Notes to Condensed Consolidated Financial Statements
December 31, 2016
(Unaudited)
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1.
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Basis of Presentation and Significant Accounting Policies
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Financial Statements
In the opinion of management, the accompanying unaudited consolidated condensed financial statements contain all adjustments necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods presented. All such adjustments are of a normal recurring nature. Operating results for the
three
month period ended
December 31, 2016
are not necessarily indicative of the results that might be expected for the year ending
September 30, 2017
.
Inventory Valuation
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 market, with cost determined on a first-in, first-out basis.
Inventory consists of the following (in thousands):
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December 31,
2016
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September 30, 2016
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Raw materials and supplies
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$
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154
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$
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149
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Finished goods
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1,117
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1,755
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$
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1,271
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$
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1,904
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Capitalized 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, as incurred. Upon product release, the amortization of software development costs is determined annually as the greater of the amount computed using the ratio of current gross revenues for the products to their total of current and anticipated future gross revenues, or the straight-line method over the estimated economic life of the products, expected to be
three years
. Amortization expense of software development costs of
$45 thousand
is included in Cost of Revenue – Product for the
three
months ended December 31,
2015
. The gross amount of capitalized external and internal development costs was
$533 thousand
at
December 31, 2016
and
September 30, 2016
and was fully amortized during the fiscal year ended September 30, 2016. There were no software development efforts that qualified for capitalization for the
three
months ended
December 31, 2016
or
2015
, respectively.
Fair Value of Financial Instruments
Nonfinancial Assets Measured at Fair Value on a Nonrecurring Basis
The Company’s goodwill, intangible assets and other long-lived assets are nonfinancial assets that were acquired either as part of a business combination, individually or with a group of other assets. These nonfinancial assets were initially measured and recognized at amounts equal to the fair value determined as of the date of acquisition. Fair value measurements of reporting units are estimated using an income approach involving discounted or undiscounted cash flow models and the public company guideline method that contain certain Level 3 inputs requiring management judgment, including projections of economic conditions and customer demand, revenue and margins, changes in competition, operating costs, working capital requirements, and new product introductions. Fair value measurements of the reporting units associated with the Company’s goodwill balances are estimated at least annually at the beginning of the fourth quarter of each fiscal year for purposes of impairment testing. Fair value measurements associated with the Company’s intangible assets and other long-lived assets are estimated when events or changes in circumstances such as market value, asset utilization, physical change, legal factors, or other matters indicate that the carrying value may not be recoverable.
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 Recurring Basis
The initial fair values of PFG debt and warrant debt (see Note 4) 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 fair value of the bifurcated conversion feature represented by the warrant derivative liability which is measured at fair value on a recurring basis is 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 reoccurring basis are summarized below (in thousands):
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December 31, 2016
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Level 1
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Level 2
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Level 3
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Total Fair Value
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Derivative liability
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—
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46
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—
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46
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$
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—
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$
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46
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$
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—
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$
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46
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September 30, 2016
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Level 1
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Level 2
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Level 3
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Total Fair Value
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Derivative liability
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—
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67
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—
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67
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$
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—
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$
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67
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$
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—
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$
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67
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Included below is a summary of the changes in our Level 3 fair value measurements (in thousands):
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PFG Debt, net of discount
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Warrant Debt
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Balance at September 30, 2016
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$
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1,225
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$
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102
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Activity during the current period:
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Payments to PFG
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(202
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)
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—
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Change in fair value
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18
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5
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Balance at December 31, 2016
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$
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1,041
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$
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107
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Financial Instruments Not Measured at Fair Value
The Company's other financial instruments consist primarily of cash and cash equivalents, accounts receivable, accounts payable and debt instruments, excluding the PFG debt. The book values of cash and cash equivalents, accounts receivable, debt
(excluding the PFG debt) and accounts payable are considered to be representative of their respective fair values. The carrying value of capital lease obligations and debt (excluding the PFG 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.
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.
When it is considered probable that a loss has been incurred, but the amount of loss cannot be estimated, disclosure but not accrual of the probable loss is required. Disclosure of a loss contingency is also required when it is reasonably possible, but not probable, that a loss has been incurred and there is a possibility the loss could be material.
No legal contingencies were recorded or were required to be disclosed for the
three
months ended
December 31, 2016
and
2015
, respectively.
