SONIC FOUNDRY, INC. The financial and business analysis below provides information thatSonic Foundry, Inc. (the "Company") believes is relevant to an assessment and understanding of the Company's consolidated financial position and results of operations. This financial and business analysis should be read in conjunction with the consolidated financial statements and related notes. This report includes estimates, projections, statements relating to our business plans, objectives, and expected operating results that are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may appear throughout this report, including the following sections: "Management's Discussion and Analysis," and "Risk Factors." These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "intend," "strategy," "future," "opportunity," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," and similar expressions. Forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause actual results to differ materially. We describe risks and uncertainties that could cause actual results and events to differ materially in "Risk Factors" (Part 1, Item 1A of this Form 10-K), "Quantitative and Qualitative Disclosures about Market Risk" (Part II, Item 7A of this Form 10-K), and in this Item 7. We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise. 27
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Table of Contents
Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
Overview
Sonic Foundry, Inc. is a trusted global leader for video capture, management and
streaming solutions. Trusted by educational institutions, corporations and
government entities, Mediasite Video Platform quickly and cost-effectively
automates the capture, management, delivery and search of live and on-demand
streaming video. Mediasite transforms communications, training, education and
events for our customers worldwide.
Critical Accounting Policies
We have identified the following as critical accounting policies to our Company
and have discussed the development, selection of estimates and the disclosure
regarding them with the audit committee of the board of directors:
• Revenue recognition, inventory reserves and allowance for doubtful accounts;
• Asset retirement obligations; • Valuation allowance for net deferred tax assets; and • Accounting for stock-based compensation. Revenue recognition We recognize revenues in accordance withFinancial Accounting Standards Board ("FASB"), Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers ("ASC 606"). Recording revenues requires judgment, including determining whether an arrangement includes multiple performance obligations, whether any of those obligations are distinct and cannot be combined and allocation of the transaction price to each performance obligation based on the relative standalone selling prices ("SSP"). Customers receive certain contract elements over time. Changes to the elements in an arrangement or, in our determination, to the relative SSP for these elements, could materially affect the amount of earned and unearned revenues reflected in our consolidated financial statements. The primary judgments relating to our revenue recognition include determining whether (i) the contract with a customer exists; (ii) performance obligations are identified; (iii) the transaction price is determined; (iv) the transaction price is allocated to performance obligations; and (v) the distinct performance obligations are satisfied by transferring control of the product or service to the client. Transfer of control is typically evaluated from the customer's perspective. At contract inception, we determine whether we satisfy the performance obligation over time or at a point in time. Revenues from software and hosting solutions are primarily recognized ratably over time or as fee-bearing usages occur. Certain software licenses are sold either on-premises or through term-based hosting agreements. These hosting arrangements provide customers with the same product functionality and differ mainly in the duration over which the customer benefits from the software. We deliver our software licenses electronically. Electronic delivery occurs when we provide the customer with access to the software and license key via a secure portal. Revenue from on-premises software licenses is generally recognized upfront at the point in time when the software is made available to the customer. Our contracts with customers for on-premises software licenses include maintenance services and may also include training and/or professional services. Maintenance services agreements consist of fees for providing software updates on an if and when available basis and for providing technical support for software products for a specified term. We believe that our software updates and technical support each have the same pattern of transfer to the customer and are substantially the same. Therefore, we consider these updates and technical support to be a single distinct performance obligation. Revenues allocated to maintenance services are recognized ratably as the maintenance services are provided. Revenues related to training services are billed on a fixed fee basis and are recognized as the services are delivered. Payments received in advance of services performed are deferred and recognized when the related services are performed. Revenues related to professional services are billed on a time and materials basis and are recognized as the services are performed. We also provide cloud-based subscriptions, which allow customers to access our software during a contractual period without taking possession of the software. We recognize revenue related to these cloud-based subscriptions ratably over the life of the subscription agreement beginning when the customer first has access to the software. We are often party to multiple concurrent contracts or contracts pursuant to which a client may purchase a combination of goods and services. These situations require judgment to determine whether multiple contracts should be combined and accounted for as a single arrangement. In making this determination, we consider whether the economics of the individual contracts cannot be understood without reference to the whole and multiple promises represent one single performance obligation. 28
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
Due to the large number, broad nature and average size of individual contracts
we are a party to, the effect of judgments and assumptions we apply in
recognizing revenues for any single contract is not likely to have a material
effect on our consolidated operations. However, the broader accounting policy
assumptions that we apply across similar arrangements or classes of clients
could significantly influence the timing and amount of revenues recognized in
our results of operations.
