Sonic Foundry's (SOFO) CEO Gary Weis on Q3 2014 Results - Earnings Call Transcript

Aug.13.14 | About: Sonic Foundry, (SOFO)

Sonic Foundry Inc. (NASDAQ:SOFO)

Q3 2014 Earnings Conference Call

August 13, 2014 4:30 PM ET

Executives

Tammy Jackson – Director, Communications

Kenneth Minor – CFO

Gary Weis – CEO

Analysts

Marco Rodriguez – Stonegate Securities Inc.

Howard Halpern – Taglich Brothers

Tammy Jackson

Good afternoon, and welcome to Sonic Foundry’s Q3 2014 Fiscal Earnings Presentation. I’m Tammy Jackson, your moderator. (Operator Instructions) We’ll begin with the Safe Harbor statements and take Q&A 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’re viewing today, as the principle means of informing the Streets and investors of our current and past results, financial projections, 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 their 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.

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 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, Ken Minor will begin today’s presentation.

Kenneth Minor

Thank you Tammy, and welcome everyone. Thank you for joining us today for our third fiscal quarter results. I’ll start, as always, by going through a few of the highlights. This is our first full quarter incorporating the results of MSKK, another full quarter of the results for MediaMission. A significant portion of the increases and the other fluctuations when comparing to prior periods will relate to the consolidations to form these. For ease and review, we included the numbers and their [earnings] as from the prior year both with and without the new [service]. So revenue grew by 41% to $11.3 million this year, that’s over Q3 of last year of $8 million, primarily due to an increased unit sold and the recognition of the units which were previously deferred from Q2 2014 later the University of Leeds.

The Sonic-only increase was about 25% which was up to $10 million at this point. Our product and other revenue grew by 46% to $6.2 million from $4.2 million. The Sonic-only portion was an increase of 39% to $5.9 million. We recorded revenue in Q3 for about 100 recorders that we shipped Leeds during – we also recorded revenue on approximately 100 recorders that we shipped Leeds during Q2 which was initially deferred for revenue recognition process.

Our event services also showed some pretty significant improvement and growth over the prior year both on a standalone basis as well as [consolidated], it’s a 63% increase on a consolidated basis, 16% standalone. Our gross margins were pretty consistent in the prior year at 69% that’s despite the lower margins for the quarter that we expected because of the large University of Leeds transaction. So quarterly, we do expect gross margins, the rates to improve in Q4.

The GAAP net income of 33,000 compared to 40,000 in Q3 of last year. We finalized the agreement with Astute Technology which provides that cost licensing agreement that we talked [more] between the both parties that resolves the complaint as well that was filed by Astute Technologies against one of our customers. We recognized an additional $28,000 of expense during Q3 and in addition to the amount to record in Q3 which represents the final valuation of the amount of the license that relates to past [views], we also recorded the last of the legal fees that we expect to occur late this and so it is now final, so we spent about $300,000 during fiscal Q3 and legal cost associated with that.

In terms of the Sonic-only results, Sonic Foundry had income $260,000 on a GAAP basis again that’s compared to the $40,000 that was last year. The GAAP EPS was a penny a share and that compares to a penny a share last year and the Sonic-only component was a $0.06 per share income. The cash balance was $3.9 million at this current period and the [other] revenue in other area that we’d like to point out was $9.3 million that compares to $8.8 million at the end of last quarter and the Sonic-only component was $8.3 million; we do have about $1 million in deferred revenue associated with ourselves.

In terms of the quarter highlights for non-GAAP purposes, our billings grew by 38% to $11.7 million over the priors 8.5, in addition to the impact of the acquisitions and the billings for additional quarters that we shipped Leeds this quarter. We billed nearly triple, now recorded last year from My Mediasite, My Mediasite and other deferred billings create the increase in billings over revenue and despite recording revenue of recorder shipped in last quarter that still resulted then and that increase of billings over revenue. Sonic-only component billings increased 19%, $10.1 million and again our event services show pretty significant improvement over the prior period, a 91% improvement on a consolidated basis, 36% went just looking at Sonic Foundry.

We achieved non-GAAP income of $857,000 this quarter, that’s $0.20 per share and that compares to $1 million of non-GAAP net income or $0.26 per share last year, the Sonic-only component was 903,000 or $0.21 per share.

In terms of the year-to-date highlights our billings grew by 33% over the prior year and again the Sonic-only if you’re looking at that separately was 14% increase, our revenue grew at 30% over 2013’s, which reached $27.4 million again this largely due to acquisitions, to Sonic-only component increased 13% to $23.7 million.

Our GAAP net loss was $1.5 million on a year-to-date basis compared to the $126,000 as I mentioned previously in Q2 in our comments, I noted there are a number of very large and unusual items that impacted this year, it’s certainly a number who are related to the acquisitions we had I think a gain associated with the step up in the valuation with MSKK offsetting a part of that was an impact with that, the net of that was $500,000 amount in addition that we had charges that were very large as well.