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 fair value of each option grant is estimated using the assumptions in the following table:
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Three Months Ended
December 31,
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2016
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2015
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Expected life
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4.9 years
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4.9 years
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Risk-free interest rate
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1.08%
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1.23%
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Expected volatility
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56.98%
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53.75%
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Expected forfeiture rate
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10.22%
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11.76%
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Expected exercise factor
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1.35
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1.43
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Expected dividend yield
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0%
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0%
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A summary of option activity at
December 31, 2016
and changes during the
three
months then ended is presented below:
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Options
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Weighted-
Average
Exercise Price
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Weighted-
Average
Remaining
Contractual
Period in
Years
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Outstanding at October 1, 2016
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1,602,822
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$
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9.51
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6.6
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Granted
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300,270
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4.75
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9.8
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Exercised
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—
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—
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0
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Forfeited
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(12,124
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)
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30.67
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1.9
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Outstanding at December 31, 2016
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1,890,968
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8.62
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6.7
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Exercisable at December 31, 2016
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1,283,111
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9.62
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5.6
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A summary of the status of the Company’s non-vested shares and changes during the
three
month period ended
December 31, 2016
is presented below:
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2016
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Non-vested Shares
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Shares
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Weighted-Average
Grant Date Fair
Value
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Non-vested at October 1, 2016
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539,985
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$
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3.21
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Granted
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300,270
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3.14
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Vested
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(230,562
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)
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1.83
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Forfeited
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(1,836
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)
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3.15
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Non-vested at December 31, 2016
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607,857
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$
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2.52
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The weighted average grant date fair value of options granted during the
three
months ended
December 31, 2016
was
$3.14
. As of
December 31, 2016
, there was
$991 thousand
of total unrecognized compensation cost related to non-vested stock-based compensation, with total forfeiture adjusted unrecognized compensation cost of
$803 thousand
. The cost is expected to be recognized over a weighted-average remaining life of
1.8
years.
Stock-based compensation recorded in the
three
months ended
December 31, 2016
was
$251 thousand
. Stock-based compensation recorded in the
three
months ended
December 31, 2015
was
$334 thousand
. There was
no
cash received from exercises under all stock option plans and warrants in either of the
three
months ended
December 31, 2016
or
2015
. There were no tax benefits realized for tax deductions from option exercises in either of the
three
months ended
December 31, 2016
or
2015
, respectively. The Company currently expects to satisfy share-based awards with registered shares available to be issued.
The Company also has an Employee Stock Purchase Plan (Purchase Plan) under which an aggregate of
150,000
common shares may be issued. A total of
18,844
shares are available to be issued under the plan. The Company recorded stock compensation expense under this plan of
$3 thousand
and
$7 thousand
during each of the
three
months ended
December 31, 2016
and
2015
, respectively.
Per share computation
Basic 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 loss. The following table sets forth the computation of basic and diluted weighted average shares used in the earnings per share calculations:
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Three Months Ended
December 31,
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2016
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2015
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Denominator for basic loss per share - weighted average common shares
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4,411,559
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4,363,740
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Effect of dilutive options (treasury method)
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—
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—
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Denominator for diluted loss per share - adjusted weighted average common shares
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4,411,559
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4,363,740
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Options and warrants outstanding during each period, but not included in the computation of diluted loss per share because they are antidilutive
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2,025,770
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1,773,057
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Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The guidance substantially converges final standards on revenue recognition between the FASB and the International Accounting Standards Board providing a framework on addressing revenue recognition issues and, upon its effective date, replaces almost all existing revenue recognition guidance, including industry-specific guidance, in current U.S. generally accepted accounting principles. The FASB subsequently issued a one-year deferral of the effective date for the new revenue reporting standard for entities reporting under U.S. GAAP. In accordance with the deferral, the guidance is effective for annual reporting periods beginning after December 15, 2017. Subsequently, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations" ("ASU 2016-08"); ASU 2016-10, "Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing" ("ASU 2016-10"); ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope
Improvements and Practical Expedients" ("ASU 2016-12"); and ASU 2016-20 "Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers ("ASU 2016-20"). The Company must adopt ASU 2016-08, ASU 2016-10 and ASU 2016-12 with ASU 2014-09. The Company is currently evaluating the timing of adopting and the related impact, if any, it may have on the consolidated financial statements.
