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Mike Niehuser is the founder of Beacon Rock Research, LLC which produces research for an institutional audience and focuses on precious, base and industrial metals, and substitutes, oil and gas, alternative energy, as well as communications and human resources. Mr. Niehuser was nominated to... More
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  • Sonic Foundry Reports Record Third Quarter Revenues 0 comments
    Aug 8, 2011 11:36 PM | about stocks: SOFO


    Sonic Foundry, Inc. (NASDAQ:SOFO) reported record revenues and billings in what seasonally is typically its strongest financial quarter. This is consistent with the seasonal buying trends of higher education, its largest customer segment, whose budget year concludes in June, and the commencement of a new budget year. These seasonal trends in the higher education segment may be offset (or made less volatile) due to increasing service (events) revenues to a rebounding corporate segment.
    Billings roughly consist of one third new customers, and two thirds existing customers. Existing customers generally provide a source of business growth, as experience generally leads to wider adoption within institutions. In addition, many of these existing customers continue to rely on Mediasite recorders that aged beyond their warranty and ability to service. These recorder units also may not accommodate software upgrades and otherwise are due for replacement to maintain increasing client user expectations. Sonic Foundry has offered discounts on these “refresh units,” both boosting sales revenues and numbers of units and accompanying lower gross margins. Management believes that the ongoing financial annuity and benefit of supporting its client base, possibly leading to greater adoption and sales penetration, more than makes up for temporary reduction in gross margins.
    Mediasite 6 Introduction May Transcend Sonic Foundry Mediasite Value Proposition
    At the commencement of the recent financial crisis, Sonic Foundry retrenched focusing nearly entirely on the higher education segment (its legacy customer segment and obvious value proposition), carefully managing product development to accommodate Mac users and currently accelerating trends for richer viewing experiences on proliferating mobile devices (especially demanded by students). 
    Mediasite recorders accept and synchronize a wide variety of rich media (video, audio, graphics, etc.) data for transmission over the Internet, creating a positive viewing experience for a live audience or replay on demand. This provides both a low-cost recording opportunity with minimal distraction for the presenter, and an exceptionally robust viewing opportunity, fully capitalizing on the flexibility and exponential communication opportunities of the Internet. This is ideally suited for the higher education segment, which accommodates demanding instructors and an increasing competitive market for students with increasing expectations for online learning options, demanding a higher quality learning experience.
    Sonic Foundry has completed developments beyond capture and viewing to providing a stable platform for institutional IT personnel. This includes both host and archival or managing burgeoning numbers of recorded lectures. They have also focused on aligning with major trends in technology combined with customer preferences. This is anticipated with a major product release of Mediasite 6 in August of 2011 to accommodate viewing rich media on mobile devices. These will initially be rolled out in the more controlled environment of discrete events deployments and later expanded to the institutionalized customer base. Cumulative product development, recently with introduction of lighter mobile recording units and backroom support, with the expanded rich viewing experience, should push Sonic Foundry to an even higher leadership position as viewers move from laptops to a variety of mobile viewing platforms.
    Fiscal 2011 Third Quarter Financial Discussion:
    Sonic Foundry reported financial results for the third quarter of its 2011 fiscal year ending June 30, 2011. Sonic Foundry reported revenues of $7.1 million in 3Q11, substantially above our estimate of $6.3 million, and about 26% above revenues of $5.6 million in 3Q10. Revenues from product sales were $3.9 million in 3Q11, about 28% over actual results for 3Q10, and well above our estimate for the quarter, of $3.1 million. This was due to the both seasonally stronger sales from the education segment in the third quarter. Revenues from services were $3.1 million in 3Q11, up 23% over $2.5 million in 3Q10, meeting our estimate of $3.15 million. Notably, event services and hosting revenues were $1.3 million in 3Q11, up 38% over 3Q10. Rapid growth in event services may lead to softening seasonality in seasonally weaker first and second quarters. 
    Total billings were $7.5 million in 3Q11, up 26% from $6.0 million in 3Q10. Product billings were $4.0 million in 3Q11, up 28% from $3.1 million in 3Q10, and service billings (for support, hosting, training, and events) were $3.5 million in 3Q11, up 24% from $2.9 million in 3Q10. Notably, billings for events and hosting services were $1.4 million, an increase of 47% over 3Q10. Billings are not revenues, but they are a helpful indicator of future revenues, and the increase in billings in the quarter is representative of the seasonality related to education in the third and fourth quarters of the fiscal year. As contracts are signed and billed, cash is collected, increasing both cash balances and unearned income, and billings become an important metric for understanding and estimating cash flow.
    In the 2Q11 and 2Q10, 66% of billings were to preexisting customers. In 3Q11, billings to education customers totaled 65%, 28% for corporate customers, 3% to government customers and 4% to other customers. International billings were 20% of total billings in 3Q11 compared to 19% in 3Q10. It is interesting that some concerns have registered among investors for sales opportunities for the Middle East or Japan. This might be offset with the potential for a weaker U.S. Dollar. Billings to existing customers, by segment, or internationally, have been remarkably consistent over the years.
