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Sonic Foundry’s (SOFO) CEO Gary Weis on Q3 2017 Results – Earnings Call Transcript

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Sonic Foundry, Inc. (NASDAQ:SOFO)

Q3 2017 Earnings Conference Call

August 10, 2017, 16:30 ET

Executives

Gary Weis – CEO, CTO and Director

Kenneth Minor – CFO and Secretary

Tammy Jackson – Director of Communications

Analysts

Operator

Good afternoon, and welcome to Sonic Foundry’s Third Quarter 2017 Earnings Call. I’m Tammy Jackson, Director of Communications for Sonic Foundry and will be moderating today’s webcast.

We’ll begin with the safe harbor statements, followed by a presentation from Gary Weis, CEO; and Ken Minor, CFO. [Operator Instructions]. Please note this presentation, including questions, is being recorded.

In compliance with the SEC regulation regarding fair disclosure, we’ll be using SEC filings and public presentations, like the one you’re viewing today, as the principal means of informing The Street and investors about our current and past results, financial projections or any material nonpublic information during those meetings.

Sonic Foundry will continue to meet with analysts, investors, the media and others on an intra-quarter basis but will not provide updates regarding quarter-to-date results, financial projections or any material nonpublic information during those meetings.

Sonic Foundry’s disclosure policy defines the period beginning on the 15th day of the third month of each fiscal quarter and ending on the day we publicly release the results of that quarter as a quiet period. During such quiet periods, we will not make any comments about our financial performance nor provide forward-looking guidance, except in press release form.

Finally, this conference will contain forward-looking statements about the products and services of Sonic Foundry within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from the forward-looking guidance we provide.

Any forward-looking statements should be considered in context of the risk factors disclosed in our periodic Forms 10-Q, 10-K and other filings with the SEC. These filings can be accessed online at sec.gov and other websites or can be obtained from the company’s Investor Relations department.

From time to time, Sonic Foundry refers to various non-GAAP financial measures or measures not defined as generally accepted accounting principles. As an example, we refer to adjusted EBITDA in this presentation. The company believes that this information is useful to understanding its operating results without the impact of the special items. Refer to our earnings release for a description and reconciliation of adjusted EBITDA.

All of the information and disclosures we make today regarding our business, including any forward-looking guidance, are as of the date given, and we assume no obligation to update or change this information, regardless of subsequent events. An archive of this presentation will be available at sonicfoundry.com for 90 days.

And now, Gary Weis, will begin today’s call.

Gary Weis

Good afternoon, everyone. Welcome to the call. I’d like to start out by covering a couple of highlights and then I’ll turn it over to Ken to go through the detailed financial results. First, I think we’re very pleased to see strong improvement over the last quarter, the second quarter of this year, in a couple of key areas. The first of those is that we had an acceleration of inventory sell-through and cash collections in the third quarter. This resulted in over $2 million in operating cash flow for the quarter. That in effect allowed us to basically fund the business through the year-to-date of the end of the third quarter, so we’re in good shape in terms of recovering from what you would perceive at the end of the second quarter.

We have maintained strong gross margins. Our products are in good shape in terms of competitive pricing. And we anticipate maintaining those gross margins going forward.

Most importantly, we have some exciting product launches that are beginning in the fourth quarter. These will allow us to, I think, more aggressively compete in newer markets in higher education, which are really the mid-tier to lower portion of the market. The upper tier, the high-value tier, we do very nicely with our existing product mix. But what we’re trying to do is address the rightsizing of our products for that mid-tier and for customers that are just entering into lecture capture in higher education.

So with that, let me turn it over the Ken to take us through the financial details.

Kenneth Minor

Thank you, Gary. First of all, I’ll go through the billings. Our middle-market education business continue to show a small declines year-over-year that draw the majority of the shortfall in our Americas business. We continue to believe, as Gary just mentioned, that some of the new products coming out, the Mini recorder, which is available this quarter, and our Catch software recorder, are also available soon will be successful in this market. Our events business includes many smaller transactions but swings pretty dramatically due to some larger deals. We had 3 very large transactions in 2016 that were not awarded in 2017 which substantially totaled the variance. Now most of these events go through cycles of size and scope and timing, et cetera, and are based on budgets. So we don’t believe this is part of the broader trend but we expect therefore we’ll see some improvement in our events business in Q4 and beyond.

