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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon, and welcome to Sonic Foundry's
Third Quarter Fiscal 2018 Earnings Webcast. I'm Tammy Jackson, Vice President of Marketing and Communications for Sonic Foundry, and I will be moderating today's webcast. We'll begin with the safe harbor statements, followed by a presentation from Gary Weis, CEO; and Ken Minor, CFO. [Operator Instructions] In compliance with the SEC regulation regarding fair disclosure, we will be using SEC filings and public presentations, like the one you are 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, nonpublic information during those meetings. Sonic Foundry will continue to meet with analysts, investors, the media and others on an intra-quarter basis but will not provide updates regarding quarter-to-date results, financial projections or any material nonpublic 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. From time to time, Sonic Foundry refers to various non-GAAP financial measures, or measures not defined as generally accepted accounting principles. As an example, we refer to the adjusted EBITDA in this presentation. The company believes that this information is useful to understanding its operating results without the impact of special items. Refer to our earnings release for a description and reconciliation of adjusted EBITDA. 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 www.sonicfoundry.com for 90 days. And now Gary Weis will begin the webcast.
Thanks, Tammy, and good afternoon, everyone. Thanks for joining us today. I'll take you through the high-level view of the results year-to-date for the business. Ken will then go ahead and elaborate on some of the detail, and I'll come back and talk a little bit more about some of the detailed elements of the business. First off, our year-to-date billings decreased by 6% over the prior year. The prior year did have a large multi-year transaction in Japan as well as revenue from our China distributor. If you adjust for those 2, we essentially are flat year-over-year with year-to-date for comparison to 2018. I think the results of the business are in line with our expectations, meaning that the performance year-to-date is pretty much consistent with what we would have been expected when we put our plan together for the full year. For revenue, a similar trend happened. There is a different adjustment here because we did have recognition of revenue from our prior Middle East transaction during 2017. That amounted to about $1.9 million. And if you adjust for that, revenue would have increased by about 1% compared to the full year of '17. Probably one of the most positive things that we see in this year is a significant increase in recorders shipped, 19% over the prior year and 46% in the newer models of 220s and RL Minis compared to the prior year. One of the things that we did during 2017 and into 2018 was rebalanced the cost mix of our recorders to offer our customers the right size recorder for each application, and we're gratified to see that, that change is having a very positive effect in terms of number of units sold. Our operating expense decreased by about $1.2 million. That was a 5% reduction. That was due to actions that we told you about back in the 2017 time period. They are just now getting full effect as we work through 2018. The tax impact is purely a financial thing and doesn't really have any effect on our operating results. And the improvement we see, including the tax credits year-over-year, is that we have cut our loss to $2.1 million in 2018. So with that, I'll turn it over to Ken, and he'll take us through the details.
Thank you, Gary. The Americas product and support line item underperformed last year for the current quarter by about $200,000. The region outperformed prior year in the first quarter and appears to be on track to do that again in Q4. There were 2 large transactions that we had anticipated would close in Q3. One of those actually closed this week, and the other one looks very promising, yet for Q4 we expect that to happen. The Americas events in cloud were consistent with the prior year, both on a quarterly basis as well as year-to-date. Both our international subsidiaries covering Benelux and Japan are exceeding expectations. Now Japan shows a decrease over the prior year of about $500,000 on a year-to-date basis, but there is an $800,000 transaction. As Gary mentioned, it was a multi-year transaction completed with Teikyo University, which was a lease financing transaction. So without that anomaly, Q3 would be flat with last year, and year-to-date, would show growth for MSKK.
