10-K 1 sofo20200825_10k.htm FORM 10-K sofo20200825_10k.htm
 
 

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal period ended September 30, 2020

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 000-30407

 

SONIC FOUNDRY, INC.

(Exact name of registrant as specified in its charter)

 

MARYLAND

 

39-1783372

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

222 W. Washington Ave, Madison, WI 53703

 

(608) 443-1600

(Address of principal executive offices)

 

(Issuer’s telephone number)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act: Common stock par value $0.01 per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    Yes  ☐    No  ☒

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a small reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

 

Accelerated filer

 

 

 

 

 

 

 

 

Non-accelerated filer

 

 

Smaller reporting company

 

 

 

 

 

 

 

 

 

 

 

 

Emerging growth company

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ☐    No  ☒

 

The aggregate market value of the registrant’s common stock held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $12,023,119.

 

The number of shares outstanding of the registrant’s common equity was 7,960,775 as of December 16, 2020.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement for the 2021 Annual Meeting of Stockholders are incorporated by reference into Part III. A definitive Proxy Statement pursuant to Regulation 14A will be filed with the Commission for required sections.

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

TABLE OF CONTENTS

 

 

 

PAGE NO.

PART I

 

 

 

Item 1.

Business

4

Item 1A.

Risk Factors

8

Item 1B.

Unresolved Staff Comments

23

Item 2.

Properties

23

Item 3.

Legal Proceedings

24

Item 4.

Mine Safety Disclosures

24

 

 

 

PART II

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

25

Item 6.

Selected Consolidated Financial Data

27

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

27

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

27

Item 8.

Consolidated Financial Statements and Supplementary Data:

 

 

Report of Wipfli, LLP, Independent Registered Public Accounting Firm

36

 

Consolidated Balance Sheets

37

 

Consolidated Statements of Operations

38

 

Consolidated Statements of Comprehensive Loss

39

 

Consolidated Statements of Stockholders’ Equity (Deficit)

40

 

Consolidated Statements of Cash Flows

41

 

Notes to Consolidated Financial Statements

43

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

68

Item 9A.

Controls and Procedures

68

Item 9B.

Other Information

69

 

 

 

PART III

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

70

Item 11.

Executive Compensation

70

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

70

Item 13.

Certain Relationships and Related Transactions, and Director Independence

70

Item 14.

Principal Accounting Fees and Services

70

 

 

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

This annual report on Form 10-K (this "Report") contains statements that are considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and its rules and regulations (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended, and its rules and regulations (the "Exchange Act"). When used in this Report, the words “anticipate”, “expect”, “plan”, “believe”, “seek”, “estimate” and similar expressions are intended to identify such forward-looking statements. These are statements that relate to future periods and include, but are not limited to, statements about the features, benefits and performance of our Rich Media products, our ability to introduce new product offerings and increase revenue from existing products, expected expenses including those related to selling and marketing, product development and general and administrative, our beliefs regarding the health and growth of the market for our products, anticipated increase in our customer base, expansion of our products functionalities, expected revenue levels and sources of revenue, expected impact, if any, of legal proceedings, the adequacy of liquidity and capital resources, and expected growth in business. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, market acceptance for our products, our ability to attract and retain customers and distribution partners for existing and new products, our ability to control our expenses, our ability to recruit and retain employees, the ability of distribution partners to successfully sell our products, legislation and government regulation, shifts in technology, global and local business conditions, our ability to effectively maintain and update our products and service portfolio, the strength of competitive offerings, the prices being charged by those competitors, and the risks discussed elsewhere herein. These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

 

PART I

 

 

ITEM 1. BUSINESS

 

Who We Are

 

Sonic Foundry (OTC Pink Sheets:SOFO) (the “Company”) is a global leader in providing fully automated and integrated enterprise video solutions that address every phase of the video life cycle.  Its Mediasite Video Platform  automates the capture, management, and delivery of live and on-demand streaming videos for more than 5,200 educational institutions, corporations, health organizations and government entities in over 65 countries around the world.

 

Sonic Foundry, Inc. was founded in 1991, incorporated in Wisconsin in March 1994 and merged into a Maryland corporation of the same name in October 1996. Our executive offices are located at 222 West Washington Ave., Madison, Wisconsin 53703 and our telephone number is (608) 443-1600. Our Sonic Foundry International B.V. ("Sonic Foundry International") (formerly Media Mission B.V.) office is located in the Netherlands, and our Mediasite K.K. ("Mediasite KK" or "MSKK") office is located in Japan. Our corporate website is www.sonicfoundry.com. In the “Investors” section of our website we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to reports required to be filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after the filing of such reports with the Securities and Exchange Commission.

 

Challenges We Address Through Our Product Offering

 

Every organization faces a fundamental need to share information and communicate efficiently. Universities and colleges connect instructors with students to educate and prepare the next generation. Businesses strive for effective communication and collaboration among employees to provide value to customers. Healthcare associations must deliver important information to the public and continuing medical education to professionals. Government agencies must keep partners, stakeholders and constituents informed to operate effectively.

 

With the onset of COVID-19 in early 2020, schools and businesses across the world have been forced into a digital-first world where video adoption and utilization is at the core of every remote working and learning solution for education, communication and collaboration.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Mediasite Video Capture Solutions

Mediasite provides the following primary flexible hardware and software solutions to record and upload any video-based content from anywhere, automatically:

 

Mediasite RL Recorders: The RL Series of built-in room appliances use schedule-based capture and advanced audio/video integration to fully automate high-quality video and content recording in lecture halls, training rooms, simulation labs and auditoriums. The room can be scheduled to automatically record and publish to Mediasite Video Platform, so instructors and speakers can focus on teaching and presenting as they are most comfortable, free from technology worries and confident that everything they say and present is being captured.

Mediasite ML Recorders: The ML Series of portable recording devices is used to capture and stream broadcast-quality video. Designed for on-the-go webcasting, hybrid events, guest speakers and conferences, the ML’s lightweight design moves easily from location to location and can be set up and ready to record in only a few minutes.

Mediasite RL Mini: The Mini provides the automation and high-quality capture Mediasite is known for in a compact, affordable device. With the Mini, there’s no need for AV in the room. Instructors simply plug in their laptop and camera and start teaching. The plug-and-play device makes it easy to build or expand automated lecture capture programs in community colleges, vocational-tech schools, small departments and even K12 classrooms.

 

Mediasite Mosaic: Formerly called My Mediasite, Mosaic allows instructors, employees and students to create great looking videos, screencasts and slideshows from their computers or mobile devices with just one click. From demos and video training to flipped classes, lectures and assignments, everything to record, upload, manage and publish personal videos is in one simple-to-use tool, requiring no pro video skills

 

As a result of COVID, many of our customers switching to mainly remote work and teaching beginning in March 2020, the need for in-room video capture slowed. That, along with the uncertainty for higher education institutions regarding their financial outlook for a diminished return to campus in the fall semester caused a noticeable delay in room expansion. As a result, the Company saw a slow down in hardware orders during the summer months when campuses are usually busy upgrading their classrooms. Offsetting the decline in room recordings, software-based capture has significantly increased. Since mid-March 2020, the Company has seen a 123 percent increase in videos created and an 109 percent increase in live sessions.

 

Mediasite Video Management and Delivery Solutions

Mediasite Video Platform (MVP) is a scalable, reliable, and secure solution to manage, search, analyze, publish, and stream video content. With MVP government, businesses, and education institutions can:

 

Automatically publish video to a learning management system (LMS), content management system (CMS), training portal or any website

Centrally manage and secure any video

Create an enterprise or campus YouTube channel

Deepen engagement and improve learning with quizzing, annotations, comments, polls, surveys and other interactive tools

Analyze viewing metrics to measure learner engagement and outcomes

Search everything with fully indexed audio, video and slide content

Stream live and on-demand video to any device

 

On-Premises or Mediasite Video Cloud

Mediasite Video Platform (MVP) is available as either an On-Premises license or as a SaaS (Software as a Service) offering within our Mediasite Video Cloud. Customers can conveniently host and manage all their content with Mediasite Video Cloud, or use it as needed for large events to divert heavy viewing traffic from their on-premises Mediasite Video Platform. Our co-located and high availability data centers and experienced team successfully manage customers’ cloud-based video streaming in a secure, fault-tolerant environment. During 2020, the Company made an investment in a new dual redundant, high availability data center in the United Kingdom, which went online at the end of September. The Company also began purchasing components to upgrade its existing US data centers, which is anticipated to go online during the first calendar quarter of 2021.

 

The investment in data center infrastructure was planned prior to the COVID crisis, however, the increased customer demand for additional storage may require further investment. Any further hardware investment required would be offset by an increase in revenue from hosting. There has been a significant increase in video content creation since the crisis started. In response to the prolific utilization of video conferencing systems like Zoom to record meetings and presentations, the Company developed and released an advanced integration to seamlessly automate workflow between Zoom, Mediasite Video Platform, and a school's LMS. This allows all video content to be edited and managed in one secure location regardless of how it was recorded.

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Challenges We Address Through Our Service Offering

 

Mediasite Events Solutions

Mediasite Events provides live and on-demand webcasting services for conferences, hybrid events and high-profile broadcasts, supplying turnkey streaming solutions for hundreds of events each year. Fortune 500 companies, universities, associations, sporting events and charitable organizations use Mediasite Events to capture, produce, and deliver high-quality event experiences, both in-person and virtually.

 

Our Mediasite Events business, both in the United States (US) and Japan, was significantly impacted by COVID. In early March 2020, all near-term, in-person events started to cancel due to concerns over the virus. While our US team's in-person pipeline for the remainder of March and April shrunk to zero, they quickly replaced in-person events with virtual events. Ever since late March 2020, our US team has been helping customers continue to have industry-specific, high-quality events via our virtual events platform, which utilizes MVP technology. As in-person events eventually resume, we are optimistic that virtual events will be an ongoing part of,or an addition to, the in-person event industry.

 

Mediasite Professional Services

Customers maximize their return on video with additional Mediasite Services including integration services, installation assistance, custom development, training and monitoring services.

 

While COVID impacted our ability to do onsite services, so far we have been able to provide the majority of our professional services remotely.

 

Mediasite Customer Care

MediasiteCustomer Care plans include software upgrades for MVP and Mediasite Capture Solutions, technical support, warranty extensions and advanced replacement on hardware, as well as access to the Mediasite Community and other online resources. Nearly all of our customers purchase a Customer Care plan when they purchase Mediasite Video Platform or Mediasite Capture Solutions. Annual service contracts for Mediasite Video Cloud include a Standard Customer Care plan.

 

COVID has not had an immediate impact on our Customer Care plans. It is, however, difficult to predict the long term impact should the pandemic continue.

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Segment Information

 

We have determined that in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280-10, Segment Reporting, we operate in three operating segments, however these segments meet the criteria for aggregation for reporting purposes as one reporting segment as of September 30, 2020.

 

Billings

 

Our services are typically billed and collected in advance of providing the service. Billings, which are a non-GAAP measure, are an important indicator of customer activity and cash flow in addition to revenue, and is therefore used by management as a key operational indicator. Billings are computed by combining revenue with the change in unearned revenue.

 

Our largest individual customers can be either value added resellers (“VARs”) or end users in the form of large higher education institutions. No single customer represented over 10% of billings or revenue in 2020 or 2019.

 

Sales

 

We sell and market our offerings through a sales force that manages a channel of value-added resellers, system integrators, and consultants. These third-party representatives specialize in understanding both audio/video systems and IT networking. We also sold to approximately 300 resellers, and over 1,150 total end users.

 

Market expansion: Over two-thirds of our revenue is realized from the education market. Recent trends due to COVID are driving rapid adoption of video as a remote work and learning solution. This development represents an exciting trend beyond the traditional academic customer base for the company.

 

For our higher education as well as corporate, government and association clients, we anticipate economic conditions will expand market demand for more outsourced services versus licensed, on-premises sales. Over the last two years, the Company has made extensive capital and technology investments to advance its services model with turnkey event webcasting, a comprehensive cloud-based Software as a Service (SaaS) datacenter, and e-commerce capabilities that position us well to deliver more diversified business services.

 

For our Mediasite Events business both in the US and Japan, we continue to see growing demand for virtual events as a result of COVID. These event-based communication, education and training platforms are expected to help drive the Company’s corporate sales activities going forward.

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Operations

 

We contract with a third party to build the hardware for our Mediasite Recorders and purchase quantities sufficient to fill specific customer orders, including purchases of inventory by resellers. Quantities are maintained in inventory by the third-party provider and shipped directly to the end customer or reseller. The hardware manufacturer provides a limited one-year warranty on the hardware, which we pass on to our customers who purchase a Mediasite Customer Care support and maintenance plan. We believe there are alternative sources of manufacturing for our recorders and believe there are additional sources and alternatives to the existing production process. In recent months, we have experienced slight delays in shipments of component parts used in our products due to the COVID crisis. In order to mitigate production delays in the future, the Company increased inventory quantities during the fourth quarter of fiscal 2020.

 

Research and Development

 

We believe that our future success will depend in part on our ability to continue to develop new business, and to enhance our existing business. Accordingly, we invest a significant amount of our resources in research and development activities, with a particular focus on our SaaS offerings. During the fiscal years ended September 30, 2020 and 2019, we spent $6.3 million and $7.4 million, respectively, on internal research and development activities in our business. These amounts represent 18% in 2020 and 21% in 2019 of total revenue.

 

Global Expansion

 

We acquired Sonic Foundry International in the Netherlands and Mediasite KK in Japan in fiscal 2014. With these acquisitions, we significantly expanded our global market reach in the Asia-Pacific Region and Europe, and accelerated our commitment to enterprise video communication world-wide.

 

Employees

 

At September 30, 2020 and 2019, we had 177 and 183 full-time employees, respectively. Our employees are not represented by a labor union, nor are they subject to a collective bargaining agreement. We have never experienced a work stoppage and believe that our employee relations are satisfactory.

 

 

ITEM 1A. RISK FACTORS

 

YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE MAKING AN INVESTMENT DECISION. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT PRESENTLY AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR BUSINESS OPERATIONS. OUR BUSINESS COULD BE HARMED BY ANY OR ALL OF THESE RISKS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE SIGNIFICANTLY DUE TO ANY OF THESE RISKS, AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. IN ASSESSING THESE RISKS, YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED OR INCORPORATED BY REFERENCE IN THIS ANNUAL REPORT ON FORM 10-K, INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES.

 

On August 26, 2020, the Securities and Exchange Commission (“Commission”) announced the adoption of amendments to modernize certain disclosures registrants are required to make pursuant to Regulation S-K.   The amendments are intended to reflect the Commission’s commitment to a principles-based, registrant-specific approach to disclosure, rooted in materiality.  The modernization of Item 105 Risk Factor Disclosures includes the following:

 

 

The requirement for inclusion of a summary risk factor disclosure of no more than two pages if the risk factor section exceeds 15 pages.

 

Refining the principles-based approach by requiring disclosure of “material” risk factors versus “most significant.”

 

The requirement to organize risk factors under relevant headings for ease of understanding, with generic risk factors placed at the end of the section.  The amendments do not specify the risk factor headings. 

 

The Company has reviewed its current risk factors and will organize them under the primary categories of company risk, industry risk, and investor risk.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Risk Factor Summary Disclosure

 

 

A.

Company Risks consist of both internal and external items and events that impact Sonic Foundry as a company.  These are further categorized as follows:

 

 

1.

Financial Risks impact the financial well-being of the Company.  Those risks include, but are not limited to the following:

 

a.

