Sonic Foundry's (SOFO) CEO Gary Weis on Q4 2016 Results - Earnings Call Transcript

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Sonic Foundry, Inc. (NASDAQ:SOFO) Q4 2016 Earnings Conference Call December 22, 2016 4:30 PM ET

Executives

Tammy Jackson - Director of Communications

Gary Weis - CEO

Ken Minor - CFO

Tammy Jackson

Good afternoon and welcome to Sonic Foundry’s Fourth Quarter 2016 Earnings Call. I'm Tammy Jackson Director of Communications for Sonic Foundry. We’ll begin with the Safe Harbor statements followed by a presentation from Gary Weis our CEO and Ken Minor our CFO. Based on investor feedback, Sonic Foundry is seeking new ways to maximize the attendee experience for this live earnings call. Therefore we will be using a slight format shift for today's webcast. Attendees will view the presentation via the webcasting platform Mediasite. And after the prepared remarks we will transition to a conference call for the question and answer portion of the presentation live attendees will only hear the Q&A if they dial in. Those watching on demand will experience an uninterrupted presentation. We will continue to use investor input in the future to evaluate the best format for investor communications.

And now for safe harbor. In compliance with the SEC regulation regarding fair disclosure, we will begin - we will be using SEC filings and public presentations like the one you're viewing and participating in today as the principal means of informing the Street and investors about our current and past results, financial projections or any material non-public information during those meetings. Sonic Foundry will continue to meet with analysts, investors, the media and others on an inter-quarter basis, but will not provide updates regarding quarter-to-date 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 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-K, 10-Q 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 recorded presentation will be available at sonicfoundry.com for 90 days.

And now Gary Weis will begin today's call.

Gary Weis

Thank you Tammy, and good afternoon everyone. I will go through the highlights first and then I'll turn it over to Ken to go through the details of the financial results. Our revenue for the quarter increased by 4%, a significant amount of that growth was caused by an increase in cloud hosting revenues, our cloud business, our hosting business continues to grow very nicely. Gross margin dollars increased and in fact are at about 75% ratio to sales. Adjusted EBITDA turned positive. The total swing was about $216,000. And as you'll see later, we continue to make good progress on all the fundamentals of the business. Billings total was 9.7 million in the fourth quarter, which was a net decline from the previous period in the previous year - the same period in the previous year. That was largely due to the fact that the fourth quarter last year in 2015 had about $2.6 million of two separate Middle East customer transactions. And so that obviously had a big increase in last year and it was difficult obviously to overcome that increase year to year. Unearned revenue has continued to increase. The increase was $1.4 million in the quarter and at the end of the year we're at 14.1 million in unearned revenue, up from 12.7 million at the beginning of the year.

So with that introduction I’ll turn it over to Ken who will take us through the details.

Ken Minor

Thank you, Gary. Our experience has been that these large transactions we're talking about are impacted by a lot of things, including some hypersensitivity to budgeting terms, technical complexities which oftentimes require some sort of customization, construction delays, political issues and a whole lot more. Now, fiscal 2015 as we said included four deals in excess of 450,000 which has been the definitional cutoff that we've used between the more normal run rate transactions and the complex ones. Fiscal 2016 didn't have any of those large transactions. The total of those large deals in fiscal 2015 was 4 million. So absent the big deals, our normal run rate business was 35.4 million in 2015, which grew to 39.5 million in fiscal 2016 or 12%. Three of those fiscal 2015 transactions were based in the Middle East with one being US based, two of those transactions totaling 2.6 million were in the fourth quarter of last year. So absent those two large deals in the fourth quarter of last year, we would have seen billings increase from 8.9 million to 9.7 million for the fourth fiscal quarter which would be a 9% growth.

The largest of these deals billed in September of 2015 for 2 million has been deferred from a revenue recognition basis. I'm happy to say that the issues that led to the deferral will resolve this month and we therefore will be recording the revenue associated with that transaction in the first fiscal quarter of 2017. I believe the product component of that being about 1.4 million which is the component that will recognize upfront. Our Chinese distributor has built a business in fiscal 2016 solely focused on Mediasite and they've developed a pretty impressive pipeline. Due to the fact that we are convinced there is significant demand in China, the team there can close those opportunities and that they are a start up and we were willing to grant them some extended payment terms. So despite the fact that they have paid us $1 million in approximate the last year, we made the decision to defer revenue associated with a $625,000 software billing that we made to them in September of this year. We believe will be able to get to their - get them back to their more normal payment terms over the next year and then at that point we'll be able to get them back to a more normal revenue recognition as well.