In July 2015, the FASB issued ASU 2015-11, "Inventory (Topic 330)" ("ASU 2015-11"). The amendments in ASU 2015-11 require an entity to measure inventory at the lower of cost and net realizable value. The amendments in ASU 2015-11 are effective for fiscal years beginning after December 15, 2016 and interim periods within those years. Early adoption is permitted. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not believe the implementation of this standard will result in a material impact to its consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, "Income Taxes (Topic 740)", ("ASU 2015-17"). ASU 2015-17 simplifies the presentation of deferred income taxes. The amendments in ASU 2015-17 are effective for financial statements issued for annual periods beginning after December 15, 2016, including interims periods within those annual periods. The amendments may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The Company does not believe the implementation of this standard will result in a material impact to its consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10)", ("ASU 2016-01"). ASU 2016-01 addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments in ASU 2016-01 are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values should be applied prospectively to equity investments that exist at the date of the adoption. The Company is currently evaluating this guidance and its impact to the consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)", ("ASU 2016-02"). ASU 2016-02 aims to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in ASU 2016-02 are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for public entities. Early application of the amendment is permitted. The Company is currently reviewing this guidance and its impact to the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-05, "Derivatives and Hedging (Topic 815)", ("ASU 2016-05"). ASU 2016-05 clarifies the effect of novation related to a derivative instrument. The amendments in ASU 2016-05 are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. An entity has the option to apply the amendments in ASU 2016-05 on either a prospective or a modified retrospective basis. The Company is currently evaluating this guidance and its impact to the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, "Derivatives and Hedging (Topic 815)", ("ASU 2016-06"). ASU 2016-06 clarify the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. The amendments in ASU 2016-06 are effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Entities should apply the amendments on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. The Company is currently evaluating this guidance and its impact to the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-08, "Revenue from Contracts with Customers (Topic 606)", ("ASU 2016-08"). The amendments in 2016-08 do not change the core principles of the previous guidance, but rather clarify the implementation guidance on principal versus agent considerations. The effective date and transition requirements for the amendments in ASU 2016-08 are the same as the effective date and transition requirements of ASU 2014-09. The Company will evaluate this guidance concurrent with ASU 2014-09.
In March 2016, the FASB issued ASU 2016-09, "Compensation-Stock Compensation (Topic 718)", ("ASU 2016-09"). ASU 2016-09 simplifies the accounting for share-based payment transactions. The amendments in ASU 2016-09 are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company is currently evaluating this guidance and its impact to the consolidated financial statements.
In May 2016, the FASB issued ASU 2016-11, "Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815)", ("ASU 2016-11"). ASU 2016-11 rescinds SEC paragraphs pursuant to the SEC Staff Announcement, "Rescission of Certain SEC Staff Observer Comments upon Adoption of Topic 606", and the SEC Staff Announcement, "Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity", announced at the March 3, 2016 Emerging Issues Task Force (EITF) meeting. The effective dates in ASU 2016-11 coincide with the effective dates of Topic 606 (ASU 2014-09) and ASU 2014-16. The Company is currently evaluating the impact of adopting ASU 2014-09 and related amendments, such as ASU 2016-11, to determine the impact, if any, it may have on the consolidated financial statements. The Company previously reviewed ASU 2014-16 and determined that is it not applicable.
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230)", ("ASU 2016-15"). ASU 2016-15 addresses classification of certain cash receipts and cash payments within the statement of cash flows. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods with those fiscal years. The Company is currently evaluating this guidance and its impact to the consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, "Income Taxes (Topic 740)", ("ASU 2016-16"). ASU 2016-16 prohibits the recognition of current and deferred income taxes for an intra-entity transfer until the asset has been sold to an outside party. The amendment in ASU 2016-16 are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. The Company is currently evaluating this guidance and its impact to the consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01 (ASC Topic 805), Business Combination: Clarifying the Definition of a Business. The amendments in this ASU change the definition of a business to assist with evaluating when a set of transferred assets and activities is a business. The Company is required to adopt the guidance in the first quarter of fiscal 2019. Early adoption is permitted. The Company is in the process of assessing the impact, if any, of this ASU on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, ("ASU 2016-16"). ASU 2017-14 simplifies the subsequent measurement of goodwill by allowing an entity to perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This update also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The amendment in ASU 2017-04 are effective for annual reporting periods beginning after December 15, 2019, including interim reporting periods within those annual reporting periods. The Company is currently evaluating this guidance and its impact to the consolidated 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 consolidated financial statements upon adoption.
2. Related Party Transactions
During the
three
months ended
December 31, 2016
, the Company incurred fees of
$31 thousand
, to a law firm, a partner of which is a director and stockholder of the Company. The Company incurred similar fees of
$32 thousand
, during the
three
months ended
December 31, 2015
. The Company had accrued liabilities for unbilled services of
$45 thousand
at both
December 31, 2016
and
September 30, 2016
, to the same law firm.
