissory note.

As soon as practicable after receipt of a written notification of
exercise and full payment for the Shares purchased, the Company shall deliver to
the Participant (or the Participant's designated broker), Share certificates
(which may be in book entry form) representing such Shares.

5.7 Restrictions on Share Transferability. The Committee may impose
such restrictions on any Shares acquired pursuant to the exercise of an Option
as it may deem advisable, including, but not limited to, restrictions related to
applicable Federal securities laws, the requirements of any national securities
exchange or system upon which Shares are then listed or traded, or any blue sky
or state securities laws.

5.8 Certain Additional Provisions for Incentive Stock Options.
---------------------------------------------------------

5.8.1 Exercisability. The aggregate Fair Market Value
(determined on the Grant Date(s)) of the Shares with respect to which Incentive
Stock Options are exercisable for the first time by any Employee during any
calendar year (under all plans of the Company and its Subsidiaries) shall not
exceed $100,000.

5.8.2 Termination of Service. No Incentive Stock Option may be
exercised more than three (3) months after the Participant's Termination of
Service for any reason other than Disability or death, unless (a) the
Participant dies during such three-month period, and (b) the Option Agreement or
the Committee permits later exercise.

5.8.3 Company and Subsidiaries Only. Incentive Stock Options may
be granted only to persons who are employees of the Company or a Subsidiary on
the Grant Date.

5.8.4 Expiration. No Incentive Stock Option may be exercised
after the expiration of ten (10) years from the Grant Date; provided, however,
that if the Option is granted to an Employee who, together with persons whose
stock ownership is attributed to the Employee pursuant to section 424(d) of the
Code, owns stock possessing more than 10% of the total combined voting power of
all classes of the stock of the Company or any of its Subsidiaries, the Option
may not be exercised after the expiration of five (5) years from the Grant Date.

5.9 Grant of Reload Options. The Committee may provide in an Option
Agreement that a Participant who exercises all or part of an Option by payment
of the Exercise Price with already-owned Shares, shall be granted an additional
option (a "Reload Option") for a number of shares of stock equal to the number
of Shares tendered to exercise the previously granted Option plus, if the
Committee so determines, any Shares withheld or delivered in satisfaction of any
tax withholding requirements. As determined by the Committee, each Reload Option
shall: (a) have a Grant Date which is the date as of which the previously
granted Option is exercised, and (b)
<PAGE>

be exercisable on the same terms and conditions as the previously granted
Option, except that the Exercise Price shall be determined as of the Grant Date.

SECTION 6
MISCELLANEOUS

6.1 No Effect on Employment or Service. Nothing in the Plan shall
interfere with or limit in any way the right of the Company to terminate any
Participant's employment or service at any time, with or without cause. For
purposes of the Plan, transfer of employment of a Participant between the
Company and any one of its Affiliates (or between Affiliates) shall not be
deemed a Termination of Service. Employment or service with the Company and its
Affiliates is on an at-will basis only.

6.2 Participation. No Employee shall have the right to be selected to
receive an Option under this Plan, or, having been so selected, to be selected
to receive a future Option.

6.3 Indemnification. Each person who is or shall have been a member
of the Committee, or of the Board, shall be indemnified and held harmless by the
Company against and from (a) any loss, cost, liability, or expense that may be
imposed upon or reasonably incurred by him or her in connection with or
resulting from any claim, action, suit, or proceeding to which he or she may be
a party or in which he or she may be involved by reason of any action taken or
failure to act under the Plan or any Option Agreement, and (b) from any and all
amounts paid by him or her in settlement thereof, with the Company's approval,
or paid by him or her in satisfaction of any judgment in any such claim, action,
suit, or proceeding against him or her, provided he or she shall give the
Company an opportunity, at its own expense, to handle and defend the same before
he or she undertakes to handle and defend it on his or her own behalf. The
foregoing right of indemnification shall not be exclusive of any other rights of
indemnification to which such persons may be entitled under the Company's
Articles of Incorporation or Bylaws, by contract, as a matter of law, or
otherwise, or under any power that the Company may have to indemnify them or
hold them harmless.