We have a history of losses.

 

b.

We may need to raise additional capital.

 

c.

If customer adoption has barriers, our business may not succeed.

 

d.

Large, multi-unit deals are needed for continued success.

 

e.

Because most of our service contracts are renewable on an annual basis, a reduction in our service renewal rate could significantly reduce our revenues.

 

f.

If we are viewed only as a commodity supplier, our margins and valuations will shrink.

 

g.

Our operating results are hard to predict as a significant amount of our sales typically occur at the end of a quarter, and the mix of product and service orders may vary significantly.

 

h.

Accounting regulations and related interpretations and policies, particularly those related to revenue recognition, cause us to defer revenue recognition into future periods for all or portions of our products and services.

 

i.

Because we generally recognize revenues ratably over the term of our service contracts, a decrease or increase in service transactions will not be fully reflected in our operating results until future periods.

 

j.

Currency exchange rate fluctuations could result in higher costs and decreased margins and earnings.

 

k.

Our ability to utilize our net operating loss carryforwards may be limited.

 

 

2.

Operational Risks disrupt fundamental daily operations of the Company.  Those risks include, but are not limited to the following:

 

a.

Operational failures in our network infrastructure could disrupt our remote hosting services, cause us to lose clients and sales to potential clients and result in increased expenses and reduced revenues.

 

b.

Our business is susceptible to risks associated with international operations.

 

c.

Supporting our existing and growing customer base and implementing large customer deployments could strain our personnel resources and infrastructure, and if we are unable to scale our operations and increase productivity, customer satisfaction and our business will be harmed.

 

d.

If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired.

 

e.

Manufacturing disruption or capacity constraints would harm our business.

 

 

3.

Strategic Risks prevent the Company from achieving its strategic objectives.  Those risks include, but are not limited to the following:

 

a.

The technology underlying our products and services is complex and may contain unknown defects that could harm our reputation, result in product liability or decrease market acceptance of our products.

 

b.

Our success depends upon the proprietary aspects of our technology.

 

c.

We may not be able to innovate to meet the needs of our target market.

 

d.

If potential customers or competitors use open source software to develop products that are competitive with our products and services, we may face decreased demand and pressure to reduce the prices for our products.

 

e.

We also rely upon trademark, copyright and trade secret laws, which may not be sufficient to protect our intellectual property.

 

f.

If other parties bring infringement or other claims against us, we may incur significant costs or lose customers.

 

g.

There is a great deal of competition in the market for our products, which could lower the demand for our products and have a negative impact on our operations.

 

h.

If our marketing and lead generation efforts are not successful, our business will be harmed.

 

i.

The length of our sales and deployment cycles are uncertain, which may cause our revenue and operating results to vary significantly from quarter to quarter and year to year.

 

j.

We depend in part on the success of our relationships with third-party resellers and integrators.

 

k.

We may need to make acquisitions or form strategic alliances or partnerships in order to remain competitive in our market, and acquisitions, strategic alliances or partnerships, could be difficult to integrate, disrupt our business and dilute stockholder value.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

4.

Compliance Risks result from non-compliance of laws and regulations from various governing bodies.  Those risks include, but are not limited to the following:

 

a.

Our customers may use our products to share confidential and sensitive information, and if our system security is breached, our reputation could be harmed and we may lose customers.

 

b.

Our business is subject to changing regulations regarding corporate governance and public disclosure that will increase both our costs and the risk of noncompliance.

 

 

5.

Industry Risks are items and events that have macro-level impacts on our industries.  Those risks include, but are not limited to the following:

 

a.

Economic conditions could materially adversely affect the Company.

 

b.

Economic conditions may have a disproportionate effect on the sale of our products.

 

c.

We could lose revenues if there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools and other education providers.

 

d.

Changes in U.S. trade policy, including the imposition of tariffs and the resulting consequences, may have a material adverse impact on our business, operating results and financial condition.

 

e.

Privacy concerns and laws, evolving regulation of cloud computing, cross-border data transfer restrictions and other domestic or foreign regulations may limit the use and adoption of our solutions and adversely affect our business.

 

f.

We face risks associated with government regulation of the internet and related legal uncertainties.

 

 

6.

Investor Risks are both internal and external risks that impact an investment made in the Company’s stock.  Those risks include, but are not limited to the following:

 

a.

The market price of our common stock may be subject to volatility.

 

b.

Our common stock is subject to low trading volume and broad price swings.

 

c.

Exercise of outstanding options and warrants will result in further dilution.

 

d.

Provisions of our charter documents and Maryland law could also discourage an acquisition of our Company that would benefit our stockholders and, due to our insiders control of a substantial percentage of our stock, our officers, directors, and major stockholders will have a substantial amount of control over whether to approve or disapprove of a transaction.

 

Following is a more detailed discussion of each risk factor outlined in the summary.

 

Company Risks – Financial

 

We have a history of losses.

Our operations have generated losses in most years. Although we were able to maintain flat revenues in fiscal year 2020 and reduce expenses, we still generated a loss for the year.  While we continue to work towards profitability and growth, we may not realize sufficient revenues or be able to sustain cost reductions to reach that goal.  We initiated a plan for reducing costs in fiscal 2019 that began with eliminating certain headcount and functions, including a reduction in senior executive positions.  In 2020, we continued that focus on cost reduction and also executed on an executive leadership change in the fourth quarter of 2020.  In that same quarter, we eliminated three additional mid to senior level sales and marketing positions, and in the first quarter of 2021, eliminated additional headcount, primarily within sales and marketing.  To achieve profitability and growth, we may need to change certain aspects of our business model.  As such, we face risks, expenses and uncertainties related to our specific business model, as well as those typically encountered by similar companies.  Those risks include, but are not limited to our ability to successfully achieve the following:

 

 

Manage the growth and profitability of our business, including known and unknown challenges and expenses;

 

Acquire new customers and retain and expand existing customers;

 

Develop new and complimentary price competitive product and service offerings, both internally and in partnership with third parties;

 

Maintain and develop relationships with strategic partners including dealers, A/V integrators, large institutional end-users, and other channel partners;

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Compete successfully with companies offering similar products and services;

 

Develop targeted marketing efforts to expand our reach into new markets and deepen penetration into existing markets;

 

Manage and scale a high-performance technology infrastructure;

 

Ensure a highly secure and reliable product platform;

 

Attract and retain highly skilled personnel to execute in a fast-paced, rapidly changing environment;

 

Navigate the ongoing evolution of changing regulatory requirements, such as privacy laws and tax laws, and how it impacts our business, including our products and services; and

 

Expand our competitive reach into international markets.

 

We have experienced some of these risks already and will continue to encounter them as the business evolves.  Failure to successfully manage them could adversely affect our financial condition and results of operations.

 

We may need to raise additional capital.

At September 30, 2020, we had cash of $7.6 million, $2.3 million of which was in our foreign operations compared to total cash of $4.3 million and foreign operations cash of $1.3 million at September 30, 2019. We no longer have a revolving credit facility for any financing needs beyond our available cash and cash generated from operations, and, there can be no assurances a revolving facility will be available. The Company has a history of losses and has historically financed its operations primarily through cash from sales of equity or debt securities, and to a limited extent, cash from operations and through credit facilities. The Company was able to maintain prior year revenue levels despite the impacts of COVID-19 and reduce operating expenses as planned to reach positive adjusted EBITDA. We cannot ensure that revenue will continue to grow given the reduction in operating expenses. If revenue is determined to be growing at a rate less than anticipated and expenses are not sufficiently reduced, our cash resources may not be sufficient to support working capital needs, and we may have to attempt to borrow additional funds from other debt providers or attempt to raise equity capital. In addition, our financial condition may, in the future, cause us to be in non-compliance with certain provisions of any debt facilities we may establish.

 

In the event we need to borrow additional money or raise additional equity capital, we may not be able to do so on acceptable terms and conditions. In that event, we may seek to raise money from entities that are affiliated with the Company, as we have done in the past. However, investors may require that their investment be in the form of convertible preferred stock or convertible debt, which will dilute the interests of our existing stockholders. The Company may need to rely on its Chairman, Mark Burish, ("Mr. Burish") to provide capital on terms reasonable and acceptable to the independent members of the Board of Directors. There is no assurance, however, that Mr. Burish, or any other affiliated party, will be willing to provide additional capital..

 

During fiscal year 2020, the Company entered into a debt conversion agreement with Mr. Burish to convert all outstanding debt owed to Mr. Burish into common stock at a conversion price of $5.00 per share.  The total debt amount, including accrued interest and fees of $5.6 million, was converted into 1,114,723 shares of common stock.  No cash was exchanged in the transaction, however, the elimination of debt improves our working capital as payments of $100 thousand plus interest beginning in August 2020 have now been eliminated. 

 

As a result of the non-cash goodwill and other intangible assets impairment charges recorded in fiscal 2018, the Company was no longer able to satisfy the NASDAQ requirement to maintain $2.5 million of stockholders' equity. On December 18, 2018, the Board of Directors approved the voluntary transfer of its common stock from the NASDAQ Stock Exchange to the OTCQB Market ("the "QTCQB"). The OTCQB Market is operated by OTC Markets Group, a centralized electronic quotation service for over-the-counter-securities. The Company ceased trading on NASDAQ at the close of business on December 28, 2018 and began trading on the OTCQB on December 31, 2018 under its current trading symbol "SOFO". The Company ceased trading on the OTCQB at the close of business on February 15, 2019 and began trading on the OTC Pink Sheets on February 18, 2019 under its current trading symbol "SOFO". The Company has remained a reporting company under the Securities Exchange Act of 1934, as amended, notwithstanding its voluntary withdrawal from the NASDAQ. As a result of the Company's inability to satisfy the NASDAQ requirements, its ability to raise equity capital may be adversely affected.

 

In the event we are able to borrow money, we may incur significant interest charges, which could harm our profitability. Holders of debt would also have rights, preferences or privileges senior to those of existing holders of our common stock. In the event we are able to raise additional equity, the terms of such financing may dilute the ownership interests of current investors and cause our stock price to fall significantly. In the event additional capital is provided by executive officers or directors, then, due to the low price levels of our common stock, control by such executive officers or directors may substantially increase.

 

We may not be able to secure debt or equity financing upon acceptable terms, if at all. If we cannot raise funds on acceptable terms, our business, operating results, and financial condition could be negatively impacted. The Company believes its cash position is adequate to accomplish its business plan through at least the next twelve months.

 

If the funds held by our foreign subsidiaries are needed for our operations in the United States, the repatriation of some of these funds to the United States could require payment of additional U.S. taxes.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

If customer adoption has barriers, our business may not succeed.

Part of our strategic challenge is to convince enterprise customers of the stability, productivity, improved communications, cost savings, suitability and other benefits of our products. The market for content delivery solutions is very complex, includes many products and solutions that address various aspects of customer needs and as a result it is often difficult for customers and channel partners to understand how our products and services compare. Further, corporate customers may use video as a tool, but may choose to rely upon their own IT infrastructure and resources to manage their video content. Because many companies generally are predisposed to maintaining control of their IT systems and infrastructure, there may be resistance to using software as a service provided by a third party. Our future revenue and revenue growth rates will depend in large part on our success in delivering these products effectively, creating market acceptance for these products in existing markets that we sell into and in new markets, and meeting customer’s needs for new or enhanced products. If we fail to do so, our products will not achieve widespread market acceptance, or will no longer be used by our customers, and we may not generate sufficient revenue to offset our product development and selling and marketing costs, which will adversely impact the valuation of the Company, the price of our stock, and will harm our business.

 

Large, multi-unit deals are needed for continued success.

We need to sell multiple units to educational, corporate and government institutions in order to sell most efficiently and become profitable. Sales of multiple units to corporate customers have lagged behind results achieved in the higher education market; consequently, we have allocated more resources to the higher education market. While we have addressed a strategy to leverage existing customers, better address the needs of potential new customers, and close multiple unit transactions, a customer may choose not to make expected purchases of our products. Despite our strategy to focus on a customer base with a recurring need to purchase our products and services, we need to identify and sell more products and services to new customers, enter new markets and reduce the rate of attrition from certain existing customers, typically those with smaller deployments. The failure to develop effective strategies to enter new markets, and increase sales will adversely impact the valuation of the Company and the price of our stock, and will harm our business.

 

Because most of our service contracts are renewable on an annual basis, a reduction in our service renewal rate could significantly reduce our revenues.

Our clients have no obligation to renew their content hosting agreements, customer support contracts or other annual service contracts after the expiration of the initial period, which is typically one year, and some clients have elected not to do so. A decline in renewal rates could cause our revenues to decline. Our renewal rates may decline or fluctuate as a result of a number of factors, including client dissatisfaction with our products and services, our slow response to customer technical inquiries, our failure to update our products to maintain their attractiveness in the market, deteriorating economic conditions or budgetary constraints or changes in budget priorities faced by our clients. If our retention rates decrease, we may need to provide more incentives, reduce pricing or increase marketing costs to improve lead generation through marketing in order to increase revenues, all of which could reduce profitability.

 

If we are viewed only as a commodity supplier, our margins and valuations will shrink.

We need to provide value-added services in order to avoid being viewed as a commodity supplier, which could adversely impact the valuation of the Company, and the price of our stock. This entails building long-term customer relationships and developing features that will distinguish our products. Our technology is complex and is often confused with other products and technologies in the market place, including video conferencing, streaming and collaboration.

 

We have developed lower cost hardware, software products and cloud solutions to better address the more cost-conscious customers. Such products have more limited features compared to our existing products. While we believe we can preserve the market for our full-featured products due to differentiation between the two and migration to full featured products, release of lower cost products has and could continue to reduce gross margins and demand for products sold at higher prices, which could adversely affect our business and operating results. Potential large-scale deployments of our products often include the lower cost products we sell, putting greater pressure on gross margin due to expectations for greater volume discounts.

 

If we fail to build long-term customer relationships, develop features that distinguish our products in the market place and address the market for lower function and cost solutions, our margins will shrink, and our stock may be adversely impacted.

 

Our operating results are hard to predict as a significant amount of our sales typically occur at the end of a quarter and the mix of product and service orders may vary significantly.

Revenue for any particular quarter is extremely difficult to predict with any degree of certainty. We typically ship products within a short time after we receive an order and therefore, we do not have an order backlog with which to estimate future revenue. Any decline or uncertainty in end-user demand could negatively impact end-user orders. Accordingly, our expectations for both short and long-term future revenue is based almost exclusively on our own estimate of future demand based on history and the pipeline of sales opportunities we manage, rather than on firm orders. The mix of product demand varies significantly from quarter to quarter, further complicating our estimated product needs. Our expense and inventory levels are based largely on these estimates. In addition, our events business is particularly unpredictable and subject to variation due to the short time-frame between when we learn of an opportunity and when the event occurs. Further, the majority of our product orders are received in the last month of a quarter; thus, the unpredictability of the receipt of these orders could negatively impact our future results. Accordingly, any significant shortfall in demand for our products or services in relation to our expectations, even if the result was a short-term delay in orders, would have an adverse impact on our operating results.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

We have experienced growing demand for our hosting and event services as well as a growing preference from our customers in purchasing our annually licensed software. As a result, we have seen an increase in service billings and recurring revenue as a percentage of total billings, and a decrease in hardware billings. We expect this trend to continue, which we expect to help improve predictability of revenue and gross margins but will delay the impact on revenue of any increase or decrease in billings during any particular quarter. We subcontract for some services required by our events customers, such as onsite management labor and closed captioning. We typically charge for such services at a lower margin than other services. The percentage of billings represented by services, provided either directly or indirectly, is also likely to fluctuate from quarter to quarter due to seasonality of event services and other factors. Since content hosting and support services are typically billed in advance of providing the service, revenue is initially deferred, leading to reduced current period revenue with a corresponding negative impact to profits or losses in periods of significant increase in the percentage of our billings for deferred services.