We had a $428,000 charge, I mentioned associated with these two patent, we’ve acquired 400 of that in Q2 and the 28 in Q3. We had $700,000 of legal expenses that were associated with that as well and of course that $490,000 of transaction costs, so a number of large unusual items in addition to that we had My Mediasite that created a growing and recurring trend of recurring revenue that’s deferred initially for revenue purposes and so that’s creating this larger GAAP net loss this period. The Sonic-only component was $1.4 million.

The gross margin again was comparable we had 72% rates in both periods, $19.7 million in gross margin of total compared to $15.2 million last year. The GAAP EPS loss was $0.36 and that compares to $0.03 per share last year. We recorded non-GAAP income of $2.5 million then which is $0.60 per share that’s up a little bit over last year’s number of $2.3 million which is $0.59 per share again these deferred billings are driving those improvements over GAAP results.

In terms of the billings mix we talked a little bit about this already that product billings you can see were up $1.3 million which is 30% improvement over last year and service billings were up a 1.9 which is a 46% improvement over last year.

And in terms of our consolidating income statement this chart does a nice job I think of laying out the contribution of the different subs that we acquire this year. So you can see with this the respective differences are you can see that Sonic had a $100,000 difference between billings and revenues again that would normally expected to be larger but with the reversal recognition of revenue associated with the amount billed last quarter that made that number narrower. In terms of MSKK there is a $300,000 difference between billings and revenues, MediaMission had a pretty nominal difference.

MSKK’s difference was primarily driven by significant amount of support billings that were bill during the quarter. The support billings of course will be revenue in the coming quarter as the services are provided, the overall billings to revenue GAAP as a result of strong service and of course the My Mediasite billings I mentioned they were partially offset by the release of the revenue associated with Leeds. MSKK’s March quarter if I haven’t mentioned this already is typically much greater than the other quarters, so that we’re in a seasonally a quieter period for that in terms of the June quarter. And that’ll be pretty similar again in September and December those are lesser quarters by far compared to the March quarter and it’s all due to the timing of deployments for higher education.

In terms of operating expenses, the expenses associated with MSKK MediaMission are largely selling related as our R&D associated expenses as well as admin as well and those are broken out of the income statement separately including those line items.

The Sonic operating expenses again include those legal defense cost which were significant this quarter and have been over the last several quarters but that’s done now in terms of those legal costs associated with the – 300,000 this year in this quarter rather and finally you see how each company contributed to non-GAAP numbers as you can see what those differences are in the case of MSKK clearly that’s driven by the difference between billings and revenues.

In terms of the statement of operations, this chart here is for the full quarter. We had as I mentioned product revenue about $6 million, it’s up $4.2 million last year. The component that’s driving that in part at least is the average selling price, the average selling price decreased slightly from last year, last year was 9200 per unit, this year was 9000 per unit. The total refresh units would often have an impact on that, but this year the refresh numbers decreased somewhat from 195 to 130, the Leeds transaction now clearly have an impact, and this is the high volume deal that’s certainly a skinnier margin that will typically do on the smaller transactions.

And we also had a pre-signification change in the ratio of rack units to non-rack units to mobile units and so that those recorders are price cheaper and then does also drive the ASP down. The number of recorders that we shipped during the quarter was 472 last year that grew to 757, this quarter that wasn’t dramatically impacted by the acquisitions since we sell to those subsidiary companies as we have in the past that we sell them so it doesn’t affect either as much because the Leeds transaction had a big impact on those unit [counts].

The operating expenses reflect an increase of $2.4 million to $7.9 million this year. It’s compared to $5.5 million last year. Selling and marketing was up $1.1 million which is a 29% increase and that’s pretty typically that in terms of the categories that impact that, higher salary, incentive compensation, benefit cost associated with slightly higher staff levels we also had an increase in travel and tradeshow tenancy fees but the primary reason by far is the increase for the acquisitions in the case of MediaMission and MSKK they carry 492,000 and 782,000 respectively of the difference of the 1.1 million. So the majority of that’s coming from the acquisitions when comparing to last year.

In terms of G&A, G&A increased by 891,000 that’s a big increase, 114,000, a 114% rather increase over the prior year and again that’s related primarily to professional fees. Our professional fees increased by 390,000 and the majority of that was legal cost associated with the skewed again that’s going away. The acquisition sort of accounted for a significant component of the remainder of that. MediaMission accounted for $88,000 of admin cost this quarter and MSKK accounted for 273,000.

Our product development cost increased 378,000 which has a 35% increase, a lot of that’s due to higher stock compensation incentive cost that’s associated with that as well as the increase in development cost further outside development cost, but again there is an impact from the acquisitions associated with MediaMission and MSKK, MediaMission account for 88,000 and MSKK for 15,000 respectively of that increase.

