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Saturday, May 1, 2010

Sonic Foundry: Déjà Vu as Pot of Gold Remains Around Corner?

Sonic Foundry (SOFO, $7.30) posted F2Q10 results and held its Webcast on Thursday. At first blush, we were disappointed:
  • 9% Y/Y revenue decline for the March quarter and essentially break-even profitability - based on our Mediasite franchise thesis, we fully expected to see better revenue and billings performance even without the larger KAUST deal this year. As awareness increases, our thesis was that seasonality would diminish and Y/Y growth in all quarters would accelerate, but we're not seeing this trend (as yet).
  • Accordingly, reasonable questions came to mind - are risk factors such as pricing pressure, competition, and execution negatively impacting the story? Perhaps some investors are right in questioning why we've not seen large deal announcements? Is this a "bad" business that can't scale and generate steady cash flows for shareholders? Will the "big deals" always be just around the corner?
  • Note that many "tech" companies are delivering consistent Y/Y growth, albeit with different business models (enabling more "linear" growth) -- examples: Blackboard Inc. (BBBB), Progress Software Corp. (PRGS), and market-darling-at-54x-2011E-earnings Salesforce.com (CRM).
Yet, we then focused on the fact that management previously guided for "mid-2010" to be the "turning point" for the company. Plus, we should acknowledge that some seasonality may always exist given typical purchasing/budget cycles and installation periods for the education sector (summer months), which represents approximately 2/3 of Sonic Foundry's business.

Other data points: service revenue increased 11% Y/Y, unearned revenue increased 4% Y/Y, gross margins remained stable at 75%, and operating expenses/cash burn are under control. Also, Sonic Foundry continues to innovate and plans to enable playback on Apple's (AAPL) new iPad as well as integration of third party content capture in the Mediasite appliance (we need more details on this) -- please see this slide from the Webcast, also with mention of a successful UNLEASH Conference:
The saving grace: management continues to point to "some of the largest transactions in company history" while somewhat tempering the outlook with mention of weak state budgets - from the release:
  • The company currently expects to see future growth in billings and revenues due to a growing number of larger opportunities found both domestically and internationally. Opportunity growth is occurring through expansion of existing customer installations along with new installations. A number of key opportunities would represent some of the largest transactions the company has executed in its history. A key driver of this demand is a growing request for online education and training and an increased comfort level with blended online learning within existing curriculums. However, the company also remains concerned with existing state budget issues that are affecting a number of state universities in the U.S. and which could have an adverse effect on business in certain areas of the country.
The following slide highlights expected business drivers:

The drivers all make sense, especially knowing that Mediasite is an indispensable utility for countless customers and deployment of online video/learning tools should keep increasing given global secular trends. Here's additional color regarding the outlook:


So, "the moment of truth" we referred to in our earlier post this week really remains this summer. We are inclined to again share the quote we relayed in our 11/19/10 post, Mediasite Franchise Value Remains Unrecognized by Market, from the beginning of Chapter 8 in More than You Know by Michael J. Mauboussin:


Of course, we won't stick around forever -- we are all too cognizant of opportunity costs. While shares of our "asset heavy" REIT and container shipping companies have performed extremely well, Sonic Foundry remains stagnant over the past year despite generally negative fundamentals for the former categories and positive annualized fundamentals for the latter (reason: former recovering from extremely depressed/irrational levels; *shipping fundamentals now improving, although excess capacity remains risk).

If we don't see revenue scaling to $6-7 million per quarter -- which would suggest operating earnings per share of $0.70-1.00 per share (please see our 3/3/10 post) -- we may fold up our tent and go home. However, even acknowledging that forecasting is a speculative game, for the company to move the annual revenue needle to $25 million from $20 million seems within striking distance. Finally, we still believe our $20-30 fair value estimate for the Mediasite franchise -- based on reproduction cost -- is rational and supported by comparable M&A transactions. Please let us know if you think otherwise as we welcome substantiated, alternate viewpoints.

For now, we keep waiting.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long SOFO.

© 2010 Jeffrey Walkenhorst
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