Notes to Condensed Consolidated Financial Statements
December 31, 2017
(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 condensed consolidated 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, 2017
are not necessarily indicative of the results that might be expected for the year ending
September 30, 2018
.
Reclassifications
Reclassifications have been made to the condensed consolidated financial statements to conform to the
December 31, 2017
presentation. These reclassifications had no effect on the Company's net loss or stockholders' equity as previously reported.
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 products, customer type, and credit risk evaluation.
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
$200 thousand
at
December 31, 2017
and September 30, 2017.
The Company's financing receivables are aggregated into the following categories:
Long-term customer support contracts: These contracts are typically entered into in conjunction with sale-type lease arrangements, over the life of which the Company agrees to provide support services similar to those offered within Mediasite Customer Care plans. Contract terms range from
3
-
5
years, and payments are generally due from the customer annually on the contract anniversary. There was
$383 thousand
and
$384 thousand
of receivables outstanding for long-term customer support contracts as of
December 31, 2017
and September 30, 2017, respectively. All amounts due were current as of the balance sheet date and there are no credit losses expected to be incurred related to long-term support contracts.
Product receivables: Amounts due primarily represent sales of perpetual software licenses to a single international distributor on invoices outstanding for product delivered from March 2016 through June 2017. There was
$2.1 million
receivable as of both
December 31, 2017
and September 30, 2017,
$1.5 million
of which has been deferred for revenue recognition purposes due to a history of delayed payment. As a result of the circumstances described, the entire allowance for losses on financing receivables of
$200 thousand
is considered attributable to this class of customer as of
December 31, 2017
.
As of
December 31, 2017
financing receivables consisted of the following (in thousands):
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December 31, 2017
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September 30, 2017
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Customer support contracts, current and long-term, gross
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$
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383
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$
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384
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Product receivables, gross
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2,051
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2,051
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Allowance for losses on financing receivables
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(200
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)
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(200
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)
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$
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2,234
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$
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2,235
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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. All amounts due are current as of the balance sheet date.
Investment in sales-type leases consists of the following (in thousands):
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December 31, 2017
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September 30, 2017
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Investment in sales-type lease
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$
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554
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$
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555
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$
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554
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$
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555
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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,
2017
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September 30, 2017
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Raw materials and supplies
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$
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143
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$
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156
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Finished goods
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791
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830
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$
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934
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$
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986
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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
.
No
amortization expense of software development costs was recorded in the three months ended
December 31, 2017
or
2016
. The gross amount of capitalized external and internal development costs was
$533 thousand
at both
December 31, 2017
and
September 30, 2017
, 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, 2017
or
2016
.
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, 2017
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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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9
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—
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9
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$
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—
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$
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9
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$
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—
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$
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9
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September 30, 2017
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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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12
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—
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12
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$
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—
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$
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12
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$
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—
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$
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12
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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, 2017
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$
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491
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$
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123
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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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19
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6
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Balance at December 31, 2017
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$
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308
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$
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129
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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, investment in sales-type lease, 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, 2017
and
2016
, 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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2017
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2016
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Expected life
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4.4 years
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4.9 years
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Risk-free interest rate
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1.79%
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1.08%
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Expected volatility
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63.49%
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56.98%
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Expected forfeiture rate
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12.53%
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10.22%
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Expected exercise factor
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1.16
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1.35
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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, 2017
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, 2017
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1,805,443
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$
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8.33
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5.0
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Granted
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6,000
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3.22
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9.8
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Exercised
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—
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—
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0.0
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Forfeited
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(65,149
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)
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13.21
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0.8
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Outstanding at December 31, 2017
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1,746,294
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8.33
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5.8
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Exercisable at December 31, 2017
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1,443,797
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5.3
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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, 2017
is presented below:
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2017
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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, 2017
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544,834
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$
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2.42
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Granted
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6,000
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1.05
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Vested
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(243,593
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)
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2.57
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Forfeited
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(4,744
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)
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2.23
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Non-vested at December 31, 2017
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302,497
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$
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2.23
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The weighted average grant date fair value of options granted during the
three
months ended
December 31, 2017
was
$1.05
. As of
December 31, 2017
, there was
$339 thousand
of total unrecognized compensation cost related to non-vested stock-based compensation, with total forfeiture adjusted unrecognized compensation cost of
$262 thousand
. The cost is expected to be recognized over a weighted-average remaining life of
1.7
years.
