Sonic Foundry's (SOFO) CEO Gary Weis on Q1 2017 Results - Earnings Call Transcript

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Sonic Foundry, Inc. (NASDAQ:SOFO) Q1 2017 Earnings Call February 9, 2017 4:30 PM ET

Executives

Kristin Zurovitch - Director of Marketing

Gary Weis - CEO

Ken Minor - CFO

Analysts

George Melas - MKH Management

Kristin Zurovitch

Good afternoon and welcome to Sonic Foundry’s First Quarter 2017 Earnings Call. I'm Kristin Zurovitch, Director of Marketing for Sonic Foundry. We’ll begin with the Safe Harbor statements followed by a presentation from Gary Weis, CEO; and Ken Minor, CFO. I'll start by going over the format for today's webcast.

Attendees will view the presentation via the webcasting platform Mediasite. And after the prepared remarks, we will have the opportunity to ask questions in the conference call. We will give you instructions on the call 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 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-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 webcast.

Ken Minor

Thank you, Christine. I'm actually Ken Minor. I'll start it this time around. I'll start by going through the financial highlights.

This has traditionally been a seasonal low quarter of the year and likewise we finished the results with expectations that are well below our expectations for the remaining quarters of the year. Revenue was up slightly over the prior year but was impacted by several large and offsetting amounts. And first of all, we did have some large percentage increases in our recurring cloud and software license business. We also recognized the product portion of the large $2 million transaction we originally shipped a year ago to a customer in the Middle East. The product amount we recognized was 1.45 million.

We do anticipate recognizing the software component of this as well, as it related to professional services later in the fiscal year. And once those services are complete, we'll do that and that total will end up being about $400,000. Our results in Japan were down year-over-year by about $700,000, which were impacted primarily by a $500,000 transaction that was last year that was not repeated in the current quarter. We do however expect a similarly sized project from the same customer to hit our fiscal second quarter.

In total, Japan should see an increase in the second quarter more than a 150% from our first quarter results and should show growth for the fiscal year. Likewise, our partner in China were at $600,000 last year compared to $300,000 this year, but expect to be in this important increase in year-over-year purchases of approximately 20%. We've previously announced last month that our China partner had paid one half of an amount originally due in December, and as a result, we made a decision to defer $625,000 that they ordered in September, which was deferred for revenue recognition purposes.

They've made all required payments now and they're in full compliance with our expectations. However we do continue to defer the $625,000 that they ordered in September as well as the $300,000 that they ordered in December. We expect that they will continue to grow their business and being compliant with our expectations in the second quarter. And we anticipate that we'll recognize at least a significant portion of those previously deferred amounts as well as what we expected to build them in March. Since the majority of that purchase of the software, I expect recognition of the deferred amount to positively impact gross margins and profitability.

Speaking of gross margins, our margins were up from the 70% amount that we recorded last year, and we expect that to grow in later quarters as our volume increases in the more seasonally stronger periods of the year as well as when we add more stronger components of the software. Our adjusted EBITDA reflects the top line results that have been fairly flat, and it reflects the increase in operating expenses; approximately half of those increased operating expenses however were tied to a payment that we owe a consultant in the Middle East project. That's a one-time project, one-time expense and we don't expect that to reoccur.

Unearned revenue decreased primarily as a result of the 1.45 million that we recognized for that project and the remainder is more typical of what we see in our first seasonal low quarter. On the billings basis, our typical products and services were flat year-over-year although impacted to a lesser extent by some project timing in our events business. The more impactful timing difference however is from the operations in Japan and China. As I mentioned, we believe these will reflect full year growth, just not in the first quarter; and together the two impacted our billings by approximately $1.1 million compared to last year, and on a billing basis and on revenue basis 1.4 million.

Despite the significant shortfall from last year, we expected results very close to this, and we took this into account when developing our plan and developing our guidance. Our loss increase $300,000 primarily as a result of higher operating cost, which were partially offset by the higher gross margins. Our operating cost as I mentioned, show an increase of $700,000 but nearly half as the one-time cost associated with the consultant I mentioned for the middle east project. The remaining $400,000 increase over last year represents a 5% increase in operating expenses, which is in line with our expectations.

