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Edited Transcript of SOFO earnings conference call or presentation 15-May-18 8:30pm GMT

Thomson Reuters StreetEvents

Q2 2018 Sonic Foundry Inc Earnings Call

MADISON Jun 18, 2018 (Thomson StreetEvents) -- Edited Transcript of Sonic Foundry Inc earnings conference call or presentation Tuesday, May 15, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary R. Weis

Sonic Foundry, Inc. - CEO, CTO & Director

* Kenneth A. Minor

Sonic Foundry, Inc. - CFO & Secretary

* Nicole Wise

Sonic Foundry, Inc. - Director of Communications

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Presentation

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [1]

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Good afternoon, and welcome to Sonic Foundry's Second Quarter 2018 Earnings Webcast. I'm Nicole Wise, Director of Communications for Sonic Foundry, and will be moderating today's webcast. We'll begin with the safe harbor statements, followed with the presentation by Gary Weis, CEO; and Ken Minor, CFO. (Operator Instructions)

In compliance with the SEC regulation regarding fair disclosure, we will be using SEC filings and public presentations, like the one you are viewing and participating in today, as the principal means of informing The Street and investors about our current and past results, financial projections or any material nonpublic information during those meetings. Sonic Foundry will continue to meet with analysts, investors, the media and others on an intra-quarter basis but will not provide updates regarding quarter-to-date results, financial projections or any material nonpublic information during those meetings.

Sonic Foundry's disclosure policy defines the period beginning on the 15th day of the third month of each fiscal quarter and ending on the day we publicly release the results of that quarter as a quiet period. During such quiet periods, we will not make any comments about our financial performance nor provide forward-looking guidance, except in press release form.

Finally, this conference will contain forward-looking statements about the products and services of Sonic Foundry within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from the forward-looking guidance we provide. Any forward-looking statements should be considered in context of the risk factors disclosed in our periodic Forms 10-Q, 10-K and other filings with the SEC. These filings can be accessed online at sec.gov and other websites or can be obtained from the company's Investor Relations department.

From time to time, Sonic Foundry refers to various non-GAAP financial measures, or measures not defined as generally accepted accounting principles. As an example, we refer to adjusted EBITDA in this presentation. The company believes that this information is useful to understanding its operating results without the impact of special items. Refer to our earnings releases for a description and reconciliation of adjusted EBITDA.

All of the information and disclosures we make today regarding our business, including any forward-looking guidance, are as of the date given, and we assume no obligation to update or change this information, regardless of subsequent events.

An archive of this presentation will be available at sonicfoundry.com for 90 days.

And now, Gary Weis will begin the webcast.

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [2]

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Thank you, Nicole. And good afternoon, everyone. Welcome to our second quarter earnings call. I'm going to make a few highlight remarks about the first half of 2018, and then Ken will get into the detailed performance of the second quarter. First thing I'd like to comment on is that our year-to-date billings for fiscal '18 decreased by 2% over the prior year, but the story's a little more complicated than that. We've had a strong performance in Japan and Benelux, Sonic Foundry International, which has offset moderate weakness in our other geographies of North America and rest of Europe.

The revenue side of the story is revenue decreased by 3% in absolute comparison to the prior year, but if you go back and adjust last year's Q1 for the large Middle East transaction of $1.5 million of revenue recognition, revenue actually increased by 6% on a comparable basis. Probably one of the things that we're most encouraged about is that the number of recorders which we've shipped in the first half of the year increased by approximately 13% over the prior year. More than 80% of that increase is in our RL220s and RL Minis compared to the prior year. You might recall that the RL20s and the Minis were introduced towards the latter part of last year, and they're part of our effort to provide capture solutions, which are rightsized for what our customers need in their operations.

The other thing that we did in 2017 is we took action to reduce our operating expense. And so on a comparable basis, our operating expense decreased by $926,000 or 6% due to those actions that are effective in the first half of the year, this year. We had a noncash tax impact due to revaluing goodwill of $1.3 million during the first half, that is really not an operational issue, it is a purely financial issue. When you look at improvement in loss from last year, the $3.0 million in the first half versus $1.1 million this year, that's inclusive of the tax credit. However, $600,000 of that improvement was in fact generated by operations. So that's a very high-level view of the first half.