 

Accounting regulations and related interpretations and policies, particularly those related to revenue recognition, cause us to defer revenue recognition into future periods for all or portions of our products and services.

Revenue recognition for our products and services is complex and subject to multiple sources of authoritative guidance, some of which are new, as well as, varied interpretations and implementation practices for such rules. These rules require us to apply judgment in determining revenue recognition. In certain situations, we may have to defer the entire amount of revenue from a transaction, even when the product has already shipped. This may occur when the customer has delayed payment on the transaction, or in certain other circumstances, such as when we agree to extend payment terms on other invoices from such customer. In addition, we always defer revenue when services are included in a transaction, and not performed. Other factors that are considered in revenue recognition include those such as standalone selling price (SSP), best estimate of selling price and the inclusion of other services and contingencies to payment terms. We expect that we will continue to defer portions or, in certain circumstances with respect to a particular customer, all of our product or service billings because of these factors, and to the extent that management’s judgment is incorrect it could result in an increase in the amount of revenue deferred in any one period. The amounts deferred may be significant and may vary from quarter to quarter depending on, among other factors, compliance with payment terms, the mix of products sold, combination of products and services sold together or contractual terms.

 

Additional changes in authoritative guidance, including the interpretation of "Revenue from Contracts with Customers (Topic 606)", or changes in practice in applying such rules could also cause us to defer the recognition of revenue to future periods or recognize lower revenue.  See Note 1 - Accounting Policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

 

Because we generally recognize revenues ratably over the term of our service contracts, decrease or increase in service transactions will not be fully reflected in our operating results until future periods.

We recognize most of our revenues from service contracts monthly over the terms of their agreements, which are typically 12 months, although terms have ranged from less than one month to 48 months. As a result, much of the service revenue we report in each quarter is attributable to agreements entered into during previous quarters. Consequently, a decline in sales, client renewals or market acceptance of our products in any one quarter will not necessarily be fully reflected in the revenues in that quarter and will negatively affect our revenues and profitability in future quarters. This ratable revenue recognition also makes it difficult for us to rapidly increase our revenues through additional sales in any period, as revenues from new clients must be recognized over the applicable agreement term.

 

Currency exchange rate fluctuations could result in higher costs and decreased margins and earnings.

The functional currency of our foreign subsidiaries in the Netherlands is the Euro and in Japan is the Japanese Yen. They are subject to foreign currency exchange rate risk. The conversion rate of the Yen to the US Dollar varied from about 105 to approximately 109 during fiscal 2020.  Similarly, the Euro varied from about 0.85 to approximately 0.92 to the US Dollar during fiscal 2020. The strength of the dollar impacts our ability to export profitably to other countries, and will likely continue to fluctuate. Any increase in the exchange rate of the US Dollar compared to the Euro or the Japanese Yen will impact our future operating results and financial position.

 

Our ability to utilize our net operating loss carryforwards may be limited.

The use of our net operating loss carryforwards may have limitations resulting from certain future ownership changes or other factors under the Internal Revenue Code and other taxing authorities. The Tax Cuts and Jobs Act of 2017 changed both the federal deferred tax value of the net operating loss carryforwards and the rules of utilization of federal net operating loss carryforwards. The Tax Cuts and Jobs Act of 2017 lowered the corporate tax rate from 35% to 21% effective for our 2018 fiscal year. For net operating loss carryforwards generated in years prior to 2018, there is no annual limitation on the utilization and the carryforward period remains at 20 years. There could be a limitation if a change in ownership occurs. However, net operating loss carryforwards generated in years after 2017 will only be available to offset 80% of future taxable income in any single year, but will not expire.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

If our net operating loss carryforwards are limited, and we have taxable income which exceeds the available net operating loss carryforwards for that period, we would incur an income tax liability even though net operating loss carryforwards may be available in future years prior to their expiration. Any such income tax liability may adversely affect our future cash flow, financial position and financial results.

 

Company Risks – Operational

 

Operational failures in our network infrastructure could disrupt our remote hosting services, cause us to lose clients and sales to potential clients and result in increased expenses and reduced revenues.

Unanticipated problems affecting our network systems could cause interruptions or delays in the delivery of the hosting services we provide to some of our clients. We are not equipped to provide full disaster recovery to all of our hosted clients. If there are operational failures in our network infrastructure that cause interruptions, slower response times, loss of data or extended loss of service for our remotely hosted clients, we may be required to issue credits or pay penalties, current clients may terminate their contracts or elect not to renew them and we may lose sales to potential clients. We have recently acquired additional hardware and systems, expect to make more significant investments in hardware and outsourced most aspects of our network infrastructure to multiple providers. We also rely on Internet systems and infrastructure to operate our business and provide our services. As a result, we are reliant on third parties for network availability, so outages may be outside our control and we may need to acquire additional hardware in order to provide an appropriate level of redundancy required by our customers. These hardware, data, and cloud computing platforms may not be available at reasonable terms or prices.

 

Our business is susceptible to risks associated with international operations.

International product and service billings were 36% of our total billings in each of the past two years and are expected to continue to account for a significant portion of our business in the future. International sales are subject to a variety of risks, including:

 

Difficulties in establishing and managing international subsidiaries, distribution channels and operations;

 

Difficulties in selling, servicing and supporting overseas products, translating products into foreign languages and compliance with local hardware requirements;

 

Difficulties in managing the demands of large international deployments, many of which distract key sales personnel from opportunities in other parts of the world;

 

Challenges associated with management transition;

 

Challenges related to language or cultural differences;

 

The uncertainty of laws and enforcement in certain countries, such as China, relating to the protection of intellectual property or requirements for product certification, protection of personal data or other restrictions;

 

Competitive pressure impacting other parts of the world;

 

Multiple and possibly overlapping tax structures;

 

Currency and exchange rate fluctuations and imposition of tariffs or quotas;

 

Difficulties in collecting accounts receivable in foreign countries, including complexities in documenting letters of credit;

 

Economic or political changes in international markets;

 

Restrictions on access to the Internet; and

 

Difficulty in complying with international employment related requirements

 

Supporting our existing and growing customer base and implementing large customer deployments could strain our personnel resources and infrastructure, and if we are unable to scale our operations and increase productivity, customer satisfaction and our business will be harmed.

Frequent enhancements to our software puts pressure on our customers to install, maintain and train their personnel on its use. Further, frequent releases of the software can lead to less product stability. As a result, our customer care and engineering resources have come under, and are expected in the future to come under significant pressure in providing the high-quality of technical support our customers expect during periods of high demand. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for support services. Increased customer demand for these services, without corresponding revenues, could increase costs and adversely affect our operating results. In addition, our sales process is highly dependent on our applications and business reputation and on positive recommendations from our existing customers. Any failure to maintain high-quality technical support, or a market perception that we do not maintain high-quality support, could adversely affect our reputation, our ability to sell our products and services to existing and prospective customers, and our business, operating results and financial position.

 

As we target more of our sales efforts at larger initial transactions, we face increasingly complex deployments requiring substantial technical and management resources, including in some cases significant product customization and integration with other applications or hardware. Customers making large expenditures for our products and services typically have higher expectations of product and service operability and response time if issues arise. Some of these customers have asked us to host their content and have significant amounts of legacy content to transfer to our datacenter. Such increased activity and storage demand on our data centers put additional strain on our personnel and hosting infrastructure. Our hosting customers typically require a high level of access, data security and need to capture and store multiple high definition streams. Such requirements require costly enhancements to our infrastructure. If we do not accurately plan for our infrastructure capacity requirements and we experience significant strains on our data center capacity, our customers could experience performance degradation or service outages that may subject us to financial penalties, result in customer losses and harm our business. As we add or change data centers or capacity, we may move or transfer our data and our customers’ data. Despite precautions taken during this process, any unsuccessful data transfers may impair the delivery of our services, which may damage our business. High demand on technical and management resources to manage large transactions distract personnel from existing customers, development of new products and other important activities which could lead to potential customer dissatisfaction, product development delays or other issues associated with the distraction.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

If a customer is not satisfied with the quality of work performed by us or a third party or with the type of services or solutions delivered, then we could incur additional costs to address the situation and delay recognition of revenue, the profitability of that work might be impaired, and the customer’s dissatisfaction with our services could damage our ability to obtain additional work from that customer. In addition, negative publicity related to our customer relationships, regardless of its accuracy, may further damage our business by affecting our ability to compete for new business with current and prospective customers.

 

If we lose key personnel or fail to integrate replacement personnel successfully, our ability to manage our business could be impaired.

Our future success depends upon the continued service of our key management, technical, sales and other critical personnel, including our Chief Executive Officer. Most of our officers and other key personnel are employees-at-will, and we cannot assure that we will be able to retain them. Key personnel have left our Company in the past, sometimes to accept employment with companies that sell similar products or services to existing or potential customers of ours. The technology industry is subject to substantial and continuous competition for engineers with high levels of experience in designing, developing and managing software and Internet-related services, as well as competition for sales and operations personnel. There will likely be additional departures of key personnel from time to time in the future and such departures could result in additional competition, loss of customers or confusion in the marketplace. As we seek to replace such departures, or expand our business, the hiring of qualified sales, technical and support personnel is difficult due to the limited number of qualified professionals. Training of new sales, technical and support personnel can take six months or longer before they become productive. Sales and technical strategies have changed and will likely change further in the future and require different skills to sell to different customer types and develop new and changing products. The loss of any key employee could result in significant disruptions to our operations, including adversely affecting the timeliness of product releases, the successful implementation and completion of Company initiatives and the results of our operations. In addition, we do not have life insurance policies on any of our key employees. If we lose the services of any of our key employees, the integration of replacement personnel could be time consuming, may cause disruptions to our operations and may be unsuccessful.

 

Manufacturing disruption or capacity constraints would harm our business.

We subcontract the manufacturing of our recorders to a third-party contract manufacturer. Although we believe there are multiple sources of supply from other contract manufacturers, as well as, multiple suppliers of component parts required by our contract manufacturer, a disruption of supply of component parts or completed products, even if short term, would have a material negative impact on our revenues. Likewise, we are susceptible to any material change in terms; such as pricing, level of services performed or changes to payment terms by our contract manufacturer. In particular, the cost of our products increased this year as a result of tariffs imposed by China. Many component parts currently have long delivery lead times or cease production of certain components with limited notice in which to evaluate or obtain alternate supply, requiring conservative estimation of production requirements. Lengthening lead times, product design changes and other third-party manufacturing disruptions have caused delays in delivery in the past. In order to compensate for supply delays, we have sourced components from off-shore locations, used cross component parts, paid significantly higher prices or premium fees to expedite delivery for short supply components and converted inventory from one version to another. We have typically maintained greater amounts of inventory as insurance against delays but currently hold substantially lower quantities of inventory in order to improve liquidity. Many of these strategies have increased our costs or require substantial resources to maintain and may not be sufficient to ensure against a product shortage. We depend on our subcontract manufacturer to produce our products efficiently while maintaining high levels of quality despite frequent changes in configuration and scheduling imposed by us. Any manufacturing or component defects, delay in production or changes in product features will likely cause customer dissatisfaction and may harm our reputation. Moreover, any incapacitation of the manufacturing site due to destruction, natural disaster or similar events could result in a loss of product inventory. As a result of any of the foregoing, we may not be able to meet demand for our products, which could negatively affect revenues in the quarter of the disruption or longer depending upon the magnitude of the event, and could harm our reputation.

 

We license technology from third parties. If we are unable to maintain these licenses, our operations and financial condition may be negatively impacted.

We license technology from third parties. The loss of, our inability to maintain, or changes in material terms of these licenses could result in increased cost or delayed sales of our software, and services, or may cause us to remove features from our products or services. We anticipate that we will continue to license technology from third parties in the future. This technology may not continue to be available on commercially reasonable terms, if at all. Although we do not believe that we are substantially dependent on any individual licensed technology, some of the component technologies that we license from third parties could be difficult for us to replace. The impairment of these third-party relationships, especially if this impairment were to occur in unison, could result in delays in the delivery of our software and services until equivalent technology, if available, is identified, licensed and integrated. This delay could adversely affect our operating results and financial condition.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Company Risks – Strategic

 

The technology underlying our products and services is complex and may contain unknown defects that could harm our reputation, result in product liability or decrease market acceptance of our products.

The technology underlying our products is complex and includes software that is internally developed, software licensed from third parties and hardware purchased from third parties. These products have, and will in the future, contain errors or defects, particularly when first introduced or when new versions or enhancements are released. We may not discover defects that affect our current or new applications or enhancements until after they are sold, and our insurance coverage may not be sufficient to cover our exposure. Further, there are third-party applications our products and services are dependent on, or integrate with, such as operating systems and learning management systems. These integrations require specialized knowledge that is difficult and expensive to maintain. Failure to maintain compatibility with such applications or identification of defects in our products and services could:

 

 

Damage our reputation;

 

Cause our customers to initiate product liability suits against us;

 

Increase our product development resources;

 

Cause customers to cancel orders, ask for partial refunds or potential customers to purchase competitive products or services;

 

Delay release or market acceptance of our products, or otherwise adversely impact our relationships with our customers; and/or

 

Cause us to allocate valuable engineering resources to fix our existing products, which may cause us to allocate fewer resources toward developing new products, or toward adding features to our existing products.

 

Our success depends upon the proprietary aspects of our technology.

Our success and ability to compete depend to a significant degree upon the protection of our proprietary technology. We currently have three U.S. patents that have been issued to us. We may seek additional patents in the future. However, it is possible that:

 

  Any patents acquired by or issued to us may not be broad enough to protect us.
  Any issued patent could be successfully challenged by one or more third parties, which could result in our loss of the right to prevent others from exploiting the inventions claimed in those patents.
  Current and future competitors may independently develop similar technology, duplicate our services or design around any of our patents.
  Effective patent protection, including effective legal-enforcement mechanisms against those who violate our patent-related assets, may not be available in every country in which we do or plan to do business.
  We may not have the resources to enforce our patents or may determine the potential benefits are not worth the cost and risk of ultimately being unsuccessful.

 

We may not be able to innovate to meet the needs of our target markets.

Our future success will continue to depend upon our ability to create an effective development product strategy, to develop new products, product enhancements and service offerings that address future needs of our existingtarget markets and enable us to expand the market for our products and service offerings. Our success is also dependent upon our ability to respond to changing standards and practices on a timely basis, particulary as customers move away from hardware to software solutions. The success of new strategies, products, product enhancements and service offerings depends on several factors, including timely completion, quality and stability, and market acceptance. Our fiscal 2021 business plan includes an expectation for revenue contribution from both new and existing customers associated with the introduction of lower priced hardware and software products in locations that can’t support our more comprehensive solutions. There can be no assurance that we will be successful in achieving our revenue expectations from these new products or that we are able to retain existing customers with our more comprehensive solutions. Our revenue could be adversely impacted if we do not capitalize on opportunities to develop innovative new products, product enhancements and service offerings that will increase the likelihood that our products and services will be accepted in preference to the products and services of our current and future competitors. Some of our prospective customers may delay the purchase of our products or services until certain features are completed, may require custom development of certain features as part of the purchase decision, or may condition additional payments tied to completion of such features. Prioritizing such custom features can be difficult to adapt to other customers and distracts our engineering team from implementing features required by other customers.