Reserves
Beginning in fiscal year 2020, the Company established a hardware inventory
reserve. In conjunction with a new hardware release due in the fourth quarter,
certain older models are no longer being actively sold and those units, along
with their corresponding raw materials, have been 100% reserved.
Credit Evaluation and Allowance for Doubtful Accounts
We assess the realization of our receivables by performing ongoing credit evaluations of our customers' financial condition. Through these evaluations, we may become aware of a situation where a customer may not be able to meet its financial obligations due to deterioration of its financial viability, credit ratings or bankruptcy. Our reserve requirements are based on the best facts available to us and are reevaluated and adjusted as additional information is received. Our reserves are also based on amounts determined by using percentages applied to certain aged receivable categories. These percentages are determined by a variety of factors including, but not limited to, current economic trends, historical payment and bad debt write-off experience. Allowance for doubtful accounts for accounts receivable and financing receivables was$236 thousand atSeptember 30, 2020 and$661 thousand atSeptember 30, 2019 . Asset retirement obligation An asset retirement obligation ("ARO") represents a legal obligation associated with the retirement of a tangible long-lived asset that is incurred upon the acquisition, construction, development, or normal operation of that long-lived asset. The Company's ARO is associated with MSKK leasehold improvements that we are contractually obligated to remove at the end of a lease to comply with the lease agreement. We recognize asset retirement obligations upon construction of leasehold improvements with such conditions if a reasonable estimate of fair value can be made. The ARO is recorded in other noncurrent liabilities in the Consolidated Balance Sheets. The associated estimated ARO is capitalized as part of the carrying amount of the long-lived asset and depreciated over its useful life. 29
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020 Valuation allowance for net deferred tax assets
Deferred tax assets and liabilities are determined based on differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. We do not provide forU.S. income taxes on the undistributed earnings of our foreign subsidiaries, which we consider to be permanently invested outside of theU.S. We make judgments regarding the realizability of our deferred tax assets. The balance sheet carrying value of our net deferred tax assets is based on whether we believe that it is more likely than not that we will generate sufficient future taxable income to realize these deferred tax assets after consideration of all available evidence. We regularly review our deferred tax assets for recoverability considering historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. Generally, cumulative losses in recent years is a significant piece of negative evidence that is difficult to overcome in determining that a valuation allowance is not needed. As ofSeptember 30, 2020 and 2019, valuation allowances have been established for allU.S. and for certain foreign deferred tax assets which we believe do not meet the "more likely than not" criteria for recognition. If we are subsequently able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been established, then we will be required to recognize these deferred tax assets through the reduction of the valuation allowance, which could result in a material benefit to our results of operations in the period in which the benefit is determined.
Accounting for stock-based compensation
The Company uses a lattice valuation model to account for all employee stock options granted. The lattice valuation model is a more flexible analysis to value options because of its ability to incorporate inputs that change over time, such as actual exercise behavior of option holders. The Company uses historical data to estimate the option exercise and employee departure behavior in the lattice valuation model. Expected volatility is based on historical volatility of the Company's stock. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogenous groups for valuation. The expected term of options granted is derived from the output of the option pricing model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods the options are expected to be outstanding is based on theU.S. Treasury yields in effect at the time of grant. Forfeitures are based on actual behavior patterns. All transactions in which goods or services are the consideration received for the issuance of equity instruments are accounted for based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measured.
Restructuring and exit activities
The determination of when the Company accrues for involuntary termination
benefits under restructuring plans depends on whether the termination benefits
are provided under an on-going benefit arrangement or under a one-time benefit
arrangement. The Company accounts for on-going benefit arrangements in
accordance with Accounting Standards Codification 712 ("ASC 712") Nonretirement
Postemployment Benefits. According to ASC 712, involuntary termination benefits
would be measured and recognized when the expense is both probable and
estimatable. For those employees who have a severance arrangement outlined under
an existing employment agreement, the communication date would be the date of
hire since at that point in time, the Company and the employee had a mutual
understanding of the agreement. The measurement and recognition date of the
expense would occur when the Company is committed to the plan and it is probable
the impacted employee is entitled to the termination benefit. The Company
accounts for one-time benefit arrangements in accordance with ASC 420 Exit or
Disposal Cost Obligations. According to ASC 420, an arrangement for one-time
employee termination benefits exists at the date the plan of termination meets
certain criteria and has been communicated to employees.
RESULTS OF OPERATIONS
You should read the following discussion of our results of operations and financial condition in conjunction with our consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K.
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
Revenue
Revenue from our business includes the sale of Mediasite recorders and server
software products and related services contracts, such as customer support,
installation, customization services, training, content hosting and event
services. We market our products to educational institutions, corporations and
government agencies that need to deploy, manage, index and distribute video
content on Internet-based networks. We reach both our domestic and international
markets through reseller networks, a direct sales effort and partnerships with
system integrators.