And I'll turn it over to Ken for him to comment on the second quarter.

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Kenneth A. Minor, Sonic Foundry, Inc. - CFO & Secretary [3]

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Thank you, Gary. First of all, I'll correct one little thing. The tax credit was actually related to the change in the tax law. So that's, but again, it was a noncash charge -- change. So it wasn't cash-related.

So regarding the details within billings, as Gary said, there's a number of areas that are outperforming and some that are doing the other direction. So -- and those have changed somewhat between Q1 and Q2. So the Americas product and support line item underperformed last year for the current quarter by about $700,000. Now that was primarily from new recorder sales. The reverse happened in Q1 where they outperformed the first quarter of the prior year by approximately $400,000, which again was also led by strong recorder sales. So historically, our sales of recorders have been pretty variable in the first half of the year, in part, because there can be large transactions of multiple recorders that can swing things, and it's a period where the -- seasonally, we have lesser performance than we have in the second half. So those kinds of volume swings can make a bigger difference.

In the Americas, events and cloud, the reverse happened. So we saw an increase slightly over the prior year in the current quarter, and that was following an underperformance in the first quarter of about $200,000. Both our international subs, as Gary mentioned, are doing very well. We saw a $300,000 improvement year-over-year in this quarter, and that was after basically the same overachievement in the first quarter. So they're running well ahead of last year, both Q1 and Q2 doing it pretty consistently.

China continues to show a weaker performance compared to last year as we transition from what was really a sole distributor model to one that's a broader approach with multiple partners. The activity in interest is strong. It does provide us comfort that the broader approach should begin to show positive performance. But this year, we didn't plan for much performance out of China other than really setting the stage for future growth in the future.

Our other international had weak results in the current quarter, which was really similar to what happened last year. So I mean, it's -- we -- and again, it can be pretty variable because we do have large transactions that are international. In Q1, the results were about triple what they were in Q2. I believe in Q3, they will go back to that approximate same level. So Q2 was very low in comparison to Q1 and Q3, our Q3 expectations. But it's very similar to what we saw last year.

So year-to-date, we're about 4% behind last year in the Americas. We're about 12% ahead in combination of Benelux in Japan from the 2 subs. On a dollar level, we're $500,000 behind now in China. And in the other international category, we're about 5% behind last year.

In terms of revenue. Our revenue was down about 1% over the prior year, and this is, of course, impacted by the billings change, but to a much lesser extent because the billings that we had from our China partner last year were deferred. The recorder decrease in billings drove reduced product revenues, while growth in events and cloud services drove increases in our service revenue. The total recurring revenue, of which, certainly, cloud and support and annual software licenses are a part, increased from 65% last year to 74% this current quarter. Gross margins were slightly reduced over the prior year, and that's primarily due to a lesser amount of software than we incurred this year versus the prior year, which had in the year-to-date amounts, a large, 1 customer transaction that was incurring in Q1 of last year.

Our operating expenses continue to run well below what they were last year, as Gary said, that we made some changes in Q3 of 2017. They were primarily employee-related, travel related, some incentives, some supplies and policy related, and I'll touch on that a little bit more as I get to the next slide.

The bottom line results were pretty consistent year-over-year. It's significantly better in a full year basis and as Gary said, the lion's share of that is because of a large noncash federal tax credit due to the changes in the tax law that affected us in Q1. We do have a pretty large deferred tax liability that's on the books, which got reduced then as a result of that rate change.

And then so some other stats reflected on this chart show that our ASP is reduced over what it was last year. And again, that's a mix change as opposed to a volume price change or a margin hit that does reflect selling more recorders that are more of the lower-cost recorders that we've been talking about as a key part of our strategy. Our operating cost, as we said, were reduced over -- during the current quarter over the prior period, and it's -- they were less in -- similarly in marketing. They were less in product development. Again, those are largely people-related and travel-related and supplies-related and so forth.

Our G&A were a little higher than last year, and that's primarily the result of an increased deferred -- or an increased charge for bad debt expense, which was associated with a couple of customers, primarily the customer in China that we've been talking about that has been slower in paying as well as a customer in Middle East.