China continues to show weak results for us as we transition from that sole distributor model that we told you about to the broader approach with multiple partners. Activity should continue to be modest going forward but now start to show results from those multiple distributors. As a reminder, our prior year billings for our Chinese distributor were recorded as billings but not as revenue. And then ultimately, we made the decision based on those slower payments to shift to more of a recording billings and revenue based on receipt of cash, which is why you see that drop this year over last year. Other international showed improvement this quarter over last year, after having a really challenging second quarter. And again, they have a lot of opportunities in Q4. So we're more optimistic that they will continue to have a pretty good result in Q4. So year-to-date then, we're about 4% behind last year in the Americas and about 5% behind in international, other than the China number I told you about. In terms of some more of the detail. Our revenue was down 12% over the prior year. And again, as Gary mentioned, that was impacted by the billings variance, of course, not counting China but also as a result of a piece of that Middle Eastern transaction. We mentioned that there is a $1.9 million transaction from -- a Middle East transaction that was billed in the prior year and recorded as revenue in the fiscal year, last year. $400,000 of that was recorded in Q3, and it was all software, so there's no cost associated with it. Year-to-date, we're now also consistent from a recurring revenue transaction. It was about 68% versus last year. Also, as Gary mentioned, we would have shown about 1% growth in revenue had we not had the full year impact of the Middle Eastern transaction. So our gross margins were also consistent for the quarter and for year-to-date, despite the large Teikyo transaction and despite the fact that last year we recorded that large software transaction with no cost associated with it. So that's encouraging to see gross margins remaining so strong despite the fact that last year had some anomalies that would have buoyed gross margins. Our operating expenses continue to run well below last year. As we mentioned, that reflects the changes that we made last year that Gary spoke about. I have some more detail that shows the split of that in the next slide. The net loss, as we mentioned for the current year, is $1 million. That compares to $500,000 last year, which is about equal to that software transaction that we mentioned that flows right to the bottom line. That was included last year. The other expenses also include a noncash charge that was related to accretion of noncash interest. That's related for that warrant put that we paid off early that was associated with Partners for Growth, and they had a $65,000 impact this year. And again, that was just noncash interest. So the year-to-date net loss improved over last year, as Gary mentioned, and that's also pretty similar improvement as to the amount of the tax change that we effected. The lower ASP that we're seeing here compared year-over-year is a direct reflection of what's happening in terms of the mix towards more and more of our lower cost recorders, the RL 220 and the RL Mini models. As Gary mentioned, we saw some pretty significant improvement year-over-year. It's about a 46% increase in the number of units shipped of those lower-cost versions over last year, but it's a 90% increase in the number of units shipped from 2 years ago. So we're seeing some pretty consistent growth in those models, which is bearing out the success of that strategy that we're implementing. Our operating costs were reduced during the current quarter over last year in selling and marketing and in product development. As we said before, that's due to the cost reduction efforts that we began in Q3 of last year. G&A did increase slightly this year over last year just for the quarter, and that's as a result of the -- some higher wages and benefits but primarily also professional fees. In terms of the balance sheet. Our current assets were primarily impacted by a decrease in accounts receivable, and that's a result of the adjustments to receivables for that Chinese distributor that was made in Q2. Goodwill and other long-term assets were reduced by $1.4 million from the September quarter versus last year, which is primarily the reduction of long-term financing receivables associated with the Chinese distributor as well. Current liabilities decreased approximately $1 million since September due to a decrease in unearned revenue. That's primarily a result of the events business. Events tends to be very strong billings quarter one quarter and a very strong revenue quarter the next quarter. So the deferred revenue switches pretty significantly from quarter to quarter. So the September quarter had a number of events that were completed in October and November of 2017 that cause their deferred revenue to decrease significantly in the December quarter. Likewise, we saw it go back up in the second quarter and then back down again in the third quarter. That's a trend that we have seen historically, and expect to continue to see. Long-term liabilities decreased over the last year by about $1.4 million. There's a number of offsetting effects there, but the reduction in long-term deferred taxes was about a $1.3 million impact, as -- and we said that, that was a Q1 event. The adjustment that we spoke of to that Chinese partner that happened in Q2 was a reduction as well. And then that was partially offset by the note payable that we took out with Partners for Growth in Q3 of $1.8 million, and about $1.3 million, $1.4 million of that is long term. So it's a number of kind of offsetting factors that drove that. So at this point then, I'll turn the presentation back over to Gary to go through a few of our key wins.