At
December 31, 2016
and
September 30, 2016
, the Company had a loan outstanding to an executive totaling
$26 thousand
. The loan is collateralized by Company stock.
3. Commitments
Inventory Purchase Commitments
The Company enters into unconditional purchase commitments on a regular basis for the supply of Mediasite product. At
December 31, 2016
, the Company has an obligation to purchase
$888 thousand
of Mediasite product, which is not recorded on the Company’s Condensed Consolidated Balance Sheet.
Operating Leases
In November 2011, the Company occupied office space related to a lease agreement entered into on June 28, 2011. The lease term is from
November 2011 through December 2018
. The lease includes a tenant improvement allowance of
$613 thousand
that was recorded as a leasehold improvement liability and is being amortized as a credit to rent expense on a straight-line basis over the lease term. At
December 31, 2016
and
September 30, 2016
, the unamortized balance was
$160 thousand
and
$182 thousand
, respectively.
4. Credit Arrangements
Silicon Valley Bank
The Company and its wholly owned subsidiary, Sonic Foundry Media Systems, Inc. (the “Companies”) entered into the Second Amended and Restated Loan and Security Agreement with Silicon Valley Bank, dated June 27, 2011, as amended by the First, Second, Third, Fourth, Fifth, Sixth, and Seventh Amendments, dated May 31, 2013, January 10, 2014, March 31, 2014, January 27, 2015, May 13, 2015, October 5, 2015, and February 8, 2016 (the Second Amended and Restated Loan Agreement, as amended by the First, Second, Third, Fourth, Fifth, Sixth, and Seventh Amendments, collectively, the “Second Amended and Restated Loan Agreement”). The Second Amended and Restated Loan Agreement provides for a revolving line of credit in the maximum principal amount of
$4,000,000
. Interest accrues on the revolving line of credit at the variable per annum rate equal to the Prime Rate (as defined) plus one and one-quarter percent (
1.25%
), which currently equates to
5.00%
. The Second Amended and Restated Loan Agreement provides for an advance rate on domestic receivables of
80%
, and an advance rate on foreign receivables of
75%
of the lesser of (x) Foreign Eligible Accounts (as defined) or (y)
$1,000,000
. The maturity date of the revolving credit facility was January 31, 2017. Under the Second Amended and Restated Loan Agreement, a term loan was entered into on January 27, 2015 in the original principal amount of
$2,500,000
which accrues interest at the variable per annum rate equal to the Prime Rate (as defined) plus two and three-quarters percent (which currently equates to an interest rate of
6.50%
), and is to be repaid in
36
equal monthly principal payments, beginning in February 2015. The Second Amended and Restated Loan Agreement also requires Sonic Foundry to comply with certain financial covenants, including (i) a liquidity financial covenant, which requires minimum Liquidity (as defined), tested with respect to the Company only (excluding the subsidiaries) of at least
1.50
:1.00 at the last day of each month and(ii) a covenant that requires a Minimum EBITDA, as defined, on a trailing six month period, of at least
$1.00
plus the net change in Deferred Revenue, as defined, with such covenant measured as of the last day of each fiscal quarter. Collections from accounts receivable are directly applied to the outstanding obligations under the revolving line of credit.
On December 9, 2016, the Companies entered into an Eighth Amendment to the Second Amended and Restated Loan and Security Agreement (the "Eighth Amendment") with Silicon Valley Bank. The Eighth Amendment: (i) extends the revolving line of credit maturity date to January 31, 2019, (ii) increases maximum subsidiary indebtedness allowable to
$1,000,000
outstanding at any one time and (iii) provides for a "streamline period", during which bank reporting is due monthly when a streamline period is in effect and weekly when a streamline period is not in effect.
At
December 31, 2016
, a balance of
$903 thousand
was outstanding on the term loans with Silicon Valley Bank, with an effective interest rate of six-and-one-half percent (
6.50%
), and a balance of
$2.6 million
was outstanding on the revolving line of credit, with an effective interest rate of five percent (
5.00%
). At
September 30, 2016
, a balance of
$1.1 million
was outstanding on the term loans with Silicon Valley Bank and a balance of
$1.6 million
was outstanding on the revolving line of credit. At
December 31, 2016
, there was a remaining amount of
$1.4 million
available under the line of credit facility for advances. At
December 31, 2016
, the Company was not in compliance with the Minimum EBITDA financial covenant in the Second Amended and Restated Loan Agreement, as amended. Silicon Valley Bank subsequently waived the covenant default.
Partners for Growth IV, L.P.