And then finally, in our balance sheet, the current assets were primarily increased -- or impacted by a decrease in accounts receivable, which really represents the seasonal changes we see in our business. So we sell less in the first and second fiscal quarter and as a result, our accounts receivable comes down.

Goodwill and other long-term assets were reduced by $1 million. Though while we expect any continued business from our distributor in China, we do think it's going to take an extended period of time for them to really ramp up like their expectations had. So we did make the decision to reverse the amount of unearned revenue that we had on the books that was in the long term. So the impact of that was to reduce the amount that was in accounts receivable, in the long-term accounts receivable account, as well as the deferred revenue accounts. The -- and that was about $1.5 million, as I said. So going forward, we'll have a broadened approach, I think, with multiple partners in China, which we don't expect that we'll see that sort of issue pop up again.

In terms of current liabilities, we did have an increase of approximately $600,000 in accounts payable and about $1 million note that's due to an affiliate. Now that note is a part of a stockholder vote that's going to occur on Thursday that we expect then to convert to preferred stock at that point. These are more than offset by the decrease as I've mentioned earlier. So the decrease in the deferred tax charge, obviously, which is a Q1 event, and the decrease associated with the deferred revenue that was in long-term, which it was pretty much offsetting those other charges I mentioned.

So long-term liabilities were reduced by $2.2 million, again, due to the unearned revenue from China as well as the tax credit.

So with that then, I'll turn the meeting back over to Gary, who'll run through a few of our business trends.

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [4]

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Thanks, Ken. Let me make a remark before I start my business trends. This year, things are somewhat unusual, schedule-wise, because we delayed our annual meeting until later in this week. And so I would encourage all of you who want to hear more about the progress of the business and some of the details of what we're doing to join that conference as well on Thursday. We are intentionally keeping the business update section as part of the earnings call a bit shorter than we normally would.

So let me jump into some of the events that we're looking at this -- in the third quarter. First off, InfoComm is always a very substantial show for us on an annual basis. The reason for that is that in spite of our broad breadth of product now for presentation and lecture composition through My Mediasite and desktop capture and so forth, we still have a major presence in terms of room-based capture, and InfoComm is where we really focus on those tools.

Some of the things that we'll be highlighting this year are video capture tools for the collaborative environment; realtime live streaming, which now supports streaming our video to the social channels, Facebook, et cetera; we also are doing things to enhance the searchability and the engagement of our videos with end-viewers; and one of the kind of neat hardware features that we're dealing with is an integration of NewTek's NDI technology to provide the ability to access our recorders remotely or keeping the recorders in a centralized location and pushing content to those recorders from remote rooms. So all of these capabilities as well as showcasing the breadth of the RL Mini and RL220 are something that's very appropriate to be done at InfoComm. So we will be doing that in June.

Let me shift to another subject, which I think has been a very positive development for us. We began work to capture videoconferencing sessions several years ago now with a product that we call Mediasite Join. And Mediasite Join originally was created by us to really be responsive to our existing customers' needs to integrate videoconferencing technology into how they taught into remote classrooms. And the capability that we allow our educational customers is to be able to capture both video and auxiliary media from videoconferencing and integrate it into the Mediasite video server library in exactly the same format and capabilities that natively captured or composed Mediasite content has.

Now at the time we did it, we also considered making it available to some of our AV partners to be a capture solution for customers that maybe didn't have Mediasite but wanted to use it to capture their videoconferencing videos. Interestingly enough, in the recent past several months, Cisco and Polycom have basically divested themselves of their capture products. And we now find that Mediasite Join, as a unified communications solution, becomes a very valuable adjunct to our AV partners to allow us to give them the capability to do what the former Cisco or Polycom products used to do. We also seamlessly integrate it with a variety of other videoconferencing services so it makes Mediasite Join a very valuable and flexible tool in the arsenal of capability that we make available to our customers.

The same phenomenon is working in China. We've been told by several of our potential new partners in China that they would like to see us use Mediasite Join in China as, again, a replacement for the Polycom capture product. So we're going to get good leverage out of our investment in Mediasite Join.

