Jeffrey Walkenh...'s  Instablog

An interesting sidebar (pointed out by someone on the Yahoo! Finance Message Board here) is to watch Sonic Foundry's earnings Webcast and compare the Mediasite delivery to that of video conferencing giant Polycom's recent earnings Webcast (PLCM) - link here. Polycom uses a pop-up window with video playback via user selected Windows Media or Real Player that has a slide window to the right. Yet, the slides didn't move for us. Instead, to share/show each new slide, a new browser window is launched each time (!!!), which -- to put frankly -- we find cumbersome and suboptimal. We suspect Polycom management would not only agree but likely prefer to use Mediasite to deliver their quarterly message (and other corporate events). Thus, as discussed in our "Get the Memo" post on 1/03/09, Polycom provides us with yet another example of an organization that needs Mediasite, albeit one sitting squarely in the video arena. Other video-related companies that could benefit include Thomson Reuters (TRI), Nasdaq OMX's (NDAQ) Shareholder.com unit, and even Cisco Systems (CSCO).

Back to results. For the quarter, revenue of $4.5 million (+12% Y/Y) was better than implied guidance for only $4.0 million and the company's GAAP net loss was only $320 thousand compared to $1.3 million (revised) in the year ago period.

Sonic's trailing twelve month income statement is as follows:

• Billings of $19.5 million were up 1% Y/Y (expect acceleration in coming quarters)
• Revenue of $19.1 was up 12% (catching up to TTM billings)
• Gross profit of $14.6 million was up 16% (margin expansion)
• GAAP operating expenses of $16.1 million were down 10% (expense reduction)
• Cash operating income of approximately negative $150 thousand (a $900 thousand Y/Y improvement)

Looking at the balance sheet: deferred revenue at 12/31/09 increased 10% Y/Y to $5.04 million, total debt increased to $1.01 million from $529 thousand a year ago, and net cash declined by $1.6 million to approximately $1.27M (total cash was $2.4 million). Net cash was down only $157 thousand Q/Q as positive working capital helped offset the company's modest operating loss. Management again noted that debt will increase to fund anticipated working capital needs to support large deals expected in coming months that should drive rapid top-line growth. Then, meaningful positive cash flow should arrive, improving the company's net cash position.

A few slide highlights - new customers:

Guidance:
More on the outlook and market position:
In Crossing the Chasm: Marketing and Selling Disruptive Products to Mainstream Customers by Geoffrey Moore (included in our reading list here), Mr. Moore shares his view of the technology adoption life cycle and strategies for making the jump -- i.e. "crossing the chasm" -- from "Early Adopters" to "Early Majority" and then to the "Late Majority". Mr. Moore's advisory firm, TCG Advisors, includes several related presentations on its Web site (link here).

In one deck, Dealing With Darwin - Innovation Vectors TCG Advisors Deck, he illustrates the life cycle with a "bowling alley" and "tornado" in the "Early Majority" phase as adoption accelerates on the way to "Main Street" adoption. Given Sonic Foundry's guidance and apparent confidence that the large deals are in process (i.e. a reality), we think Mediasite is currently making the leap to mainstream adoption. Of course, execution is critical during this stage and, along with IT budget pressures, represents a primary risk factor.

Let's briefly consider two scenarios:

• (1) The best case scenario for investors: earnings power finally becomes material in calendar 2010, although the Market (today) may not believe the future promise until micro-cap Sonic truly shows it the money (within next six months). At that point, interest in "the story" suddenly perks up and valuation expands along with investor/media interest. We've seen it before with other companies. If quarterly revenue can scale to the mid-$6 million range, we estimate quarterly earnings of around $0.25, or approximately one dollar annualized. At that level, even a conservative P/E multiple puts shares meaningfully higher.

• (2) The worst case scenario: large deals fail to materialize and the business trends flat and/or erodes and funding is a problem in a still fragile economy. The stock languishes and declines.

Which scenario is most likely? Per our "Which Way from Here" presentation, we quickly admit that short-term forecasting is a fool's game. Also, traditional value investors might pass over Sonic Foundry given a history of operating losses and a small net cash position (limited margin of safety, at first blush). We acknowledge that our ownership stake falls into the speculative camp and, as noted in the past, we consider our investment somewhat akin to late stage venture capital.