Thanks, Ken. Let me make a few comments before getting into 3 specific customer wins that we're proud of that have occurred this year. Let me talk a little bit about what drives the business during 2018, to give you some sense of how customers are buying from us. We have a group of customers that are continuing, very loyal customers that spend a significant amount of money with us each and every year. Those customers are predominantly managed by our named accounts team in North America and our international team and to some degree in Japan. We find that those customers are totally committed to Mediasite and are totally convinced of the value of Mediasite from a standpoint of student outcome and student retention and so forth. Typically, what will happen though is those customers will only refresh or expand their bases when they have access to funding to implement specific projects. So the greatest limiting factor that we have in growing the business is our customers spending incremental money on proven technology that they're convinced assists them in helping their students, but they can only make those investments when they have access to funding through either grants or donor contributions or whatever. That is the single limiting factor that we have. So let me describe now 3 new customers. So that comment I just made was about our existing customer base in higher education. Let me now talk about some key wins that we've had this year that kind of illustrate how we are succeeding with customers, new customers as they invest in both lecture capture and video management. Cuyahoga Community College, good example of a customer who wanted to integrate all of its video management into one platform. As you can see from the quote, one of the driving factors was in fact the ability to save money, but also after they have imported that pre-existing content into Mediasite, they now have access to that video in a much more capable and viewer-friendly way than they would have had through any of their separate systems before. Integration with LMSs is always a big factor for higher education because most of the navigation that students have to get to the content for courses that they're taking is through a learning management system like Blackboard or Desire2Learn or any of the other ones that we support. So this customer made the decision based on expansion of capability and the ability to save money by integrating together all of their various video assets into one video content management platform. The other thing this illustrates is that more and more customers are not just buying lecture capture solutions. They want to blend presentations or lectures that have been captured using our technology with importing video from other sources. And the strong video management platform that we have enables them to do that. Switching into a different part of the world, into Pakistan. We have a customer there through a dealer that basically reached the customer that is expanding video technology into their digital learning project across 5 campuses in Pakistan. Again, all of the same things that I described in my last commentary about Cuyahoga applies to this university as well. They value all of the aspects from lecture capture through video content management. The quote you see is, one of the motivators for them was to differentiate themselves from other universities and other solutions for students in Pakistan. This is a good example of a customer that was not reached through a direct sales effort on our part but rather through a dealer who had good inroads into the management of this university, and we then supported that dealer as they successfully sold the Mediasite technology. And finally, Deakin University. This is an example where this was a hard-fought competitive evaluation in Australia. And frankly, that's a part of the world that is increasingly competitive. And we were very pleased that our products and pricing allowed us to win against competitors such as Kaltura or Echo360 or Panopto. Again, this solution will integrate content created by other solutions and will integrate with our room recording technology and our Catch technology. So Deakin will be a large user of both Catch and physical recorders, which again is all integrated into the same scheduling and management systems that support Mediasite. The Australian universities have a different calendar year, if you will. They tend to do their back-to-school reach in the December time frame. So as we move into late calendar 2018, we'll be working with them very closely to do the full campus deployment. This is another example that we worked very closely with one of our partners in Australia to successfully sell and ultimately support this customer. Switching over to events. We have many long-term relationships with large customers that have a variety of events that they support throughout the year. Wolters Kluwer is probably -- not probably, is certainly our largest events customer, and they put on a number of events for the medical industry, and we are their go-to provider for all of those events. Autodesk, different kind of customer, they do their captures for events for their own education for their own customers of their product set. And Fiserv, another customer that uses webcast increasingly for a variety of communications to their global workforce. The thing that I'm trying to emphasize here is that our success with customers and events is a lot driven by our strategic partner relationships with those customers. Now we take on new smaller customers based on the competitiveness of our packaged offerings. I'm going to talk about that here on the next slide. For the last 5 or 6 years, we have worked with a variety of software partners who would customize the front end to our capture capabilities at events by providing customer application support for the end customer. What we learned over the last several years is that we could position ourselves to provide that capability as an extension of our products and services directly. So we came up with something called Mediasite Connect for online events, and that product has now been successfully deployed by several events customers over the past several months, and we'll be continuing to grow our use of that as we move forward in 2018 and 2019. Let me now switch to innovation. We have, I