Stock-based compensation recorded in the
three
months ended
December 31, 2017
was
$244 thousand
. Stock-based compensation recorded in the
three
months ended
December 31, 2016
was
$251 thousand
. There was
no
cash received from exercises under all stock option plans and warrants in either of the
three
months ended
December 31, 2017
or
2016
. There were no tax benefits realized for tax deductions from option exercises in either of the
three
month periods ended
December 31, 2017
or
2016
, 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
200,000
common shares may be issued. A total of
57,390
shares are available to be issued under the plan, which includes 3,271 shares issued on January 2, 2018. The Company recorded stock compensation expense under this plan of
$1 thousand
and
$3 thousand
for the
three
months ended
December 31, 2017
and
December 31, 2016
, respectively.
Preferred stock and dividends
In May 2017, the Company created a new series of preferred stock entitled "9% Cumulative Voting Convertible Preferred Stock, Series A" (the "Preferred Stock, Series A").
One thousand
shares were authorized with a stated value and liquidation preference of
$1,000
per share. In August 2017,
1,500
additional shares were authorized for an aggregated total of
2,500
shares. Holders of the Preferred Stock, Series A will receive monthly dividends at an annual rate of
9%
, payable in additional shares of Preferred Stock, Series A. Dividends declared on the preferred stock are earned monthly as additional shares and accounted for as a reduction to paid-in capital since the Company is currently in an accumulated deficit position. Each share of Preferred Stock, Series A is convertible into that number of shares of common stock determined by dividing $4.23 into the liquidation amount. There were
2,209
and
1,510
shares of Preferred Stock, Series A issued and are outstanding as of
December 31, 2017
and
September 30, 2017
, respectively.
On November 7, 2017, the Company entered into an Agreement in which a single holder's right to convert shares of Series A Preferred Stock into common stock is waived until shareholder approval has been obtained. The agreement not to convert applies to
1,977
shares outstanding as of December 31, 2017. The right to vote said shares of Series A Preferred Stock to approve the issuance of the Series A Preferred Stock has also been waived.
The Company considered relevant guidance when accounting for the issuance of preferred stock, and determined that the preferred shares meet 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 share.
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:
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Three Months Ended
December 31,
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2017
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|
2016
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Denominator for basic net income (loss) per share - weighted average common shares
|
4,458,075
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4,411,559
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Effect of dilutive options (treasury method)
|
54,747
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|
|
—
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Denominator for diluted net income (loss) per share - adjusted weighted average common shares
|
4,512,822
|
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|
4,411,559
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Options, warrants and convertible shares outstanding during each period, but not included in the computation of diluted net income (loss) per share because they are antidilutive
|
2,348,585
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|
2,025,770
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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 2014-17, "Income Statement—Reporting Comprehensive Income (Topic 220), Revenue Recognition (Topic 605), and Revenue from Contracts with Customers (Topic 606)" ("ASU 2017-14"). The Company must adopt ASU 2016-08, ASU 2016-10, ASU 2016-12, and ASU 2017-14 with ASU 2014-09.
We anticipate that adoption of FASB Topic 606 may have a significant impact on our consolidated financial statements. We are continuing to assess all potential impacts of the standard. We are in the process of reviewing white papers and other technical and AICPA guidance regarding potential impacts to revenue for annual and multi-year software licenses. We are also still evaluating any changes that may occur to how expenses are recognized upon adoption of the new standard. Due to the complexity of certain customer contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing.
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 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", ("ASU 2017-01"). 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 February 2017, the FASB issued ASU 2017-05, "Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets", ("ASU 2017-05"). ASU 2017-05 clarifies the scope of Subtopic 610-20, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets, which provides guidance for recognizing gains and losses from the transfer of nonfinancial assets in contracts with noncustomers. The amendments in ASU 2017-05 are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. The Company is in the process of assessing the impact, if any, of this ASU on its consolidated financial statements.
In March 2017, the FASB issued ASU 2017-07, "
Compensation-Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost", ("ASU 2017-07"). ASU 2017-07 was issued to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost within an entity's financial statements.