Japan, however, showed very strong results compared to last year and for the quarter, based primarily on the large transaction that we spoke over the last quarter with Teikyo University.

In terms of some of the other financial highlights. Our revenue was equal to last year, which, of course, was impacted by the billings variances but also includes recognition of software revenue and events that were deferred until completion of this quarter. We continue to see strong growth in recurring revenue in our annual license fees and cloud services that increased 14% in Q3 over the prior year. Year-to-date, it’s even more significant. We saw an increase of 17% year-over-year, and together with other recurring components of our business, our recurring revenue was at $6 million this quarter, which is 58% of the total revenue.

Gross margins, likewise, were consistent with last year and were — as were our operating expenses, which, of course, led then to a slight improvement in the net loss and our adjusted EBITDA. And as Tammy mentioned, you can say see a reconciliation of net loss to adjusted EBITDA in our press release.

More notable, of course, as Gary mentioned, is the $1 million improvement from our second quarter loss and a turnaround of $1.6 million of cash that was used in operations during the first 6 months of the quarter to $2.3 million of cash generated from operations in the third quarter. Similarly, cash improved from $850,000 at the end of the second quarter to $1.6 million and debt was reduced from $6.3 million to $4.1 million.

In terms of some of the other data points that we often refer to, our recorder transactions increased 7% during the quarter. The — we saw a similar decline in the ASP for those recorders as we see in past periods. The change reflects, as we said before, to — reflect the selling of lower cost solutions for rooms that don’t require the functionality as the higher recorder or higher-value recorders that we have. As I mentioned earlier, the introduction of the Mini is expected to continue that trend. And so you will see, we believe, growing units again going forward, as well as continue to reduce ASP and, of course, reduce cost of sales that goes with that.

In terms of our operating cost, they were down slightly over last year, which is driven by lower selling and marketing cost for the most part, including incentive compensation and travel. Our general and administrative costs were up about $100,000 over last year, and that’s primarily due to increase in the allowance for bad debts. I expect we’ll see for the reductions in Q4 operating expenses as we begin to see the impact of some of the cost reduction plans that we put in place.

In terms of the balance sheet, as I mentioned earlier, the biggest driver current assets is the drop in accounts receivable due to the acceleration of collections. AR dropped about $2.4 million. Similarly, we’re able to reduce inventory by nearly half now that we’ve introduced our newest version of recorders and don’t have to have the safety stock that we had on hand with the previous version and during our last fiscal quarter.

Our current liabilities were reduced primarily due to the recognition of deferred revenue related to that eMAM transaction. The largest component of that happened in Q1 but approximately $300,000 was also recorded in Q3 and that was due to the software component of that transaction.

During the year, we should $750,000 of preferred stock, the majority of which was through an insider. I do expect to receive a commitment from the same insider to provide up to $1 million of additional capital on essentially the same terms. Now that can be drawn at our direction during the next year as we needed or if we needed, in the combination of recurring customer accounts receivable and inventory, a modest increase in our equity and combined with a significant reduction in our debt has already significantly improved our balance sheet. By May of next year, both of our term loans, the Silicon Valley Bank and Partners for Growth will be paid, which will further, of course, improve our balance sheet.

So at this point then, I’m going to turn the presentation back over to Gary, who will go through a few more of the business trends.

Gary Weis

Thanks, Ken. So I think just to summarize that again, you can see that we’ve made some significant good progress in the third quarter. We anticipate that we will increase that progress or continue that progress going forward into the fourth quarter.

I’m going to now cover a couple of highlights of the third quarter. The first has to do with our events business. And one thing I want to reemphasize what Ken said as he was making his remarks, the events business is somewhat cyclical in that it is driven by our larger customers deciding to fund various events they do throughout the year. We have seen that change year-over-year in the past. We’ll see that change in the future. But I just wanted to highlight one of the events that we did conduct and try to emphasize how we bring added value to our events customers.

