Sonic Foundry's (SOFO) CEO Gary Weis on Q1 2016 Results - Earnings Call Transcript

| About: Sonic Foundry, (SOFO)

Sonic Foundry, Inc. (NASDAQ:SOFO)

Q1 2016 Earnings Conference Call

February 11, 2016, 16:30 ET

Executives

Gary Weis - CEO

Ken Minor - CFO

Analysts

Operator

Welcome to Sonic Foundry's First Quarter 2016 Earnings Call. I'm Tammy Jackson and will be moderating today's webcast. We will begin with the Safe Harbor statements followed by a presentation from Gary Weis, our CEO and Ken Minor, our CFO. At any time during the presentation you can click on the ask button to pose a question. If you ask a question please provide your full name so we can identify you for our online audience. 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're viewing today as the principle means of informing the Street and investors as to both 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 year 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. 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 presentation.

Gary Weis

Good afternoon everyone. Thanks Tammy. We have a little bit of a change in format to the presentation today than we usually do for those of you that have seen these calls before. I'm going to make a few introductory remarks about the highlights of the quarter and I will then turn it over to Ken who will take you through the details of the financials. And then I'll come back and talk about a few of the other business elements that have matured during the quarter.

So let me talk about the highlights. First off, we have about a 12% growth in billings in the quarter over the previous year's quarter that exceeded our expectations estimates for the quarter. So we are very pleased with the billings results for the first quarter. That resulted primarily from strength in the non-North American part of the business, Japan and China between the two of them generated 55% year over year growth in that segment of the business. The Japan growth is largely a result of a recovery in Japan for a number of reasons. We have a new management team in Japan which has done an excellent job of getting the year off to a good start.

China is obviously a new geographic element of the business that we didn't have in the first quarter last year. So between the two of them they gave us a lot of strength in results for the quarter.

One other things that I think has become clear to us is that we are creating disruption in the unified communications video conferencing recording space and what I mean by that is that our comprehensive services and offerings packaged together a set of capabilities that really isn't available from any other single player in the segments that we serve. I'll talk a little bit more about that in detail during the remaining part of the presentation.

And finally we did have a significant growth in higher education in our cloud service which I'll talk about next. You have heard us talk in the past about the University of Bristol, it is an educational institution in the United Kingdom. They began deploying media site about a year ago for the fall semester of 2015. They are kind of an opportunity similar to Leeds which we've talked a lot about, the difference is two fundamental aspects, number one, they chose to implement in our cloud as opposed to an on premise implementation which was done at Leeds. And secondly, they decided to implement lecture capture in phases as opposed toward stages as opposed to rolling out all at once.

They found that during their initial rollout students overwhelmingly valued lecture capture and by the end of the first year they had over 200,000 views of content that was captured during the year. In the first quarter of this year they have chosen to expand their capture side of content by 60%. So it's an example once you're in a customer you deliver quality services to the customer, they value those services and they expand the usage of our products.

Now let me talk about a few strategic wins and what I mean by strategic in higher education, I mean setting the stage for future growth in these two opportunities. The first one is Ocean [ph], Ocean is a service provider for higher education and other industries. We have signed an agreement with them to provide media site services as part of their general regional educational network. We've done something similar in the past with the MCNC and UNINETT Norway, MCNC based in North Carolina and it works very much to our advantage because we can showcase our technology, it's almost like a cloud offering meaning they host the capability in their network infrastructure and customers can very readily and easily and quickly deploy our technology as part of their service offering. So we look forward to partnering with them and to really see growth down the line as more and more of their customers adopt media sites, video content management and media sites capture technology.

The second opportunity that we think was very strategic for us in the first quarter was a master agreement with California State University system to basically establish media site as the video content management solution for the entire system. Now media site is already deployed in Lecture Capture mode in a number of schools in the system but this really represents a system wide establishment of media site as the standard for video content management within the system. So we again feel very good about these two opportunities closing and providing us with a future basis of growth in those two segments.

Now we've had other substantial wins and expansions, Harvard University uses our cloud service. They continue to grow and expand the amount of content that's captured and viewed using our infrastructure. Duke University similarly they are nursing school, did a hardware refresh of recorders, during the quarter and Kansas State University also a cloud user did a renewal on expansion of their services. So again, establishing a relationship, growing the relationship because of the high quality and capability of our solutions.

On the event side we continue to work with VMware for their VMworld Conference in the U.S. and EMEA. We added eBay as a customer for their developers conference and also Under Armor for global company meetings. The events business as you know is a little bit of a different character than our standard product but we feel very good about customers continuing to use that service as a way to capture both on premise events and hybrid events.

So with that’s kind of an overview of the significant accomplishments for the quarter. I will turn it over to Ken and he will talk about the details of the financial trends.