The amendments in ASU 2017-07 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 May 2017, the FASB issued ASU 2017-09, "Compensation-Stock Compensation (Topic 718)", ("ASU 2017-09"). The amendments in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. The amendments in ASU 2017-09 are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual reporting periods. The Company is in the process of assessing the impact, if any, of this ASU on its consolidated financial statements.
In July 2017, the FASB issued ASU 2017-11, "Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815)", ("ASU 2017-11"). This update was issued to address complexities in accounting for certain equity-linked financial instruments containing down round features. The amendment changes the classification analysis of these financial instruments (or embedded features) so that equity classification is no longer precluded. The amendments in ASU 2017-11 are effective for annual reporting periods beginning after December 15, 2018, including interim reporting periods within those annual reporting periods. Early adoption is permitted. The Company is in the process of assessing the impact, if any, of this ASU on its 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.
Recently Adopted Accounting Pronouncements
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, and was adopted by the Company as of October 1, 2017. The amendments may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. The implementation of this standard did not result in a material impact to its consolidated financial statements.
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, including interim periods within those annual periods, and was adopted by the Company as of October 1, 2017. The implementation of this standard did not result in a material impact to its consolidated financial statements.
2. Related Party Transactions
During the
three
months ended
December 31, 2017
, the Company incurred fees of
$51 thousand
to a law firm, a partner of which is a director and stockholder of the Company. The Company incurred similar fees of
$31 thousand
during the
three
months ended
December 31, 2016
. The Company had accrued liabilities for unbilled services of
$58 thousand
and
$55 thousand
at
December 31, 2017
and
September 30, 2017
, respectively, to the same law firm.
At
December 31, 2017
and
September 30, 2017
, the Company had a loan outstanding to an executive totaling
$26 thousand
. The loan is collateralized by Company stock.
On November 7, 2017, the Company entered into an Agreement with Mr. Burish such that Mr. Burish waived his right to convert any of his holdings of Series A Preferred into common stock until shareholder approval has been obtained, and also to waive his right to vote his shares of Series A Preferred Stock to approve the issuance of the Series A Preferred Stock.
On November 9, 2017, the Company sold to Mark Burish
$500 thousand
of shares of Preferred Stock, Series A, at
$762.85
per share. Mark Burish is a director of the Company and beneficially owns more than
5%
of the Company’s common stock. All sales of Preferred Stock, Series A, were approved by a special committee of disinterested directors.
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, 2017
, the Company has an obligation to purchase
$573 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, 2017
and
September 30, 2017
, the unamortized balance was
$73 thousand
and
$95 thousand
, respectively.
In October 2016, the Company also occupied office space related to a lease agreement entered into on August 1, 2016. The lease term is from
October 2016 through December 2020
. The lease includes five months of free rent of
$130 thousand
that was recorded as a deferred rent liability and is being amortized as a credit to rent expense on a straight-line basis over the lease term. At
December 31, 2017
and
September 30, 2017
, the unamortized balance was
$101 thousand
and
$110 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, Seventh, Eighth, Ninth, and Tenth Amendments, dated May 31, 2013, January 10, 2014, March 31, 2014, January 27, 2015, May 13, 2015, October 5, 2015, February 8, 2016, December 9, 2016, March 22, 2017, and May 10, 2017 (the Second Amended and Restated Loan Agreement, as amended by the First, Second, Third, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, and Tenth 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 two percent (
2.00%
), which currently equates to
6.50%
. 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 is January 31, 2019. 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
7.25%
), 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) with respect to the Company only, on a monthly basis, of at least
1.60
:1.00 for each month-end that is not the last day of a fiscal quarter, and
1.75
:1.00 for each month-end that is the last day of a fiscal quarter, and (ii) a covenant that requires the Company to achieve, commencing with the period ending September 30, 2017, and continuing each quarterly period thereafter, measured as of the last day of each fiscal quarter, on a trailing six (6) month basis ending as of the date of measurement, (a) EBITDA (negative EBITDA) plus (b) the net change in Deferred Revenue (as defined) during such measurement period, of at least Zero Dollars (
$0.00
) Collections from accounts receivable are directly applied to the outstanding obligations under the revolving line of credit.