Our events in cloud services have both shown significant growth for the fourth fiscal quarter as well as the full year. Cloud services in particular increased 38% this quarter and it was 35% for the full year. Likewise, our annualized software licenses showed significant increases even greater, 53% increase for the year and 40% for the full year. The additional income statement statistics our revenue as Gary mentioned did increase 4% that's both for the quarter and for the full year. And again those - both those periods were impacted by our decision to defer the revenue associated with the Chinese distributor. Gross margin improved by 3 percentage points in both the quarter and the annual periods. That is as a result of the increased cloud and software revenue as well as some hardware cost reductions and some efficiencies that we saw in our events business. Together those improvements drove a nice improvement in our EBITDA from an $823,000 [ph] loss last year to $524,000 of income this year as well as some significant quarterly improvement. Likewise, the loss was reduced from 4.5 million last year to 3.3 million this year and from 1.2 million in Q4 of last year to 847,000 this year.

Our ASP and recorder units were impacted this year for both the quarter and the full year as a result of the greater mix of lower volume transactions which led to the better ASP and a lower volume counts. Our operating expenses were pretty flat year over year with the biggest increase coming in our product development area and that was associated primarily with a slightly higher headcount in product development as well as a greater use of outsourced engineers for some limited term projects. On the balance sheet, these amounts, the amounts that we have invested in inventory and accounts receivable were reduced this year and led to some cash savings. Our current liabilities also were reduced. We reduced our trade credit and that was offset though with a nice increase in our deferred revenue. The current portion of that went from 11.4 million to 12.8 million.

I mentioned success we've had with our cloud services. We've also as I mentioned had the success in our annual software licenses that's been not just this quarter but throughout the year. Together with our support in our events, our recurring revenue has seen significant growth and now represents over 60% of our billings, it was about 61% for the full year. In total now, our recurring revenue is over $23 million annually. This chart summarizes our results over the last couple of years and combines the quarters into half-year chunks, I think it helps take out some of the noise and I think it does also demonstrate the improvement that we've made steadily over the last two years. Obviously, we still have some work to do but it's important to note that our EBITDA as we said swung from a loss last year to consistent income both in the first half and the second half of this year. Obviously that speaks well for improving our operating cash flow, which from a cash statement standpoint saw probably the most significant improvement, our cash used in operations last year was 3.1 million whereas we provided cash from operations of 1.7 million this year. So a $4.8 million swing in the cash from operations that was generated.

And that's it for my remarks, so at this point, I'll turn the presentation back over to Gary who will run through a few more charts.

Gary Weis

Thanks, Ken. I think I want to start by talking a little bit about the growth that we had in 2016. And as we've already pointed out several times, if you look at the total growth you would be looking at a very small number. But this year we have really focused on doing some interesting things in our base business and this chart just highlights some of the success areas we've had. Our acquisitions in Japan and the Netherlands performed very nicely in 2016 and this is a full year basis. Our events business increased by 19% and our cloud business by 35%. Now all of the large deals were outside of these areas. So these are our comparable growth 2016 over 2015 and large deals had no impact on these numbers. The other thing that I would point out that we are encouraged about is in the United States in our [indiscernible] business for higher education, we actually saw about a 5% to 6% growth in the year. So our core business recurring business if you will excluding large deals has done quite nicely in 2016 and we're quite optimistic that that same trend will continue in 2017.

So I want to talk a little bit about what we've done in -- started to do in 2016 and are going to continue to do in 2017 with a great deal of focus. And I'll exemplify this with a deal that we did with Noordhoff Health. One of the things that we've become convinced of in order to build our recurring revenue base and build our sales to smaller units of sale, we really need to have relationships with companies that can package our technology as part of a broader sale. Noordhoff is an excellent example of that. The product they sell to their customers which are largely European hospitals and health care organizations are meant to provide assistance or training or information to help those organizations maintain their accreditation and so forth in their local regulatory environments.

We have partnered with them now to co-create learning solutions, which use Mediasite technology that can be used as that deployment of their high value services to their customers, and at the same time, give those customers the ability to capture their own personalized video training. We're very excited about that model and frankly we think that can apply to a lot of other industries and we're going to really focus on that in 2017 expanding it.

The other two partnerships are more technology partnerships and they've been done to address the needs of customers who need to deploy video within their own private networks. We are particularly happy about the Ramp partnership because it allows us to reinvigorate our use of multicast technology, which we have developed over the years using Microsoft's Media Services, which are now transitioning out to in favor of more industry standard video services. So all of these partnering activity will I think set ourselves up for better growth in 2017.

I want to spend a few minutes talking about China and I want to put in perspective what Ken said earlier in his remarks. We obviously are attempting to do everything we can to support our China distributor. They have an excellent pipeline. They have an excellent selling program in China, but the way things work in China is that you have to convince not just the government, but also the education authorities in the various schools to budget for their use of technology in the subsequent year.

So 2016 saw relatively low user revenue to the distributor in China, but they were also in order to do their distribution arrangement with us, obligated to meet a minimum revenue commitment. So we were sensitive to that and from what we can see, they've done an absolutely excellent job at convincing all of the parties to provide strong budget support for the programs their customers are bringing forward in 2017. Now, they also have commercial corporate customers as well. But frankly, we think some of the work they're doing with the local school districts in Dalian province will yield a very substantial growth for them in 2017 and beyond.