Our cash balance is at 1.1 million, but off course does not represent that $2 million letter of credit that is due on April 8th, related to that Middle East project. It also doesn’t reflect other impacts that we expect in the near term. So, together with availability of our line of credit with banks and sufficient, we expect it will have sufficient resources to accomplish our plan through the next reminder of the year. We had a balance of $2.6 million on our line of credit as a maximum balance of 4 million. Additionally, our operations in Japan are in the process of increasing availability with their lender by ¥50 million.

Our ASP is very much comparable in the prior period with recorders a bit higher that includes refreshes. We did include recorders in the amount recognized for the Middle East project as well. Now, again, our selling and marketing change over last year was driven primarily by the middle east project, but product development was also little higher, during the quarter primarily as a result of increased outsourced cost and the expansion of our quality control group. Our current assets reflect a reduction of cash of $700,000, that’s primarily due to some delayed payment terms from some of our customers

Obviously, the receipt of the $2 million LC on April 8th level of significant impact on that, likewise our China partner and our customer in Japan impacted cash with approximately $300,000 that was paid by China in January and $500,000 we expect from the significant Japanese customer in April. Our current liabilities are up primarily due to our 1.2 million increases in our line of credit and off course that will go down upon settlement of the accounts that partially occur in January into much greater extent, the amounts that we expect in April. The long-term liabilities were impacted by a $400,000 reduction in long-term debt, which was partially offset by an increase in on our revenue.

And that does it for my comments on the financial results. At this point, I will turn the presentation over to Gary, who will run us through a few of the business trends.

Gary Weis

Thanks, Ken. Good afternoon everyone. I want to begin before I get into the presentation by emphasizing what Ken has gone through. Our annual plan was done in a way that anticipated probably of closing deals throughout the year and so the results for the first quarter are well within expectations for the full year plan, and we're certainly reaffirming our full year guidance at this time. The other thing I'd like to comment before I get into presentation is our large opportunities pipeline. We continue to actually grow that pipeline and for the first time in several years, we're seeing actually an increase in pipeline in the United States.

So, the trend in higher education from our prospective is picking up in the United States, and we also see several large opportunities in Western Europe and in Hong Kong. So, the reality of the big deal distribution this year, the big opportunity distribution this year is spread more across all of the regions, as opposed to just focused on the Middle East. We still do have several opportunities in the Middle East as well; and as we've discussed in the past, these deals are lumpy and they're very difficult to predict closing. The quality of the pipeline is excellent, it's just as to what quarter an individual opportunity will close or whether it'll make it into the 2017 fiscal year or the 2018 fiscal year is very difficult for us to predict and you've seen that in the past.

Now, we've always talked in the past about finding ways to offset the lumpiness of the business. And the key to us to achieve that is by finding ways to grow recurring revenue. If we have long term contracts with customers and we understand the dynamics of how those recurring revenues will renew year-over-year, and in fact going into contracts that have a longer commitment in just a single year, we think we can do a lot to add additional sources revenue in a more predictable way that isn't dependant on the lumpiness of our large opportunities. Now, our core business is demonstrating this. We've begun to see the pay off in investments we've made in annually licensed products.

I think we've given you statistics of an increase in recurring revenue from the standpoint compared growing faster than our normal revenue growth; that's due not just to annual license products, but also to hosting customers both from the standpoint of individual new customers and existing customers growing their usage. However, we also think there're other things that we can do to accelerate revenue in a recurring fashion and I want to spend a few minutes talking about a major element that's new to our business plan in 2017. We believe there's a growing opportunity to work with large customers and these customers tend to be corporate customers as opposed to higher education customers.

To embed our technology into offerings those customers are selling to their revenue base, that are much higher value and that drag along our technology capabilities that are integrated into their overall product offering. This will allow it to leverage the sales force of those partnering customers; and at the same time, we're designing them to license and price them in a way that produces recurring revenue. So, what are the target customer attributes that we have for this new initiative? The first is obviously it has to be a customer who wants to use video content as part of their existing business, and we refer to it as embedding video infrastructure in these partner and customer's systems and applications.

We're focused on some net new market segments; healthcare is an obvious one; and I'm going to talk about an example in healthcare here in a minute. We also want to target enterprises that have strong existing channels in direct sales organization and in fact that are generating today from an information content product that they're selling to their customers. Now, I want to emphasize that we feel very comfortable that we can do this with our existing technology because we've invested in APIs in that technology that leverage the core product architecture that already exists. So, will there be some customization? Yes, but that customization will be secured by long-term commitments from these potential partnering customers.