6.4 Successors. All obligations of the Company under the Plan, with
respect to Options granted hereunder, shall be binding on any successor to the
Company, whether the existence of such successor is the result of a direct or
indirect purchase, merger, consolidation, or otherwise, of all or substantially
all of the business or assets of the Company.

6.5 Beneficiary Designations. If permitted by the Committee, a
Participant under the Plan may name a beneficiary or beneficiaries to whom any
vested but unpaid Option shall be paid in the event of the Participant's death.
Each such designation shall revoke all prior designations by the Participant and
shall be effective only if given in a form and manner acceptable to the
Committee. In the absence of any such designation, any vested benefits remaining
unpaid at the Participant's death shall be paid to the Participant's estate and,
subject to the terms of the Plan and of the applicable Option Agreement, any
unexercised vested Option may be exercised by the administrator or executor of
the Participant's estate.
<PAGE>

6.6 Nontransferability of Options. No Option granted under the Plan
may be sold, transferred, pledged, assigned, or otherwise alienated or
hypothecated, other than by will, by the laws of descent and distribution, or to
the limited extent provided in Section 6.5. All rights with respect to an Option
granted to a Participant shall be available during his or her lifetime only to
the Participant.

6.7 No Rights as Shareholder. No Participant (nor any beneficiary)
shall have any of the rights or privileges of a shareholder of the Company with
respect to any Shares issuable pursuant to an Option, unless and until
certificates representing such Shares shall have been issued, recorded on the
records of the Company or its transfer agents or registrars, and delivered to
the Participant (or beneficiary).

6.8 Withholding Requirements. Prior to the delivery of any Shares or
cash pursuant to an Option, the Company shall have the power and the right to
deduct or withhold, or require a Participant to remit to the Company, an amount
sufficient to satisfy Federal, state, and local taxes (including the
Participant's FICA obligation) required to be withheld with respect to such
Option (or exercise thereof).

6.9 Withholding Arrangements. The Committee, in its sole discretion
and pursuant to such procedures as it may specify from time to time, may permit
or require a Participant to satisfy all or part of the tax withholding
obligations in connection with an Option by (a) having the Company withhold
otherwise deliverable Shares, or (b) delivering to the Company already-owned
Shares having a Fair Market Value equal to the amount required to be withheld.
The amount of the withholding requirement shall be deemed to include any amount
which the Committee determines, not to exceed the amount determined by using the
maximum federal, state or local marginal income tax rates applicable to the
Participant with respect to the Option on the date that the amount of tax to be
withheld is to be determined. The Fair Market Value of the Shares to be withheld
or delivered shall be determined as of the date that the taxes are required to
be withheld.

SECTION 7
AMENDMENT, TERMINATION, AND DURATION

7.1 Amendment, Suspension, or Termination. The Board, in its sole
discretion, may amend or terminate the Plan, or any part thereof, at any time
and for any reason. The amendment, suspension, or termination of the Plan shall
not, without the consent of the Participant, alter or impair any rights or
obligations under any Option theretofore granted to such Participant. No Option
may be granted during any period of suspension or after termination of the Plan.

7.2 Duration of the Plan. The Plan shall commence on the date
specified herein, and subject to Section 7.1 (regarding the Board's right to
amend or terminate the Plan), shall remain in effect thereafter. However,
without shareholder approval, no Incentive Stock Option may be granted under the
Plan after January 1, 2005.
<PAGE>

SECTION 8
LEGAL CONSTRUCTION

8.1 Gender and Number. Except where otherwise indicated by the
context, any masculine term used herein also shall include the feminine; the
plural shall include the singular and the singular shall include the plural.

8.2 Severability. In the event any provision of the Plan shall be
held illegal or invalid for any reason, the illegality or invalidity shall not
affect the remaining parts of the Plan, and the Plan shall be construed and
enforced as if the illegal or invalid provision had not been included.

8.3 Requirements of Law. The granting of Options and the issuance of
Shares under the Plan shall be subject to all applicable laws, rules, and
regulations, and to such approvals by any governmental agencies or national
securities exchanges as may be required.

8.4 Compliance with Rule 16b-3. Transactions under this Plan with
respect to Section 16 Persons are intended to comply with all applicable
conditions of Rule 16b-3. To the extent any provision of the Plan, Option
Agreement or action by the Committee fails to so comply, it shall be deemed null
and void, to the extent permitted by law and deemed advisable by the Committee.