 

 

If potential customers or competitors use open source software to develop products that are competitive with our products and services, we may face decreased demand and pressure to reduce the prices for our products.

The growing acceptance and prevalence of open source software may make it easier for competitors or potential competitors to develop software applications that compete with our products, or for customers and potential customers to internally develop software applications that they would otherwise have licensed from us. One of the aspects of open source software is that it can be modified or used to develop new software that competes with proprietary software applications, such as ours. Such competition can develop without the degree of overhead and lead time required by traditional proprietary software companies. As open source offerings become more prevalent, customers may defer or forego purchases of our products, which could reduce our sales and lengthen the sales cycle for our products or result in the loss of current customers to open source solutions. If we are unable to differentiate our products from competitive products based on open source software, demand for our products and services may decline, and we may face pressure to reduce the prices of our products, which would hurt our profitability. If our use of open-source is challenged and construes unfavorably, our operating results could be adversely impacted.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

We use open source software in our application suite. Although we monitor our use of open source software closely, the terms of many open source licenses have not been interpreted by United States courts, and there is risk that such licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to commercialize our products. In such event, we could be required to re-engineer our technology or to discontinue offering all or a portion of our products in the event re-engineering cannot be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.

 

We also rely upon trademark, copyright and trade secret laws, which may not be sufficient to protect our intellectual property.

We also rely on a combination of laws, such as copyright, trademark and trade secret laws and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our technology. We have registered three U.S. and four foreign country trademarks. These forms of intellectual property protection are critically important to our ability to establish and maintain our competitive position. However, it is possible that:

 

 

Third parties may infringe or misappropriate our copyrights, trademarks and similar proprietary rights.

 

Laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or to deter others from developing similar technologies, particularly in foreign countries where the laws may not protect our proprietary rights as fully or as readily as Unites States laws.

 

There have been attacks on certain patent systems, increasing the likelihood of changes to established laws, including in the United States. We cannot predict the long-term effects of any potential changes, which could be detrimental to our licensing program.

 

Effective trademark, copyright and trade secret protection, including effective legal-enforcement mechanisms against those who violate our trademark, copyright or trade secret assets, may be cost prohibitive or unavailable or limited in foreign countries.

 

Contractual agreements may not provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.

 

Other companies may claim common law trademark rights based upon state or foreign laws that precede the federal registration of our marks.

 

Policing unauthorized use of our services and trademarks is difficult, expensive and time-consuming, and we may be unable to determine the extent of any unauthorized use.

 

Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third parties to benefit from our technology without paying us for it, which would significantly harm our business.

 

If other parties bring infringement or other claims against us, we may incur significant costs or lose customers.

Other companies may obtain patents or other proprietary rights that would limit our ability to conduct our business and could assert that our technologies infringe their proprietary rights. We have incurred substantial costs to defend against such claims in the past and could incur legal costs in the future, even if without merit, and intellectual property litigation could force us to cease using key technology, obtain a license or redesign our products. In the course of our business, we may sell certain systems to our customers, and in connection with such sale, we may agree to indemnify these customers from claims made against them by third parties for patent infringement related to these systems, which could harm our business.

 

There is a great deal of competition in the market for our products, which could lower the demand for our products and have a negative impact on our operations.

The market for our products and services is intensely competitive, dynamic and subject to rapid technological change. The intensity of the competition and the pace of change are expected to increase in the future, and likely will require the Company to compete on price and our offerings more than in the past, which could adversely affect our business and operating results. Increased competition has reduced gross margins, has resulted in new customer losses and may result in loss of market share, any one of which could seriously harm our business. Competitors vary in size and in the scope and breadth of the products and services offered, many of which have greater financial resources, greater name recognition, more employees and greater financial, technical, marketing, public relations and distribution resources than we have. In addition, new competitors with greater financial resources may arise through partnerships, distribution agreements, mergers, acquisitions or other types of transactions at any time. In particular, large companies have begun to make investments in and/or partner with smaller companies to enter the lecture capture and video management markets.

 

Various vendors provide lecture capture, enterprise webcasting or video content management capabilities, but few offer an end-to-end solution that addresses all phases of the video content lifecycle (capture, delivery, transformation and management) in a single platform like Mediasite.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Lecture capture solutions designed specifically for higher education differ in their technology approach.

 

 

Appliance- or room-based lecture capture provides a fully integrated system with complete recording automation for live or on-demand content. The automated, pre-scheduled workflow results in the greatest faculty and staff adoption and largest volumes of recorded content in the shortest amount of time.

 

Software-based lecture capture that resides on a podium or computer in the classroom also captures and publishes rich media content, but relies on campus- or user-supplied hardware.

 

Desktop capture tools reside on individual users’ laptops or computers allowing them to record user-generated content.

 

Few lecture capture vendors offer a mix of all lecture capture approaches to best suit customers’ needs. Most vendors, including Extron and Panopto, support only one approach to lecture capture. Likewise, a very small number of vendors provide an integrated platform like Mediasite to archive and manage video and rich media recorded with their solution. Most rely on a third-party platform, typically the institution’s learning or course management system, to publish, search and secure content.

 

Enterprise video management solutions serve as centralized media repositories that facilitate the delivery, publishing and management of on-demand video. Unlike Mediasite, most platforms do not include a video capture, webcasting or live streaming component, but instead ingest or import video-based content captured by other third-party devices or solutions. Also, most other platforms focus on ingesting video-only content rather than rich video which combines multiple synchronous video and/or slide streams into an interactive media experience.

 

Some current and potential customers develop their own home-grown lecture capture, webcasting or video content solutions which may also compete with Mediasite. However, we often find many of these organizations are now looking for a commercial solution that offers comprehensive management capabilities, requires fewer resources and internal maintenance and delivers a less cumbersome workflow.

 

The competitive environment has required us to make changes in our products, pricing, licensing, services, or marketing to maintain and extend our current technology. Price concessions or the emergence of other pricing, licensing, and distribution strategies or technology solutions of competitors has impacted revenue growth and may in the future further reduce our revenue, margins or market share. Other changes we have to make in response to competition, such as our desktop user intergace, could cause us to expend significant financial and other resources, disrupt our operations, strain relationships with partners, release products and enhancements before they are thoroughly tested or result in customer dissatisfaction, any of which could harm our operating results and stock price.

 

If our marketing and lead generation efforts are not successful, our business will be harmed.

We believe that continued marketing efforts will be critical to achieve widespread acceptance of our products. Our marketing strategies and campaigns may not be successful, and we may not be able to generate sufficient cash flow from operations to cover the expenses required to implement effective strategies and campaigns. For example, failure to adequately generate and develop qualified sales leads could cause our future revenue to decrease. In addition, our inability to generate and cultivate qualified sales leads into large organizations, where there is the potential for significant use of our products, could have a material adverse effect on our business. We may not be able to identify and secure the number of strategic qualified sales leads necessary to help generate marketplace acceptance of our products. If our marketing or lead-generation efforts are not successful, our business and operating results will be harmed.

 

The length of our sales and deployment cycles are uncertain, which may cause our revenue and operating results to vary significantly from quarter to quarter and year to year.

During our sales cycle, we spend considerable time and expense providing information to prospective customers about the use and benefits of our products without generating corresponding revenue. Our expense levels are relatively fixed in the short-term and based in part on our expectations of future revenue. Therefore, any delay in our sales cycle could cause significant variations in our operating results, particularly because a relatively small number of customer orders represent a large portion of our revenue.

 

Our largest potential sources of revenue are educational institutions, large corporations and government entities that often require long testing and approval processes before making a decision to purchase our products, particularly when evaluating our products for inclusion in new buildings under construction, high dollar transactions or competitive bids. In general, the process of selling our products to a potential customer may involve lengthy negotiations, collaborations with consultants, designers and architects, time consuming installation processes and changes in network infrastructure in excess of what we or our VARs are able to provide. In addition, educational institutions that started with small pilots are committing to more complex installations and expanding to include undergraduate classrooms, which, due to the increased size of these types of transactions, typically require a longer sales cycle. Also, our enterprise accounts are less motivated by seasonal sales and promotions, and therefore are frequently difficult to finalize. As a result of these factors, our sales and deployment cycles are unpredictable. Our sales and deployment cycles are also subject to delays as a result of customer-specific factors over which we have little or no control, including budgetary constraints, existing infrastructure technical issues and internal approval procedures, particularly with customers or potential customers that rely on government funding.

 

Our products are aimed toward a broadened user base within our key markets and these products are relatively early in their product life cycles. We cannot predict how the market for our products will develop, and part of our strategic challenge will be to convince targeted users of the productivity, improved communications and test scores, cost savings and other benefits. Accordingly, it is likely that delays in our sales cycles with these products will occur and this could cause significant variations in our operating results.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Sales of some of our products have experienced seasonal fluctuations which have affected sequential growth rates for these products, particularly in our first fiscal quarter. For example, there is generally a slowdown for sales of our products in the higher education and corporate markets in the first fiscal quarter of each year. Seasonal fluctuations could negatively affect our business, which could cause our operating results to fall short of anticipated results for such quarters. As such, we believe that quarter-to-quarter comparisons of our revenues, operating results and cash flows may not be meaningful and should not be relied upon as an indication of future performance.

 

We depend in part on the success of our relationships with third-party resellers and integrators.

Our success depends on various third-party relationships, particularly in our non-higher education business, with certain international geographies and our events services operations. The relationships include third party resellers, as well as, system integrators that assist with implementations of our products and sourcing of our products and services. Identifying partners, negotiating and documenting relationships with them and maintaining their relationships require significant time and resources from us. In addition, our agreements with our resellers and integrators are typically non-exclusive and do not prohibit them from working with our competitors or from offering competing products or services. We have limited control, if any, as to whether these strategic partners devote adequate resources to promoting, selling and implementing our products as compared to our competitor’s products. Our competitors may be effective in providing incentives to third parties to favor their products or services. If we are unsuccessful in establishing or maintaining our relationships with these third parties, our ability to compete in the marketplace or to maintain or grow our revenue could be impaired and our operating results would suffer.

 

We may need to make acquisitions or form strategic alliances or partnerships in order to remain competitive in our market, and recent acquisitions, strategic alliances or partnerships, including the acquisition of Mediasite KK and Sonic Foundry International, could be difficult to integrate, disrupt our business and dilute stockholder value.

We completed the acquisitions of Mediasite KK in Japan and MediaMission (now Sonic Foundry International) in the Netherlands in fiscal 2014. As a result of these acquisitions, we must integrate our products, services, dispersed operations, management systems and very different cultures. In the future, we may acquire or form strategic alliances or partnerships with other businesses in order to remain competitive or to acquire new technologies. Acquisitions, alliances and investments involve numerous risks, including:

 

The potential failure to achieve the expected benefits of the combination or acquisition;

 

Difficulties in and the cost of integrating operations, technologies, services and personnel;

 

Diversion of financial and managerial resources from existing operations;

 

Risk of entering new markets in which we have little or no experience or where competitors may have stronger market positions;

 

Potential write-offs of acquired assets or investments, and potential financial and credit risks associated with acquired customers;

 

Potential loss of key employees;

 

Inability to generate sufficient revenue to offset acquisition or investment costs;

 

The inability to maintain relationships with customers and partners of the acquired business;

 

The difficulty of transitioning the acquired technology onto our existing platforms and maintaining the security standards consistent with our other services for such technology;

 

Potential unknown liabilities associated with the acquired businesses;

 

Unanticipated expenses related to acquired technology and its integration into existing technology;

 

Negative impact to our results of operations because of the depreciation and amortization of amounts related to acquired intangible assets, fixed assets and deferred compensation, and the loss of acquired deferred revenue and unbilled deferred revenue;

 

Delays in customer purchases due to uncertainty related to any acquisition;

 

The need to implement controls, procedures and policies at the acquired company;

 

Challenges caused by distance, language and cultural differences;

 

In the case of foreign acquisitions, the challenges associated with integrating operations across different cultures and languages and currency, technological, employee and other regulatory risks and uncertainties in the economic, social and political conditions associated with specific countries; and

 

The tax effects of any such acquisitions.

 

Our failure to successfully manage the acquisitions of Mediasite KK and Sonic Foundry International, or other future acquisitions, strategic alliances or partnerships could seriously harm our operating results. In addition, our stockholders would be diluted if we finance the future acquisitions, strategic alliances or partnerships by incurring convertible debt or issuing equity securities.

 

Company Risks – Compliance

 

Our customers may use our products to share confidential and sensitive information, and if our system security is breached, our reputation could be harmed and we may lose customers.

Our customers may use our products and services to share confidential and sensitive information, the security of which is critical to their business. Third parties may attempt to breach our security for customer hosted content or the networks of our customers.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Malicious third-parties may also conduct attacks designed to temporarily deny customers access to our services. Customers may take inadequate security precautions with their sensitive information and may inadvertently make that information public. We may be liable to our customers or subject to fines for a breach in security, and any breach could harm our reputation and cause us to lose customers. In addition, customers are vulnerable to computer viruses, physical or electronic break-ins and similar disruptions, which could lead to interruptions, delays or loss of data. We may be required to expend significant capital and other resources to further protect against security breaches or to resolve problems caused by any breach, including litigation-related expenses if we are sued.

 

Our business is subject to changing regulations regarding corporate governance and public disclosure that will increase both our costs and the risk of noncompliance.

As a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002. While we have developed and instituted a corporate compliance program based on what we believe are the current best practices and continue to update the program in response to newly implemented regulatory requirements and guidance, we cannot assure that we are or will be in compliance with all potentially applicable regulations.

 

Although our non-affiliate market capitalization was less than $75 million at March 31, 2020 and we were therefore not required to have an auditor attestation on our internal controls over financial reporting for fiscal 2020, SEC rules may in the future require us to have such an attestation if our non-affiliate market capitalization exceeds a certain threshold. We have found material weaknesses in our internal control over financial reporting in the past and cannot assure that in the future our management or our auditors, will not find additional material weaknesses in connection with our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot assure that we could correct all such weaknesses to allow our management to attest that we have maintained effective internal controls over financial reporting as of the end of our fiscal year in time to enable our independent registered public accounting firm to attest that such assessment will have been fairly stated in our Annual Report on Form 10-K to be filed with the Securities and Exchange Commission or attest that we have maintained effective internal control over financial reporting as of the end of our fiscal year. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, fines, or other sanctions or litigation. In addition, the disclosure of any material weakness in our internal control over financial reporting could have a negative impact on our stock price.

 

On June 28, 2018, the SEC adopted amendments that raise the thresholds in the smaller reporting company ("SRC") definition, thereby expanding the number of smaller reporting companies eligible to comply with the scaled disclosure requirements in several Regulation S-K and Regulation S-X items. On March 12, 2020, the SEC adopted an amendment that provides for a new subset of firms with annual revenues of less than $100 million and a public float of $250 million or more, but less than $700 million, or public float of $75 million or more, but less than $250 million, regardless of annual revenues, that also qualify as smaller reporting companies to be exempt from the requirement to have an auditor attestation on its internal controls over financial reporting. The amended definition of a smaller reporting company, and the creation of a new subset of firms that are exempt from the auditor attestation requirement, reduces the likelihood that the Company would be required to have auditor attestation on our internal controls over financial reporting in future periods.

 

Industry Risks

 

Economic conditions could materially adversely affect the Company.