On May 13, 2015, Sonic Foundry, Inc., entered into a Loan and Security Agreement (the “Loan and Security Agreement”) with Partners for Growth IV, L.P. (“PFG”), (the “Loan and Security Agreement”).
The Loan and Security Agreement provides for a Term Loan in the amount of
$2,000,000
, which can be disbursed in two (2)Tranches as follows: Tranche 1 was drawn in the amount of
$1,500,000
shortly after execution thereof; and Tranche 2 in the amount of
$500,000
, was drawn on December 15, 2015.
Each tranche of the Term Loan bears interest at
10.75%
per annum. Tranche 1 of the Term Loan was payable interest only until November 30, 2015. Beginning on December 1, 2015, principal is due in
30
equal monthly principal installments, plus accrued interest, continuing until
May 1, 2018
, when the principal balance is to be paid in full. Tranche 2 of the Term Loan is payable in
29
equal monthly principal installments, plus accrued interest, beginning January 1, 2015 and continuing until May 1, 2018.
The principal of the Term Loan may be prepaid at any time, without a prepayment fee.
Coincident with execution of the Loan and Security Agreement, the Company entered into a Warrant Agreement (“Warrant”) with PFG. Pursuant to the terms of the Warrant, the Company issued to PFG a warrant to purchase up to
50,000
shares of common stock of the Company at an exercise price of
$9.66
per share, subject to certain adjustments, of which
37,500
were exercisable with the disbursement of Tranche 1 and
12,500
became exercisable with the disbursement under Tranche 2. Pursuant to the Warrant, PFG is also entitled, under certain conditions, to require the Company to exchange the Warrant for the sum of
$200,000
. Each warrant issued has an exercise term of
5 years
from the date of issuance. On August 12, 2015, the Company and PFG entered into a waiver agreement to waive a then existing covenant default and to change the exercise price of the aforementioned warrants from
$9.66
per share to
$6.80
per share.
The warrants can be settled for cash in the event of acquisition of the company, any liquidation of the company, or expiration of the warrant. The Company has determined the cash payment date to be the expiration date (
May 14, 2020
). Due to the fixed payment amount on the expiration date, the warrant structure is in substance a debt arrangement (the “Warrant Debt”) with a
zero
interest rate, a fixed maturity date and a feature that makes the debt convertible to common stock. The Warrant Debt had a fair value of
$80 thousand
at the time of issuance. The derivative had a fair value of
$136 thousand
. The conversion feature is an embedded derivative; thus, for accounting purposes, the conversion feature is bifurcated and accounted for separately from the PFG Debt and Warrant Debt as a derivative liability measured at fair value at each reporting period.
At
December 31, 2016
, the estimated fair value of the derivative liability associated with the warrants issued in connection with the Loan and Security Agreement, was
$46 thousand
compared to
$67 thousand
at September 30, 2016. The change in the fair value of the derivative liability for the
three
months ended
December 31, 2016
, was recorded as a
gain
of
$21 thousand
included in the other income (expense).
The proceeds from the Loan and Security Agreement were allocated between the PFG Debt and the Warrant Debt (inclusive of its conversion feature) based on their relative fair value on the date of issuance which resulted in carrying values of
$1.784 million
and
$216 thousand
, respectively. The conversion feature of
$216 thousand
is treated together as a debt discount on the PFG Debt and will be accreted to interest expense under the effective interest method over the
three
-year term of the PFG Debt and the
five
-year term of the Warrant Debt. For the
three
months ended
December 31, 2016
, the Company recorded accretion of discount expense associated with the warrants issued with the PFG loan of
$5 thousand
as well as
$18 thousand
related to amortization of the debt discount in each respective period. The Company recorded accretion of discount expense of $
3 thousand
, as well as
$15 thousand
related to amortization of the debt discount in the
three
months ended
December 31, 2015
. At
December 31, 2016
, the fair values of the PFG Debt and the Warrant Debt (inclusive of its conversion feature) were
$1.041 million
and
$153 thousand
, respectively.
The fair values of term debt and warrant debt are based on the present value of expected future cash flows and assumptions about current interest rates and the creditworthiness of the Company (Level 3). At December 14, 2015, the carrying amounts of the Company’s term debt and warrant debt totaled
$1.784 million
and
$216 thousand
, respectively. At December 14, 2015, the Company’s term debt and warrant debt were recorded at fair value. At
December 31, 2016
, the derivative liability was remeasured at fair value. The fair value of the bifurcated conversion feature represented by the warrant derivative liability is 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 previously for share-based compensation which were generally observable (Level 2).