8.5 Governing Law. The Plan and all Option Agreements shall be
construed in accordance with and governed by the laws of the State of Maryland.

8.6 Captions. Captions are provided herein for convenience only, and
shall not serve as a basis for interpretation or construction of the Plan.

EXECUTION

IN WITNESS WHEREOF, Sonic Foundry, Inc., by its duly authorized
officer, has executed the Plan on the date indicated below.

SONIC FOUNDRY, INC.

Dated as of: December 1, 1995 By
------------------------------
Monty R. Schmidt,
Effective as of: January 1, 1995 President

<PAGE>

EXHIBIT 10.2

SONIC FOUNDRY, INC.

NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN

ARTICLE 1

GENERAL

1.1 PURPOSE. The purpose of the Sonic Foundry, Inc. Non-Employee
Directors' Stock Option Plan is to secure for Sonic Foundry, Inc. and its
stockholders the benefits of the incentive inherent in increased common stock
ownership by the members of the Board of Directors of the Company who are not
employees for the Company.

1.2 MAXIMUM NUMBER OF SHARES. The Maximum number of shares of Common
Stock that may be offered under the Plan is 90,000 subject to adjustment as
provided in Section 3.1 below. The Common Stock to be issued may be either
authorized and unissued shares or issued shares acquired by the Company. In the
event that Options granted under the Plan shall terminate or expire without
being exercised in whole or in part, new Options may be granted covering the
shares not purchased under such lapsed Options.

1.3. DEFINITIONS. The following words and terms as used herein shall have
that meaning set forth therefor in this Section 1.3 unless a different meaning
is clearly required by the context. Whenever appropriate, words used in the
singular shall be deemed to include the plural and vice versa, and the masculine
gender shall be deemed to include the feminine gender.

1.3.1 "BOARD" or "BOARD OF DIRECTORS" shall mean the Board of
Directors of the Company.

1.3.2 "CODE" shall mean the Internal Revenue Code of 1986, as
amended, or any successor statute. Reference to a specific section of the Code
shall include a reference to any successor provision.

1.3.3 "COMMON STOCK" shall mean the common stock of the Company.

1.3.4 "COMPANY" shall mean Sonic Foundry, Inc. and its successors.

1.3.5 "EFFECTIVE DATE" is defined in Section 3.9.

1.3.6 "FAIR MARKET VALUE" of the shares of Common Stock shall mean
the closing price on the date in question (or, if no shares are traded on such
day, on the next preceding day on which shares were traded), of the Common Stock
as reported on the American Stock Exchange or such other exchange on which the
stock is listed, or if such
<PAGE>

stock is not listed on a securities exchange in the United States, the mean
between the dealer closing "bid" and "ask" prices on the over-the-counter market
as reported by the National Association of Security Dealers Automated Quotation
System (NASDAQ), or NASDAQ'S successor, or if not reported on NASDAQ, the fair
market value of such stock as determined by the Board in good faith and based on
all relevant factors.

1.3.7 "NSO" shall mean a nonqualified stock option granted in
accordance with the provisions of Article 2 of this Plan.

1.3.8 "NON-EMPLOYEE DIRECTOR" shall mean a member of the Board of
Directors who is not an employee of the Company.

1.3.9 "OPTION" shall mean an NSO.

1.3.10 "OPTIONEE" shall mean a Non-Employee Director to whom an
Option is granted under the Plan.

1.3.11 "PLAN" shall mean the Sonic Foundry, Inc. Non-Employee
Directors' Stock Plan, as set forth herein and as amended from time to time.

1.4 ADMINISTRATION. The Plan shall be administered by the Board.

1.4.1 The Board shall have all the powers vested in it by the terms
of the Plan, such powers to include authority (within the limitations described
herein) to prescribe the form of the agreement embodying awards of nonqualified
stock options made under the Plan. The Board shall, subject to the provisions of
the Plan, grant Options under the Plan and shall have the power to construe the
Plan, to determine all questions arising thereunder and to adopt and amend such
rules and regulations for the administration of the Plan as it may deem
desirable. Any decision of the Board in the administration of the Plan, as
described herein, shall be final and conclusive. The Board may act only by a
majority of its members in office, except that the members thereof may authorize
any one or more of their number or the Secretary or any other officer of the
Company to execute and deliver documents on behalf of the Board.