Revenue in both fiscal 2020 and fiscal 2019 totaled
• Product and other revenue from the sale of Mediasite recorder units and server
software decreased from
2020. Mediasite recorder revenue declined
fiscal 2020. The table below outlines units sold as well as the proportion of
mobile units to rack units, which continues to widen as sales of the mobile
units decline.
2020 2019
Units sold 1,114 1,269
Rack to mobile ratio 11.9 to 1 8.2 to 1
Average sales price, excluding support (000's)
272 547
• Services revenue represents the portion of fees charged for Mediasite customer
support and hosting contracts amortized over the length of the contract,
typically 12 months. It also includes point in time service revenue such as
installations and training, custom development, and event services. Total
services revenue increased from
in fiscal 2020 primarily due to increases in custom development and hosting
revenues as compared to fiscal 2019.
• At
expect to recognize $10.4 million in the next twelve months, including
approximately $4.1 million in the quarter ending December 31, 2020 . At
September 30, 2019 , $11.5 million of revenue was deferred. The increase indeferred revenue is due to increased billings in the fourth quarter of fiscal
year 2020 compared to the same period in 2019.
• Other revenue relates to freight charges billed separately to our customers.
Gross Margin Total gross margin in fiscal 2020 was$25.1 million or 72% compared to$25.5 million or 73% in fiscal 2019. The slight decline year over year is attributed to the establishment of an$122 thousand obsolescence reserve for inventory as well as additional labor costs associated with a custom development project. The Company expects the gross margin percentage to be reduced slightly in fiscal 2021, as a result of increased costs associated with our new data center in theUK . 31
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
Operating Expenses
Selling and Marketing Expenses
Selling and marketing expenses include wages and commissions for sales, marketing and business development personnel, print and digital advertising, tradeshows and various promotional expenses for our products. Timing of these costs may vary greatly depending on introduction of new products and services or entrance into new markets, or participation in major tradeshows.
Selling and marketing expense decreased
• Salary, commissions and benefits decreased by
headcount in the later half of 2019.
• Advertising and professional services decreased by $209 thousand .
• T&E decreased
• Selling and marketing expenses for
accounted for
aggregate increase of $78 thousand from the prior year.
At September 30, 2020 , we had 97 employees in selling and marketing, a decrease
from 117 employees at September 30, 2019 . Of the 97 employees in selling and
marketing at September 30, 2020 , 50 are employed by our foreign subsidiaries. We
do not anticipate an increase in selling and marketing headcount in fiscal 2021.
General and Administrative Expenses
General and administrative ("G&A") expenses consist of personnel and related costs associated with the facilities, finance, legal, human resources and information technology departments, as well as other expenses not fully allocated to functional areas.
G&A expenses decreased by
• Decrease in non-severance related compensation and benefits of
due to attrition in Q2 of fiscal 2020.
• Decrease in severance expense for executives of $93 thousand .
• Increase in professional fees of
the work of the special committee.
• Depreciation decreased $148 thousand compared to fiscal 2019.
• G&A expenses for
thousand and $880 thousand , respectively, in fiscal 2020, an aggregate
decrease of $246 thousand from the prior year.
At
Product Development Expenses
Product development expenses include salaries and wages of the software research and development staff and an allocation of benefits, facility and administrative expenses.
Product development expenses decreased
• Decrease in compensation and benefits of
of two senior level management positions in fiscal 2019, as well as other
attrition during late fiscal 2019 and early fiscal 2020 that was not
backfilled until later in the year.
• Professional services increased by
non-recurring engineering resources.
• Product development expenses for Sonic Foundry International and MSKK
accounted for
an aggregate increase of
subsidiaries.
At September 30, 2020 , we had 48 full-time employees in product development
compared to 43 employees at September 30, 2019 . Of the 48 employees in product
development at September 30, 2020 , 8 are employed by our foreign subsidiaries.
There were no software development efforts in fiscal 2020 or 2019 that qualified
for capitalization. We do not anticipate an increase in product development
headcount in fiscal 2021.
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
Other Income and Expense, Net
Interest expense for fiscal 2020 decreased $239 thousand compared to fiscal
2019, mainly as a result of the Burish debt to equity conversion in May 2020 .
The Company also recorded $79 thousand of interest expense during fiscal 2020
related to the accretion of discounts on the PFG Loan and Warrant Debt compared
to $74 thousand in the same period last year. In addition, the Company recorded
amortization expense related to the back-end fee on the PFG loan of $50 thousand
during both fiscal 2020 and fiscal 2019. The Company also recorded $84 thousand
of interest expense through May 14, 2020 related to the accretion of discounts
on the Burish notes payable compared to $79 thousand in fiscal 2019.