Weakness in domestic markets and global uncertainties exist in many areas of focus for us including the United Kingdom, Japan and the Middle East. Many of our customers rely on local, state or Federal government funding, both domestic and international. The Japanese government provides subsidies to support higher education from time to time but has not been consistent. Any future delay or elimination of government programs will have a negative impact on our operations in Japan. Any continuing unfavorable economic conditions could continue to negatively affect our business operating results or financial condition, which could in turn affect our stock price. Weak economic conditions and the resulting impact on the availability of public funds along with the possibility of state and local budget cuts and reduced university enrollment could lead to a reduction in demand for our products and services. In addition, a prolonged economic downturn could cause insolvency of key suppliers resulting in product delays, inability of customers to obtain credit to finance purchases of the Company’s products and inability or delay of our channel partners and other customers to pay accounts receivable owed to us.

 

Economic conditions may have a disproportionate effect on the sale of our products.

Many of our customers will look at the total A/V equipment and labor cost to outfit a typical conference room or lecture hall as one amount for budgetary purposes. Consequently, although our products represent only a portion of the total cost, the cost of the entire project of outfitting a room or conference hall may be considered excessive and may not survive budgetary constraints. Alternatively, our resellers may modify their quotes to end customers by eliminating our products or substituting less expensive products supplied by our competitors in order to win opportunities within budget constraints. Event service partners may similarly suggest that customers eliminate recording and webcasting as a means of reducing event cost. Consequently, declines in spending by government, educational or corporate institutions due to budgetary constraints may have a disproportionate impact on the Company and result in a material adverse impact on our financial condition.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

We could lose revenues if there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools and other education providers.

Most of our customers and potential customers are public colleges, universities, schools and other education providers who depend substantially on government funding. Accordingly, any general decrease, delay or change in federal, state or local funding for colleges, universities, schools and other education providers could cause our current and potential customers to reduce or delay their purchases of our products and services, or to decide not to renew service contracts, either of which could cause us to lose revenues. In addition, a specific reduction in governmental funding support for products such as ours would also cause us to lose revenues. Unfavorable economic conditions may result in further budget cuts and lead to lower overall spending, including information technology spending, by our current and potential clients, which may cause our revenues to decrease.

 

Changes in U.S. trade policy, including the imposition of tariffs and the resulting consequences, may have a material adverse impact on our business, operating results and financial condition.

The U.S. government has indicated its intent to adopt a new approach to trade policy and in some cases to renegotiate, or potentially terminate, certain existing bilateral or multi-lateral trade agreements. It has also initiated tariffs on certain foreign goods and has raised the possibility of imposing significant, additional tariff increases or expanding the tariffs to capture other types of goods. In response, certain foreign governments have imposed retaliatory tariffs on goods that their countries import from the U.S. Changes in U.S. trade policy have resulted in one or more foreign governments, including China, adopting responsive trade policies that make it more difficult or costly for us to do business in or import our products from those countries.  As a result of tariffs in China, the cost of our products has increased. Additional trade restrictions may lead to increased prices to our customers, which may reduce demand, or, if we are unable to achieve increased prices, result in lowering our margin on products sold.

 

We cannot predict the extent to which the U.S. or other countries will impose quotas, duties, tariffs, taxes or other similar restrictions upon the import or export of our products in the future, nor can we predict future trade policy or the terms of any renegotiated trade agreements and their impact on our business.  The adoption and expansion of trade restrictions, the occurrence of a trade war, or other governmental action related to tariffs or trade agreements or policies has the potential to adversely impact demand for our products, our costs, our customers, our suppliers, and the U.S. economy, which in turn could have a material adverse effect on our business, operating results and financial condition.

 

Privacy concerns and laws, evolving regulation of cloud computing, cross-border data transfer restrictions and other domestic or foreign regulations may limit the use and adoption of our solutions and adversely affect our business.

Regulation related to the provision of services on the Internet is increasing, as federal, state and foreign governments continue to adopt new laws and regulations addressing data privacy and the collection, processing, storage and use of personal information, including health data. In some cases, foreign data privacy laws and regulations, such as the European Union’s General Data Protection Regulation that was enacted in May 2018, and an amended Act on the Protection of Personal Information in Japan, impose new obligations directly on us both as a data controller and a data processor, as well as on many of our customers. These new laws may require us to make changes to our services and/or our customers to meet the new legal requirements, and may also increase our potential liability exposure through higher potential penalties for non-compliance. Further, laws such as the European Union’s proposed e-Privacy Regulation are increasingly aimed at the use of personal information for marketing purposes, and the tracking of individuals’ online activities. These new or proposed laws and regulations are subject to differing interpretations and may be inconsistent among jurisdictions. These and other requirements could reduce demand for our services, require us to take on more onerous obligations in our contracts, restrict our ability to store, transfer and process data or, in some cases, impact our ability to offer our services in certain locations or our customers' ability to deploy our solutions globally. For example, ongoing legal challenges in Europe to the mechanisms allowing companies to transfer personal data from the European Economic Area to the United States could result in further limitations on the ability to transfer data across borders, particularly if governments are unable or unwilling to reach new or maintain existing agreements that support cross-border data transfers, such as the EU-U.S. and Swiss-U.S. Privacy Shield framework. Additionally, certain countries have passed or are considering passing laws requiring local data residency. In addition, domestic data privacy laws, such as the California Consumer Privacy Act (“CCPA”), which took effect in January 2020, continue to evolve and could expose us to further regulatory burdens. Further, laws such as the European Union’s proposed e-Privacy Regulation are increasingly aimed at the use of personal information for marketing purposes, and the tracking of individuals’ online activities. The costs of compliance with, and other burdens imposed by, privacy laws, regulations and standards may limit the use and adoption of our services, reduce overall demand for our services, make it more difficult to meet expectations from or commitments to customers, lead to significant fines, penalties or liabilities for noncompliance, or slow the pace at which we close sales transactions, any of which could harm our business.

 

We likely will need to acquire software and hardware in order to enhance our ability to defend and to detect intrusions to our network infrastructure. These enhancements will be expensive and require significant staff time to deploy and develop. These risks are mitigated, to the extent possible, by our ability to maintain and improve business and data governance policies, enhanced processes and internal security controls, including our ability to escalate and respond to known and potential risks. Our executive management are regularly briefed on our cyber-security policies and practices and ongoing efforts to improve security, as well as periodic updates on cyber-security events. In addition, we update our Audit Committee at least annually regarding our processes for evaluating and mitigating risks including cyber related risks. Although we have developed systems and processes designed to protect our customers’ and our customers’ customers’ proprietary and other sensitive data, we can provide no assurances that such measures will be effective.

 

In addition to government activity, privacy advocacy and other industry groups have established, or may establish, new self-regulatory standards that may place additional burdens on us. Many of our customers in the European Union face increasingly complex procurement requirements that have delayed some projects and caused us not to be successful in winning other opportunities. If we are unable to maintain these certifications or meet these standards, it could adversely affect our ability to provide our solutions to certain customers and could harm our business.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Our customers and potential customers do business in a variety of industries, including financial services, the public sector, healthcare and telecommunications. Regulators in certain industries have adopted and may in the future adopt regulations or interpretive positions regarding the use of cloud computing and other outsourced services. The costs of compliance with, and other burdens imposed by, industry-specific laws, regulations and interpretive positions may limit customers’ use and adoption of our services and reduce overall demand for our services.

 

The costs of compliance with, and other burdens imposed by laws, regulations and standards, may limit the use and adoption of our service and reduce overall demand for it, or lead to significant fines, penalties or liabilities for any noncompliance.

 

Furthermore, concerns regarding data privacy may cause the users of our customers’ data to resist providing the data necessary to allow our customers to use our service effectively. Even the perception that the privacy of personal information is not satisfactorily protected or does not meet regulatory requirements could inhibit sales of our products or services, and could limit adoption of our cloud-based solutions.

 

We face risks associated with government regulation of the internet and related legal uncertainties.

Currently, few existing laws or regulations specifically apply to the Internet, other than laws generally applicable to businesses. Many Internet-related laws and regulations, however, are pending and may be adopted in the United States, in individual states and local jurisdictions and in other countries. These laws may relate to many areas that impact our business, including encryption, network and information security, and the convergence of traditional communication services, such as telephone services, with Internet communications, taxes and wireless networks. These types of regulations could differ between countries and other political and geographic divisions both inside and outside the United States. Non-U.S. countries and political organizations may impose, or favor, more and different regulation than that which has been proposed in the United States, thus furthering the complexity of regulation. Certain countries have implemented, or may implement, legislative and technological actions that either do or can effectively regulate access to the Internet, including the ability of Internet Service Providers to limit access to specific websites or content. In addition, state and local governments within the United States may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for, and the costs associated with, our products and services. The adoption of such laws and regulations may harm our business.

 

Investor Risks

 

The market price of our common stock may be subject to volatility.

In the past and through 2020, the trading prices of the securities of technology companies have been more volatile than the broader market. Factors affecting the market price of our common stock include:

 

 

Variations in our operating results, earnings per share, cash flows from operating activities, deferred revenue and other financial metrics and non-financial metrics, and how those results compare to investor expectations;

 

Our announcement of actual results for a fiscal period that are higher or lower than expected results;

 

Changes in the estimates of our operating results or changes in recommendations by securities analysts that elect to follow our common stock;

 

Announcements of technological innovations, new services or service enhancements, strategic alliances or significant agreements by us or by our competitors;

 

Announcements by us or by our competitors of mergers or other strategic acquisitions, or rumors of such transactions involving us or our competitors;

 

Announcements of customer additions and customer cancellations or delays in customer purchases;

 

Recruitment or departure of key personnel;

 

Disruptions in our service due to computer hardware, software, network or data center problems;

 

The economy, market conditions in our industry and the industries of our customers;

 

The issuance of shares of common stock and preferred stock by us, whether in connection with an acquisition or a capital raising transaction;

 

Low trading volumes of our shares and inconsistent trading activity;

 

Issuance of debt, changes to, defaults or non-renewal of debt facilities and other convertible securities;

 

Failure to meet OTC market requirements; and

 

Any other factors discussed herein.

 

In addition, if the market for technology stocks or the stock market in general experiences uneven investor confidence, the market price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The market price of our common stock might also decline in reaction to events that affect other companies within, or outside, our industry even if these events do not directly affect us.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Our common stock is subject to low trading volume and broad price swings.

Our common stock is quoted on the OTC Market (“OTC Pink Sheets”) administered by the Financial Industry Regulatory Authority under the symbol “SOFO” since February 18, 2019. Prior to that, our common stock was traded on the OTCQB since December 31, 2018 and before that, the NASDAQ exchange under the same symbol. Trading of our stock on the OTC Pink Sheets has often been subject to very low volumes, broad price swings and often with no Company news.

 

Exercise of outstanding options and warrants will result in further dilution.

The issuance of shares of common stock upon the exercise of our outstanding options and warrants will result in dilution to the interests of our stockholders, and may reduce the trading price of our common stock.

 

At September 30, 2020, we had 299 thousand outstanding warrants and 1.7 million of outstanding stock options granted under our stock option plans, 1.4 million of which are immediately exercisable.

 

While nearly all outstanding warrants and options are currently priced above the market price of our common stock, dilution to the interests of our stockholders will likely occur if or when they are exercised. Additional options and warrants may be issued in the future at prices not less than 85% of the fair market value of the underlying security on the date of grant. Exercises of these options, or even the potential of their exercise may have an adverse effect on the trading price of our common stock. The holders of our options are likely to exercise them at times when the market price of the common stock exceeds the exercise price of the securities. Accordingly, the issuance of shares of common stock upon exercise of the options will likely result in dilution of the equity represented by the then outstanding shares of common stock held by other stockholders. Holders of our options can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms, which are more favorable to us than the exercise terms provided, by these options.

 

Provisions of our charter documents and Maryland law could also discourage an acquisition of our Company that would benefit our stockholders and, due to our insiders control of a substantial percentage of our stock, our officers, directors, and major stockholders will have a substantial amount of control over whether to approve or disapprove of a transaction.

Provisions of our articles of incorporation and by-laws may make it more difficult for a third party to acquire control of our company, even if a change in control would benefit our stockholders. Our articles of incorporation authorize our board of directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Furthermore, our articles of incorporation provide for a classified board of directors, which means that our stockholders may vote upon the retention of only one or two of our five directors each year. Moreover, Maryland corporate law restricts certain business combination transactions with “interested stockholders” and limits voting rights upon certain acquisitions of “control shares.” In addition, even when there are no interested stockholders involved in a transaction, Maryland law requires that a transaction involving a merger, consolidation, transfer of assets, or share exchange, must be approved by the affirmative vote of at least two-thirds of the Company’s stockholders.

 

Our executive officers and directors together beneficially own, on an “as converted basis”, over 50% of our outstanding common stock, and Mr. Burish, individually, owns nearly 42% on an as converted basis. As a result, these stockholders, if they act together or in a block, or individually in the case of Mr. Burish, could have significant influence over most matters that require approval by our stockholders, including the approval of significant corporate transactions, even if other stockholders oppose them. In addition, under federal law, in many circumstances a company such as Sonic Foundry is not required to disclose that negotiations relating to a merger or to a sale of its stock or assets are occurring until a material definitive agreement has been reached. Concentration of ownership as described here might also have the effect of delaying or preventing a change of control of our Company that other stockholders may view as beneficial.

 

 

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

Our principal office is located in Madison, Wisconsin in a leased facility of approximately 26,000 square feet. The building serves as our corporate headquarters, accommodating our general and administrative, product development and selling and marketing departments. We believe this facility is adequate for our needs. The current lease term for this office expires on December 31, 2021. The rent for the remainder of the lease period is approximately $60 thousand per month.

 

Our operations in Japan are managed in Tokyo, Japan in a leased facility of approximately 9,874 square feet with a term expiring on December 31, 2021. The facility includes sales, technical and administrative functions. The rent through December 31, 2020 is approximately $41 thousand per month. Beginning on January 1, 2021, the monthly rent will increase to approximately $55 thousand per month.

 

Our European operations are managed in Utrecht, Netherlands in a leased facility of approximately 3,886 square feet with a term expiring on January 31, 2022. The facility includes sales, technical and administrative functions. The rent for the remainder of the lease period is approximately $5 thousand per month.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

ITEM 3. LEGAL PROCEEDINGS

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Price Range of Common Stock

 

Our common stock was initially traded on the American Stock Exchange under the symbol “SFO,” beginning with our initial public offering in April of 1998. On April 24, 2000, our common stock began trading on the NASDAQ Global Market under the symbol “SOFO.” Effective September 16, 2009, we transferred the listing of our common stock to the NASDAQ Capital Market. Effective December 31, 2018, we transferred the listing of our common stock to the OTCQB Market under the symbol "SOFO". Effective February 18, 2019, we transferred the listing of our common stock to the OTC Pink Sheets under the symbol "SOFO". The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported on the NASDAQ Capital Market, the OTCQB Market, and the OTC Pink Sheets.

 

   

High

   

Low

 

Year Ended September 30, 2021:

               

First Quarter (through November 27, 2020)

    3.80       2.76  

Year Ended September 30, 2020:

               

First Quarter

    1.40       0.92  

Second Quarter

    3.95       1.28  

Third Quarter

    5.23       2.00  

Fourth Quarter

    4.96       3.07  

Year Ended September 30, 2019:

               

First Quarter

    1.71       0.60  

Second Quarter

    1.77       0.62  

Third Quarter

    1.17       0.72  

Fourth Quarter

    1.44       0.86  

 

Dividends

 

The Company has not paid any cash dividends and does not intend to pay any cash dividends in the foreseeable future. The Company is prohibited from paying any cash dividends pursuant to the terms of the loan and security agreement with Partners for Growth.