    Gross margin was about 69.5% in 3Q11, down from 74.4% in 3Q10. The lower gross profit reflected increased direct and outsourced event labor costs (primarily closed captioning) and lower markups with “refresh” units (discounted units for customers whose recorders had reached the end of hardware warranty eligibility). Average sale price of units decreased to $9,500 per unit in 3Q11, down from $9,900 in 3Q10. Sonic Foundry shipped a record 419 units in 3Q11, up from 313 units in 3Q10. Sales of rack-to-mobile units remained basically unchanged at 2.9 units to one in 3Q11, compared to 2.5 units to one in 3Q10. It was noted on the conference call that there is good potential for gross margin expansion. Overall, increasing revenues exceeded declines in gross margins, allowing Sonic Foundry to report an increase in gross income to $4.9 million in 3Q11, up 17.8% from $4.2 million in 2Q10, and beating our estimate of $4.5 million. 
    Sonic Foundry has maintained excellent operating expense control during a period of growing sales and seasonality in the education segment. Operating expenses were $4.6 million in 3Q11, up 18.5% from $3.9 million in 3Q10. Selling and marketing expense was $3.0 million in 3Q11, or 42.1% of sales, compared to $2.5 million in 3Q10, or 44.5% of sales. While this was above our estimate of $2.7 million for the quarter, and 19% above $2.5 million in 3Q10, this was notably lower as a percentage of sales. In addition, general and administrative expenses were $720,000 in 3Q11, up 25.9% over $572,000 in 3Q10 due to benefits and stock compensation, but close to our estimate of $700,000. Product development was $863,000 in 3Q11, slightly above $777,000 in 3Q10, and our estimate of $800,000 for the quarter. The slight increase in product development, for the fourth quarter in a row, is associated with higher stock compensation. Product development is important for the continual improvement in the value proposition to customers, as well as assimilation of Mediasite with market trends for viewing presentations on mobile devices. 
    We find it interesting that while total operating expenses of $4.6 million were the highest in three years, total operating expenses as a percentage of revenues declined to 64.4% in 3Q11, down from 68.5% in 3Q10, and the lowest level in the company’s history. This is an indication of improving operating leverage, as revenues and billings increase, and as the company continues to demonstrate strong operating expense management. Sonic Foundry reported operating income of $361,000 in 3Q11, slightly better than an operating profit of $330,000 in 3Q10. Sonic Foundry reported a net income of $212,000 in 3Q11, or $0.06 per share, meeting our net income estimate, and net income of $203,000 or $0.06 per share in 3Q10. (They noted that Non-GAAP earnings were $1.1 million in 3Q11, or $0.26 per share, compared to $853,000 in 3Q10, or $0.23 per share (diluted).)
    Unearned revenues were $5.7 million at the end of 3Q11, up slightly from $5.3 million in 2Q11. Unearned income characteristically increases in the second half of its fiscal year and runs off in the first half. Sonic Foundry reported cash balances of $4.2 million at the end of 2Q11, unchanged from the previous quarter. As of June 30, 2011, Sonic Foundry had no debt outstanding on its revolving credit line. They appear to have more adequate capital and liquidity with growing confidence in cash flow from operations to meet required working capital needs. 
    Earlier Guidance and Our Model
    On its 1Q11 conference call, management offered a wide range of potential quarterly year-over-year sales growth of 10% to 40%. Currently, management anticipates a typically strong fourth quarter, which based on prior seasonality, is highly likely and predictable. Based on the progress year to date, management affirms that top line revenue growth for fiscal 2011 should reach 20% over fiscal 2010 results. Also, as in prior years, higher levels of sales and marketing in the first half of the fiscal year lead to higher revenues in the later half, in addition to higher billings and unearned income. While management has not offered guidance for fiscal 2012, it is clear that they are optimistic about their product offering and pipeline of business to domestic higher education, international sales to Japan and possibly the Middle East, as well as high growth in event services. While they do not anticipate increasing headcount in general and administrative, some increases are anticipated in sales and marketing as well as product development. Lastly, improving cash flow, the result of higher revenues, and improving gross and operating margins, should lead to higher cash flow, providing both working capital and retirement of long-term debt.
    We were satisfied with 3Q11 financial results meeting or exceeding our earnings model. We were not only surprised by the increase sales of units but also by the combination of higher revenues with weaker gross margins offset to meet our earnings forecast. For this reason, we are leaving our model unchanged except for a slight upward adjustment for revenues, leaving our earnings estimate unchanged for 4Q11 and fiscal 2012. Based on our model we anticipate earnings per share of $0.03 and $0.57 in fiscal 2011 and 2012, respectively. In addition, our model forecasts sales per share of $6.69 and $7.08 in fiscal 2011 and 2012, respectively.
    Conclusion and Recommendation
    Sonic Foundry reported record revenue growth in both products and services, with notable increases in its events services, in 3Q11, the first of two of its seasonally stronger quarters. They continue to demonstrate increasing cash flow and operating leverage and anticipate new product introductions in the current quarter to accommodate changes in mobile devices, which may further secure their leadership position. While somewhat concerned about uncertain economic conditions, Sonic Foundry is well positioned with a product, now regarded as indispensable, both to institutions looking for cost effective means to deliver products, as well as viewers increasingly demanding a higher quality online learning experience.
    Management previously noted increasing activity for mergers and acquisitions in the education segment at 4x to 8x sales. This was not unusual during high periods of growth prior to the economic downturn in 2008. We reiterate our Buy rating and our 12-month price target to $25.00 per share, about 3.5x forward sales per share, or about 40x our fiscal 2012 earnings forecast. We have increasing confidence in our earnings forecast due to the company’s value proposition, industry trends for lecture capture on demand converging with mobile devices, and sustained organic revenue growth.
    Stocks: SOFO
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