At
December 31, 2016
, a balance of
$1.1 million
was outstanding on the term debt with PFG, with an effective interest rate of ten-and-three-quarters percent (
10.75%
). At
September 30, 2016
, a balance of
$1.3 million
was outstanding with PFG.
The Term Loan is collateralized by substantially all the Company’s assets, including intellectual property, subject to a first lien held by Silicon Valley Bank, The Term Loan requires compliance with the same financial covenants as set forth in the loan from Silicon Valley Bank. At
December 31, 2016
, the Company was not in compliance with the Minimum EBITDA financial covenant in the Loan and Security Agreement. On February 8, 2017, the Company and PFG entered into a Modification No. 2 to the Loan and Security Agreement (“Modification No. 2”). Under Modification No. 2: (i) waives the Minimum EBITDA covenant default for December 31, 2016 (ii) the Liquidity covenant was modified to require minimum Liquidity (as defined) with respect to the Company only, on a monthly basis, of at least
1.60
:1.00 for the first and second month of each quarterly fiscal period; and
1.75
:1.00 for the third month of each quarterly fiscal period, replacing the previous Liquidity requirement of
1.5
:1.0 for each month-end.
Other Indebtedness
At
December 31, 2016
, a balance of
$428 thousand
was outstanding on the line of credit with Mitsui Sumitomo Bank. At
September 30, 2016
, a balance of
$198 thousand
was outstanding on the line of credit. The notes and credit facility are both related to Mediasite K.K., and both accrue interest at an annual rate of approximately one-and-one half percent (
1.575%
).
At
December 31, 2016
, there was
no
outstanding balance on the subordinated note payable related to the acquisition of Sonic Foundry International (formerly MediaMission), with an annual interest rate of six-and-one half percent (
6.5%
). At
September 30, 2016
, the outstanding balance was
$93 thousand
.
In the
three
months ended
December 31, 2016
, a foreign currency
gain
of
$6 thousand
was realized related to re-measurement of the subordinated notes payable related to the Company’s foreign subsidiaries. In the
three
months ended
December 31, 2015
, a foreign currency
gain
of
$6 thousand
was recorded related to the remeasurement of the subordinated notes payable.
5. Income Taxes
The Company’s practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accruals for interest and penalties on the Company’s Condensed Consolidated Balance Sheets at
December 31, 2016
or
September 30, 2016
, and has not recognized any interest or penalties in the Condensed Consolidated Statements of Operations for either of the
three
months ended
December 31, 2016
or
2015
, respectively.
6. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the
three
months ended
December 31, 2016
are as follows:
|
|
|
|
|
Balance at September 30, 2016
|
$
|
11,310
|
|
Foreign currency translation adjustment
|
(448
|
)
|
Balance at December 31, 2016
|
$
|
10,862
|
|
7. Subsequent Events
On February 8, 2017, the Company and PFG entered into a Modification No. 2 to the Loan and Security Agreement (“Modification No. 2”). Under Modification No. 2: (i) waives the Minimum EBITDA covenant default for December 31, 2016 (ii) the Liquidity covenant was modified to require minimum Liquidity (as defined) with respect to the Company only, on a monthly basis, of at least 1.60:1.00 for the first and second month of each quarterly fiscal period; and 1.75:1.00 for the third month of each quarterly fiscal period, replacing the previous Liquidity requirement of 1.5:1.0 for each month-end.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Risks and Uncertainties
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 I, Item 1A of the Company’s Annual Report on Form 10-K for the Fiscal Year ended
September 30, 2016
and Part II, Item 1A of this Form 10-Q), “Quantitative and Qualitative Disclosures about Market Risk” (Part I, Item 3 of this Form 10-Q and Part II, Item 7A of the Company’s Annual Report on Form 10-K for the Fiscal Year ended
September 30, 2016
), and “Management’s Discussion and Analysis” (Part I, Item 2 of this Form 10-Q). We undertake no obligation to update or revise publicly any forward-looking statements, whether because of new information, future events, or otherwise.
Overview
Sonic Foundry, Inc. is a trusted global leader for video capture, management and webcasting solutions in education, business and government. The patented Mediasite Video Platform transforms communications, training, education and events for our customers.
RESULTS OF OPERATIONS
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.