On December 22, 2017, the Company entered into an Eleventh Amendment to the Second Amended and Restated Loan and Security Agreement (the “Eleventh Amendment”) with Silicon Valley Bank. Under the Eleventh Amendment: the Minimum EBITDA covenant was modified to require Minimum EBITDA (as defined) plus the net change in Deferred Revenue, (i) for the period ending December 31, 2017, measured on a trailing three (3) month basis, to be no less than negative (
$1,900,000
); (ii) for the quarterly period ending March 31, 2018, measured on a trailing three (3) month basis, to be no less than
Zero
Dollars, and (iii) for the quarterly period ending June 30, 2018, and each quarterly period thereafter, in each case measured on a trailing six month basis, to be no less than
Zero
Dollars.
At
December 31, 2017
, a balance of
$69 thousand
was outstanding on the term loans with Silicon Valley Bank, with an effective interest rate of seven-and-one-quarter percent (
7.25%
), and a balance of
$1.6 million
was outstanding on the revolving line of credit, with an effective interest rate of six-and-one-half percent (
6.50%
). At
September 30, 2017
, a balance of
$278 thousand
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, 2017
, there was a remaining amount of
$1.6 million
available under the line of credit facility for advances. The Second Amended Agreement, as amended, contains events of default that include, among others, non-payment of principal or interest, inaccuracy of any representation or warranty, violation of covenants, bankruptcy and insolvency events, material judgments, cross defaults to certain other indebtedness, and material adverse changes. The occurrence of an event of default could result in the acceleration of the Companies’ obligations under the Second Amended Agreement, as amended. At
December 31, 2017
, the Company was in compliance with all covenants in the Second Amended and Restated Loan Agreement, as amended.
Pursuant to the Second Amended Agreement, as amended, the Companies pledged as collateral to Silicon Valley Bank substantially all non-intellectual property business assets. The Companies also entered into an Intellectual Property Security Agreement with respect to intellectual property assets.
Historically, the Company has relied on the ability to draw proceeds as needed from its revolving line of credit with Silicon Valley Bank to fund operations, and plans to do so for at least the next 12 months. At December 31, 2017 we had a balance of
$1.6 million
outstanding on this line of credit, which matures January 31, 2019. The Company may not have sufficient liquidity available to repay the line of credit at the time of maturity. The Company expects to renew the line of credit prior to the due date, however, the decision to renew is solely at the discretion of Silicon Valley Bank.
While the Company expects the line of credit will be renewed at terms similar to those that are currently in place, management’s analysis of the Company's ability to continue as a going concern must consider the possibility that SVB will not consent to renew the agreement. The Company believes it has access to other sources of capital, but has no plans, nor taken any action to refinance the Silicon Valley Bank debt.
To evaluate the Company’s likelihood that the line of credit agreement would be renewed on or before January 31, 2019, the Company considered its long-term relationship with the lender, consistent payment history on both the line of credit and term loans held by Silicon Valley Bank, and the fact that the line is secured by the Company’s accounts receivable, which was
$5.9 million
at December 31, 2017.
Accordingly, the Company believes that it is probable that management’s plans to renew the line of credit agreement will fully mitigate the conditions identified.
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.
On December 28, 2017, the Company and PFG entered into a Modification No. 4 to the Loan and Security Agreement (“Modification No. 4”). Modification No. 4: the Minimum EBITDA covenant was modified to require Minimum EBITDA (as defined) plus the net change in Deferred Revenue (i) for the period ending December 31, 2017, measured on a trailing three (3) month basis, to be no less than negative (
$1,900,000
); (ii) for the quarterly period ending March 31, 2018, measured on a trailing three (3) month basis, to be no less than
Zero
Dollars, and (iii) for the quarterly period ending June 30, 2018, and each quarterly period thereafter, in each case measured on a trailing six month basis, to be no less than
Zero
Dollars.