Ken Minor

Thank you, Gary. To begin with I'm going to run through a few of the details regarding our quarterly billings. As Gary mentioned billings did increase 12% year over year, regionally as he mentioned our billings increased year over year due primarily to growth in Japan and with sales to our new distributor in China. Billings outside North America did increase 55% over the prior year as a result. China is reflecting the contractual purchases from our exclusive partner in China which has been in place now since about Q3 of last year, while Japan reflects slightly better currency rates compared to the prior year, strong demand as well as a lot of activity with pharmaceutical companies as well as higher education.

By revenue source we saw significant growth in billing for software products over last year which is due primarily the mix of billings that our partner in China chose to take. Another statistic that I think is useful to understand is that the recurring component of our business, service billings are typically about half of our billings and in any given period that's typically about where it ranges. Support is a large component of that and it's recurring annually. Hosting events also make up the majority of the rest of that service. Hosting is also annually recurring as well as many events do recur each year. So, together about 40% of our billings are recurring on an annual basis.

Regarding few of the other breakdowns that we do by vertical and by geography we look at a couple different ways here. We're able to show that our strategy to focus on higher education continues to pay off with strong results for about 54% of total billings from higher education. Corporate fell short compared to last year but it's expected to be positively impacted throughout the rest of this year as we address needs of the corporations have in our market which are largely to deal with me as I joined and our product enhancements and features that we will be doing as part of our edge products. As I mentioned in my last slide international was very strong this year reflecting our strategy to invest in a couple of businesses two years ago and we purchased Mediasite K.K in Japan two years ago as well as our investment in purchasing Media Mission in the Netherlands and again as well as our focus on adding resources and investing in other locations like we have done in China as well as India.

In terms of our top five deals we've put the slide together in the past. It shows the top five deals aggregated together for the last few quarters and you'll see that it reflects the lumpiness that we see in our business. In a lot of quarters we see where a single transaction is greater than all of the top five transactions for a number of other quarters combined. Typically in the first quarter of the year like in this first quarter of this year we've done it the hard way. So we have a lot of smaller transactions that we were able to complete and win with a lot of frequency. In terms of some of the additional quarterly data there are a few trends I want to point out on the slide. One is that our ASP is down by design and we came out with a lower price for quarter last year which again was about Q2 of last year allows us to reach rooms that don't support large investment navy equipment. This is primarily smaller lecture room, small classrooms. They of course have smaller, lower unit cost as well and they preserve the margins that way. Our unit count is up over the prior year and are heavily discounted quarter sales for those quarters that have reached the end of their useful life was down compared to last year gain that helps our margins.

From an operating expense basis, expenses were up just 2.1% over the prior year, that's essentially equal to the increase in wages over the last year. In terms of some other financial highlights, revenue was up over last year by 4%, now the revenue increase was well short of the increase in billings for a couple of key reasons. In Q1 of last year we had two transactions again two international transactions totaling $620,000 that were billed in Q4 of the prior year and recognized as revenue in Q1 of '15 and without that that one year anomaly last year. The revenue growth year over year would have been 12% almost identical to what we have in billings. Our gross margin rate was slightly up over last year that's as a result of a number of factors some of them going either direction. We have our outsourced labor cost and our events business was down considerably over last year reflecting some greater efficiencies.

We have greater sales of higher margin software products I mentioned earlier in my remarks. The lesser mix of the refresh [ph] units again I mentioned earlier has a positive impact. Now those are partially offset by significant pass through [indiscernible] source of billings and revenues that Japan had this last year, this last quarter rather and Japan had one particular customer that asked our operation in Japan to source other products and features that are in addition to me to Mediasite K.K. and distant to media side and as a result we purchased those for this customer and pass them through at a reduced margin.

Our operating expenses were up 200,000 over the prior year just 2.7% as I mentioned interest was up 86,000, now that does reflect a higher rate with partners for growth but the majority of that increase in interest is not cash it's the non-cash component of accretion of interest that's related to the amortization of debt discount. Our adjusted EBITDA when you add back the depreciation, the amortization interest, taxes in non-cash stock compensation was almost identical to last year.

And regarding the balance sheet, current assets decreased over the prior fiscal year and primarily as a result of collection of seasonally higher billings from Q3 and Q4 of last year so we had a lot of collections in Q1. Likewise the decrease in current liabilities it was working capital related with a majority of that decrease coming from vendor debt for the recorded as well as from reduced balance of accrued liabilities. Our unearned revenue was 12.2 million at December 31 that's down from September which was at 12.7 but again that's the typical result that we see in the first half of our fiscal year. So the first two quarters of the fiscal year we typically see unearned revenue decrease and we see that increase in Q3 and Q4. So it's reflecting the seasonal differences that we see in higher education. Together non-cash unearned revenue and deferred taxes now represent about 2/3rds of our liabilities.