Q1-2017
compared to
Q1-2016
Revenue in
Q1-2017
increased
$216 thousand
, or
2%
to
$9.3 million
, from
Q1-2016
revenue of
$9.1 million
. Revenue consisted of the following:
|
|
•
|
Product and other revenue from sale of Mediasite recorder units and server software was
$3.8 million
in
Q1-2017
and
$3.9 million
in
Q1-2016
. Revenue of 208 recorders billed in Q4-2015 and shipped in Q1-2017 for an international customer was recognized during Q1-2017, and the units are included in the units sold figures shown below.
|
|
|
|
|
|
|
|
|
|
|
Q1-2017
|
|
Q1-2016
|
Recorders sold
|
464
|
|
|
362
|
|
Rack units to mobile units ratio
|
9.8 to 1
|
|
|
3.4 to 1
|
|
Average sales price, excluding service (000’s)
|
$
|
7.3
|
|
|
$
|
6.9
|
|
Refresh Units
|
92
|
|
|
76
|
|
|
|
•
|
Services revenue represents the portion of fees charged for Mediasite customer support contracts amortized over the length of the contract, typically 12 months, as well as training, installation, event and content hosting services. Services revenue
increased
$339 thousand
or
7%
from
$5.2 million
in
Q1-2016
to
$5.5 million
in
Q1-2017
primarily due to an increase in hosting contract billings. At
December 31, 2016
,
$12.1 million
of revenue was deferred, of which we expect to recognize
$10.6 million
in the next twelve months, including approximately
$4.0 million
in the quarter ending March 31, 2017. At
September 30, 2016
,
$14.1 million
of revenue was deferred.
|
|
|
•
|
Other revenue relates to freight charges billed separately to our customers.
|
Gross Margin
Q1-2017
compared to
Q1-2016
Gross margin for
Q1-2017
was
$6.7 million
or
72%
of revenue compared to
Q1-2016
gross margin of
$6.4 million
or
70%
. The significant components of cost of revenue include:
|
|
•
|
Material and freight costs for the Mediasite recorders. Costs for
Q1-2017
Mediasite recorder hardware and other costs totaled
$1.2 million
, along with
$72 thousand
of freight costs, and
$428 thousand
of labor and allocated costs, compared to
Q1-2016
Mediasite recorder costs of
$1.4 million
for hardware and other costs,
$76 thousand
for freight and
$415 thousand
of labor and allocated costs. This resulted in gross margin on products of
55%
in
Q1-2017
and
52%
in
Q1-2016
.
|
|
|
•
|
Services costs. Staff wages and other costs allocated to cost of service revenue were
$911 thousand
in
Q1-2017
and
$846 thousand
in
Q1-2016
, resulting in gross margin on services of
84%
in
Q1-2017
and
84%
in
Q1-2016
.
|
Operating Expenses
Selling and Marketing Expenses
Selling and marketing expenses include wages and commissions for sales, marketing and business development personnel, print advertising 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.
Q1-2017
compared to
Q1-2016
Selling and marketing expenses
increased
$398 thousand
or
9%
from
$4.4 million
in
Q1-2016
to
$4.8 million
in
Q1-2017
. Differences in the major categories include:
|
|
•
|
Increased
salary, incentive compensation and benefits of
$239 thousand
mainly due to a increase in incentive compensation amounts related to the large international transaction from Q4-2015 that was recognized in Q1-2017.
|
|
|
•
|
Advertising & tradeshow expenses
increased
by
$120 thousand
.
|
|
|
•
|
Costs allocated from general and administrative
decreased
by
$136 thousand
primarily as a result of lower stock compensation and bonus expense.
|
|
|
•
|
Selling and marketing expenses for Sonic Foundry International and Mediasite KK accounted for
$72 thousand
and
$825 thousand
respectively, an aggregate
increase
of
$189 thousand
from
Q1-2016
.
|
We anticipate selling and marketing headcount to remain consistent throughout the remainder of the fiscal year.
General and Administrative Expenses
General and administrative (“G&A”) expenses consist of personnel and related costs associated with the facilities, finance, legal, human resource and information technology departments, as well as other expenses not fully allocated to functional areas.
Q1-2017
compared to
Q1-2016
G&A expenses
decreased
$21 thousand
or
1%
from
$1.47 million
in
Q1-2016
to
$1.45 million
in
Q1-2017
. Differences in the major categories include:
|
|
•
|
Increase
d salary and benefits of
$26 thousand
due to an increase in compensation rates and benefits.
|
|
|
•
|
Decrease
in bad debt expense of
$71 thousand
due to the write off of an uncollectible account in Q1-2016.
|
|
|
•
|
G&A expenses for Sonic Foundry International and Mediasite KK accounted for
$38 thousand
and
$262 thousand
, respectively, an aggregate
increase
of
$33 thousand
from
Q1-2016
.
|
We anticipate general and administrative headcount to remain consistent throughout the remainder of the fiscal year.