We’ve seen trends in the last several years of companies like Citrix Synergy putting out events in person. And this particular event had 5500 people attending the event in person at the event site. Now what they do, though, is extend the viewership to that event to remote or virtual users. And they make available the content on demand after the event is completed. So that event that was intended — attended in person by 5500 people resulted in a very short time frame of over 100,000 views to the content. Now we do excellent job of project management both on-site and remotely to ensure that the captures happen appropriately. We have a variety of different capture options that relate to just simple slides and audio all the way up to multiple video and slides and audio. We can stream live and do interactive chat and we also do some custom portal work for these larger customers, as well as capture all of their breakout sessions. So the point I’ll leave you with is that we think we had tremendous value in our events business to a customer event. Our business in Japan also does this similarly. They’re very well positioned in the pharmaceutical industry in Japan and we’re noted for both our function and our quality.

At the last call, I had a couple of questions on Join, and I’d like to highlight a couple of Join wins in this quarter. The University of British Columbia and the Western New Mexico University. One is an on-premise Join implementation at the British Columbia and the other is hosted or cloud implementation. In both cases, we have a wide range of integration options to permit capturing various forms of videoconferencing input either on-premise or remotely. Typically, what will happen is customers will integrate the Join capability with other aspects of Mediasite, like room-based capture, like My Mediasite, et cetera. The beauty of this is that as more and more universities move into collaboration for teaching remote populations of students, we can capture the interaction of those classes with the students using the Join technology and to the viewer, the content that is captured look seamless to any other Mediasite content.

I also want to talk a little bit about China. As I think you’re aware, in any of our business endeavors, timing always can vary from what we planned for versus what actually happens. China is no different than that. We’ve invested in our partnership with China now for a couple of years. And this is the quarter where we’re starting to see some really significant traction in terms of China booking business with customers inside China. One win involved a Chinese university, which is affiliated with a very significant western university. They saw Mediasite as a tool to facilitate not just the traditional lecture capture or content composition that we usually do but also to get into a newer area called student video assignment submission. And this is a really interesting application where the student can actually submit their assignments via video through Mediasite capture and the student — and the faculty can then review that and assess it and grade it. In some of our other customers, they are doing something similar in that instructors at the University of Leeds will actually comment on a student submission in video, which is very effective to the student. The student gets a lot more feedback from the educator if they see that feedback in both video and slide input. So that was a very competitive win for us. We bid out significant competition. And our partner in China, Pushi, is going to build on that. The other thing is that Pushi Tech has continued to develop its business in China. They are actually, in addition to just selling our products, they are integrating our products into applications that they are developing in China to better address the Chinese market. Some of this activity is also manifesting itself in startup of our events business, the live streaming business for video inside of China. And that training involves government agencies, as well as individual corporate customers. I think that what we’ve seen is a very significant investment by Pushi Tech and we see the Neusoft Corporation still very much engaged with Pushi in pursuing some of their larger opportunities.

Lecture capture continues to thrive and grow and evolve in various university situations. And in the United Kingdom, there has been an effort lately through something called the Teaching Excellence Framework that is really overseen or sponsored by the government to rate universities and their delivery of education to students. We’re very pleased to announce and to congratulate our partner, the University of Leeds. They attained a top gold rating from the Teaching Excellence Framework. And that award helps them to better recruit students and better establish the value of the University of Leeds content and education inside the United Kingdom and actually worldwide. So again, we congratulate Leeds for that. The University of Bristol is another one of our significant customers in the United Kingdom. The difference is that Bristol uses our cloud service. The University of Leeds implements our capabilities on-premise and in their own data centers. Actually, Bristol has had a more evolutionary program than Leeds. Leeds installed everything at one time, Bristol has been evolving and growing. And for the fall semester coming up, they’ll make a significant expansion in terms of investing in capturing and creating content on-campus. Their push for student usage of the video content of lecture capture content has really resulted in very aggressive viewership and participation from students.