Now, the first example of this is Noordhoff Health, we've talked about his before, but we haven’t giving you any lot of detail on what it is. I'm going to share with you some other detail and I'll actually show you there websites, it's already up and running, and I'm happy to report that we're actually starting close business under this arrangement in the second quarter. The Noordhoff Health is a business unit of Noordhoff Publishers. They are very large company with presence in predominantly Western Europe and in the Netherlands and in Germany. They have created a healthcare portal knows as Health Video Baby Effect, which is what I am going to demo for you here in a minute.

They already have built a subscription video library of over a 100 videos that help their customers attend compliance and training for their hospitals and for their clinics. We're providing not just the Mediasite capability for Noordhoff to compose that content, but we're also hosting the use of by My Mediasite in our cloud to allow their customer to create their own content and to potentially barter that content with Noordhoff in the future. Now, the example, I've shown you a URL at on the slide that is open. So, if you want to check it out yourself you can. What I've now placed up here is the, is in fact the webpage that you get, if you were to navigate to that URL. And obviously, I apologize it's in Dutch, but you'll get -- I think you get the grip to this as we show you a demonstration.

Now, all of these represent Mediasite composed videos. And what these are our teasers for the actual content that you need to have a license to view by being a customer of Noordhoff Health. I will simply show you one of these videos, it is being displayed at slow frame rate, but I want to go a video, but you will get an idea. This happens to be a video snippet that helps to educate or explain to hospital personnel how to wash their hands. And so, again you will -- I'll view display for just a minute more and you will obviously see that it's instructive.

Now, all of the other videos are similar, but different in terms of content and the package that Noordhoff sells to their customer is really oriented toward being able to allow the customer to, not just use the videos, but also to obtain their ability to use Mediasite to create your own videos. So, just to summarize it, we were very excited about this, we have a pipeline of other customer opportunities that we're pursuing. Noordhoff Health impact is a subsidiary business unit of Noordhoff Publishers. I think Noordhoff Publishers will also have some interest in using a similar strategy in their business.

Now, we've talked about our arrangement with CSCU [ph] in the past, I'm happy to say that we've already achieved implementations with two new customers under this. I'd emphasize before that, this is not an offering that provide an instant high revenue generation situation. This is an enablement win. It provides us with contact with other customers in the system. It provides preferred pricing for those customers of our technology, and there's actually two Mediasite solutions in these master enablement agreements. One is for video content management. The other is for video content capture.

We think this will offer our named accounts team that deals with CSCU, an excellent opportunity to call us more business and by the way we're pursuing other opportunities with similar systems or with operators that provide the hosting of our content inside their own network infrastructures. An example of that is NTT in Japan. So, again we're finding ways to reach customers that we don't have to dedicate sales resource to achieve. Now, Ken has also talked about a large Japanese customer that has closed a fair amount of business over time with us, it's Teikyo University. Now, this university has multiple campuses and in fact there're several other campuses that aren't listed on the slide that we're also prospecting into.

The opportunity that will close in the second quarter is actually a refresh of an initial sale in 2012 to 42 classrooms in the medical school. We're very happy with that customer implementation. They're obviously very happy with us, because they're refreshing their recorder technology. We provide other value through our Japanese team to this customer in terms of room control systems et cetera. Last quarter, Q1 of 2016, we had a large opportunity in the Hachioji campus, which is another active learning situation in Teikyo that we closed and that's the large transaction. It wasn't offset in this quarter, but we will do another opportunity, the refresh opportunity going forward into Q2.

Now, this customer is very involved in trying to measure the effectiveness of video to help them improve their student grades and retentions and graduation rates. As I said before many of customers have anecdotal information regarding those success rates but I believe a number of our customers including Teikyo are working hard to provide studies that will actually document that success.

Now, I'll talk a little bit about some of the other activities that are going on internationally. We talked a number of times about Japan in terms of their success. They're going into the second quarter being their strongest quarter of the year and we're quite confident that that quarter will have a great amount of success for them the team in Japan and for us in total. We also are starting to see the impact of some of the partnerships that have turned up with Sony and NTT and others. And so, towards the third and fourth quarter, we look for adding growth from those as well.

