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Sonic Foundry Inc. (NASDAQ:SOFO)

F1Q10 Earnings Call

January 28, 2010 04:30 p.m. ET

Executives

Ken Minor - CFO

Rimas Buinevicius - CEO and Chairman

Analysts

Operator

(Operator instructions). We will begin Q&A directly after the prepared remarks. In compliance with the SEC regulation regarding fair disclosure, we will be using SEC filings and public presentations like the one you are viewing and participating in today as the principle means of informing the street and investors as to both our current and past results as well as providing guidance on our projected operating results.

Sonic Foundry will continue to meet with analysts, investors, the media and others on an inter-quarter basis but will not provide updates regarding quarter-to-quarter date results, financial projects or any material, non-public 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 27 A of the Securities Act of 1933 and 21 E of the Securities Exchange Act of 1934.

Forward-looking statements include statements about our products and services, our customer base, new partnerships, our future operating results and any statements we make about the company’s future including responses to your questions. These types of statements address matters that are subject to many risks and uncertainties. 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.

All of the information and disclosures we make today regarding our business including any forward-looking guidance are as of the day 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 30 days and now Ken Minor will begin today’s presentation.

Ken Minor

Thank you, Erica and good afternoon everyone. I will begin by going through some of the quarterly highlights. In a quarter that’s typically our lowest seasonal point of the year we were able to grow overall revenue by 12%, grow service revenue by 14%, maintain our gross margins, decrease our operating expenses 14% and reduce the GAAP loss by nearly $1 million to a net loss of $320,000.

As a reminder all share and per share amounts I report today and going forward reflect our one for ten, our reverse stock split of common shares which we completed on November 16 of 2009.

In terms of the trailing financial key results, we typically realized as I said a seasonal drop of billings in Q1 of each year, you will note the reduction was quite nominal this time around from $4.7 million in Q4 of ‘09 to $4.3 million in Q1 of 2010. We recorded an increase in revenues over Q4 of ‘09 recognized the third highest revenue amount in this trend despite the seasonality.

The continued reductions in operating expenses are providing for similar improvements to our bottom line. Unearned revenue again continues its upper trend in the year-over-year results as well reflecting the increase in our service revenues. In terms of our mix of billings, we saw growth over year-over-year in both product and service offerings.

We saw some rebound in the corporate spending and continued strong results in our international arena, driving greater growth in new product billings. While recurring and high margin service offerings remain consistent due to the value of our support of new products which were partially offset by some slightly lower events results.

In terms of our year-over-year summary, we again grew revenues to $4.5 million, which is 12%, gross margins were 77% in Q1 of 2010 which is roughly consistent with the 78% we recorded in Q1 of ‘09. Operating expenses reflect a pretty significant decrease coming in at $3.7 million in Q1 of 2010 compared to the $4.3 million a year ago, we saw a decreased compensation cost which was the more significant contributor to the overall decrease from last year due to modest reduction in headcount and reduced incentive compensation.

We also saw a non-cash stock compensation expense which was significantly lower than last year with a credit balance this year of $77,000 due to the impact of some forfeitures and that compares to an expense of $205,000 last year. The GAAP net loss of $320,000 or $0.09 a share this quarter compares to a loss of $1.3 million or $0.36 per share last year.

The non-GAAP adjustments that reconcile the GAAP to the non-GAAP results include non-cash depreciation and amortization which were comparable at $133,000 this year compared to $160,000 in Q1 of ‘09. These stock compensation which as I said a moment ago were actually a credit balance this year of $77,000 that compares to the $205,000 last year and a more typical going forward Q result for our stock comp would be about $75,000 or $80,000 positive.

So not the larger $200,000 we recorded from last year, certainly not the credit balance that we saw this quarter. Revenue exceeded billings by $231,000 in Q1 of 2010 that compares to the $57,000 a year ago. Non-cash deferred income taxes associated with the tax amortization and goodwill was $60,000 in 2010 and that compares to $36,000 in Q1 of ‘09.

So after applying these adjustments, we achieved a non-GAAP Q1 2010 loss of $435,000 which equates to $0.12 per share and that compares to a non-GAAP loss of $932,000 or $0.26 per share last year. In terms of the detailed financial statements of product revenues also increased to $184,000 or 11% from $1.7 million in ‘09 to $1.9 million in 2010.