Now I want to take a minute to set up the next several slides. We stratify our customers based on how they use our products and the complexity of that usage and the experience of that usage. So in our core named accounts segment, with 300 to 400 customers, many of those customers are long-term Mediasite customers and have grown to be campus-wide implementations of Mediasite. Those customers are extremely loyal. Those customers are continuing to grow our technology, use insider their campuses. And that part of the business is capable of growing within our existing core product line very nicely. What we do find though is on the lower end of customers, where they’re either new to lecture capture or they have a strict budgetary constraint in terms of how they implement lecture capture that we have in the past had a reputation, a little bit undeserved in my opinion, but we’ve had a reputation, of being the high quality and therefore high price provider. We’re doing some major effort to changing that perception, both from the standpoint of marketing and product packaging. So one of the targets that we have is middle-market higher education. This is community colleges, small to medium-sized schools in existing universities and schools that want to expand Mediasite to low technology classrooms. Now we have, as always, wanted to offer our customers choices. And so one of the things you’ll see in our product setup is that we want low-cost hardware options as well as low-cost software options. And to accomplish that, on August 14, we’ll be introducing something called the Mini, the RL Mini. Now I want to very carefully differentiate this from our existing lower end recorder series, the RL 120 or 220. Those recorders continue to be rack mounted form factors, one new form factors that are meant to integrate with audiovisual equipment that’s installed either in a classroom or in a control center. There are more options and more flexibility to those products. However, where someone wants to place a lower-cost capture device in the classroom and don’t require it to be rackmounted and so forth, the many will fit that bill perfectly. It can integrate with Mediasite platform either on-premise and cloud. It has all of the capabilities of automation and scheduling that any of our other recorder families have. And it will be offered in bundles in a very price-competitive way for these smaller customers.

Now complementing the Mini is something called Mediasite Catch, which we’ve talked about before. Mediasite Catch has now exited the development process and this fall will be fully available in production for implementation in schools. So a school implementation plan can be 100% Catch. It can be a certain percentage Catch or Mini or it can be 100% Mini and it can be totally cloud-based. And we think that, that mix-and-match capability will give customers the ability to fit Mediasite into just about any budget that you could imagine. And as I said, we are going to be pricing these bundles aggressively to encourage early update and to then continue on and evolve if the customer desires into our higher-level products and recorders.

So we are — to summarize quickly, we are very excited about the prospects of our new programs that I’ve just described. We — just to set the expectation, this is not going to generate a hockey stick in revenue. This is really meant to continue to grow their business in a very well-planned, well-coordinated way. And we are, though, confident that we’ll create a new base of customers that will evolve upward into other products.

So with that, I think we’ll now move into the question-and-answer. I’ll remind everybody that either you can do this interactively by clicking the speech bubble on the Mediasite player or you can call 1-844-887-9401. So with that, I will turn it over to the operator to poll for questions.

Question-and-Answer Session

Operator

Tammy Jackson

We have some online questions that we’ll start with. There has been concern that private equity companies have been investing in competitors. We do not — how can you elaborate on plans for competing against these companies as they get investments?

Gary Weis

So let me try to state at my own terms and I’ll try to answer the question that I state. The — I think the question deals with the fact that we are public company, and we’re well-established public company. And newer, more startup-oriented private equity companies are coming into the video field and in particular intellectual lecture capture and presentation capture. And how do we see that environment and how do we plan to compete to, is that a fair phrasing of it? So let me take 2 shots at it. The first, yes, that’s certainly true and what we have seen, though, is that higher education is a really difficult market to serve and — serve well and grow and succeed in. Being a startup company or a small player, it’s not easy to get into that market.

And we have that experience, and we have done it for years and we have a loyal base of customers. That loyal base of customers is not really amenable for prospecting from those kinds of companies. From a technology perspective, I think what you see happening is that the development ability of a small company, a startup company, is kind of enhanced by things like Microsoft Azure or Amazon AWS, meaning you can get into development and implementation on a pretty low cost budget. While that’s true, building in the kinds of reliability and support features that are necessary to meet the requirements of these markets are not as trivial. And so it’s one thing to put up an application or a new service that does a set of things that are all software-based. It’s another thing to put that into a real world environment where maybe you need to capture content at an off-site location and maybe you need to ensure that you capture it regardless of whether your communications link is up or down and so forth.