At
December 31, 2017
, the estimated fair value of the derivative liability associated with the warrants issued in connection with the Loan and Security Agreement, was
$9 thousand
compared to
$12 thousand
at September 30, 2017. The change in the fair value of the derivative liability for the
three
months ended
December 31, 2017
, was recorded as a
gain
of
$3 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
$1.8 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, 2017
, the Company recorded accretion of discount expense associated with the warrants issued with the PFG loan of
$6 thousand
, as well as
$18 thousand
related to amortization of the debt discount. The Company recorded accretion of discount expense of $
5 thousand
, as well as
$18 thousand
related to amortization of the debt discount in the
three
months ended
December 31, 2016
. At
December 31, 2017
, the fair values of the PFG Debt and the Warrant Debt (inclusive of its conversion feature) were
$308 thousand
and
$138 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
$1.8 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, 2017
, 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, 2017
, a balance of
$308 thousand
was outstanding on the term debt with PFG, with an effective interest rate of ten-and-three-quarters percent (
10.75%
). At
September 30, 2017
, a balance of
$491 thousand
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, 2017
, the Company was in compliance with all financial covenants in the Loan and Security Agreement.
Other Indebtedness
At
December 31, 2017
, a balance of
$580 thousand
was outstanding on the line of credit with Mitsui Sumitomo Bank. At
September 30, 2017
, a balance of
$417 thousand
was outstanding on the line of credit. The credit facility is related to Mediasite K.K., and accrues interest at an annual rate of approximately one-and-one half percent (
1.5%
).
At both
December 31, 2017
and
September 30, 2017
, there was
no
outstanding balance on the subordinated note payable related to the acquisition of Sonic Foundry International (formerly MediaMission).
In the
three
months ended
December 31, 2017
,
no
foreign currency
gain
or loss 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, 2016
, 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, 2017
or
September 30, 2017
, and has not recognized any interest or penalties in the Condensed Consolidated Statements of Operations for either of the
three
months ended
December 31, 2017
or
2016
, respectively.
On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which significantly changes existing U.S. tax law and includes provisions that affect our business. The TCJA reduces the U.S. federal statutory tax rate from 35% to 21% effective January 1, 2018. The TCJA is effective in the second quarter of fiscal year 2018 and the effective tax rate for the quarter ended December 31, 2017 is a blended rate reflecting the anticipated benefit of the three quarters of federal tax rate reductions for fiscal 2018. During the three months ended December 31, 2017, we recorded an income tax benefit of
$1.3 million
resulting from the application of TCJA to existing deferred tax balances based on reasonable estimates for those tax effects. The deemed repatriation of undistributed foreign earnings is not expected to result in a material change to our financial results. Our accounting for the tax effects of the TCJA will be completed during the measurement period, which should not extend beyond one year from the enactment date. The final impact of the TCJA may differ due to and among other things, changes in interpretations, assumptions made by the Company, the issuance of additional guidance, and actions the Company may take as a result.
6. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill for the
three
months ended
December 31, 2017
are as follows:
|
|
|
|
|
Balance at September 30, 2017
|
$
|
10,455
|
|
Foreign currency translation adjustment
|
13
|
|
Balance at December 31, 2017
|
$
|
10,468
|
|
7. Subsequent Events
On January 19, 2018, the Company and Mark Burish entered into a Subscription Agreement (the “Subscription Agreement”) pursuant to which (i) Mr. Burish purchased a
10.75%
Convertible Secured Subordinated Promissory Note for
$500,000
in cash; and (ii) Mr. Burish agreed to purchase an additional Note for
$500,000
in cash, if requested by the Company at any time prior to Sonic Foundry’s 2018 annual meeting of stockholders (each, a “Note”, and collectively, the “Notes”).
No later than the third business day following the approval by the stockholders of the Company of the conversion of the Notes sufficient to comply with rules and regulations of Nasdaq and the Securities and Exchange Commission, the Notes will be
automatically convertible into that number of shares of Series A Preferred Stock determined by dividing the total principal and accrued interest due on each Note by
$542.13
(the “Conversion Rate”). Principal and accrued and unpaid interest on each Note, if not converted, will be due and payable on September 30, 2019. Interest will accrue at the rate of
10.75%
per annum. The Notes are secured by all assets of the Company, and are subordinated to all senior indebtedness.
Prior to obtaining stockholder approval of the conversion, the Company will not issue any shares of Series A Preferred Stock to Mr. Burish upon conversion of the Notes.