Some of the reasons for that, units shipped increased from 183 a year ago to 195 in this period. The ratio of rack units to mobile remained pretty consistent from year-to-year was is 2.1 to 1 this period compared to 2.2 to 1 last year. Our average selling price likewise improved year-over-year and was $10,800 in Q1 of 2010 and that compares to 10,000 even in Q1 of 2009.

The operating expenses again as I pointed out saw decreases, selling and marketing decreased $445,000, 17% from Q1 of ‘09 and that’s due primarily to reduced salaries and incentive compensation. Product development likewise decreased by $192,000 which is 21%, also due to reduced compensation costs, but also due to facilities expenses allocated to product development from G&A and G&A remained pretty flat.

In terms of the balance sheet, current assets decreased in Q4 from $7.3 million to $6.5 million due to reductions in each of accounts receivable, inventory and other current assets, cash decreased approximately $200,000 to slightly less than we anticipated in our plans. We are tracking where we want to be for that. Unearned revenue decreased slightly as well and again that’s anticipated from the $5.2 million a year in September to $5.0 million in Q1 of 2010 and that primarily is due to a couple of large events which were performed which were recognized in Q1 of 2010 and billed in Q4 of 2009. So it showed as a drop in the deferred revenue category.

And that’s it for the financial slides. At this point, then I will turn it back over to Rimas to go through the business highlights.

Rimas Buinevicius

Okay thank you, Ken. So we started out in the second quarter with really the best starting point we’ve had in years as far as I can remember. We made nice progress in the first quarter which as Ken mentioned typically the slowest seasonal quarter that we have and we have I would say a much lesser hurdle to get over to get to that ultimate GAAP breakeven and profitable goal that we have for this year.

So the optimism for 2010 we reiterate what we said from the last call. We continue to have some large deals, as a matter of fact we closed a large deal this week in the Community College systems, over $500,000. We are seeing a lot of opportunities in the international side. You are going to hear a lot more about these opportunities as they build, but this is giving us some real optimism in terms of what we are seeing in the business going forward.

Service revenues also helped offset perhaps the slower product sales quarter that we usually see in Q1 and you are starting to see that deferred revenue line continue to grow nicely and we still reiterate that we may see a substantial swing in positive cash flow mid year really through [mix].

So coupled with that expenses are well in check as you saw with the results this quarter in comparison to last Q. We’ve continued to cut our costs substantially and so all of this is playing very well in terms of the P&L. New customers this quarter will see that something is coming back now. The corporate customer is starting to come back and we have a much larger percentage of corporate sales this quarter than we’ve had maybe in the last four to six quarters and so you will see a mix here of corporate as well as university customers and here as well as international.

In terms of breakdown getting to the point which I just mentioned corporate is now 34% versus education which is 56%. This is probably also not surprising given that higher education usually buys in the spring, summer fall timeframes and larger volume and so seeing some of that corporate side is what we would have expected.

Likewise some of the event services out of the business almost all of it tends to be corporate, so that would be classified on that slice. If we look at that the customers and categorize them between whether they are new customers or existing customers, you will see a fairly some stable numbers here in terms of the last three quarters or so or roughly in about the 70% to 75% range for the existing customers and this has allowed us to get through the last year in terms of the recession and all that and a pretty stable scenario.

We are seeing some of the new customers being added as I mentioned from the corporate side, but that’s pretty much steady also in sort of the 25% to 30% range. If we take a look at what’s happening in the corporate side, 34% of total billings was 28% a year ago. Of course that year ago quarter was a very slow, disastrous quarter in terms of the recession [as such].

And then when we look at some of the research that’s out there, Forrester Research is giving you some of the data so that you can get a pretty good sense of what’s going on out there. Last year we saw a decline in overall IT spending of about 8.2% and their prediction for 2010 is that it will actually grow 6.6% and I think we are feeling that same effect that there is actually normal buying coming back into the market.

Of course reiterating some of the applications that people use Mediasite for, customer training, internal communications, sales and marketing, the R&D, HR executive communications and such. Those are all candidates for Mediasite implementations and as I’ve pointed out in my previous corporate slide, that’s what typically the corporate customers are buying for.