China is also an extremely interesting opportunity to us. Ken has already talked about the background financially with the company there. But we work very closely with them to help understand their pipeline and look at the opportunities that they have and we ensure that our technology will help them win those opportunities. They have some very large school districts in Japan that we expect them to close now that the Chinese New Year is concluded, and so we look forward to each quarter being successfully strong from China.

So that includes my prepared remarks. There is slide up now that shows you the dial in number for the Q&A. I will remind everybody that if you're going to participate in the audio conference, please disconnect from the webcast to ask question. There is timing delay that will cause confusion, if you don’t do that. And so, we will pause for brief interval here, and we'll turn it over to the conference call operator to poll for question and to connect you into answer your questions.

Question-and-Answer Session

Operator

Yes, thank you. And as mentioned, we will now begin the question and answer session, and if you're on the webcast and would like to ask a question, please disconnect and dial 1-844-887-9401 or 412-317-67-97, and that’s the Sonic Foundry call. Again, if you're on the webcast and would like to ask a question, please disconnect and dial 1-844-887-9401 or 1-412-317-6797 and that’s the Sonic Foundry call. [Operator Instructions] Okay, we do have a question and the first question comes from Robert Schatz [ph] [Indiscernible]

Unidentified Analyst

Quick question for you. On this new area with businesses, have besides that health company over in the Dutch there? Have you spoken to any other companies about this and what was their feelings about it?

Gary Weis

Yes Rob, we've spoken to probably four, five other companies seriously, not just casually. And I don’t want to get into who those are obviously, but we're finding a lot of interest in the concept. Frankly, we have another customer in Japan, which we talked about before called IMS. And we been working with them, they are also a healthcare information provider in Japan. And we've been working with them to begin with using our events team in Japan to post there events, but we're also integrating our polling -- not our polling capability, but our information collection capability to feed data into their customer management system. So that’s one example of another customer that we begun the dialog with, that one's a little bit more complex because the integration required with their customer management system. But we've four or five other opportunities, I would say mostly in Western Europe and in the United States.

Operator

And the next question comes from [indiscernible] as well.

Unidentified Analyst

I just have one quick question. I've seen some of the competition has seek out some additional financing and worked that deals with some private equity administrators and also some big Wall Street banks for some capital expansion. I was wondering, is Sonic seeking any investment funds to come in and help them expand as well?

Gary Weis

We're not at this time, as Ken's pointed out, the plan that we're on is to improve our fundamentals by balancing top line growth with a profit, with net income; and our judgment is that we've an adequate source of revenue in our existing customer base and product capability and as we've looked at other possible acquisitions, and we've looked at other investments in product creation frankly there's nothing that has come out that suggested that we would want to go out and raise money or seek financial funding to make those kinds of investments. Ken do you have anything to add?

Ken Minor

That’s right. We're not looking to add any capital at this point. I mean the business plan does support our needs for the foreseeable future. We're obviously focused on a partnering strategy that we think can help grow the top line without additional investments.

Operator

Thank you. And the next question comes from George Melas with MKH Management.

George Melas

I have questions on sales and marketing, [Indiscernible] 90% of revenue being [Indiscernible] with your existing customer. And I look at your sales and marketing, and it's pretty hefty numbers, over 60% of revenue. So maybe high 40s to low 50s, how are you spending your sales and marketing resources? And is it primarily sort of account management or maybe looking [Indiscernible]?

Gary Weis

Let me start with that and Ken can maybe flash it out with some additional numbers. But I would observe that most of our sales and marketing costs is really sales cost, and in this particular quarter as Ken has pointed out, there was a commission arrangement with a Middle East consulting firm that made the expenses in the quarter, not typical.

Ken Minor

The deal is about $300,000.

Gary Weis

Right, the typical investment that we've or the cost we've is in sales, and it really is account teams, commissioned accounts team, and sales support teams that take care of growing and supporting our -- either our existing customers or acquisition of new customers. One of the reasons the numbers show such bias to existing customers is partly in the way that we count customers in higher education. So, I'll take an example of Harvard, Harvard is one of our most successful and large cloud customers and we treat Harvard as a customer.