 

 

Conversion of Related-Party Debt to Equity

 

On March 5, 2020, the Company announced that its special committee of disinterested and independent directors retained Silverwood Partners LLC, an investment banking firm specializing in digital media technology, to evaluate strategic alternatives for the Company. 

 

On April 8, 2020, the company received an offer from Mr. Mark Burish, the current Chairman of the Board, to purchase all outstanding shares of the Company’s common stock not presently held by Mr. Burish for $5.00 per share. After concluding no other strategic alternatives existed for the Company at that time, the Company announced on April 27, 2020 that its special committee of disinterested and independent directors had accepted the offer from Mr. Burish.  

 

Shortly following the announcement, however, a number of shareholders advised they were opposed to the transaction and felt opportunities available to the company now, in view of the video-first, distance learning environment resulting from the COVID crisis, may provide pathways to achieve greater value.  Concerned that a proposal would not obtain the required shareholder approval, the ompany and Mr. Burish agreed to not pursue the transaction at that time, and instead, continue to pursue other strategic alternatives to enhance both Company and shareholder value, improve the Company’s financial position, and provide the Company with resources to further its growth opportunities. 

 

On May 14, 2020, the Company announced it had agreed to convert $5.6 million of existing secured debt to Mr. Burish into 1,114,723 shares of its common stock at $5.00 per share.  The transaction was recommended by the Company’s special committee of disinterested and independent directors and unanimously approved by all disinterested directors of the Company.  Silverwood Partners LLC issued a fairness opinion in connection with the transaction. 

 

 

 

 

 

 

 

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

 

 

 

 

The Company relied on Section 4(a)(2) of the Securities Act of 1933, as amended, to issue the Promissory Notes and stock, inasmuch as the director and the affiliated party both received from the Company information that registration would provide and neither the Company nor any person acting on its behalf offered or sold the Notes or stock by any form of general solicitation or general advertising.

 

 

Holders

 

At December 14, 2020, there were 227 common stockholders of record and approximately 3,000 total shareholders. Many shares are held by brokers and other institutions on behalf of shareholders.

 

Equity Compensation Plan Information

 

                   

Number of

 
   

Number of securities

   

Weighted average

   

securities

 
   

to be issued upon

   

exercise price of

   

remaining

 
   

exercise of

   

outstanding

   

available for

 

Plan category

 

outstanding options

   

options

   

future issuance

 
                   

Equity compensation plans approved by security holders (1)

    1,707,515     $ 5.09       967,117  

Equity compensation plans not approved by security holders (2)

                 

Total

    1,707,515     $ 5.09       967,117  

 

 

(1)

Consists of the 2009 Stock Incentive Plan, Employee Incentive Stock Option Plan and the Directors Stock Option Plans. For further information regarding these plans, reference is made to Note 5 of the financial statements.

 

(2)

Consists of the Non-Qualified Stock Option Plan. For further information regarding this plan, reference is made to Note 5 of the financial statements.

 

 

 

 

 

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

 

The selected financial and operating data were derived from our consolidated financial statements. The selected financial data set forth below is qualified in its entirety by, and should be read in conjunction with, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto appearing elsewhere in this annual report on Form 10-K (in thousands except per share data).

 

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

   

Years Ended September 30,

 
   

2020

   

2019

   

2018

   

2017

   

2016

 

Statement of Operations Data:

                                       

Revenue

  $ 34,753     $ 34,781     $ 34,544     $ 36,000     $ 37,975  

Cost of revenue

    9,634       9,280       9,656       9,867       9,985  

Gross margin

    25,119       25,501       24,888       26,133       27,990  

Operating expenses

    24,383       28,009       29,118       30,091       30,266  

Impairment of goodwill & intangible assets

                11,809       600        

Income (loss) from operations

    736       (2,508 )     (16,039 )     (4,558 )     (2,276 )

Other income (expense), net

    (109 )     (117 )     142       (65 )     (178 )

Interest expense, net

    (658 )     (897 )     (601 )     (495 )     (594 )

Benefit (provision) for income taxes

    (148 )     (90 )     4,332       79       (269 )

Net loss

  $ (179 )   $ (3,612 )   $ (12,166 )   $ (5,039 )   $ (3,317 )

Dividends on preferred stock

  $     $ (122 )   $ (257 )   $ (169 )   $  

Net loss attributable to common shareholders

  $ (179 )   $ (3,734 )   $ (12,423 )   $ (5,208 )   $ (3,317 )

Basic net loss per common share

  $ (0.02 )   $ (0.64 )   $ (2.67 )   $ (1.17 )   $ (0.76 )

Diluted net loss per common share

  $ (0.02 )   $ (0.64 )   $ (2.67 )   $ (1.17 )   $ (0.76 )

Weighted average common shares:

                                       

– Basic

    7,216,135       5,833,301       4,655,520       4,436,333       4,389,421  

– Diluted

    7,216,135       5,833,301       4,655,520       4,436,333       4,389,421  

 

Balance Sheet Data at September 30:

 

2020

   

2019

   

2018

   

2017

   

2016

 

Cash and cash equivalents

  $ 7,619     $ 4,295     $ 1,189     $ 1,211     $ 1,794  

Working capital (deficit)

    (1,488 )     (847 )     (5,765 )     (4,833 )     (3,720 )

Total assets

    22,629       15,180       13,583       28,356       33,082  

Long-term liabilities

    5,373       7,602       3,451       8,147       7,249  

Stockholders’ equity (deficit)

    (1,048 )     (6,253 )     (6,458 )     3,118       6,516  
 

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The financial and business analysis below provides information that Sonic 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.

 

 

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 with Financial 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.

 

 

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 at September 30, 2020 and $661 thousand at September 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.

 

 

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 for U.S. income taxes on the undistributed earnings of our foreign subsidiaries, which we consider to be permanently invested outside of the U.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 of September 30, 2020 and 2019, valuation allowances have been established for all U.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 the U.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.

 

 

 

 

 

 

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 $34.8 million. Revenue consisted of the following:

 

 

 

 

Product and other revenue from the sale of Mediasite recorder units and server software decreased from $11.6 million in fiscal 2019 to $10.3 million in fiscal 2020. Mediasite recorder revenue declined $1.1 million from fiscal 2019 to 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)

  $5.30     $5.30  

Refresh Units

  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 $23.2 million in fiscal 2019 to $24.4 million in fiscal 2020 primarily due to increases in custom development and hosting revenues as compared to fiscal 2019.

 

 

At September 30, 2020, $12.1 million of revenue was deferred, of which we 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 in deferred 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 the UK.  

 

 

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 $1.7 million, or 12%, from $14.7 million in fiscal 2019 to $13.0 million in fiscal 2020. Fluctuations in the major categories include:

 

 

Salary, commissions and benefits decreased by $760 thousand due to reduced headcount in the later half of 2019.
 

Advertising and professional services decreased by $209 thousand.
 

T&E decreased $691 thousand due to the impact of COVID on travel beginning in February 2020.  

 

Selling and marketing expenses for Sonic Foundry International and MSKK accounted for $653 thousand and $2.6 million, respectively in fiscal 2020, an 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 $874 thousand, or 15%, to $5.1 million in fiscal 2020 from $5.9 million in fiscal 2019. Fluctuations in major categories include:

 

 

Decrease in non-severance related compensation and benefits of $347 thousand due to attrition in Q2 of fiscal 2020.  

 

Decrease in severance expense for executives of $93 thousand.

 

Increase in professional fees of $207 thousand due to costs associated with the work of the special committee.
 

Depreciation decreased $148 thousand compared to fiscal 2019.

 

G&A expenses for Sonic Foundry International and MSKK accounted for $288 thousand and $880 thousand, respectively, in fiscal 2020, an aggregate decrease of $246 thousand from the prior year.

 

At September 30, 2020, we had 16 full-time employees in G&A, a decrease from 23 full-time employees at September 30, 2019. Of the 16 employees in G&A at September 30, 2020, 5 are employed by our foreign subsidiaries. We do not anticipate an increase in G&A headcount in fiscal 2021.

 

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 $1.1 million, or 14%, from $7.4 million in fiscal 2019 to $6.3 million in fiscal 2020. Fluctuations include:

 

 

Decrease in compensation and benefits of $1.1 million due to the elimination 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 $170 thousand due to the utilization of non-recurring engineering resources.

 

Product development expenses for Sonic Foundry International and MSKK accounted for $457 thousand and $318 thousand, respectively, for fiscal 2020, an aggregate increase of $11 thousand from the prior year related to the 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.

 

 

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 in Japan and the 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.

 

 

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 the UK that went live in September 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 with Mr. 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 September 30, 2020, there was no balance outstanding on the line of credit with Mitsui Sumitomo Bank. 

 

At September 30, 2020, the Company had $860 thousand outstanding, net of warrant debt and debt discounts, related to notes payable with PFG V.  At September 30, 2019,  the Company had $6.4 million outstanding, net of warrant debt and debt discounts, related to notes payable with PFG V and Mr. Burish.  During fiscal 2020, the Company fully converted $5.6 million of subordinated debt due to Mr. Burish into common stock, which did not and will not require cash settlement.

 

At September 30, 2020 approximately $2.3 million of cash and cash equivalents was held by the Company’s foreign subsidiaries.

 

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.

 

 

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

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Derivative Financial Instruments

 

Pursuant to Item 305 of Regulation S-K, the Company, as a smaller reporting company, is not required to provide the information required by this item.

 

Interest Rate Risk

 

Our cash equivalents, which consist of overnight money market funds, are subject to interest rate fluctuations, however, we believe this risk is minimal due to the short-term nature of these investments.

 

At September 30, 2020, none of the Company’s $3.8 million in outstanding debt is variable rate, therefore we an increase in the level of interest rates would not have a material impact on our Consolidated Financial Statements. We monitor our positions with, and the credit quality of, the financial institutions that are party to any of our financial transactions.

 

Foreign Currency Exchange Rate Risk

 

The functional currency of our foreign subsidiaries in the Netherlands is the Euro and in Japan is the Japanese Yen. They are subject to foreign currency exchange rate risk. Any increase or decrease in the exchange rate of the U.S. Dollar compared to the Euro or Japanese Yen will impact our future operating results and financial position.

 

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

To the Shareholders, Audit Committee and Board of Directors

Sonic Foundry, Inc. and Subsidiaries

 

Opinion on the Consolidated Financial Statements

 

We have audited the accompanying consolidated balance sheets of Sonic Foundry, Inc. and Subsidiaries (the “Company”) as of September 30, 2020 and 2019, and the related statements of operations, comprehensive loss, stockholders’ equity (deficit), and cash flows for the years ended September 30, 2020 and 2019, and the related notes (collectively referred to as the “consolidated financial statements”).  In our opinion, the consolidated financial statements present fairly, in all material aspects, the financial position of the Company at September 30, 2020 and 2019 and the results of its operations and its cash flows for the years ended September 30, 2020 and 2019, in conformity with accounting principles generally accepted in the United States of America.

 

Change in Accounting Principle

 

As discussed in Note 1 to the financial statements, the Company changed its method of accounting for leases for the year ended September 30, 2020, due to the adoption of Accounting Standards Update No. 2016-02, Leases (Topic 842), and its related amendments.

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits.  We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB.  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.

Accordingly, we express no such opinion. 

 

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks.  Such procedures included examining on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements.  Our audits also included evaluating the accounting principles used and the significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.  We believe that our audits provide a reasonable basis for our opinion. 

 

/s/ Wipfli LLP

 

We have served as the Company’s auditor since 2019.

 

Minneapolis, Minnesota

December 22, 2020

 

 

 

 

 

Sonic Foundry, Inc.

Consolidated Balance Sheets

(in thousands, except for share and per share data)

 

 

   

September 30,

 
   

2020

   

2019

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 7,619     $ 4,295  

Accounts receivable, net of allowances of $236 and $135

    6,250       6,532  

Inventories

    1,167       558  

Investment in sales-type lease, current

    275       163  

Capitalized commissions, current

    440       464  

Prepaid expenses and other current assets

    1,065       972  

Total current assets

    16,816       12,984  

Property and equipment:

               

Leasehold improvements

    1,128       1,121  

Computer equipment

    7,960       5,610  

Furniture and fixtures

    1,366       1,233  

Total property and equipment

    10,454       7,964  

Less accumulated depreciation and amortization

    7,295       6,396  

Property and equipment, net

    3,159       1,568  

Other assets:

               

Investment in sales-type lease, long-term

    76       134  

Capitalized commissions, long-term

    100       106  

Right-of-use assets under operating leases

    2,081        

Other long-term assets

    397       388  

Total assets

  $ 22,629     $ 15,180  

Liabilities and stockholders’ equity (deficit)

               

Current liabilities:

               

Accounts payable

    2,689       843  

Accrued liabilities

    2,565       2,216  

Unearned revenue

    10,402       9,610  

Current portion of finance lease obligations

    119       194  

Current portion of operating lease obligations

    1,425        

Current portion of notes payable and warrant debt, net of discounts

    1,104       968  

Total current liabilities

    18,304       13,831  

Long-term portion of unearned revenue

    1,736       1,842  

Long-term portion of finance lease obligations

    89       179  
Long-term portion of operating lease obligations     665        

Long-term portion of notes payable and warrant debt, net of discounts

    2,673       5,429  

Derivative liability, at fair value

    66       9  

Other liabilities

    144       143  

Total liabilities

    23,677       21,433  

Commitments and contingencies

               

Stockholders’ equity (deficit):

               

Preferred stock, $.01 par value, authorized 500,000 shares; none issued

           

9% Preferred stock, Series A, voting, cumulative, convertible, $.01 par value (liquidation preference of $1,000 per share), authorized 4,500 shares; zero shares issued and outstanding, at amounts paid in

           

5% Preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 1,000,000 shares, none issued

           

Common stock, $.01 par value, authorized 10,000,000 shares; 7,965,325 and 6,749,359 shares issued and 7,952,609 and 6,736,643 shares outstanding

    80       67  

Additional paid-in capital

    209,022       203,735  

Accumulated deficit

    (209,519 )     (209,340 )

Accumulated other comprehensive loss

    (462 )     (546 )
Treasury stock, at cost, 12,716 shares     (169 )     (169 )
Total stockholders’ equity (deficit)     (1,048 )     (6,253 )
Total liabilities and stockholders’ equity (deficit)   $ 22,629     $ 15,180  

 

See accompanying notes to the consolidated financial statements.

 

 

 

Sonic Foundry, Inc.

Consolidated Statements of Operations

(in thousands, except for share and per share data)

 

 

   

Years Ended September 30,

 
   

2020

   

2019

 

Revenue:

               

Product and other

  $ 10,339     $ 11,631  

Services

    24,414       23,150  

Total revenue

    34,753       34,781  

Cost of revenue:

               

Product and other

    4,430       4,387  

Services

    5,204       4,893  

Total cost of revenue

    9,634       9,280  

Gross margin

    25,119       25,501  

Operating expenses:

               

Selling and marketing

    13,025       14,727  

General and administrative

    5,055       5,929  

Product development

    6,303       7,353  

Total operating expenses

    24,383       28,009  

Income/(loss) from operations

    736       (2,508 )

Non-operating income (expenses):

               

Interest expense, net

    (658 )     (897 )

Other expense, net

    (109 )     (117 )

Total non-operating expenses

    (767 )     (1,014 )

Loss before income taxes

    (31 )     (3,522 )

Income tax provision

    (148 )     (90 )

Net loss

  $ (179 )   $ (3,612 )

Dividends on preferred stock

          (122 )

Net loss attributable to common stockholders

  $ (179 )   $ (3,734 )

Loss per common share:

               

Basic net loss per common share

  $ (0.02 )   $ (0.64 )

Diluted net loss per common share

  $ (0.02 )   $ (0.64 )

Weighted average common shares – Basic

    7,216,135       5,833,301  

– Diluted

    7,216,135       5,833,301  

 

See accompanying notes to the consolidated financial statements.

