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Thursday, July 30, 2009

Sonic Surviving Turmoil, Answers Questions, Raises Guidance (not kidding)

Last week, we provided an update on Sonic Foundry (SOFO, $0.63) and included our top ten questions for management. The company reported results today and, on the Mediasite Webcast, management mostly answered our key questions. Due to limited time, we can't recount all answers here, but recommend watching the Webcast for those interested - link to new Mediasite version 5.1 Webcast here. We find the 5.1 player very impressive.

June quarter revenue of $5.0 million was down 7% Q/Q and 1% Y/Y as seasonal strength didn't materialize. We were afraid this might happen amidst the state budget crisis as well as retrenchment by private institutions (pension/endowment funds down significantly). However, management relayed some good news: with 46 state budgets now approved, customers are moving forward with purchases and the company expects to realize better-than-expected revenue in the September quarter. As a result, management raised fiscal 2009 revenue guidance from +15-20% to >20% Y/Y. Since very few companies are growing in the current environment, and even fewer are raising guidance, we are encouraged by the increased forecast. In addition, federal stimulus money is coming down the pike, which should assist cash-strapped schools (depending upon allocation) and boost spending for online learning platforms/applications (President Obama's 10 year program - per Sonic Foundry, includes $500 million for this purpose).

While there are really no direct comparable companies for microcap Sonic Foundry, for reference, audio/video companies Polycom (PLCM) reported June quarter revenue down 15% Y/Y while Tandberg saw revenue increase 5% Y/Y in the quarter. Major tech titan IBM saw June quarter software revenue down 7% Y/Y (flat in constant currency) and Adobe (ADBE) reported revenue down 10% Y/Y in its most recent quarter (end-May). Arrow Electronics (ARW), a global electronic components distributor and enterprise IT solutions provider, reported a 24% Y/Y decline (excluding acquisitions) for the June quarter in the company's solutions segment (mostly small/medium sized business customers). Commenting on the segment's results, Arrow noted the following in its press release:
  • "sales were at the low end of our expectations, due to lower demand and IT spending, as capital-intensive projects continue to be highly scrutinized."
So, difficult times in the technology sector with negative/slow growth for most players. Sonic Foundry's anticipated >20% revenue growth appears a major coup, although we submit that the company should be growing given its smaller size and favorable secular trends. We would expect better growth in a "normal" economy.

Sonic's trailing twelve month income statement is as follows:
  • Billings of $19.7 million were up 13% Y/Y
  • Revenue of $18.5 was up 14%
  • Gross profit of $14.1 million was up 19% (margin expansion)
  • GAAP operating expenses of $16.8 million were down 15% (expense reduction)
  • Cash operating income of approximately negative $250 thousand (a $4.3 million Y/Y improvement)
Looking at the balance sheet: deferred revenue at 6/30/09 increased 29% Y/Y to $4.7 million, total debt increased to $1.25 million from $726 thousand a year ago, and net cash declined by $1.5 million to approximately $1.25M (total cash was $2.4 million). Sonic continues to use cash for working capital, although the company tends to generate cash during the September and December quarters as receivables are collected. Considering only accounts receivable, inventory, and accounts payable, working capital increased by $900 thousand (+43%) Y/Y to $2.9 million, which explains a majority of Y/Y cash consumption. The company's accounts payable are the primary difference, down nearly one million Y/Y to $1.5 million. As previously noted, we would prefer a larger cash position, but remain comfortable that Sonic Foundry's access to an additional $3 million from Silicon Valley Bank allows breathing room to fund working capital needs. As noted in our post last week, we believe Sonic Foundry can generate free cash flow in fiscal 2010 if growth remains similar to fiscal 2009. We think incremental economic weakness and related budget woes are the key risk factor to achieving excess cash flow.

Below, we include our updated "June quarter" snapshot which shows muted to no seasonality relative to past years.

The key focal point for us remains the Mediasite franchise, which we believe continues to grow in value as customers expand footprints, new customers join the community, and -- importantly -- the global A/V channel increasingly recommends Mediasite for rich media Webcasting. We think the channel promotes Mediasite because the solution works extremely well, is reliable, and has a clear product development road-map. The growing, installed customer base, combined with brand recognition, trust, and global distribution, are all difficult for a competitor to replicate and take years to establish. In our view, these aspects mitigate the risk of rapid technological change and help secure Mediasite's leading position in the marketplace.

On the customer front, Sonic referenced the following additions:

One that we didn't recognize is "UNIDO" (we guessed United Nations based on the logo, but were not sure about the "IDO"). A quick search and voilĂ : The United Nations Industrial Development Organization (UNIDO) - link here. While we don't know the extent of their Mediasite use, this is exacty the type of organization that can meaningfully benefit from the use of Mediasite and expose others to the solution (everyone wins).

We're optimistic that we'll continue to see more Mediasite use outside of higher education, similar to what S&P is now doing. Mediasite v5.1 with players that can be embedded on Web pages may help. While we're biased, we write this almost as fact without regard to our SOFO interest: we are disappointed whenever we run into a Cisco (CSCO) WebEx presentation for a one-to-many broadcast type event because the Mediasite end-user experience is far superior. We think anyone who has experienced both will agree with us, but please comment if otherwise. In our view, Sonic Foundry should capitalize on the Mediasite advantage, perhaps by partnering with additional, large-scale Webcast providers or other companies that can effectively help spread the word. We believe management is working toward this end.

One more final point that supports our franchise thesis: Sonic Foundry's services business continues to grow, with revenue increasing 17% Y/Y to $2.4 million and approaching a $10 million annual run rate. We expect recurring license revenue (60% of services revenue) to keep building on the balance sheet as deferred revenue and then contributing to services revenue as annual contracts are amortized. As this occurs, additional installation, consulting, hosting, and events service revenue should also compound as Sonic Foundry participates in a growing, global Webcasting market (particularly whenever economies rebound).

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO, short ARW.

© 2009 Jeffrey Walkenhorst
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