think, seen a very strong interest in rapid migration to Mediasite 7.2.2. That's not a name that just rolls off your tongue, but that is the nomenclature that we use to describe our evolution of server releases to our customers. We had worked closely with a number of customers over the past year to understand real enhancements to the product that they wanted to see coming forward in their next back-to-school cycle or in their next evolution of their use of the product in enterprises. And this slide lists a number of those features. Things like live streaming to social channels is increasingly of interest to our customers. Obviously, increasing our searchability and accessibility to help customers find engaging videos is an important aspect. But most importantly, out of all of this, especially in our education customers, is that what differentiates us, one of the things that differentiates us is the fact that we have workflows that allow our customers to tailor how they want to deliver video to their end users. They can control the video. They can decide whether credentials are required to access various videos. They can make distribution of video open if they choose to. And all of those tools now are evolving into newer user interfaces that make it much easier for the end user of the customer to navigate to the content that's important for them. On top of that, which I -- what I guess what I would describe as the basics of the product, is a whole range of interactivity that is helping educators in higher education make better use of lectures that they've already captured or make better use of their interaction with their students. I'm going to talk about 2 of these in particular that I think are very important to our customers as they implement 7.2.2 in the fall school year, back-to-school year. The first one is student assignment submissions. And this came about really from our work with Leeds several years ago due to the realization by some of the educators that it would be far more effective for students to submit the assignments that have been handed out, especially for team assignments, to submit it in video form. Now that in some way stood our product on its head because we have always focused on video being created by an educator and then controlled and distributed to students. This is very different. This is each individual student or group of students submitting their comment -- their submissions of their assignments to their instructor, to their educator, and that has to remain private between the student and the educator. It also can't be changed once the student submits it. So it took a fair amount of effort on our part to fold the whole idea of assignment submission into our workflows and to manage the content appropriately the way the educators and students expected it to be managed. The second thing that I'll spend a little time talking about is quizzes. We find increasingly that educators want to produce content or capture and edit content that's engaging to the students so that they know how the student is viewing the content and know whether the student is really understanding the content. And our ability to let the educator compose quizzes and tests, and this is clearly in an on-demand world, and insert them at time offsets in the video and score those answers by students and know that the student interacted with the video as opposed to just starting the video and let it play back from start to finish. So this is all about helping the educator better understand the quality and effectiveness of the video material that they are creating and providing to their students. And we have gotten very strong positive reviews from our user community about the capabilities that we've built. There is already a huge list of requested enhancements, which we'll work through as we progress to our next releases of the software. Just to speak to the rapid customer adoption of Mediasite 7.2.2. I won't read these quotes, but these are 2 quotes from some of our large customers, James Cook University and University of Leeds. We are very confident that this release of software can be taken up rapidly by the customer, and we can support it in that sense and make it very reliable and perform very well in a diverse set of customer environments. Unlike some of our competitors, we still support a full on-premise and hosted solution based on what our customers want to buy, and we've built in the tools to allow us to support on-premise implementations in a very effective and very similar way to what we do in our cloud offering or hosted offering. These are testimonials by these 2 customers that they were very successful in the uptake of 7.2.2. One of the things that we found in Europe is that there has been an increasing demand for hosted delivery of our solutions. And we had evolved a service with a data center provider in the Netherlands that frankly we had outgrown. And so during the early part of this year, 2018, we began to select a new vendor, Equinix, as a replacement for that vendor. And we successfully migrated all of our processing out of the old center into the new center without a single impact on our customers. This is a tribute to the team's ability to support customers in an effective manner but also to go through the technology and logistics of undertaking a major data center move in a very nondisruptive way. The vendor is turning out to be very capable, and we're very, very pleased with that choice. Before I end my comments, I'll mention one other aspect. We have continued to progress with Mediasite Join. We have now implemented live streaming as part of Join, and we're beginning to offer that to select customers as they require it. We are finding in China that there's a number of customers that are interested in using Join as a technology replacement for the video content capture solutions that Cisco and Polycom have basically abandoned, and so we think we have a very clear field to substitute Join as technology for AV integrators as they want to assist their customers in capturing video conferencing, almost separately from the way that we integrate with Mediasite as a lecture capture or a content management solution. So that work is going very well as well. So that concludes our prepared remarks. Tammy, I'll go over to you and let you ask any questions that have come in.