When the next school buys our service at Harvard, it took a fair amount of sales effort even through with their proffered lecture capture provider, to close that deal, price that deal, support the roll out excreta. And so the next school at Harvard is counted as sales into an existing customer. So, the model that we have for our named accounts, sales operation is really focused on taking care of university customers and then up selling either into existing schools where we have a penetration or new schools with those customer. We do prospect for brand new universities as well, but the explanation I just gave is the reason why it looks so strongly buy us toward existing customer business.

Kristin Zurovitch

And just a support on the marketing side, I think our marketing budget for this year is about 6% of revenue and so it's obviously the small component within that sales and marketing total budget line. And it's primarily focused on trade shows and obviously we're not marketing the students, we're marketing the schools that the purchasing decision may occur at that schools, and so usually a trade shows or other webcast webinars those sort of things.

George Melas

On as you first [Indiscernible] on the universities, do they all have a dilution at this point or you have to displace a competitor incumbent there? That's there, what the [Indiscernible]?

Gary Weis

Well, that’s a very interesting question and it gets kind of at the heart for the length of our selling cycle in universities. We run the gamut of universities who are making a strategic investment in implementing lecture, capture essentially for the first systematized time, meaning they may have experimented in a few class rooms. But when they go to scale out, they needed industrial strength, a high quality solution; and we already talked about Leeds [ph], as University of Leeds is one of the examples of that type of customer, that is unusual.

The more typical situation would be a university where we may already have a presence. And one of the schools in that university may have used a competitive solution in the past and we have an opportunity to displace that competitor. Sometimes that happens, because they need a refresh and the competitors technology and they are looking at our technology as a superior technology to replace the existing vendors technology or it could be that there host of other reasons why they may want to move to a different technology.

But it’s a blend of the two, the other material factor in again selling into a university is new buildings, so where we are being incumbent in the school, if the school decides either refurbishing existing building or build a brand new class new building, we're I don’t say automatically but we have the highly favored technology to go into that expansion.

Operator

And the next question comes from Robert Lurwo [ph] with Axiom Wealth Trust.

Unidentified Analyst

Gary and Ken, Robert Lurwo. This new business that you're getting involved with Noordhoff and some of the other online systems, you mentioned in there that you sell Mediasite to them and then they have the opportunity to create videos utilizing the Mediasite technology. How do you build for this? Is this a standard agreement that you signed with them, that's on a yearly basis and they can do what they want with Mediasite? Or when they create new videos they have to compensate you?

Gary Weis

That is an excellent question. The first phase of this because it's -- because we want it get it going faster and make it simple. We've licensing agreements with these companies that are pretty straightforward and you're right they're based upon what I would call usage metrics as opposed to their revenue metrics, but we're very well -- very far down the path of looking at revenue sharing models for other customers or do we involve existing customers into that kind of the model, because we would like to participate in that upside, but again to be direct, right now we want to get in and establish our position in a most direct and straightforward process and sometimes that selling something that is a very simple contractual sale. Almost always though there're annual commitments for either cloud services or licenses for software.

Unidentified Analyst

I guess I'm looking for something in new business that's going to bring more to the bottom line and achieve the results that you guys I know want to achieve and that we as stockholders want to see happen. And in your last call, Ken mentioned that you thought in '17, you'd be at least flat and maybe be able with the Chinese situation to [Indiscernible] for the deficit, are we still looking at that?

Ken Minor

Yes sir. In fact, we've our -- the leader of the Chinese business will be here in March working with our team to share his strategic and competitive opportunities for the rest of the year and we'll work very closely with him to help him win some of those opportunities. Some of those opportunities frankly are as large as 750 rooms for customers.

Unidentified Analyst

So, when we look back at Leeds, Gary. And we thought that would lead into many more -- you're still confident that that Leeds implementation will bring more business for you in that arena?

Gary Weis

Absolutely, in fact we're engaged in a couple of larger opportunities in the UK as we speak.

Operator

Thank you. [Operator Instructions] All right, there's nothing more at the present time and I would like to return the call to Gary Weis for any closing comments.

Gary Weis

Okay, thank you operator. Well, thanks very much participating. We appreciate your questions. I think the feedback we've got is using the format that we've taken is preferred by a lot of people out there. So, we'll continue to run this format. And again, I'd like to thank you for your participation and look forward to talking to you at the next call in about 90 days. Thanks very much.

Ken Minor

Thank you.

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