The non-GAAP results that the adjustments that we look at the adjusted GAAP, non-GAAP include a number of items including non-cash depreciation which increased of 328,000 versus 301,000 last year. Our stock comp also increased a 199,000 this year that compares to 138,000 last year and the billings exceeded revenue by a pre-significant amount of both periods it would have exceeded even more had the Leeds transaction that happened, the way it did but our billings exceeded revenues by 438,000 this year and that compares to 483,000 last year.

And the tax expense is a little bit different this year but given the fact that MSKK had a loss this period. So we actually had a tax benefit associated with MSKK so that the tax benefit this period was 169,000, 177,000 of that was for MSKK that compares to $60,000 tax expense last year. So we excluded the effect of those items as well as the effect of the patent cost. Again this quarter that we just added an additional 28,000 to that but on a year-to-date basis that’s 428. So when you apply all those numbers you get the numbers I quote earlier from the 857 and the $1 million from last year.

In terms of the year-to-date numbers, again similarly our product revenue increased $3 million to 30%, it was a 30% increased to 10.2 and it’s again driven primarily by unit count. Our unit count increased from 1,044 last year to 1,383 this year. But again the international product demand is a major driver for that. Our operating expenses reflect an increase of 41% over the prior year again coming in at $21.4 million versus 15.2, our selling and marketing increased $2.5 million versus 26% again it’s the typical drivers for Sonic being higher depreciation, higher travel and tradeshow cost, but the primary driver of this was the increase due to the acquisitions MediaMission accounted for $201,000 of the increase and MSSK accounted for $1.5 million of that increase.

The G&A also increased there was a $1.8 million for the year-to-date period that’s a 75% increase and again that’s primarily professional fees, professional fee increases was a total of $993,000 so that was obviously a pretty significant chunk of that and the remainder of that again is primarily acquisition related with 544,000 coming from MSKK and 176,000 from MediaMission.

Product development increased 963,000 which has a 31% increase as a result in primarily from a number of things 269,000 of capitalized software development cost that we incurred last year that’s why that reduced our expense from last year and we also incurred $200,000 for higher headcount compensation costs, which were headcount related increases late last year so it wasn’t really an impact this year but the year-over-year numbers had an impact.

And then finally $126,000 for some rather limited outside development cost that we’ve incurred as well. The impact for MediaMission and for Mediasite KK was $60,000 for MediaMission and $186,000 for MSKK.

And again the one-time rather unusual items of $428,000 for the patent issue and $490,000 for transaction cost. So when you look at those reconciliations of GAAP to non-GAAP again our stock are rather our non-cash depreciation and amortization was $997,000 this period, stock compensation was $669,000, our billings was significantly greater than revenue of $1.7 million compared to $928,000 last year. And the tax expense was $1.1 million this year compared to $180,000 and the difference is all deferred related so it’s all non-cash.

We excluded all those one-time, all those non-cash items as well as the one-time expenses for new transaction cost in the patents. So when you add all those transactions roughly end up with the $2.5 million I mentioned earlier for non-GAAP versus $2.3 million last year.

And then finally the final chart that I’m going to show you is our balance sheet, the current assets increased from $12.6 million last year to $17.8 million as of June 30th of this year. This is largely due to the acquisitions, goodwill and other intangibles also largely due to the acquisitions and increased from $8.4 million last year, last year end to 15.5. The increase is primarily both goodwill as well as the value of customer relationships that we allocate value to when we make those acquisitions. In addition we also recorded a $673,000 license fee associated with Astute, so that’s also included in that intellectual property.

The current long-term liabilities increased from $13.6 million to $24 million, and that includes those the similar two significant non-cash items that we’ve talked about at length in the past, $9.3 million for deferred revenue, $4.4 million for deferred taxes and together and it’s about 57% of the total liabilities in that non-cash component. In addition the big change this quarter was the accrual of the remaining amount to be pad for Astute of $733,000.

Finally in the longer-term liability sections, we had $2.2 million in notes payable to Silicon Valley Bank in the term loan. We also have revolving line of credit facility which maintains that same balance of $3.0 million of availability and there is no balance drawn on that letter of credit as of the end of the quarter. And lastly, the liabilities also include $2.6 million in subordinated notes that are due to the MSKK and MediaMission with about $2.2 million of that that’s due in the first half of fiscal 2015.

And that’s it then for the financial presentation portion of our earnings presentation. So at this point, I am going to turn the presentation over to Gary who can let us through a few of the business drivers.

Gary Weis

Thank you, Ken. Good afternoon everyone. Let me begin before I get into the usual charts about the parameters of the business for the quarter by telling you that we are extremely pleased with our growth in terms of both revenue and billings for the quarter. Things have begun to come together and all of the dimensions of the initiatives we’ve taken over the past several years and we’re beginning to see trends which are very important to us that allow us to gauge more and more higher education customers beginning to make strategic investments in lecture capture. So I will take you through some of those trends as we go through the presentation.