1.4.2 To the fullest extent permitted by law, each person who is or
shall have been a member of the Board shall be indemnified and held harmless by
the Company against and from any loss, cost, liability, or expense that may be
imposed upon or reasonably incurred by him or her in connection with or
resulting from any claim, action, suit, or proceeding to which he or she may be
a party or in which he or she may be involved by reason of any action taken or
failure to act under the Plan and against and from any and all amounts paid by
him or her in settlement thereof, with the Company's approval, or paid by him or
her in satisfaction of any judgment in any such action, suit, or proceeding
against him or her, provided that the person shall give the Company an
opportunity, at its own expense, to handle and defend the same before the person
undertakes to handle and defend it on his or her own

2
<PAGE>

behalf. The foregoing right of indemnification shall not be exclusive of any
other rights of indemnification to which such person may be entitled under the
Company's Amended and Restated Articles of Incorporation or Bylaws, as a matter
of law, or otherwise, or any power that the Company may have to indemnify them
or hold them harmless.

1.5 ELIGIBILITY REQUIREMENTS. Each Non-Employee Director shall be eligible
to receive Options to accordance with Article 2 below. The adoption of this Plan
shall not be deemed to give any director any right to or be granted options to
purchase Common Stock, except to the extent and upon such terms and conditions
as set forth in this Plan.

ARTICLE 2

TERMS AND CONDITIONS OF OPTIONS

2.1 GRANT. Options granted under the Plan shall be evidenced by an
agreement in such form as the Board shall prescribe from time to time in
accordance with the Plan and shall comply with the terms and conditions set
forth under this Article 2.

2.2 NUMBER OF SHARES. Each Non-Employee Director shall receive an Option
for 10,000 shares of Common Stock upon his initial appointment to the Board,
except that each Non-Employee Director currently in Office shall receive an
Option for 10,000 Shares of Common Stock on the date this Plan is adopted by the
Directors. In addition, each year, commencing with the year 1998, as of the date
of the Annual Meeting of Stockholders of the Company, each Non-Employee Director
who is then reelected or who is continuing as a member of the Board after the
adjournment of the Annual Meeting shall receive an Option for 10,000 shares of
Common Stock.

2.3 OPTION PRICE. The Option exercise price shall be the Fair Market Value
of the Common Stock on the date of the Annual Meeting of Stockholders.

2.4 METHOD OF EXERCISE. An Option may be exercised by a Non-Employee
Director during such time as may be permitted by the Option and the Plan by
providing written notice to the Board and tendering the purchase price in
accordance with the provisions of Section 2.5, and complying with any other
exercise requirements contained in the Option or promulgated from time to time
by the Board.

2.5 METHOD OF PAYMENT. Each Option shall state the method of payment for
the Option price upon the Option. The method of payment stated in the Option
shall include payment in full (a) in United States dollars in cash or by check,
bank draft or money order payable to the order of the Company, (b) in the
discretion of and in the manner determined by the Board, by the delivery of
shares of Common Stock already owned by the Optionee, (c) by any other legally
permissible means acceptable to the Board at the time of the grant of the Option
(including a promissory note or cashless exercise as permitted under the Federal
Reserve

3
<PAGE>

Board's Regulation T, subject to applicable legal restrictions), or (d) in the
discretion of the Board, through a combination of (a), (b) and (c) of this
Section 2.5. If the option price is paid in whole or in part through the
delivery of shares of Common Stock, the decision of the Board with respect to
the Fair Market Value of such shares shall be final and conclusive.

2.6 TERM AND EXERCISE OF OPTIONS.

2.6.1 One hundred percent (100%) of the total number of shares of
Common Stock covered by the Option shall become exercisable beginning with the
first anniversary date of the grant of the Option and shall be exercisable by
the Non-Employee Director for a period of ten (10) years from the date of grant.
Not less than one hundred (100) shares may be exercised at any one time unless
the number exercised is the total number at the time exercisable under the
Option.