 

 

 

Sonic Foundry, Inc.

Consolidated Statements of Comprehensive Loss

(in thousands)

 

 

   

Years Ended September 30,

 
   

2020

   

2019

 

Net loss

  $ (179 )   $ (3,612 )
Other comprehensive loss                

Foreign currency translation adjustment

    84       130  

Comprehensive loss

  $ (95 )   $ (3,482 )

 

See accompanying notes to the consolidated financial statements.

 

 

 

Sonic Foundry, Inc.

Consolidated Statements of Stockholders’ Equity (Deficit)

(in thousands)

 

 

                                   

Accumulated

   

Receivable

                 
                   

Additional

           

other

   

for common

                 
    Preferred     Common     paid-in     Accumulated     comprehensive     stock     Treasury        
   

stock

   

stock

   

capital

   

deficit

   

loss

   

issued

   

stock

   

Total

 

Balance, September 30, 2018

  $ 1,651     $ 51     $ 200,130     $ (205,728 )   $ (676 )   $ (26 )   $ (169 )   $ (4,767 )

Stock compensation

                177                               177  

Conversion of preferred stock

    (1,773 )     6       1,767                                

Issuance of common stock and warrants

          10       1,109                               1,119  

Warrants issued in connection with subordinated notes payable

                674                               674  

Preferred stock dividends

    122             (122 )                              

Cancellation of receivable for common stock issued

                                  26             26  

Foreign currency translation adjustment

                            130                   130  

Net loss

                      (3,612 )                       (3,612 )

Balance, September 30, 2019

  $     $ 67     $ 203,735     $ (209,340 )   $ (546 )   $     $ (169 )   $ (6,253 )

Stock compensation

                158                               158  

Issuance of common stock and warrants

          2       135                               137  

Common stock issued for extinguishment of related-party debt

          11       4,994                               5,005  

Foreign currency translation adjustment

                            84                   84  

Net loss

                      (179 )                       (179 )

Balance, September 30, 2020

  $     $ 80     $ 209,022     $ (209,519 )   $ (462 )   $     $ (169 )   $ (1,048 )

 

See accompanying notes to the consolidated financial statements.

 

 

 

Sonic Foundry, Inc.

Consolidated Statements of Cash Flows

(in thousands)

 

 

   

Years Ended

 
   

September 30,

 
   

2020

   

2019

 

Operating activities

               

Net loss

  $ (179 )   $ (3,612 )

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

               

Amortization of other intangibles

    231       307  

Depreciation and amortization of property and equipment

    889       970  

Loss on sale of fixed assets

          8  

Provision for doubtful accounts - including financing receivables

    111       116  

Provision for inventory reserve

    122        

Loss on extinguishment of related party debt for equity

    26        

Stock-based compensation expense related to stock options and warrants

    158       177  

Stock issued for board of director's fees

    63       246  

Deferred loan interest to related party

    317       259  

Remeasurement loss (gain) on derivative liability

    57       (8 )

Changes in operating assets and liabilities:

               

Accounts receivable

    268       950  

Financing receivables

          293  

Inventories

    (729 )     472  

Investment in sales-type lease

    (48 )     120  

Capitalized commissions

    30       123  

Prepaid expenses and other current assets

    (57 )     15  

Right-of-use assets under operating leases

    492        

Operating lease obligations

    (528 )      

Other long-term assets

           

Accounts payable and accrued liabilities

    1,503       (204 )

Other long-term liabilities

    (2 )     (68 )

Unearned revenue

    617       (900 )

Net cash provided by (used in) operating activities

    3,341       (736 )

Investing activities

               

Purchases of property and equipment

    (1,736 )     (433 )

Net cash used in investing activities

    (1,736 )     (433 )

Financing activities

               

Proceeds from notes payable

    3,157       5,500  

Proceeds from lines of credit

          9,199  

Payments on notes payable

    (1,358 )     (833 )

Payments on lines of credit

          (10,098 )

Payments of debt issuance costs

          (110 )

Proceeds from issuance of common stock

    73       873  

Payments on capital lease and financing arrangements

    (202 )     (250 )

Net cash provided by financing activities

    1,670       4,281  

Changes in cash and cash equivalents due to changes in foreign currency

    49       (6 )

Net increase in cash and cash equivalents

    3,324       3,106  

Cash and cash equivalents at beginning of year

    4,295       1,189  

Cash and cash equivalents at end of year

  $ 7,619     $ 4,295  

Supplemental cash flow information:

               

 

 

Sonic Foundry, Inc.

Consolidated Statements of Cash Flows

(in thousands)

 

 

Interest paid

  $ 148     $ 618  

Income taxes paid, foreign

    154       99  

Non-cash financing and investing activities:

               

Property and equipment financed by finance lease or accounts payable

    724       186  

Debt discount and warrant

          679  

Preferred stock dividend paid in additional shares

          122  

Conversion of preferred shares to common shares

          1,773  
Common stock issued for extinguishment of related party debt     5,005        

 

See accompanying notes to the consolidated financial statements.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

 

1. Basis of Presentation and Significant Accounting Policies

 

Business

 

Sonic Foundry, Inc. (the Company) is in the business of providing video enterprise solutions and services for the digital-first, distance learning and corporate communications market.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Sonic Foundry Media Systems, Inc., Sonic Foundry International B.V. (formerly Media Mission B.V.) and Mediasite K.K. All significant intercompany transactions and balances have been eliminated.

 

Use of Estimates

 

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America (US GAAP), management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expense during the period. Actual results could differ from those estimates.

 

Assets Recognized from the Costs to Obtain a Contract with a Customer

 

Sales commissions and related expenses are considered incremental and recoverable costs of acquiring customer contracts. These costs are capitalized and amortized on a straight-line basis over the anticipated period of benefit, which we have determined to be the contract period, typically around 12 months. Assets recorded are included in current assets and other long-term assets. Amortization expense is recorded in sales and marketing expense within our consolidated statement of operations. We calculate a quarterly average percentage based on actual commissions incurred on billings during the same period and apply that percentage to the respective periods’ unearned revenues to determine the capitalized commission amount.

 

Revenue Recognition

 

We generate revenues in the form of hardware sales of our Mediasite recorder and Mediasite related products, such as our server software and other software licenses and related customer support and services fees, including hosting, installations and training, and events services. Software license revenues include fees from sales of perpetual and term licenses. Maintenance and services revenues primarily consist of fees for maintenance services (including support and unspecified upgrades and enhancements when and if they are available), hosting, installation, training and other professional services.

 

Invoices are billed when a customer contract, purchase order or signed quote is obtained from the customer. No revenue is recognized prior to such a customer authorization. In some renewal circumstances, we continue to provide services, typically customer support, during the period when our sales team is working to obtain a customer authorization to avoid customer attrition. Typically, we would bill for this period such that the customer support contract does not lapse. Consistent with historical company practices, we would recognize revenue for the periods where services have already been rendered once customer authorization has occurred.

 

Products

 

Products are considered delivered, and revenue is recognized, when title and risk of loss have been transferred to the customer or upon customer acceptance if non-delivered products or services are essential to the functionality of delivered products. Under the terms and conditions of the sale, this occurs at the time of shipment to the customer. Product revenue currently represents sales of our Mediasite recorder and Mediasite related products such as our server software and other software licenses.

 

Services

 

The Company sells support and content hosting contracts to our customers, typically one year in length, and records the related revenue ratably over the contractual period. Our support contracts cover phone and electronic technical support availability over and above the level provided by our dealers, software upgrades on a when-and-if-available basis, advance hardware replacement and an extension of the standard hardware warranty from 90 days to one year. The manufacturers the Company contracts with to build the units provide a limited one-year warranty on the hardware. The Company also sells installation, training, event webcasting, and customer content hosting services. Revenue for those services is recognized when performed in the case of installation, training and event webcasting services. Occasionally, the Company will sell customization services to enhance the server software. Revenue from those services is recognized when performed, if perfunctory, or under contract accounting. Service amounts invoiced to customers in excess of revenue recognized are recorded as deferred revenue until the revenue recognition criteria are met.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Revenue Recognition

 

In accordance with ASC Topic 606, Revenue from Contracts with Customers ("ASC 606"), revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods and services. To achieve this core principle, we apply the following five steps:

 

 

1.

Identify the contract with a customer. A contract with a customer exists when: (1) we and the customer have approved the contract and both parties are committed to perform their respective obligations; (2) we can identify each party’s rights regarding the products or services to be transferred; (3) we can identify the payment terms for the products or services to be transferred; (4) the contract has commercial substance as our future cash flows are expected to change; and (5) it is probable that we will collect substantially all of the consideration to which we are entitled in exchange for the products or services. Any subsequent contract modifications are analyzed to determine the treatment of the contract modification as a separate contract, prospectively or through a cumulative catch-up adjustment.

 

2.

Identify the performance obligations in the contract. Performance obligations are promises to transfer a good or service to the customer. Performance obligations may be each individual promise in a contract, or may be groups of promises within a contract that significantly affect one another. To the extent a contract includes multiple promises, we must apply judgment to determine whether promises are capable of being distinct and distinct in the context of the contract. If these criteria are not met, the promises are accounted for as a combined performance obligation.

 

3.

Determine the transaction price. The transaction price is the total amount of consideration to which we expect to be entitled in exchange for transferring promised products and services to a customer.

 

4.

Allocate the transaction price to performance obligations in the contract. The allocation of the transaction price to performance obligations is generally done in proportion to their standalone selling prices (“SSP”). SSP is the price that we would sell a distinct product or service separately to a customer and is determined at contract inception. If SSP is not available through the analysis of observable inputs, this step is subject to significant judgment and additional analysis so that we can establish an estimated SSP. The estimated SSP considers historical information, including demand, trends and information about the customer or class of customers.

 

 

5.

Recognize revenues when or as the company satisfies a performance obligation. We recognize revenues when, or as, distinct performance obligations are satisfied by transferring control of the product or service to the customer. A performance obligation is considered transferred when the customer obtains control of the product or service. 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. Revenue is recognized when performance obligations are satisfied.

 

Our contract payment terms are typically net 30 days. We assess collectability based on a number of factors including collection history and creditworthiness of the customer, and we may mitigate exposures to credit risk by requiring payments in advance. If we determine that collectability related to a contract is not probable, we may not record revenue until collectability becomes probable later.

 

Our revenues are recorded based on the transaction price excluding amounts collected on behalf of third parties such as sales taxes, which are collected on behalf of and remitted to governmental authorities.

 

Nature of Products and Services

 

Certain software licenses are sold either on-premise 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-premise software licenses is generally recognized upfront at the point in time when the software is made available to the customer. Revenue from term-based hosted licenses are recognized ratably over the term of the agreement.

 

Our contracts with customers for on-premise and hosted 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 over the term of the agreement. 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 recognized as the services are performed.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

In the case of the Company’s hardware products with embedded software, the Company has determined that the hardware and software components function together to deliver the product’s essential functionality, and therefore, are considered to be one performance obligation. The revenue from the sale of these products along with other products and services we provide requires an allocation of transaction price based on the stand-alone selling price of each component.

 

The Company also offers hosting services bundled with events services. The Company recognizes events revenue when the event takes place and recognizes the hosting revenue over the term of the hosting agreement.

 

Judgments and Estimates

 

Our contracts with customers often include promises to transfer multiple products and services. Determining whether products and services are considered distinct performance obligations that should be accounted for separately from one another sometimes requires judgment.

 

Judgment is required to determine standalone selling prices (“SSP”) for each distinct performance obligation. We typically have more than one SSP for each of our products and services based on customer stratification, which is based on the size of the customer, their geographic region and market segment. We use a cost plus margin approach to determine SSPs for hardware. We use historical sales data to determine SSPs for perpetual software licenses. For both on-premise and term-hosted agreements, events services, training and professional services, SSPs are generally observable using internally developed pricing calculators and/or price sheets. For maintenance services, SSPs are generally observable using historical renewal data.

 

Concentration of Credit Risk and Other Risks and Uncertainties

 

As of September 30, 2020, of the $7.6 million in cash and cash equivalents, $5.3 million is deposited with 2 major U.S. financial institutions. At times, deposits in these institutions exceed the amount of insurance provided on such deposits. The Company has not experienced any losses on such amounts and believes that it is not exposed to any significant credit risk on these balances. The remaining $2.3 million of cash and cash equivalents is held by our foreign subsidiaries in financial institutions in Japan and the Netherlands and held in their local currency. The cash held in foreign financial institutions is not guaranteed. If the funds held by our foreign subsidiaries were needed for our operations in the United States, the repatriation of some of these funds to the United States could require payment of additional U.S. taxes.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

The Company’s wholly-owned subsidiaries operate in Japan and the 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.

 

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.

 

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 at September 30, 2020 and $661 thousand at September 30, 2019.

 

Currently the majority of our product inventory purchases are from one third-party contract manufacturer. Although we believe there are multiple sources of supply from other contract manufacturers as well as multiple suppliers of component parts required by the contract manufacturers, a disruption of supply of component parts or completed products, even if short term, would have a material negative impact on our revenues. At September 30, 2020 and 2019, this supplier represented 33% and 31%, respectively, of total accounts payable. We also license technology from third parties that is embedded in our software. We believe there are alternative sources of similar licensed technology from other third parties that we could also embed in our software, although it could create potential programming related issues that might require engineering resources.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

 

Trade Accounts Receivable

 

The majority of the Company’s accounts receivable are due from entities in, or distributors or value-added resellers to, the education, corporate and government sectors. Credit is extended based on evaluation of a customer’s financial condition and, generally, collateral is not required. Accounts receivable are typically due within 30 days and are stated at amounts due from customers net of an allowance for doubtful accounts. Accounts outstanding longer than the contractual payment terms are considered to be past due. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Company’s previous loss history, the customer’s current ability to pay its obligation to the Company, and the condition of the general economy and the industry as a whole. The Company writes-off accounts receivable when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. Interest is not accrued on past due receivables.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Financing Receivables

 

Financing receivables consist of customer receivables resulting from the sale of the Company's products and services, primarily software and long-term customer support contracts, and are presented net of allowance for losses. The Company has a single portfolio consisting of fixed-term receivables, which is further segregated into two classes based on type of product and lease.

 

Amounts receivable of $526 thousand at September 30, 2019 primarily represent sales of perpetual software licenses to a single international distributor on invoices outstanding for product delivered from March 2016 through June 2017.  

 

The Company generally determines its allowance for losses on financing receivables at the customer class level by considering a number of factors, including the length of time financing receivable are past due, historical and anticipated experience, the customer’s current ability to pay its obligation, and the condition of the general economy and the industry as a whole. The Company writes-off financing receivables when they become uncollectible, and payments subsequently received on such receivables are credited to the allowance for financing receivable losses. Interest is not accrued on past due receivables.  There was an allowance of $526 thousand at September 30, 2019.