The first one is on our top five enterprise deals based on billings. You’ve seen these charts before but clearly in the second and third quarter you see the significant impact of the Leeds transaction. You also see in this quarter the impact of the NYU transactions. So I think it’s safe to say that when we have large deals in the quarter, we produced pretty strong results in the top five deals. You can see in the past the average of all five of the top deals have been 100 million and now in this quarter you see it substantially over $2 million. Part of our strategy that we’ve explained in the past is to cultivate relationships with large potential higher education institutions and then as we capitalize on those relationships and we begin to close business, you see the positive impact it can have in terms of the deals structure of the business.

The chart that’s here the seasonality of the business is actually identical to the one that we showed you last quarter. That’s because we haven’t yet got in the third and fourth quarter together to add into the chart. We would expect that when we do that you will see continued very positive growth in both billings and revenue and you will strongly believe to see the beginning of a positive trend in net income and the improvement in non-GAAP net income.

The next several charts all kind of tell the same story based on the impact of Leeds. So I would note that these are Sonic-only charts, they do not include the MSKK or MediaMission portion of the business. In this particular case for the third quarter and for the second quarter you see a decline in the percentage of business sold to existing customers because of the large impact of the Leeds deal which obviously at the start of the second quarter was a new customer.

From the standpoint of higher education versus the other sectors of the business again Sonic-only you can see the impact here of again Leeds in higher education.

For the next one, I can get it there we go, again same story since Leeds is in UK you see the reality of the big impact on international as opposed to domestic.

So let me now talk a little bit about the business metrics, let me begin to talk a little bit about the strategy and the positive impact of that strategy going forward for the foreseeable future in Sonic Foundry. 10 years ago this company was all about lecture capture. What we discovered at that time is that there weren’t significant enough numbers of video assets in either higher education or business customers to make transformation or search or management the main event. The main event was helping our customers capture video content and in higher education that’s called lecture capture in the corporate world that’s called presentation capture.

What we’ve seen evolved in the last several years is that higher education and corporate video has changed the point where individual content owners want to create their own content on the desktop on the laptop in the personal setting without necessarily standing up in front of the audience to do the capture, we’ve addressed both through My Mediasite for personal capture and expanding our room-based lecture capture options in terms of multiple video et cetera in the rooms. That strategy has worked very well for us and I’ll show you the continued growth in My Mediasite sales on the next chart.

As we see customers creating larger and larger volumes of content, the issue shifts to finding that content, transcoding it to make it available in any and all formats that the viewers of that content need especially mobile devices and to be able to search and collaborate and editing that content. So our investments in transformation and transcoding and editing et cetera are now essential features of the Mediasite Technology that allow our customers to capitalize on the investments they’ve made in capturing video. As their video libraries grow they need to manage those video libraries. They need to understand how their viewers are using the content. So analytics becomes one of the key elements and the Mediasite Technology integrates analytics into the whole stream of capture transformation and playback.

So again people are now beginning, customers are now beginning to see the value of a single solution not just capturing a little bit video here not just searching a little bit video there but making an investment in a strategic system that allows them to not only capture, and transform and manage the content but also deliver it to their viewing audience. And again what we’ve seen is the viewing audience is expanding exponentially.

At the last earnings call we talked a little bit about our growth statistics in terms of viewing the content that’s because customers are using video to communicate more and more with students with members of their corporate staff and with customers.

I’d talked a little bit before about My Mediasite and its increasing adoption, you can see the number for the third quarter both in terms of billings dollars and in terms of the numbers of customers. Frankly the way we’ve designed our licensing program for My Mediasite as customers begin to use more and more of My Mediasite resources for their content creators we are set to enjoy larger revenues in billings as well. So this is really kind of just the start of the growth story and in future sessions we’ll be able to publish some use of statistics will show both the content created and the viewership of My Mediasite generated content.

In terms of market leadership, for the seventh year in a row we have been named by Frost & Sullivan as the market leader in global lecture capture. The Frost & Sullivan study changes over the years and so if you look at the details of the study you will see that they’ve added in new applications into the space that we’re in, but in terms of the core applications that we deliver our market share is growing and are obviously we are still the market leader in total.

One of the things we’ve started to do is look at the impact of Mediasite Technology on different groupings of higher education customers. It’s no secret that disciplines like medical, business, engineering need to present video as a key element in either training the people or in capturing real life experiences in using the various technologies that students are learning. That’s actually true in the medical world. A lot of these names that you see on this chart use our technology to help students capture and view their performance in a clinical setting, and that it provides a very valuable coaching experience by the educators to help point out what the student did right or wrong during the simulations during the various activities. They also use it in the traditional way to create and capture content for lectures.

The key element of this is that we are in over 1250 colleges and universities that they use a variety of our technologies and in this case in medical even among the top rating medical schools you see a tremendous growth in using Mediasite.