However, we find comfort through our extensive technology industry experience and Mediasite franchise analysis. Notably, we see and hear increasing, consistent, and favorable feedback from customers -- for the latest, please see the Big Bend Webinar this week:



While acknowledging risk factors, we can now feel even better with our November conclusion on the back of reiterated guidance -- given the company's expanding customer roster and forthcoming campus-wide adoptions, we continue to believe our initial thesis: competitive advantages point to a powerful, sustainable franchise -- Sonic Foundry is (1) far along the learning curve with (2) intellectual property protection, and (3) very satisfied, captive customers that face high switching and search costs. Points (1) – (3) are both related to and strengthened by (4) economies of scale and (5) leading market share.

Furthermore, our intrinsic value estimate of $20-27 is supported by an estimate of reproduction cost as well as the probable private market value that would be awarded by an informed strategic buyer based on trailing financial results (without the benefit of insights into Sonic's pipeline that might support a higher "PMV", 2009 M&A comps provide support).

We will follow-up in February with a bit more on how to interpret forward guidance.

Disclosure: Long SOFO.

However, we came across a 102nd use today: funeral Webcasting. This wasn't our idea, but comes from a serious article in IEEE Spectrum that a business colleague happened to send our way in relation to a completely different topic. The article, entitled "Funeral Webcasting is Alive and Well", includes an overview of happenings in the area -- we include some pertinent excerpts in our blog here.

We're not sure if any funeral homes are using Mediasite or if Sonic Foundry has ventured down this path. Funeral webcasting is far outside of the company's bread and butter, institutional focus areas and, no doubt, carries different economics. However, the trend clearly illustrates just how ubiquitous Webcasting and rich media is becoming in our lives. We can now fairly say that Mediasite has 102 potential uses.

Disclosure: long SOFO.

• [the IEA's] prescription would lead to greenhouse gas concentrations being stabilised at the equivalent of 450 parts per million (ppm) of carbon dioxide - a level that, according to some analyses, offers a good chance that the rise in the global average temperature since pre-industrial times could be kept within 2C.
• Without these policies, the agency calculates that concentrations will soar to 1,000ppm by mid-century - levels that, in many scientists' views, would lead to catastrophic and irreversible consequences.
• But political and financial capital needs to be invested soon if the world is to follow the 450ppm path, it says, with emissions needing to peak around 2020.

The article included the following graph showing potential Co2 emissions and reductions, revealing that approximately one half of reductions from the reference scenario result through "End-use efficiency":

This brings us to our primary topic: companies that manufacture electric batteries for cars and other applications (i.e. end-use efficiency). We previously commented on this sector in our post,
Berkshire Hathaway's BYD Purchase - Great "Trade" yet Long-Term Economics are Critical Question in July. In that analysis, we noted the following regarding BYD based on the company's 2008 annual report:

• Gigantic revenue growth
• But, margin compression
• And, low return metrics
• With huge capital consumption to fund growth
• Quick conclusion: the facts tell us that BYD operates in a low margin, low return, competitive business that consumes significant capital.

In August, we continued our "clean tech" analysis with Competition for BYD and Divergent Views on "Green" Cars - EVs versus Hybrids. In addition to competition from the auto makers mentioned in that post, we are aware of other companies aggressively seeking market share in the battery segment: Ener1 (HEV, $7.04) and A123 Systems (AONE, $23.06). Both companies are growing top-line rapidly while losing money and consuming massive amounts of capital to fund expansion.If large operating losses and capital consumption weren't enough to make us cautious with regard to these companies, valuation presents another red flag. On an enterprise value basis, Ener1 is valued at 38 times trailing twelve month revenue and 8 times 2010E revenue. The Market is enthusiastic about recent program wins and DOE grants.

A123, which only went public a few weeks ago at $13.50 and is up 71%, is valued at 24 times TTM revenue. If we apply the same blistering +69% Y/Y revenue growth reported for the company's most recent quarter to TTM revenue of $90 million, the company is valued at 14 times estimated forward revenue of $152 million.

In both cases, we understand that the Market is embracing the growth potential of the businesses, yet the valuations appear very rich. As we recently pointed out for Blue Nile (NILE, $61.26), ENER and AONE appear to be trading on/in thin air.

Briefly, let's take a closer look at A123 Systems. The company has big backers, including GE (GE, $16.79), Qualcomm (QCOM, $42.45), and Motorola (MOT, $8.13), all of which retained a large ownership position post IPO:

Disclosure: no positions.