2.6.2 Notwithstanding the foregoing no Option or any part of an
Option shall be exercisable unless written notice of the exercise is delivered
to the Company specifying the number of shares to be purchased and payment in
full is made for the

2.7 DEATH OR OTHER TERMINATION OF POSITION AS A DIRECTOR. Subject to the
provisions of Section 2.6:

2.7.1 If a person shall cease to be a Non-Employee Director for any
reason, such person, or in the case of death, the executors, administrators,
legatees or distributees of such person, as the case may be, may at any time
prior to the date of the expiration of the Option, exercise the Option with
respect to any shares of Common Stock as to which such person has not exercised
the Option on the date the person ceased to be such a Non-Employee Director.

2.7.2 In the event any Option is exercised by the executors,
administrators, legatees or distributees of the estate of a deceased Optionee,
the Company shall be under no obligation to issue Common Stock thereunder unless
and until the Company is satisfied that the person or persons exercising the
Option are the duly appointed legal representatives of the deceased Optionee's
estate or the proper legatees or distributees thereof.

2.8 TRANSFERABILITY OF OPTIONS. The Option shall not be transferable by
the Optionee otherwise than by will or the laws of descent and distribution, and
shall be exercisable during his lifetime only by him or by his legal guardian or
representative, except that the option may also be transferable to members of
the optionee's Immediate Family (defined hereinbelow), to a partnership whose
members are only the optionee and/or members of the optionee's Immediate Family,
or to a trust for the benefit of only the optionee and/or members of the
optionee's Immediate Family.

4
<PAGE>

An individual's "Immediate Family" includes only his or her spouse, parents
or other ancestors, and children and other direct descendants of that individual
or of his or her spouse (including such ancestors and descendants by adoption).

2.9 DELIVERY OF CERTIFICATES REPRESENTING SHARES. As soon as practicable
after the exercise of an Option, the Company shall deliver, or cause to be
delivered, to the Non-Employee Director exercising the Option, a certificate or
certificates representing the shares of Common Stock purchased upon the
exercise. Certificates representing shares of Common Stock to be delivered to a
Non-Employee Director shall be registered in the name of such director.

2.10 RIGHTS AS A STOCKHOLDER. A Non-Employee Director shall have no rights
as a stockholder with respect to any shares of Common Stock covered by his or
her Option until the date on which he or she becomes a record owner of the
shares purchased upon the exercise of the Option (the "record ownership date").
No adjustment shall be made for dividends (ordinary or extraordinary, whether in
cash, securities or other property), distributions, or other rights for which
the record date is prior to the record ownership date, except as provided in
Article 3.

ARTICLE 3

MISCELLANEOUS

3.1 STOCK ADJUSTMENTS.

3.1.1 In the event of any increase or decrease in the number of
issued shares of Common Stock resulting from a stock split or other division or
consolidation of shares or the payment of a stock dividend (but only on Common
Stock) or any other increase or decrease in the number of such shares effected
without any receipt of consideration by the Company, then, in any such event,
the number of shares of Common Stock that remain available under the Plan, the
number of shares of Common Stock covered by each outstanding Option, and the
purchase price per share of Common Stock covered by each outstanding Option
shall be proportionately and appropriately adjusted for any such increase or
decrease.

3.1.2 Subject to any required action by the stockholders, if any
change occurs in the Common Stock by reason of any recapitalization,
reorganization, merger, consolidation, split-up, combination or exchange of
shares, or of any similar change affecting Common Stock, then, in any such
event, the number and type of shares covered by each outstanding Option, and the
purchase price per share of Common Stock covered by each outstanding Option,
shall be proportionately and appropriately adjusted for any such change. A
dissolution or liquidation of the Company shall cause each outstanding Option to
terminate.

5
<PAGE>

3.1.3 In the event of a change in the Common Stock as presently
constituted that is limited to a change of all of its authorized shares with par
value into the same number of shares with a different par value or without par
value, the shares resulting from any change shall be deemed to be shares of
Common Stock within the meaning of the Plan.

3.1.4 To the extent that the foregoing adjustment relate to stock
or securities of the Company, such adjustments shall be made by, and in the
discretion of, the Board, whose determination in that respect shall be final,
binding and conclusive.