In business schools, especially in U.S. News World report identified best grad schools for 2014, we are in over 50% we have a technology presence with Mediasite in over 50% of those graduate business schools and again this trend is tool for both the educator and the student. So if you are in a MBA class and you are a working person in that MBA class and you can’t necessarily be there for 100% of the class work because of Mediasite’s capturing of those lectures and even problem solving sessions among the students you can then connect in on demand and you are transpired while you were absent. The graduate business school sees that tremendous potential in adding value to their students and they have been one of the fastest sales and fastest uptake in using Mediasite Technology.

We’ve talked in the past about MOOC and MOOC have a wide range of definition and so Loops can be something as simple as individual educator sharing their lectures with anyone in the world who wants to view those lectures. We have found that edX has really put a lot more structure around MOOC and the thought leaders frankly in MOOC come from schools like TU Delft and Harvard and Massachusetts Technology.

We have presenters in all of those institutions. Those institutions especially TU Delft are capitalizing on Mediasite, rich media capture technology to be able to really provide great value to the viewers of the MOOCs.

Now one of the trends that I want to talk a little bit about is that more and more large sophisticated universities are elevating lecture capture to strategic importance for their schools. One thing that brick and mortar schools want to do is to help the student value the extra educational experience that they get by being on a campus but by the same token they want to have an electronic presence for the delivery of content to those students. Lecture capture especially using Mediasite Technology is the idea of way to do that.

What we found in this space, five years or six years or seven years ago was selling to individual schools and universities. And the central services departments of the IT departments had not yet raised lecture capture to a strategic level. So you might get into the engineering school and then the business school and then the medical school and you would kind of evolve your way into more and more presence on a campus that’s how NC State grew to over 200 rooms that they capture with Mediasite Technology today.

However, in last year as we’ve focused to capitalize on this by taking and transforming our sales force two-thirds of our sales force into a relationship management named account selling presence in the universities where we think this trend is beginning to happen, we found that more and more are centralizing on the strategy for Mediasite development across their entire campus. Schools like Texas Text, schools like Florida or NC State or Ohio State University have adapted the centralized practice.

Some of those schools in particular NYU and Harvard have decided to implement in our hosted cloud offering as well. Frankly we’re very proud that NYU and Harvard have both made this decision in last quarter of this quarter and it’s very exciting for us to work with institutions of that degree of sophistication.

Now another good example of a strategic investment in lecture capture was what happened with the University of Leeds. They make the decision to implement 239 classrooms for the fall semester using Mediasite recording technology and with that comes all of our search capabilities, playback capabilities, transformation capabilities et cetera. We’re proud to say that that implementation is well underway, we’re very working very closely with Leeds, the point is it’s all automated, there is no large increase in administrative staff or anything else that the university needs to make lecture capture a reality out of 239 classrooms.

They are using My Mediasite as a way to offer their educators a chance to create private content. They are using our advanced integration services to be able to do custom operational tools around Mediasite. They are integrating with learning management systems. So this again is part of the trend of a centralized strategy to use Mediasite but one that emphasizes the degree of automation and the degree of support that we can provide universities in this transformation.

Our events business continues to move along rapidly. Again the trend here is that we have an enterprise grade video solution both from the capture editing and management perspective. And more and more large sophisticated event customers are turning to that technology to be able to automate and capture content and make that capture content available through either local attendees or live streamed attendees. Ellucian and ACC, American College of Cardiology are just two examples, both of these are in the second or third year of working with us here at Sonic Foundry. Lot of other customers in development and again we feel that the trend is to rely on our sophisticated technology to make the event more valuable for the participants.

And finally, I wanted to reiterate our 13% billings growth guidance and we’re pretty confident that we’ll get to the $39 million plus we’ll have the impact of several large transactions, which we’ve now largely already accomplished $1 million to $2 million so we’re reiterating that.

From the bottom-line a lot of things happened during the year. We can do a good job of bringing out the impact of those various things, we will not live up to the guidance that we said at the beginning of the year. We think that all of those are one-time impacts meaning they are not a result of a change in the operating structure or profitability of the business but nevertheless they had to be accounted for in the current year.

A lot of them had to do with Astute, the cost of the acquisition, some timing issues with the acquisition in terms of offset higher education revenue in MSKK in Japan, but we are very, very confident that the one-time effects will be gone as we move into the next year and that we will see MSKK having a very strong April quarter for their results because of some very exciting things that are happening in Japan with Mediasite Technology. So as the last sentence here says that we will expect the pretax before the patents up, we will be approximately breakeven as opposed to the 2% to 4% guidance that we have previously established.

And so with that, we will open it up for questions and go on.

Question-and-Answer Session

Operator

And at this point we’ll advise our analyst to join us. (Operator Instructions). Our first question comes from start Marco Rodriguez, Marco’s location. That line is open, go ahead.