Continuing on the Join live conversation you were just having, do you see that being a game changer for Sonic Foundry?
I'm always a little bit hesitant to use terms like game changer because that usually implies to the people who are listening as to kind of a hockey stick growth in revenue, and I certainly don't see it as that. But what I do see it as generating another recurring form of revenue that has, I think because of what I described with the exiting of the capture business by Polycom and Cisco, a very steady and good future, especially when paired with the support offerings of our AV partners. So it's a very positive element, but I won't go so far as to claim that it's a game changer.
You mentioned Catch and then features such as quizzing and chat in your remarks. Have these been released to the market? And if so, how long have they been out?
Both Catch and the quizzing and interactivity features that I described are an integral part of 7.2.2. We have had several beta programs with customers for Catch probably starting, I would estimate, 5, 6 months ago. And we also had been working with a couple of customers with the interactivity features in beta releases of 7.2.2 as well. It is now fully generally available. So it hit the market about, I'm going to say, 30 days ago in terms of full general availability.
Do you expect to see many customers upgrade to the new release of Mediasite?
We are seeing that happen rapidly. Those 2 comments that I quoted were both customers, large customers with very significant production implementations, migrating very quickly to 7.2.2. In our hosting infrastructure, we offer customers a release choice as a way to ensure their satisfaction with moving to a new release, and the movement to 7.2.2 is, I don't have the numbers in my head, but I would say close to half of our customers in hosting have already moved to 7.2.2. So significant uptake.
What is your customer churn rate? And are you adding new customers?
Well, certainly, we're adding new customers. I think the 3 examples I gave are examples of brand-new customers. I'll try to characterize the churn rate, and this will take just a little bit of time to set this up. We have 2 primary ways that we reach and support customers. One is through our direct sales force with our named accounts section. The churn rate there is extremely low. I would say we would lose a handful of customers on an annual basis, and usually they would be small customers that had not fully put the energy behind doing a effective implementation of Mediasite. We do not generally do training or implementation support directly with end users. That's up to the customer. And clearly, if the product isn't well positioned inside the customer for the kind of support doing those functions, then it will become problematic. And that's really significantly the reason why we would lose a named account customer, small numbers. For the other side of the business, we rely on dealers to bring us the customer, and those customers tend to be smaller customers with, again, a lower ability to invest in supporting and promulgating the product within their organizations. The churn rate there is higher. So I'll characterize it. In total, in terms of dollars, over the past 4 years, we have added new customers at the range of as high as $6 million or $7 million in 2015, to $2 million to $3 million, $3.5 million in the other years, and our customer losses have typically been between $1 million and $2 million. So that gives you some gross sense of how the numbers play out.
A couple of questions about market share. Do you see competitive solutions taking market share from Sonic Foundry?
No, we do not. I'll piggyback in something I said earlier. The biggest dynamic that is a limiting factor for us is the ability for our customer to fund the acquisition of our technology and spend money with us. I think we have seen very low attrition of customers to competitive solutions, which would be a sign of losing market share to competitors. What we do think affects all of our competitors is the fact that growth rates in the industry, especially in higher education, are just very slow. We've seen some pickup of that in the third quarter, and we see it -- we have seen it accelerating to some extent in the fourth quarter. We've seen some competitive wins going into the fourth quarter. We've seen some large refreshes where customers have gotten money to expand or refresh our technology. So we're optimistic that we will see better growth in 2019. But I have to say the biggest thing that I think impedes our ability to generate faster growth is customer ability to spend.
Is the company expected to reach breakeven or approach profitability in the near future?
That's certainly one of our primary goals. It is a matter of blending the cost structure that we have with the ability to grow the business. I think it's premature at this point to make any predictions about 2019. I think 2018 will be progress over 2017, and I think 2019 will be progress over 2018. But I can't provide any more specifics than that.