Speaking of seasonal changes, this is a chart that we also put up on a regular basis that we only update every other quarter but I think it's still relevant to remind everyone of the seasonal differences from period to period. And so we look at the right side of this chart it shows first half versus second half in each of these periods and it shows that the second half is always much, much stronger than the first half in relation to both Billings and for revenues. That’s something that we expect to continue and again that's a result of our focus on higher education which tends to do the majority of their deployments in periods when the classes are in session. So from about May through about September is when we see all those deployments which covers parts of our third fiscal quarter and our fourth fiscal quarter. So, fiscal '16 is expected to be the same. I think we'll see an increase in billings in Q2 this year and a significant increase in Q3 and Q4 over where we're at today.

And at this point then I'll turn the presentation back over to Gary, who will run us through a few of the business trends.

Gary Weis

Thanks, Ken. I'm going to start talking a little bit about what analysts tell us about the market growth that we participate in and there's a couple of points I'll make up front both of these analysts, Frost & Sullivan and Wayne House [ph] define what they cover to be broader than the markets we directly participate in and the next chart will show that quite evidently.

In Frost & Sullivan they tend to focus on more Lecture Capture, the capture side of the business and higher education and there is no question that Sonic Foundry has been and continues to be the leader in that market that they measure. North America is by their account the largest and fastest growing market and they believe that market revenue is expected to double by 2019. We are always in close contact with the analysts. We try to explain to them what our products are focused on and what portions of their market we are competing heavily in. They give us back feedback in terms of how we compare in those more narrow niches but they do not publish statistics for those more narrow niches. Wayne House [ph] is much more focused on enterprise streaming and as a result that market is really something is much broader than the segment that we compete in. They too show that the market is projected to grow by 19%. If you go back a number of years ago, I think both of their projections was much more substantial growth than that but I think both the enterprise streaming and the Frost & Sullivan view of enterprise video has somewhat stabilized in terms of growth expectations.

And this is a very busy chart, some of our direct competitors are on this chart. Some of our indirect competitors are on this chart and frankly there's a lot of people on this chart that we have no relationship with in terms of competing in those market segments. The chart divides up the difference between closed and open and versus single feature, the strength of our offerings is in the end to end solution world. Now we take a different view of open versus closed. We integrate with a number of other technologies especially in the LMS space. So when you think closed it's not closed that we deliver everything. We deliver a core, a video content management but we are very good about integrating that core capability with other providers, LMS being the principal example.

On the open side people tend to say they offer open source code and allow people to modify that code, that's not the business we’re in. Now we do focus on an end to end solution that blends both content creation and capture with content management and I think are acknowledged as the leader in that integration. I've taught many times in the past about our strength in higher education and that strength is largely based on the fact that we directly sell to the top 400 higher education customers globally. We do that in a way that means we have direct visibility into what they're planning to do in the future and invariably when they get funding to do a project whether it's building a new building, renovating a building, building a new campus, we’re there to capture that business in the accounts that we cover through our named account organization. That success continues to be true, we continue to grow, we had a very nice performance in the first quarter in terms of growth in named account. What we realize we need to do is get stronger positioning in the enterprise opportunities, enterprise to us is corporations. Some of the logos on the right are examples but the essence of what we are about in 2016 is to provide solutions that are leveraged on our video capabilities. Mediasite Join is the one that this chart is focused on. And Mediasite Join is really a video conferencing capture capability that works with all of the major video conferencing vendors.

Once the video is captured it's available for management by our video content management platforms. And you'll see us roll out a number of enhancements to that during 2016, we’re very excited about that. We have already over 100 customers that are either piloting or have licensed this product or service from us.

I'm going to talk a little bit about what is fueling our international momentum and I'm just going to use these three examples to make the point. One of the things we've talked about is that a number of our customers are mission critical users of our capabilities and mission critical means if you're going to set an expectation in a higher education university that the instructor can count on when that presentation is available for the student and the student can count on when it's available to the student you have to live up to those service levels, students these days leave a lecture and expect the lecture to be available online in 10 minutes. Now if you’re going to do that you need to manage your resources very carefully. If you're in our hosted cloud we do that for you. If you've got your own enterprise deployment of Mediasite you must manage certain elements of it yourself. We offer a tool called Mediasite customer assurance premium Mediasite customer assurance that are mission critical customers are beginning to adapt very rapidly. This feature to our standard support can add between 10% and 15% to our support billings. It's very interesting technology and we've gotten very positive feedback from 10 mission critical customers that are already using the capability. We said in last quarter's presentation that in addition to China we were looking to India to be another way to grow our market outside of the United States. I'm happy to tell you that that's beginning to take hold. There are a number of the military officer training academies probably 8 or 10 of them in India that are using Mediasite, have selected Mediasite to be used for training programs and our strategy in India is a little different than it was in China.