Marco Rodriguez – Stonegate Securities Inc.

Good afternoon guys. Thank you for taking my questions. I was wondering if you provide a little more color on the delay side of MSKK. Is this an execution issue or other driving that result there?

Gary Weis

No, we are happy to explain that. The Japanese government is very interested in investing in transforming higher education in Japan. They had launched a program to provide some subsidiaries to Japanese universities, which had originally been scheduled to begin in the current quarter and next quarter, but they’ve been time shifted now by about six months. So we will see the impact now in our first and second quarter of next year as opposed to the third and fourth quarter of this year. And at the time that we originally put our view of the acquisition of plan in place, we didn’t have the knowledge of that shift by the Japanese government. So it has nothing to do with execution on the ground, it has to do with the availability of that funding from the government for the higher education university to spend with Sonic Foundry.

Marco Rodriguez – Stonegate Securities Inc.

Got it. Okay. And then moving on down in terms of the gross margin. I understand that Leeds is a high volume type and you’ve got some favorable pricing there. Can you kind of give us a sense as far as the impact on this quarter’s results?

Kenneth Minor

It clearly had a two to three points of margin impact, so we would have certainly been I think in the 72% range without that and since we and this is kind of little bit I didn’t do the calculation but I am pretty confident that we’re looking at three points of margin impact. But we recognizes I think I mentioned the full transaction for Leeds for the recorder component and so the component that we ship in Q3 as well as a component that we ship in Q2. So the revenue impact associated with that was about a 1.4. So there is pretty significant percentage of our revenues that are based on that lower margin impact.

Gary Weis

I think looking at the year-to-date numbers, really addresses what Ken just said, the year-to-date is nowhere as just the quarter.

Marco Rodriguez – Stonegate Securities Inc.

And that impact you just mentioned there why the product gross margins went from 63% down to 56%?

Gary Weis

Well because the Leeds transaction was sound for that and so clearly the Leeds transaction brought the product gross margin down significantly during the quarter.

Marco Rodriguez – Stonegate Securities Inc.

Got it. Okay. And is that something that we should expect with the large kinds the large volume type clients for this sort of discontinuing little prevalent?

Tammy Jackson

Well I’ll take a shot of that one. We would be happy to see the next 250 recorder deal come through so we’ll price it accordingly to win that business. I think that the thing that I would emphasize though is this is not a trend in lower margin overall. This is only happening when we have large single customer opportunities and if you go back to the five biggest deals you see the impact in terms of billings. So yeah, we will be very competitive on very large deals, but it is a very large deal thing, not a general erosion in margin.

Kenneth Minor

That’s right. And we are also looking at hardware components different solutions that can reduce some of the cost other quarter as well and I think that will allow us to get some of that backward.

Marco Rodriguez – Stonegate Securities Inc.

I understand. And I am not sure if I missed this but what are the business revenue in Q3?

Kenneth Minor

Do you recall which event it was, I guess it was Ellucian and...

Gary Weis

And in the quarter I think it was both Ellucian and ACC.

Marco Rodriguez – Stonegate Securities Inc.

Okay. And what was the total revenue, about revenue in the events business I’m just trying to?

Kenneth Minor

Let me give that to you offline I don’t have that at the top of my mind, we are actually Marco filing the Q today so you will have all of that information as well.

Marco Rodriguez – Stonegate Securities Inc.

Perfect. And I think there is a lot of moving parts, lot of one-time items that you talked about in the quarter results and year-to-date results. I’m just trying to get a little bit better of a sense on the G&A side I mean we were weighing just shy of a million you are now up about 1.6 close to 1.7 million. What kind of a clean number that we should be modeling of it?

Kenneth Minor

Well the excess professional fees is about 400,000 and in this quarter are certainly something that I don’t expect to recur and the vast majority of that was student related and legal cost and I certainly don’t expect that to recur. So there is about 400,000 right off the top. There are other smaller 1z, 2z kinds of things that will have some impact and vary from quarter to quarter. Some of those are typically a little bit less in Q1 and Q2 but I think in terms of the easiest way I think you get a view from Q4 as it take – they consume a lot closer.

Marco Rodriguez – Stonegate Securities Inc.

Got it. And last the question, in terms of the pretax margins for the strip model one top adding what sort of margin are we talking about looking at.

Kenneth Minor

For this full year?

Marco Rodriguez – Stonegate Securities Inc.

That’s correct.

Kenneth Minor

With the breakeven after adjusting for that Astute transaction would result in operating income essentially of about $500,000 loss or $400,000 loss, so then adding back the transaction cost are in there as well so, you can adjust that with the transaction cost so, I guess that’ll get you back to essentially about that same number then?

Marco Rodriguez – Stonegate Securities Inc.

Tom, the breakeven after you take out all those one-time.