No, I think that's fair enough. We're obviously not prepared to provide guidance for fiscal '19 at this point. But the -- we've already initiated some cost reduction efforts that we took place in 2017. We don't have any plans to make other significant cost reduction changes at this point. So our plan is to grow the top line and reach profitability as a result of doing that and maintaining our cost structure as flat or, if we can, down, but relatively flat. So it's going to take a little bit of time. That's not something we expect to turn around in the next couple of quarters, for sure. So it's something we'll grow into.
Will you need to raise cash in the near future?
We are not planning on that. We again, in all candor, in 2017, the recorder mix switch of customers moving from higher-priced recorders to lower-priced recorders and our existing customer base not having available money to invest in expansion or refreshes as much as we would like them to, did impact us from a cash perspective, and we did raise money during 2017 -- or during 2018. We're...
Both.
Both. And we're, I think, optimistic that the recorder remix is behind us now based on 2018 results, and we are pretty confident that plans for 2019 will not involve any additional needs for cash.
Yes, that is absolutely the plan. And we do have -- the note that we just closed with Partners for Growth result in a $2 million takedown at close. And there's an additional $0.5 million available to us through the end of December, which I would expect we'll probably take down as well. So that's sitting out there available to us now. We don't need it now. We don't plan to take it until we need it. In addition to that, I mean, as you can see on the balance sheet, we do have cash on the balance sheet. And some of that is sitting at our subs, which can be transferred back, if necessary. In addition, we have a fair amount of availability in the line of credit. So between the cash on the balance sheet and the availability currently today plus the $0.5 million available under the Partners for Growth note, we've got in round numbers $4.5 million to $5 million of additional availability. I mean, that does give us some comfort that we've got a plan that will work with that level of financing.
And the goal, obviously, is to get to a cash neutral from an operations perspective as quickly as we can.
Have you conducted due diligence in merging with another company in this space? Together, combined companies could accelerate sales, accelerate growth and create much larger valuation for shareholders.
We are always interested in talking to possible players, both in the industry and outside the industry. I think video has a growing value in a number of ancillary industries. The people may find a value and we're certainly interested in talking to people that would fill that bill. I think in the industry itself, as I said, everybody has the growth problem. And while consolidation can help from a standpoint of competition, it's not a silver bullet if the customers don't have money to spend more money with the combined company. I think scale makes a big deal of difference. I think if you can build revenue scale on top of the expense structure that we have by acquiring customers that are using similar video products, then that would be potentially advantageous. But I guess to directly answer the question, we have looked at everybody who is out there that would want to have a conversation. We're not at all parochial about wanting to stay independent, if you will.
Besides the education market not adopting video as quickly as expected, what are other obstacles Sonic Foundry's facing? And what are you doing to remove those obstacles?
Well, I think there's an out of -- this will be redundant for both the things I've said in the past. But the obstacles we face are not fixable by us taking an action internally in the company and just deciding to change something internally and removing an obstacle. Please don't see it that way. We see higher education being limited in spending. We've seen that situation develop over the last 2, 3, 4 years. We tried to find an adjacent market with Join, and we're somewhat successful with that, but no hockey stick. We have tried to find ways to penetrate other geographies like China. But again, not anything that happens quickly. We are still very optimistic about that, but it's going to take time. So those are principally the things that we have done outside of higher education. But they are all external things that take time to develop.
All right. No further questions.
Okay. Would you like to elaborate on anything I have?
I think you covered it well.
Anyway, I thank you all for attending. We, Ken and I and the entire management team is really focused at continuing to evolve the business in a variety of ways to build scale and to find sources of revenue that are ancillary to higher education. We all very much want to do that, and we are optimistic that the fourth quarter is going to see some of that come to fruition but also see higher education maybe start to spend a little bit more money. So we're optimistic about the fourth quarter and the result that'll have for full year and full year results. So thanks, again, for coming. And we will see you in -- actually more than 90 days because it will be the close of the fiscal year.