Shifting over a little bit to the education side, there are some new statistics that also that I would like to share with you. There is a little bit of a uncertainty out there I would say coming this summer with state budgets and such and trying to give you a little bit of an idea of how this is balancing out in terms of our anticipation for revenue. So right now there is still and we believe continues to be a strong trend towards online learning whether you call it blended learning, distance learning.

If you compare the 2008 numbers which just came out of Sloan-C versus 2007, you can see that there is a 17% increase in the number of students that are taking at least one online course. We of course think that as Ubiquity happens with video on the web, more people have access to it as more people start deploying as you get to the last mile with some of the bandwidth issues and such, this number should continue to increase.

And so there’s also clearly a preference for this from the student side of things. Then also in comparison to traditional education versus online enrolments, we are seeing about a 17% growth rate versus the 12% which is comparing very favorably towards electronic forms of media and education.

And then one in four higher education students now take at least one course online and so there’s comparison to several years ago when we started introducing our product, these are dramatic shifts in the way things are shifting. We are seeing the blended learning aspects. So it’s not just one or the other, a combination of inclass learning and then having the electronic supplement are also driving some of this.

In terms of the economic and social impact and what’s going on in education, I want to point out that sometimes the justification for Mediasite and putting rich media and webcasting in place aren’t necessarily purely for classroom reasons. Bad economic times are driving a lot of enrolments and we are finding that people are going back and trying to get an education or using it and in some cases as an insurance policy in case something would happened in the work place. They will obviously put their applications in and then go back to school.

And we are seeing an older audience, older adult learners now happening. So there’s likewise this decreased availability of good jobs and so people are getting retrained, trying to get educated to be qualified for some of those better jobs that are out there. The other component are things that are related to health and H1N1 which was a big scare and remains a big scare I suppose this season. It was one of the justifications for many schools to say we need to ramp up our efforts to get online learning in place.

And so this tends to be the justification and then of course the systems and implementation ends up being used for more than just the contingency plans if you will. We see that 20% of schools with no current online offerings are planning to introduce online classes and perhaps one of the phenomena we are seeing is that we are seeing a shift now in community colleges. We had a webcast with Big Bend Community College after the heart of this H1N1 peace as well as their usage in the community college space.

Federal funding is helping drive some of that, and so we are seeing of this 20%. I think schools have previously may not have considered Mediasite for budget reasons or what have you there is a little bit of a shift going on. Likewise our public institutions which relates very much to what I just said, they get qualified for Federal funding they maybe doing jobs training programs, they might be community colleges, 74% of them are more likely to believe in online education versus the private side or the four private four profit side of things.

On the service side of the business, this is actually something we've been pointing out for the last couple of years that we expect services to start balancing or increasing above the product side, and sure enough this quarter we had 57% of service revenues as compared to 43% in product, and so this helps offset those slower seasonal product quarters, and as we go forward, as we look out for the next several year, we think that this phenomenon will continue and this will help buffer some of the spikes that you've seen and the volatility you've seen in our performance.

Year-end contract renewals are part of this components. So a lot of institutions will choose to renew their contracts at the end of the year. You'll see our sales force try to drive some of those contract renewals as well, so that will build up on the deferred revenue side, and then as a benchmark of course, our deferred revenue line item continues to climb and up to $5 million, which is 4.6 a year ago.

And then we had $320,000 in our event services group, and that's something where we see a lot bit of spikiness in terms of the event side of things, but we are seeing also the same phenomenon as we are seeing in education, a pursuit of larger deals, and so you tend to see some seasonality here on the event service side of things in terms of large scale events, and likewise, as we stated last quarter, we are also seeing as virtualization of events and we are pursuing a lot opportunities there.

On the capital position side of things, the key thing and the key measure here is that over the last four or five, six quarters, we consistently now demonstrated stabilized cash flow. We've written out the recession, and we believe now that we are about to turn this inflection point towards positive cash flow, and as such there is no current plans to issue any equity. I know that some people had some issues about us procedurally re-registering our shelf.

This is normal procedure for us. We will if there is ever a moment to issue more equity at a much higher share price, and if there are strategic reasons to do so, what have you, then we have a tool at our disposal to do that, and that's really no more no less in terms of what the shelf is all about.