Tammy Jackson

No I said breakeven after we take out the Astute. Right so, in other words we’re looking at about $500,000 loss on an operating income line item including the Astute transaction, including the Leeds transaction cost and so if I start with that $500,000 loss I don’t add back if it want to again strip out the one times add back the $500,000 for the transaction cost, add back the $500,000 for Astute, add back the $700,000 of cost related to legal fees associated with Astute and those three items right there account for $1.2 million of additional to – I am sorry, $1.7 million of additional to that operating income line item.

Marco Rodriguez – Stonegate Securities Inc.

So, the breakeven is a non-GAAP margin correct?

Kenneth Minor

The breakeven is a non-GAAP margin and the reason I did it that way because that’s the way that we provide guidance last quarter. I realize it’s a little bit complicated way of describing what guidance is but if we’re going to try and compare of what we said last time and I needed to try and keep that comparison equal as well.

Marco Rodriguez – Stonegate Securities Inc.

Got it, understood. Thanks a lot guys.

Gary Weis

You bet.

Kenneth Minor

Thanks Marco.

Operator

Thanks to Marco. Next to Howard Halpern. Howard your line is open. Go ahead.

Howard Halpern – Taglich Brothers

Hi, guys. In terms of selling and marketing is the third quarter pre-representatives going forward around that $4.7 million?

Gary Weis

Not actually this quarter is a very high expense quarter for marketing because of all the tradeshows we do in the quarter. So, the third quarter is always a heavy marketing expenses quarter and by return to Canada try to provide quantification of that but there is that makes it a little bit higher expense quarter than normal.

Kenneth Minor

Right and obviously you’ve got the impact of acquisitions but I think if you go back in terms of the last several years you will see that the impact from Q3 to Q4 I think has always resulted in a reduction sales and marketing costs and I think in probably that $300,000 to $500,000 range so, a pretty significant drop.

Howard Halpern – Taglich Brothers

Okay. And in terms of I guess even looking forward are you pretty confident than being able to achieve GAAP net income for 2015?

Kenneth Minor

Yes.

Gary Weis

Absolutely.

Kenneth Minor

Absolutely.

Gary Weis

Yeah. We did said I think a year and a half ago a general guidance that we were attending to achieve 15% pretax net income for fiscal 2015. I think that we are obviously not pleased with the fact that we didn’t make a step forward we originally said we’d be 5% this year I believe from original guidance that we had. We firmly believe that’s due to the one-time impacts that we have already described so, will we get to the full 15% that’s still the plan. We will obviously publish guidance after we get through the fourth quarter to reaffirm that or to change that but we have no reason to indicate that we won’t be substantially GAAP positive profit next year.

Kenneth Minor

That’s right.

Howard Halpern – Taglich Brothers

Okay and sort of like you discussed earlier next year you know the due payments that you have to make to Astute will basically be offset by the lower legal cost that’s correct?

Gary Weis

Well those payments won’t result in expense I mean those have been recorded already and so that’s not an expense that will impact those quarters. What will impact the quarter is we will be amortizing the amount if the license that we recorded but that’s going to go over a course of five to six years through 2020. So, that will have about $100,000 impact on the annual basis from an expenses standpoint which will obviously after this year be non-cash.

Howard Halpern – Taglich Brothers

Okay. You talked a little bit about I guess your cloud services and really two marquee universities choosing the cloud services. Is that part of the whole bundle in the price or is that a separate service that you as other universities had or existing customers potentially move over or will that be a revenue source?

Gary Weis

Well we have a pretty robust hosting business today typically what’s happening in the past to smaller corporations and universities took advantage of our cloud services and most of the larger universities selected to hosted on-prem meaning they would purchase a software license to run on their own servers on-prem. In the case of this quarter with NYU and Harvard both of those schools selected to use our hosting offering for a variety of reasons. So, we see that as an excellent addition to our hosting infrastructure. I think what I would try to flush out a little bit more. We sell the hosting service on a one year contract or we will consider monthly – typically a one year contract.

We sell the recorders on an upfront purchase plan so, all of these universities that equip rooms will buy the recorders using our traditional business model so, the recorders aren’t included in the revenue from hosting if you will. But for customer like to install on-prem they buy a license and that license isn’t upfront purchase of perpetual license. So, I don’t want to leave anybody with the implication that one of these methods has a higher margin. They both have good strong margins and we’re agnostic in terms of what the customers choose to do. Because it is better for the customer to host then we wanted to host, if it is better for the customer to buy a site license we want them to buy a site license.

Howard Halpern – Taglich Brothers

Okay, got it. Thanks and keep up the great work.

Gary Weis

Thank you.

Operator

Thanks for that question. (Operator Instructions).

Kenneth Minor

Alright well thanks guys. I think at this point what we will do is we’ll take questions from people are posting from the Internet. I think I am sure we have a few of those as well and we’ll try to take those for the next 10 minutes or so.

Tammy Jackson

Okay, there are several questions around asking for updates on the previously mentioned large Middle East deals. Can you give an update?