Warrants were also issued in connection with the Burish note. For further details, see Note 3 - Credit Arrangements and Note 10 - Related Party Transactions.
During fiscal 2020, a change in fair value of$57 thousand was recorded related to the fair value remeasurement on the derivative liability associated with the PFG V Loan and Warrant Debt compared to a change in fair value of$5 thousand during fiscal 2019. No foreign currency exchange gain or loss was recorded related to re-measurement of the subordinated notes payable related to the Company's foreign subsidiaries in either fiscal 2020 or 2019.
Provisions Related to Income Taxes
The Company believes the valuation allowance for its deferred tax assets is appropriate. See Note 6 - Income Taxes for further details. The repatriation of undistributed foreign earnings is not expected to result in a material change to our financial results.
Foreign Currency Translation Adjustment
The Company's wholly-owned subsidiaries operate inJapan andthe Netherlands , and utilize the Japanese Yen and Euro, respectively, as their functional currency. Assets and liabilities of the Company's foreign operations are translated into US dollars at period end exchange rates whiles revenues and expenses are translated using average rates for the period. Gains and losses from the translation are deferred and included in accumulated other comprehensive loss on the consolidated statements of operations. 33
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
For the year ended September 30, 2020 , the Company's foreign currency
translation adjustment was a gain of $84 thousand compared to a gain of
$130 thousand in the year ended September 30, 2019 . The gain in fiscal 2020 is
attributable to the continued strengthening in the Japanese Yen and the Euro
compared to the U.S. dollar.
During fiscal 2020, the Company recorded an aggregate transaction loss of
$36 thousand compared to an aggregate loss of $157 thousand during fiscal 2019.
The aggregate transaction gain or loss is included in the other expense line of
the consolidated statements of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of liquidity are its cash and debt and equity financing. During fiscal 2020, the Company generated$3.4 million of cash in operating activities compared with$736 thousand of cash used in operating activities in fiscal 2019. The Company had a decrease in net loss in fiscal 2020 as compared to fiscal 2019 of$3.4 million , mainly due to cost saving measures instituted in fiscal 2019 and continued in fiscal 2020. Capital expenditures for property and equipment were$1.7 million in fiscal 2020 compared to$433 thousand in fiscal 2019. The large increase is related to our new data center in theUK that went live inSeptember 2020 as well as work in progress for our new US data center that is expected to go live in Q2 of fiscal 2021. The Company generated$1.7 million of cash from financing activities during fiscal 2020, primarily due to proceeds from the PPP loan of$2.3 million , the Mediasite K.K. term debt of$463 thousand , and the Mediasite K.K.government assistance loan of$378 thousand . The Company also received$73 thousand from the issuance of common stock. These transactions were partially offset by debt and capital lease payments of$1.5 million . For the same period in fiscal 2019, the Company generated$4.3 million of cash from financing activities, primarily due to proceeds from the issuance of term debt of$500 thousand with PFG V and$5.0 million withMr. Burish . The Company also received$873 thousand from the issuance of common stock and 728,155 warrants during Q3-2020. These transactions were partially offset by debt and capital lease payments of$1.1 million .
At
AtSeptember 30, 2020 , the Company had$860 thousand outstanding, net of warrant debt and debt discounts, related to notes payable with PFG V. AtSeptember 30, 2019 , the Company had$6.4 million outstanding, net of warrant debt and debt discounts, related to notes payable with PFG V andMr. Burish . During fiscal 2020, the Company fully converted$5.6 million of subordinated debt due toMr. Burish into common stock, which did not and will not require cash settlement.
At
The Company believes its cash position plus available resources is adequate to
accomplish its business plan through at least the next twelve months. We will
likely evaluate operating and capital leases opportunities to finance equipment
purchases in the future We may also seek additional equity financing, or issue
additional, but there are no assurances that these will be on terms acceptable
to the Company.
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Sonic Foundry, Inc.
Annual Report on Form 10-K
For the Year Ended September 30, 2020
Contractual Obligations
The following summarizes our contractual obligations at September 30, 2020 and
the effect those obligations are expected to have on our liquidity and cash flow
in future periods (in thousands):
Less than Years Years Over
Contractual Obligations: Total 1 Year 2-3 4-5 5 years
Product and service purchase
commitments $ 1,252 $ 838 $ 414 $ - $ -
Operating lease obligations 2,305 1,532 564 140 70
Capital lease obligations (a) 221 129 87 5 -
Notes payable (a) 3,574 1,050 2,524 - -
(a) Includes fixed and determinable interest payments
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