And so in addition because of that, we may as we mentioned last quarter, we are likely seek and obtain additional debt financing under more conventional terms to help assist in what we think is going to be a significant manufacturing build up the spring, and we don't believe that this is going to be any great burden to us. We think it's going to be fairly short term also in terms of the way the cash flow works.

So if you look at outlook in guidance, seen a noticeable improvement in that corporate demand, international demand which is something that we touch on also last quarter remained very strong for us, and we expect that that's going to really show itself through the rest of the year to domestic public side of things, domestic public higher education, that remains a little bit uncertain on a quarter-to-quarter basis, I think the states themselves, will be facing some very significant budget challenges, but here in Wisconsin as well as in other states I know that there is a strong push to try to preserve the education budgets as much as possible simply doesn’t make sense if you cut education when unemployment is rising, and I think hopefully legislators understand that, but having said that a lot of the universities now are becoming more self funding.

So the burden will fall in terms of on the students probably, in terms of higher tuitions and such even if the budget problems continue at the state level. As we mentioned we don't expect to see any changes in the gross margins. They have been very stable for the last couple of years. Continued top line growth in 2010 we anticipate some really good things happening there, and then overall decrease in year-over-year offering expenses. I mean that's a formula for really successful story in terms of getting your cost down and getting your growth up.

So concluding our formal presentation, we expect to see the large deal impacts starting actually this quarter, I mentioned though we had some community college business that happened this quarter, and will end up seeing some of the impact there, but also start seeing some of the summer and spring activity that we mentioned earlier. We are going to be scaling up the manufacturing service side of our operations so as we get bigger deals out there, and the implementations get larger and that will perhaps introduce more complexity internally for us in terms of supporting our customers but already from a lot of different angles, whether it's on the hosting side, whether it's on the consulting support side of things, integration, training, what have you, this is basically what we've been waiting for in terms of how we built the company.

And we are continuing to establish ourselves as a footprint platform of choice in this knowledge based online video market and are very excited about our current market position and the way the market is responding to this.

So with that, we'll be taking some of the questions.

Question-and-Answer Session

Unidentified Analyst

Thank you. Our first question has to do with community colleges, you know at the state of the union speech, President Obama called on Congress to finish work on the measure to revitalize community colleges, if this is implemented by Congress, how would this affect sales of media site to the community colleges, who currently lack funding?

Rimas Buinevicius

Yeah and that's I think have a statistic, couple of earnings call back about community colleges and what kind of funding they are going to get. I don't remember the exact figures, but I know that this has been part of the Obama administration's initiative to try to upgrade what it is that higher education specifically community colleges get so, and part of that is IT spending and updating the infrastructure.

The biggest complaint we've had from the last five, six, seven years of going out and selling this at that level is that they simply didn't have the money, they didn't have the staff, the resources to implement, although they had the will to do it, and I think maybe the things are coming to match in terms of the [well] meeting the budgets and such and now being able to do some things, and that's certainly what we are seeing in terms of the customers that are buying from us. They are getting both State and Federal money to help, support work for us training.

Usually it's very regional base, so there is a lot of strong push for states to do something at a regional level, though usually try to create training programs to some specific economic activity, that's going on and therefore, it's a very tight nit community oriented activity that tries to get people educated in the workforce, so we think it bodes very well, certainly expands the scope of what we think is out there for us then because traditionally, we've been chasing the normal four year public, and private university and if the university colleges can fall into the fold, that's a good thing.

Unidentified Analyst

Several questions related to financing, please provide more details on debt financing and the use of proceeds, and also could you speak to your comfort with securing financing for increased working capital needs?

Ken Minor

Sure. I can address that. First of all, we have a line of credit in place with the bank, and it's only partially taped, in fact it's been, we've been borrowing only about 300,000 on that so there is certainly availability left under that line of credit. There is a term loan as well as revolving line of credit. And obviously the point of the line of credit is to provide full working capital financing, so that's available first of all.

Second of all, we are looking at another opportunity. It's a traditional lending facility, that would provide for an additional term loan and it's not huge, not sizeable but it would assist us in ramping up some of the manufacturing capacity that we believe we are going to need in order to support working capital needs going forward, so to an extent that we decide that that current facility is not as large as we'd like. I believe that will be available to us.