Gary Weis

Certainly the large Middle East deals were all progressing. We actually have gotten a word from the first dealer that will be installing the first building in Kuwait that their estimate is that by the end of the calendar they will begin procurement. So, we would look to that to be first quarter fiscal 2015 business, there is a chance a part of it will come in the fourth quarter but I would really point toward the first quarter of 2015 for that.

Several other universities in either Kuwait or Saudi Arabia are progressing. It is frankly a slow process when you spec into a university construction project you are dictated by an educator or administrator of the school deciding to make the strategic investment in lecture capture you are working with the facilities management team who decided to build lecture capture into buildings as they are being built.

So, I certainly was reminiscent not making that remark, it’s part of my general remarks but yes all of those deals are still in play everything gives us a great deal of confidence that they are going to happen but as usual I have to dance all through the timing because it is impossible for us to control the time.

Tammy Jackson

In terms of the larger centralized deployments like the university needs are there how many of those opportunities are in the 2015 forecast? And Sonic Foundry’s plan to winning additional campus wide deployments?

Gary Weis

Let met describe a little bit the process. I don’t think it would be fair to suggest that Sonic Foundry can cause a university to make that kind of a strategic investment in the case of Leeds just for our technology alone it was pretty close to $2 million and we’re generally 10% to 20% of the total cost of putting up rooms and actually implementing the program. What happens is that each of these universities goes through a fairly lengthy process deciding that there is value to the students that the educator supported et cetera and then typically it involves funding, meaning somebody at the university they are benefactor or donator or whatever has to put up the money which in the large university could be $2 million or $3 million or $4 million or $5 million in total and that’s when Sonic Foundry is in the ideal position of winning that business.

Over the past several years as we’ve seen universities make that decision we want every one of them. And we’re really well positioned with our named account teams to be in universities where those discussions are going up. Sonic Foundry won’t make them or sell them on the idea of investing $5 million for lecture capture that will happen as part of the strategic process of those universities.

But because of the way that we’ve established relationships either because we’re already in the school and one of these universities or because we’ve been selling to these universities over the last couple of years we will be the best position party to win the business when it happened. So the question you asked was a forecast for 2015 that’s still under development and as we finalized our plan for 2015 we’ll be doing, we’ll be able to better talk about that but I will tell you that in our account review process, in our planning review process we talked to each one of the account executives and look for their identification of potential opportunities.

Tammy Jackson

Can you provide any more color on 2015 guidance both on top line and bottom line results that to be said?

Gary Weis

I think it is premature at this point I mean I think we’re still under the process of doing the work to come up with firm numbers for that so I certainly –

Tammy Jackson

That means probably complete the planning process which actually will be we’re just starting this week and we’re I think again as we’re confident that we’re GAAP profitable, we’re confident we’re going to see some pretty significant growth again next year and we’re confident we’ll see some of those larger deals again next year. But in terms of picking numbers it’s a little bit premature to do that.

Gary Weis

But the best I can give you is that would be probably very disappointed if we didn’t grow at least the same way that we’ve grown this year.

Tammy Jackson

Last question, what are the risks to growing the business to $50 million in revenue in next year?

Gary Weis

Somebody is trying to put words in our mouth. The personal opinion without trying to commit to a guidance number of $50 million it’s not so much risk, it’s where is the funding in the various universities for those large deals that’s one element. Secondly, you’ve seen us over the past two years, develop other service oriented potential revenue producing I’ll say services, that can be sold in a different manner than large deals were sold to customers today.

And as we develop our plan for 2015 we are looking at three or four additional service offerings that we’ll be able to generate revenue in smaller increments but we will be able to do so with sales and marketing programs that are not as relationship dependent as large accounts are. So clearly we want to produce as much top-line growth as we can for 2015, we’ll do it carefully so that we balance it with the need to produce net income. But as we’ve said we were not prepared to print to a number today.

Tammy Jackson

You made changes to your sales model a couple quarters ago, is the sales team executing on that plan or you’re anticipating any under changes?

Gary Weis

No the sales team is executing very well on that plan and just for the record we began making those changes 18 months ago. It takes a lot of deliberate planning and education and work with our sales team members, our account executives to ensure that they were ready to play those roles. We have excellent sales leadership in terms of the overall team and I think we’ve done a very good job of making that transformation I see no reasons to change any of that going forward we may add small amounts of resource where it can be productive one or two additional sales people but there is more of the same it’s not changing organization.

Tammy Jackson

There are no more questions.

Gary Weis

Well thank you for attending the call today. We are extremely pleased with the growth performance in the quarter. We’re very encouraged by what we see in the pipeline. We believe that we’ll have a strong fourth quarter from the standpoint of billings. We also anticipate it to be a net income profitable quarter and so we will come back and see you in three or four months and do the next earnings call.

Kenneth Minor

Thank you.

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