 

During fiscal year 2020, it was determined that the financing receivable would not be collected.  Therefore, both the financing receivable of $526 thousand and the corresponding reserve of $526 thousand were written off.

 

Investment in Sales-Type Lease

 

The Company has entered into sales-type lease arrangements with certain customers, consisting of recorders leased with terms ranging from 3-5 years.

 

Investment in sales-type leases consisted of the following (in thousands) as of September 30, 2020:

 

Investment in sales-type lease, gross:

       

2021

  $ 276  

2022

    76  

Gross investment in sales-type lease

    352  

Less: Unearned income

    (1 )

Total investment in sales-type lease

  $ 351  
         

Current portion of total investment in sales-type lease

  $ 275  

Long-term portion of total investment in sales-type lease

    76  
    $ 351  

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Inventory

 

Inventory consists of raw materials and supplies used in the assembly of Mediasite recorders and finished units. Inventory of completed units and spare parts are carried at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis.

 

Inventory consists of the following (in thousands):

 

   

September 30,

 
   

2020

   

2019

 

Raw materials and supplies

  $ 267     $ 163  

Finished goods

    1,022       395  
Less: Obsolescence reserve     (122 )      
Inventories   $ 1,167     $ 558  

 

Software Development Costs

 

Software development costs incurred in conjunction with product development are charged to research and development expense until technological feasibility is established. Thereafter, until the product is released for sale, software development costs are capitalized and reported at the net realizable value of the related product. Typically, the period between achieving technological feasibility of the Company’s products and the general availability of the products has been short. Consequently, software development costs qualifying for capitalization are typically immaterial and are generally expensed to research and development costs.

 

Property and Equipment

 

Property and equipment are recorded at cost and are depreciated using the straight-line method for financial reporting purposes. The estimated useful lives used to calculate depreciation are as follows:

 

   

Years

 
   

(In Years)

 

Leasehold improvements

    5 to 15  

Computer equipment

    1.5 to 5  

Furniture and fixtures

    3 to 15  

 

Depreciation expense is not included in cost of good sold.

 

Impairment of Long-Lived Assets

 

Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset. Key assumptions utilized in the analysis of undiscounted cash flows for each asset or asset group being tested included 1) whether cash flows were attributable solely to the asset or group, or to an entire reporting unit; and 2) the useful lives of the asset or asset group. Forecasts used in the analysis were also consistent with those used in determining fair value of reporting units during goodwill impairment testing.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Asset Retirement Obligation

 

An asset retirement obligation (“ARO”) associated with the retirement of a tangible long-lived asset is recognized as a liability in the period in which it is incurred or becomes determinable, with an associated increase in the carrying amount of the related long-term asset.  The cost of the tangible asset, including the initially recognized asset retirement cost, is depreciated over the useful life of the asset.  As of September 30, 2020, the Company has recorded a liability of $134 thousand for retirement obligations associated with returning the MSKK leased property to the respective lessors upon the termination of the lease arrangement. 

 

A summary of the changes in the ARO is included in the table below (amounts in thousands):

 

Asset retirement obligation at September 30, 2018

  $ 121  

Accretion expense

    2  
Foreign currency changes     6  

Asset retirement obligation at September 30, 2019

    129  

Accretion expense

    2  

Foreign currency changes

    3  

Asset retirement obligation at September 30, 2020

  $ 134  

 

Comprehensive Loss

 

Comprehensive loss includes disclosure of financial information that historically has not been recognized in the calculation of net income. Our comprehensive loss encompasses net loss and foreign currency translation adjustments. Assets and liabilities of international operations that have a functional currency that is not in U.S. dollars are translated into U.S. dollars at year-end exchange rates, and revenue and expense items are translated using weighted average exchange rates. Any adjustments arising on translation are included in stockholders’ equity (deficit) as an element of accumulated other comprehensive loss.

 

Advertising Expense

 

Advertising costs included in selling and marketing, are expensed when the advertising first takes place. Advertising expense was $395 thousand and $444 thousand for years ended September 30, 2020 and 2019, respectively.

 

Research and Development Costs

 

Research and development costs represent product development and are expensed in the period incurred, unless they meet the criteria for capitalized software development costs.

 

Income Taxes

 

Deferred tax assets and liabilities are determined based on differences between the financial statement and tax basis 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 for U.S. income taxes on the undistributed earnings of our foreign subsidiaries, which we consider to be permanently invested outside of the U.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 of September 30, 2020 and 2019, valuation allowances have been established for all U.S. and for certain foreign deferred tax assets which we believe do not meet the “more likely than not” criteria for recognition.

 

The Company also accounts for the uncertainty in income taxes related to the recognition and measurement of a tax position and measurement of a tax position taken or expected to be taken in an income tax return. The Company follows the applicable accounting guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure related to the uncertainty in income tax positions.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Fair Value of Financial Instruments

 

In determining the fair value of financial assets and liabilities, the Company currently utilizes market data or other assumptions that it believes market participants would use in pricing the asset or liability in the principal or most advantageous market, and adjusts for non-performance and/or other risk associated with the Company as well as counterparties, as appropriate. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:

 

Level 1 Inputs: Unadjusted quoted prices which are available in active markets for identical assets or liabilities accessible to the Company at the measurement date.

 

Level 2 Inputs: Inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability.

 

Level 3 Inputs: Unobservable inputs for the asset or liability used to measure fair value to the extent that observable inputs are not available, thereby allowing for situations in which there is little, if any, market activity for the asset or liability at measurement date.

 

The hierarchy gives the highest priority to Level 1, as this level provides the most reliable measure of fair value, while giving the lowest priority to Level 3.

 

Financial Liabilities Measured at Fair Value on a Recurring Basis

 

The fair value of the bifurcated conversion feature represented by the warrant derivative liability associated with the PFG debt is measured at fair value on a recurring basis based on a Black Scholes option pricing model with assumptions for stock price, exercise price, volatility, expected term, risk free interest rate and dividend yield similar to those described for share-based compensation which were generally observable (Level 2).

 

Financial liabilities measured at fair value on a recurring basis are summarized below (in thousands):

 

September 30, 2020

 

Level 1

   

Level 2

   

Level 3

   

Fair Value

 

Derivative liability

  $     $ 66     $     $ 66  

 

                           

Total

 

September 30, 2019

 

Level 1

   

Level 2

   

Level 3

   

Fair Value

 

Derivative liability

  $     $ 9     $     $ 9  

 

The gain or loss related to the fair value remeasurement on the derivative liability is included in the other income (expense) line on the Consolidated Statements of Operations.

 

Financial Liabilities Measured at Fair Value on a Nonrecurring Basis

 

The initial fair values of PFG debt and warrant debt (see Note 3) were based on the present value of expected future cash flows and assumptions about current interest rates and the creditworthiness of the Company (Level 3). 

 

The Burish warrant was measured at fair value using a Black Scholes model and the remaining fair value was allocated to the related Burish note purchase agreement (see Note 3) which management believes materially approximated the fair value based on calculating the present value of expected future cash flows (Level 3). The non-recurring fair value measurements were performed as of the date of issuance of the note purchase agreement and warrant. The discount was being amortized over the life of the related debt until the May 2020 Burish debt to equity conversion.  

 

Financial Instruments Not Measured at Fair Value

 

The Company's other financial instruments consist primarily of cash and cash equivalents, accounts receivable, investment in sales-type lease, financing receivables, accounts payable and debt instruments and capital lease obligations. The book values of cash and cash equivalents, accounts receivable, investment in sales-type lease, and accounts payable are considered to be representative of their respective fair values due their short term nature. The carrying value of capital lease obligations and debt including the current portion, approximates fair market value as the variable and fixed rate approximates the current market rate of interest available to the Company.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Legal Contingencies

 

When legal proceedings are brought or claims are made against the Company and the outcome is uncertain, we are required to determine whether it is probable that an asset has been impaired or a liability has been incurred. If such impairment or liability is probable, and the amount of loss can be reasonably estimated, the loss must be charged to earnings.

 

No legal contingencies were recorded for either of the years ended September 30, 2020 or 2019.

 

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 homogeneous 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 the U.S. Treasury yields in effect at the time of grant. Forfeitures are based on actual behavior patterns. The expected exercise factor and forfeiture rates are calculated using historical exercise and forfeiture activity for the previous three years.

 

The fair value of each option grant is estimated using the assumptions in the following table:

 

   

Years Ending September 30,

 
   

2020

   

2019

 
Expected life (years)   4.5 - 4.8     4.3 - 4.5  

Risk-free interest rate

  0.24% - 1.63%     1.43% - 2.93%  

Expected volatility

  72.40% - 82.38%     60.19% - 70.63%  

Expected forfeiture rate

  12.76% - 15.38%     13.51% - 14.79%  

Expected exercise factor

  1.2     1.2  

Expected dividend yield

  %   %

 

Preferred Stock and Dividends

 

The Company considered relevant guidance when accounting for the issuance of preferred stock, and determined that the preferred shares met the criteria for equity classification. Dividends accrued on preferred shares will be shown as a reduction to net income (or an increase in net loss) for purposes of calculating earnings per common share. See Note 5 - Stockholders' Equity (Deficit) for further details.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

Per Share Computation

 

Basic earnings (loss) per share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares that may be repurchased, and excludes any dilutive effects of options and warrants. In periods where the Company reports net income, diluted net income per share is computed using common equivalent shares related to outstanding options and warrants to purchase common stock. The numerator for the calculation of basic and diluted earnings per share is net income (loss) attributable to common stockholders. The following table sets forth the computation of basic and diluted weighted average shares used in the earnings per share calculations:

 

   

Years Ending

 
   

September 30,

 
   

2020

   

2019

 

Denominator for basic earnings (loss) per share

               

-weighted average common shares

    7,216,135       5,833,301  

Effect of dilutive options and warrants (treasury method)

           

Denominator for diluted earnings (loss) per share

               

-adjusted weighted average common shares

    7,216,135       5,833,301  

Options and warrants outstanding during each year, but not included in the computation of diluted earnings (loss) per share because they are antidilutive

    2,006,073       2,024,589  

 

Liquidity

 

At September 30, 2020 approximately $2.3 million of cash and cash equivalents was held by the Company’s foreign subsidiaries.

 

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, but there are no assurances that these will be on terms acceptable to the Company.

 

 

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, such as those documented by employment agreements, in accordance with Accounting Standards Codification 712 ("ASC 712") Nonretirement Postemployment Benefits.  Under ASC 712, liabilities for postemployment benefits are recorded at the time the obligations are probable of being incurred and can be reasonably estimated. The Company accounts for one-time employment benefit arrangements in accordance with ASC 420 Exit or Disposal Cost Obligations. When applicable, the Company records such costs into operating expense.  

 

During the year ended September 30, 2020, the Company expensed involuntary termination benefits of $705 thousand under ASC 712, compared to $1.0 million in the same period last year.    

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

Recent Accounting Pronouncements

 

In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes", ("ASU 2019-12"). The amendments in this ASU affect entities within the scope of Topic 740. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Early adoption of the amendments is permitted, including adoption in any interim period for public entities for periods for which financial statements have not yet been issued. An entity that elects to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. An entity that elects early adoption much adopt all the amendments in the same period. The Company is currently evaluating the guidance and its impact to the financial statements.

 

Accounting standards that have been issued but are not yet effective by the FASB or other standards-setting bodies that do not require adoption until a future date, which are not discussed above, are not expected to have a material impact on the Company’s financial statements upon adoption.

 

Recently Adopted Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)", ("ASU 2016-02") as well as several other related updates which were codified as ASC 842. On October 1, 2019, we adopted this update using the modified retrospective method through a cumulative-effect adjustment. The reported results for the fiscal year ended September 30, 2020 reflect the application of Topic 842, while the comparative information has not been restated and continues to be reported under the related lease accounting standards in effect for those periods. The adoption of this update represents a change in accounting principle and resulted in the recognition of right-of-use assets and lease liabilities of $2.5 million on October 1, 2019. We elected the package of practical expedients, which permits us to leverage our prior conclusions about lease identification, lease classification and initial direct costs incurred. We also elected the practical expedient to combine lease and non-lease components when determining the value of right-of-use assets and lease liabilities. The primary effect of adopting this update relates to the recognition of our operating leases on our consolidated balance sheets and providing additional disclosures about our leasing activities. Leases previously designated as capital leases are now identified as finance leases and continue to be reported on the consolidated balance sheets. Leases previously identified as sales-type leases, where the Company is a lessor, continue to be reported on the consolidated balance sheets. Refer to Note 2 - Commitments for additional disclosures related to our leasing activities.

 

In June 2018, the FASB issued ASU 2018-07, "Compensation-Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting", ("ASU 2018-07"). The standard addresses aspects of the accounting for nonemployee share-based payment transactions. The amendments in ASU 2018-07 are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The adoption of ASU 2018-07 did not have a material impact on the total non-cash expense associated with nonemployee stock option grants issued during fiscal year 2020.

 

In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurements", ("ASU 2018-13"). ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in ASU 2018-13 are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted, and the adoption of ASU 2018-13 did not have a material impact on the Company's consolidated financial statements.

 

 

Sonic Foundry, Inc.

Annual Report on Form 10-K

For the Year Ended September 30, 2020

 

 

 

2. Commitments

 

Leases

 

The Company has operating leases for corporate office space with various expiration dates. Our leases have remaining lease terms of up to three years, some of which include escalation clauses, renewal options for up to twelve years or termination options within one year.

 

We determine if an arrangement is a lease upon contract inception. The Company has both operating and finance leases. Right-of-use assets represent our right to use an underlying asset for the lease term, and lease liabilities represent our obligation to make lease payments according to the arrangement.

 

A contract contains a lease if the contract conveys the right to control the use of the identified property, plant or equipment for a period of time in exchange for consideration. At commencement, contracts containing a lease are further evaluated for classification as an operating or finance lease where the Company is a lessee, or as an operating, sales-type or direct financing lease where the Company is a lessor, based on their terms.

 

Lease right-of-use assets and lease liabilities are recognized as of the commencement date based on the present value of the lease payments over the lease term. The lease right-of use asset is reduced for tenant incentives and includes any initial direct costs incurred. We use the implicit rate when it is readily determinable. Otherwise, the present value of future minimum lease payments is determined using the Company's incremental borrowing rate. The incremental borrowing rate is based on the interest rate of the Company's most recent borrowing.

 

The lease term we use for the valuation of our right-of-use assets and lease liabilities may include options to extend or terminate the lease when it is reasonably certain that we will exercise those options. Lease expense is recognized on a straight-line basis over the expected lease term for operating leases. Amortization expense of the right-of-use asset for finance leases is recognized on a straight-line basis over the lease term and interest expense for finance leases is recognized based on the incremental interest rate.

 

Right-of-use assets and lease liabilities are recognized for our leases. Right-of-use assets under finance leases are included in property and equipment on the consolidated balance sheets and have a net carrying value of $191 thousand at September 30, 2020.

 

We have operating lease arrangements with lease and non-lease components. The non-lease components in our arrangements are not significant when compared to the lease components. For all operating leases, we account for the lease and non-lease components as a single component.

 

As of September 30, 2020, future maturities of operating and finance lease liabilities for the fiscal years ended September 30 are as follows (in thousands):

 

   

Operating Leases

   

Finance Leases

 

2021

  $ 1,531     $ 129  

2022

    464       79  

2023

    100       8  

2024

    106       5  

2025

    34        

Thereafter

    70        

Total

    2,305       221  

Less: imputed interest

    (215 )     (13 )

Total

  $ 2,090     $ 208