3.1.5 Except as hereinabove expressly provided in this Section 3.1,
a Non-Employee Director shall have no rights by reason of any division or
consolidation of shares of stock of any class or the payment of any stock
dividend or any other increase or decrease in the number of shares of stock of
any class or by reason of any dissolution, liquidation, merger or consolidation,
or spin-off of assets or stock of another corporation; and any issuance by the
Company of shares of stock of any class, securities convertible into shares of
stock of any class, or warrants or options for shares of stock of any class
shall not affect, and no adjustment by reason thereof shall be made with respect
to, the number or price of shares of Common Stock subject to the Option.

3.1.6 The existence of the Plan, and the grant of any Option
pursuant to the Plan, shall not affect in any way the right or power of the
Company to make adjustments, reclassifications, reorganizations or changes of
its capital or business structure or to merge or to consolidate, or to dissolve,
to liquidate, to sell, or to transfer all or any part of its business or assets.

3.2 LISTING AND REGISTRATION OF COMMON STOCK. Each Option shall be subject
to the requirement that if at any time the Board of Directors shall determine,
in its discretion, that the listing, registration or qualification of the Common
Stock covered thereby upon any securities exchange or under any state or federal
laws, or the consent or approval of any governmental regulatory body, is
necessary or desirable as a condition of, or in connection with, the granting of
such Option or the issuance or purchase of shares thereunder, such Option may
not be exercised unless and until such listing, registration, qualification,
consent or approval shall have been effected or obtained free of any conditions
not acceptable to the Board. Notwithstanding anything in the Plan to the
contrary, if the provisions of this Section 3.2 become operative, and if, as a
result thereof, the exercise of an Option is delayed, then and in that event,
the term of the Option shall not be affected. Notwithstanding the foregoing or
any other provision in the Plan, the Company shall have no obligation under the
Plan to cause any shares of Common Stock to be registered or qualified under any
federal or state law or listed on any stock exchange or admitted to any national
marketing system.

3.3 TERM OF THE PLAN. The Plan shall terminate upon the earlier of the
following dates or events; (a) upon the adoption of a resolution of the Board
terminating the Plan; or (b) ten years from the Effective Date.

6
<PAGE>

3.4 AMENDMENT OF THE PLAN; TERMINATION. The Board may, insofar as
permitted by law, from time to time, with respect to any shares of Common Stock
at the time not subject to Options, suspend, discontinue or terminate the Plan
or revise or amend it in any respect whatsoever.

3.5 APPLICATION OF FUNDS. The proceeds received by the Company from the
sale of Common Stock pursuant to Options will be used for general corporate
purposes.

3.6 NO OBLIGATION TO EXERCISE. The granting of any Option under the Plan
shall impose no obligation upon any Optionee to exercise such Option.

3.7 NO IMPLIED RIGHTS TO DIRECTORS. Except as expressly provided for in
the Plan, no Non-Employee Director or other person shall have any claim or right
to be granted an Option under the Plan. Neither the Plan nor any action taken
hereunder shall be construed as giving any Non-Employee Director any right to be
retained as a Director or in any other capacity.

3.8 WITHHOLDING. Whenever the Company proposes or is required to issue or
transfer shares of Common Stock under the Plan, the Company shall have the right
to require the Optionee to remit to the Company an amount sufficient to satisfy
any federal, state or local withholding tax liability prior to the delivery of
any certificate or certificates for such shares. Whenever under the Plan
payments are to be made in cash, such payments shall be made net of an amount
sufficient to satisfy any federal, state or local withholding tax liability.

3.9 CONDITIONS PRECEDENT TO EFFECTIVENESS. The Plan shall become effective
upon the adoption of the Plan by the Board of Directors.

<PAGE>

EXHIBIT 23.2

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
Amendment No. 2 of the Registration Statement on Firm 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.

Milwaukee, Wisconsin /s/ Ernst & Young LLP
April 1, 1998

<PAGE>

EXHIBIT 23.3

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 Amendment Number 2 of 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.

Madison, Wisconsin WILLIAMS, YOUNG & ASSOCIATES, LLC
March 31, 1998
/s/ Williams, Young & Associates, LLC