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.
Q1-2017
compared to
Q1-2016
Product development expenses
increased
by
$337 thousand
, or
21%
from
$1.6 million
in
Q1-2016
to
$2.0 million
in
Q1-2017
. Differences in the major categories include:
|
|
•
|
Increase
in compensation and benefits of
$249 thousand
due to a increase in headcount.
|
|
|
•
|
Increase
in professional services of
$71 thousand
, primarily related to an increase in outsourced labor.
|
|
|
•
|
Costs allocated from general and administrative
decreased
by
$50 thousand
primarily as a result of lower stock compensation and bonus expense.
|
|
|
•
|
Product development expense for Sonic Foundry International and Mediasite KK accounted for
$90 thousand
and
$70 thousand
respectively, an aggregate
increase
of
$65 thousand
compared to
Q1-2016
.
|
We anticipate product development headcount to remain consistent throughout the remainder of the fiscal year. We do not anticipate that any fiscal
2017
software development efforts will qualify for capitalization.
Other Income and Expense, Net
Interest expense for the
three
months ended
December 31, 2016
increased
$1 thousand
compared to the same period last year. The Company also recorded
$5 thousand
of interest expense for the
three
months ended
December 31, 2016
, related to the accretion of discounts on the PFG Loan and Warrant Debt. The Company recorded accretion of discount expense of
$3 thousand
for the
three
months ended
December 31, 2015
.
During the
three
months ended
December 31, 2016
, a
gain
of
$21 thousand
was recorded related to the fair value remeasurement on the derivative liability associated with the Loan and Security Agreement and Warrant Debt with PFG. A gain of
$62 thousand
was recorded related to the fair value remeasurement for the
three
months ended
December 31, 2015
.
In the
three
months ended
December 31, 2016
and December 31, 2015, a foreign currency
gain
of
$6 thousand
was also realized related to re-measurement of the subordinated notes payable related to the Company’s foreign subsidiaries.
Liquidity and Capital Resources
The Company’s primary sources of liquidity are its cash, the revolving line of credit, and, during the first three months of fiscal 2017, cash provided by operating activities. During the first
three
months of fiscal
2017
, the Company
used
$828 thousand
of cash from operating activities compared with
$899 thousand
of cash provided by operating activities in the same period of fiscal
2016
. The decrease in cash generated from operating activities was primarily due to a decrease in working capital in fiscal
2017
as compared to fiscal
2016
.
Capital expenditures were
$548 thousand
in the first
three
months of fiscal
2017
compared to
$77 thousand
in the same period in fiscal
2016
. Majority of the increase in expenditures for fiscal 2017 relate to costs associated with the leasehold improvements and office furniture and equipment purchases for the new Mediasite KK office.
The Company
generated
$767 thousand
of cash from financing activities during the first
three
months of fiscal
2017
, primarily due to proceeds from its line of credit and partially offset by payments on term debt facilities. For the same period in fiscal
2016
, the Company used
$122 thousand
of cash for financing activities, mainly due to payments on debt.
At
December 31, 2016
, the Company had a
$4.0 million
revolving line of credit with Silicon Valley Bank. The line of credit bears interest at prime rate plus
1.25%
. Collections from accounts receivable are directly applied to the outstanding obligations under the revolving line of credit. The Company borrowed a net of $1.0 million during the first
three
months of fiscal
2017
. At
December 31, 2016
, the outstanding balance was
$2.6 million
. The highest balance on the line of credit during the quarter was
$3.1 million
. At
December 31, 2016
, there was a remaining amount of
$1.4 million
available under the line of credit for advances.
At
December 31, 2016
, a balance of
$428 thousand
was outstanding on the line of credit with Mitsui Sumitomo Bank. At
September 30, 2016
, a balance of
$198 thousand
was outstanding on the line of credit. The notes and credit facility are both related to Mediasite K.K., and both accrue interest at an annual rate of approximately one-and-one half percent (
1.575%
).
At
December 31, 2016
, the Company had
$2.1 million
outstanding, net of warrant debt and debt discounts, related to notes payable with Silicon Valley Bank and PFG. The Company made payments resulting in a net pay down of
$497 thousand
on notes during the
three
months ended
December 31, 2016
compared to net proceeds of
$53 thousand
on notes in the same period of fiscal
2016
.
At
December 31, 2016
, approximately
$751 thousand
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 lease opportunities to finance equipment purchases in the future and anticipate utilizing the Company’s revolving line of credit to support working capital needs. We may also seek additional equity financing, although we currently have no plans to do so.