So I think the composite of both the technology and the startup nature of these companies is certainly something we have to watch and certainly is something that will drive our pricing and so forth to ensure that we compete. But I don’t see it as one of those things that — an impulsed kind of change in the market.

Tammy Jackson

How is Mediasite differentiating itself from the other lecture capture and video content management providers? For example, the top companies capture content live stream, have searched capabilities, et cetera. What are the areas where Mediasite stands out from the pack? And what are future developments that will help Mediasite grow faster than the others?

Gary Weis

It’s an excellent question. It is fairly complicated answer, but let me take a stab. First off, I think Mediasite’s core differentiator for the past several years has been automation and scale and high availability. We continue to see a demand for that, and it clearly is a differentiator for any large-scale implementation, and we will continue to exploit that as a differentiation. I think beyond that, though, what we see as functional differentiation is adding features that do more for video engagement with an audience. And it really are 2 different paths, if you’re online live versus on-demand. One of the things that we are doing is evolving a set of tools for building in interactivity and engagement into Mediasite for on-demand content. We have begun to review those capabilities with educators. We get a lot of positive feedback.

Yes, there are competitors that are doing that but they tend to do it on the side of a video solution as opposed to core part of a video solution. And so I think that is one opportunity that we have to differentiate ourselves. But in a workflow and systems way, not just in an ad hoc difficult to support way. I think the other thing that comes out of that is data analytics, and we have a rich set of analytics in our product today, but engagement expands those analytics substantially. And so now you have answers to questions. You have times that people interact with the different quizzing or testing capabilities and the volume of data grows. And so we’re doing some work to help our customers use that data and to integrate that data into their own analytics systems and business systems inside their own businesses.

Tammy Jackson

Next question. How do you see the future of video on the web? And specifically, in education and the enterprise? Is it like the dot coms where many companies will be acquired and only a couple dominant players will remain? Or do you see it playing out the way a Microsoft dominated the enterprise in education with the Windows platform? Or will this area of the video market remain fragmented with opportunities for many players to coexist and growth for all?

Gary Weis

Well, that was a mouthful. I think you’ll see a little bit of all of that. I frankly think the least probable is the Microsoft Windows model. I think that video is not at the level of scale yet that would allow you to easily predict that kind of a thing happening anytime soon. I do think that Microsoft is looking to add video in a variety of ways to some of their cloud-based services, like Office 365. I don’t see that as a threat to companies like Sonic Foundry. I see that as a different kind of video capability integrated into a different set of applications. I think in terms of the coalescence of the players in the market, I do think you’ll see activity in that regard, but I don’t think it’s one of those things that will happen really, really fast. I think it will happen evolutionarily. And I think putting together the pieces is not easy to lay out as a road map for what makes the most sense. I think there are opportunities where companies who are specialized more on the hardware side, may want to get more into a video solutions business in terms of content management. I think companies that are in content management may want to reach out to provide more comprehensive capture solutions. There’s a lot of different ways that combination could happen. But from where we sit, we want to maintain our flexibility to provide the best solutions for our customers. And if opportunities like that arise, obviously, we’ll listen. We’ll have discussions. We’ll think about it. But there’s nothing a on the horizon that I can speak to that would indicate any kind of early coalescence.

Tammy Jackson

That’s all. There are no more questions.

Gary Weis

Operator, are there any questions from you?

Operator

No, sir. On the conference call side, we do not have any questions at this time.

Gary Weis

Okay. I think we will then wrap up the call. Again, I’d like to thank you for attending this afternoon. The next call as, I am sure most of you are aware, won’t happen until the late December — early December time frame. And because it’s, obviously, the end of the fiscal year, we remain very optimistic about the business dynamics here at Sonic Foundry. I think that we have put in place some of the innovative new technologies that will allow us to expand into different markets, and we are again very optimistic that a variety of things will come together in the fourth quarter and beyond. So thank you very much for attending the call.

Kenneth Minor

Thank you.

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