In China, we found a major partner and player in Neusoft to drive our penetration into China very quickly. India is a much more regional situation, and so instead what we're doing is we're targeting segments where funding is available and I picking out key projects and establishing our reputation in India. In the United Arab Emirates, we’ve done a closed opportunity with a technology college that has a total of seven campuses. Mediasite has been selected for Lecture Capture and it will be deployed over time in all seven of those campuses. So again, good presence outside the United States, good growth.

Mediasite K.K. is clearly key to achieving our goals for 2016. The management in Mediasite K.K. is crafting partnerships with other large name brands in Japan. We see that beginning to take hold. We're not going to talk about all of that today, but the one that we are talking about is Otsuka which is a pharmaceutical company. They are the second largest pharmaceutical company in Japan. We are capturing events for them and we are leading up to crafting a partnership with a global health information company in Japan and outside of Japan for that matter that you'll hear us talk more about next quarter.

One thing we have to do if we’re managing the relationships that we have with our top universities is we depend very much on advocates in those customers to grow our business and so we've invested in developing a Mediasite community with over 2000 individual members, we’re very active in helping them organize themselves in various events some of which are listed here on this chart and really the intent is to make sure that at an execution level we have advocates who are delighted with our products and services and they stand ready to recommend us for future expansion in those schools.

So it's a combination of inside advocates and our own named accounts management capability. So, in terms of our outlook for fiscal 2016 we’re reaffirming our full year guidance. As I said we -- our billings in the first quarter actually exceeded our expectations so we're well on the way to achieving the full year guidance in terms of what we expect for the second quarter. We expect both billings and revenue to grow in the second quarter over the first quarter. We have talked in the past about large opportunity that has been in the process of shipping into the school. We’re now very comfortable that that will be fully closed in the second quarter and will be realized as revenue in the second quarter. So we're very enthused about getting off to a good start for 2016. We have a number of activities going on that I think will amplify our strengths that we’ve alluded to in this presentation and we’re looking forward to updating you on progress in those at the next earnings call in about three months.

So with that, I will turn it over to Tammy to moderate any questions that you might have.

Question-and-Answer Session

Operator

Q - Unidentified Analyst

First question is where do you see the biggest opportunities in with the Enterprise Products that you're coming out with in the coming year?

Gary Weis

Let me let me talk about a couple. I mentioned Join briefly, and I think that the way we've succeeded with Join up to this point is selling it as an add on service or licensed product to existing Mediasite customers. What we see happening beginning in the second quarter is selling that service to customers of video conferencing hardware independent to Mediasite meaning if a customer has Polycom or Cisco or any other vendors video conferencing equipment we will be able to capture that video and then make it available, make the individual video sessions available to the customer for distribution in whatever way they want to use the video content. We will do that through our existing AV partners and we’re very optimistic that that will be another growth path in enterprise.

Secondly and long term probably equally or more important to us is that we’re developing with very small incremental investment, a set of capabilities that surround Mediasite and how it works within the fire wall of an enterprise customer. The extreme to that would be Sandia Labs where --because the security situations they must have everything self-contained, but many other enterprise customers have the same requirements. What you find in a corporate network is that the bandwidth necessary to connect the locations within that firewall is not free and video taxes, the existing bandwidth. We are doing a number of things to optimize video delivery inside the customer's network both from the standpoint of caching technology and in terms of multicast technology. So that plus an offering that will provide more assistance to the customer in terms of implementing the solution we think will put us in very good stead with the enterprise customer.

Unidentified Analyst

Alan Greenberg asks, are you doing anything about identifying new channel partners? Is there an ideal channel partner that could help you drive more growth?

Gary Weis

Let me start with the tail end of the question first. We've been working with partners for a lot of years in the United States and in Western Europe and frankly we have not identified any single partnership that somehow leapfrogs us ahead in the video content management space. So it's just a straight forward answer to that part of the question. We are very interested in forming partnerships with other players especially outside the United States. I think the partnership with Neusoft is a good example. In many countries we will not directly know the market and rely on a local partner to do that.

Now in the case of Neusoft to kind of get into the second part of your question, they have a systems integration capability that allows them to integrate video into applications and frankly that's a very desirable attribute as opposed to our traditional partners which tend to be a AV integrators that deal with rooms and AV technology in-rooms and work with us to fulfill the customer's needs in-room. Neusoft is actually creating applications that will integrate our capabilities into those applications and if those kind of opportunities present themselves in the future we would value those and we would take advantage of them.

Operator

Thank you. There are no further questions at this time.

Gary Weis

Very good. Thank you. So I would thank everybody who participated in today's call. We're excited to make progress in the second quarter and Ken and I look forward to seeing you again in about three months.

Ken Minor

Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!