Unidentified Analyst

Also some other questions related to pipeline, can you provide more color on previous statements about multi-million dollar deals and the works and does that still hold, and could you speak to the split between US and international?

Rimas Buinevicius

I guess I don't know how much market reiterate. I think I opened up that way, and you know that everything is still in the mix in terms of what we are talking about. Here we have probably a half dozen deals that are as big as what we sold in the Saudi Arabia somewhere in that range the $500,000 to plus $2 million range now. Many of them are developing and are very mature in terms of where we think they are going through a sales process if you will, and time wise, they are all looking like, they are probably slated between say the spring through maybe mid 2011.

So we tend to see, our outlook tends to go about two years out in terms of some of these projects. They take longer because some of these are new buildings, new projects being put up and so the architect, some things tend to put the building up first and then the IT work comes in later, and so we are very optimistic about what's going on out there, and it's really the key to what we've been trying to drive this business toward. Small deals are great, we like them but they plant the seeds if you will, the real objective here is to spread Mediasite across an enterprise, make it a platform of choice for video and webcasting and so that's really what the objective is. And we are staring to meet that objective with our sales.

Ken Minor

In terms of the split, 22% of our billings in Q1 were from international, which is as higher than a historic trends.

Unidentified Analyst

We also have a couple of questions relating to Apple's iPad announcement about whether or not Mediasite presentations will play there, and is there any strategy to approach iPad, given that it maybe a favorite among university students?

Rimas Buinevicius

Well it's typical of the Apple fads that are out there we suppose. We are always suppose to respond at a knee jerk whenever the Steve Jobs announcements comes out, I say that cynically, but whatever it's hard to develop something when it's announced yesterday. So we always respond to the market and whatever sort of ubiquity is out there, and we certainly will respond with the products in terms of media sites supporting anything that has any momentum out there and a lot of volume and our customers request it.

I will say though that we often get these sort of knee jerk reactions when the latest sort of fad comes and then six months later the fad disappears, and so we've seen these sort of fits and starts and things like that, that happen, but the Apple product line is a very strong product line and so we support it, and we've supported it in over the last several years and we plan to continue to support it so what the device is the end user device and how the playback its really more of Apple's issue in terms of what the capabilities are in terms of playing the media and all that. It's irrelevant to us because for us, we just end up playing on anything. Our objective is to be able to play on mobiles, tablets, notebooks whatever the case maybe and that's what being a rich media platform is all about.

Unidentified Analyst

And our last question has to do with expenses versus new business. Over the last year or two, you have made great strides in cutting expenses and some of this cost cutting undoubtedly involve personal lay-offs, do you foresee the need to higher additional sales and support staff as the new business, corporate business sales pick up or do you feel the sales force, you have in place currently can handle the growth?

Rimas Buinevicius

I think its the sales force and then I would say maybe the more valid statement is probably the support staff that we are going to need to support our customers when some of the projects get larger, and some of the implementations get larger to be able to have a quality experience, and so of course, you know as the business grows, you are going to see added personnel and supporting things that are going to be put into place, but it's going to be done, we think at a point now where the cost certainly will not overcome what kind of revenue flow we end up seeing, I think that's the key here.

When we started the business, when you are dealing with say an average transaction of $20,000 and you have to have all that staff in place and a lot of overhead to support it, that's where the hurdle rate is until you catch up. Now the difference is that when you start selling much larger deals, the amount of support necessary to do that, it may rise a little bit, but it doesn't rise in a one-to-one ratio, and so we really start getting the efficiencies in place as these larger deals start happening, and so that was the whole concept from the beginning in terms of how we develop the product and what we anticipated.

Ken Minor

She is shaking her head. I guess that's the last question.

Rimas Buinevicius

All right, and then so we're closing on that note, and then finally we will have our shareholder meeting on March 4th at 9 a.m. at Monona Terrace in Madison, Wisconsin, and that will be webcast, so we look forward to seeing you then and thanks for tuning in.

Ken Minor

All right thanks.

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Source: Sonic Foundry Inc. F1Q10 (Qtr. End 12/31/2009) Earnings Call Transcript
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