We have spent a lot of time in the past and will continue to spend time talking about large deals. As you've all been aware from our past circumstances, they're very difficult to predict when they will close. But we have a very high confidence that we have several deals remaining in the Middle East where we are the committed provider of the video service. But the customer is not going to buy that service until the building is ready and they're prepared to deploy it. That will continue to be something we have to manage and frankly we don't have a whole lot of influence over managing it.

We just have to work with the customer to make sure we can provide what they need when they'll need it. However, in addition to those Middle East opportunities, there have been a number of RFIs and RFPs that have developed in the United Kingdom, in Western Europe and in Asia-Pac, in Hong Kong. And we see an excellent opportunity to close, especially those in the fiscal year of 2017. We've also begun to be quite successful in the market for video in India. We're working closely with a couple of partners in India. It will not be like China in the sense of having a distribution agreement, but it will be I think an opportunity for us to bid on some large deals, some of which may in fact involve government agencies in India.

So we're very optimistic about developing that market in 2017, but we don't look for a lot of revenue or billings for that in the year 2017. South Africa continues to be a successful opportunity for us with funding from the South African government. For our distributed Mediasite solution, we've learned in Africa that it takes time, but it also is governed by the local conditions on the ground and our partner there in South Africa, the University of the Free State is a very good partner. They're going to push that out as quickly as they can to over 100 schools in the Free State and surrounding areas.

Now, I thought I would spend a minute talking a little bit about why we're very confident about the long-term growth future of the business. We knew in 2013 that we would face great challenges in kind of achieving the growth in our base business that we wanted to achieve and that our investors want us to achieve. And in order to supplement that growth, we started layering in various strategies to build other markets in other geographies and build other markets with other products and partnering activities.

So the first of those was in 2014 where we acquired MediaMission and Mediasite KK and as I’ve told you, those investments are now paying off handsomely. We had some obvious concerns along the way in 2015 with the Japanese currency exchange rate and with the introduction of a new management team in Japan, but those issues are behind us and in 2016, as I said earlier, we had substantial growth in both of the acquisitions and our plan for 2017 is frankly significantly more growth from those two entities than in our base business in Western Europe and in the United States. In addition though, we wanted to take advantage of the growth in the China market.

We’ve already talked about that and this chart has, I think, a realistic forecast of what we would expect to achieve in future years with China. 2017 will still be largely sourced by our revenue commitment with them, but we would expect to see significant growth beyond the revenue commitment in 2018 and 2019. We're also introducing in 2017 a new software product called Catch and that product we think will enable us to penetrate a lot more classrooms, both in our existing customer base and new customers and we've again realistically forecast what we think the growth from Catch will be. That is another example of a recurring license product and an annual license product. So we will see continued recurring revenue from that as well.

And finally, we see India beginning to open up albeit small in, certainly small in 2017, but growing in 2018 and 2019. So if you look at the two sets of years, 2016 backward and 2017 forward, the growth rate that we would see at the end of the 2019 period would be substantially higher than what we've seen so far up to 2016.

So let's talk a minute about outlook. Ken and I have spent a lot of time trying to share the best information we can with our investors and if you were to go back in time and look at our outlook or guidance process for 2014, you would see that we separated the base business from large deals. In 2015 and 2016, we tried to combine them and because of the volatility in closing those deals, we've decided this year to go back to separating the two pieces. We are very happy with our large deal pipeline, but because of the difficulties in closing them on our schedule versus the customer schedule, we have established a range of 0 to $2 million.

On our base business, as we've said, we grew at 12% in 2016. We're, I think, realistically saying that we will grow at a range of 5% to 7% or approximately 2 million in the base business in 2017. And obviously we're going to work hard to make that a bigger number. Now when you consider those ranges in terms of revenue, we think we will certainly continue to make progress in EBITDA and GAAP net income, but we would believe that at the higher end of those ranges, we would show net income profitability during 2017.

So that I think covers the fixed remarks. What I'd like to now do is spend one second talking to you about the change in format. Because of our use of streaming technology, it makes it very difficult to have an interactive Q&A session over a dial in phone number. So what we've decided to do is we will now end the streaming part of the broadcast, the fixed remarks and we will ask all of you who would like to ask questions to dial into the number that you see here, 1-844-887-9401. We’ll then conduct the Q&A session. And as Tammy pointed out, we will continue to record video and audio from the Q&A session and for anyone who would want to reference it on demand, the entire presentation, both the fixed remarks and the Q&A will be available on our website.

So with that, we'll take a pause of about 2 minutes and then we'll be on the telephone bridge to take questions. Thank you.

Question-and-Answer Session

Q -

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