Another area of input that we've had from our customers in the past several years is the need to deal with voice as a searchable element of a video presentation. Ultimately, I think our customers would very much like to use automated technology to generate closed captions for a variety of reasons. Our view is that all of the general technology available today to process voice into text probably doesn't yield high enough accuracy to really generate closed caption without editing. But in reality, the human-based capturing of closed captions is pretty expensive option that most of our schools find really not affordable.

So we're making our integration with IBM Watson available to customers as part of our 7.2 Mediasite server product line. And most definitely, the text that's generated from voice absolutely adds to the searchability of the video captured presentations. And if customers choose to, they can also use the tool to generate actual closed caption.

I'll talk a little bit about China. We're beginning to adjust our China strategy to compensate for our original exclusive distributors' challenges in getting the kind of penetration they need into the China market. PushiTech was originally part of Neusoft inside China, and it later became a spin-off from Neusoft. The team at Pushi is very aggressive about using our technology as part of application solutions that they're developing as well as simply selling our technology in the same way that we do in the rest of the world, but just like you've heard us say, markets sometimes are slower to develop than what you'd like to see.

When we first started with PushiTech in China, we had a very substantial revenue commitment that was a multi-year revenue commitment. And in the -- in 2017, and certainly, in 2018, PushiTech has had to back off that and hence, we've basically changed our strategy to not rely on them exclusively but to develop other potential partners in China. That work is going well, and in fact, several of those potential partner candidates are very interested in Join as a technology base to deploy inside China.

In parallel with integrating technology into the applications that PushiTech is developing, there are a number of traditional company -- customers such as the Xi'an Jiaotong-Liverpool University. Most of these universities have some affiliation with Western universities. And in this particular case, this university has installed over 20 of our recorders and is using Mediasite in a new campus at -- in one of the cities in China, really a pretty much traditional Mediasite application, but a customer that's been very impressed with our capabilities and support. We see other customers developing like this, and we're looking for not just PushiTech but other partners to help us reach those customers.

I mentioned at the outset that our shareholder meeting is on Thursday, 9:00 a.m. The link that you see on this slide can be used to access that shareholder meeting on a live streaming basis, and we would encourage you to connect and view that meeting. We'll be going into more detail on how we see our business strategy evolving, and again, we just encourage you, if you're interested in more information, to participate in the Annual Shareholder Meeting.

So with that, I will turn it over to Nicole to ask any of your questions.

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Questions and Answers

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [1]

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Thank you, both. We do have some questions coming in. The first one is about market size. During previous calls, you mentioned that the market size for Mediasite was not as big as you expected. Do you see the market size starting to grow, and a second -- a follow-up question is how are the health markets doing for Mediasite?

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [2]

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So let me start with the first one. One of the things we'll probably talk in a little more detail about at the annual meeting is how we view the market and how we see it evolving over time. The question poses the comments that we've made in the past or states the comments we've made in the past that the market is not growing as fast as we would like, and that certainly is true. But the market is not a monolith; it varies by both industry and by geography. And higher education in North America and Western Europe, with the exception of Benelux, most definitely has grown slower than we would like it to grow or, frankly, we would have anticipated it growing 3 or 4 or 5 years ago.

That, by the way, is not unique to Sonic Foundry. That is a statement of the addressable market and I believe all of our competitors see it the same way. So we can't change that. We have to, instead, adapt what we do to try to get the most revenue growth out of other geographies and out of other close technology applications. And so we've talked already about the acquisitions that we did in 2014, 2015, that's now starting to pay off very well for us in Japan and in the Benelux. The start-up always, when you do something like that, takes time and unfortunately, sometimes more time that you'd like. But we're now seeing the results of that investment in 2018.

We also are still very encouraged about China. The parallel is there with what we saw with our other acquisitions, it takes time. But the China market is huge. We've proven, I think, not just to ourselves but to potential customers in China that the quality and capability of what Mediasite offers is very desirable. We just now have to continue to develop those customers and to develop the applications that PushiTech is pushing to its market potential in China. The second part of the question was?

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [3]

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How are the health markets doing?

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [4]

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Thank you. The health markets, we've kind of decomposed into 2 pieces. One is teaching schools, and both nursing and doctoral teaching schools, where the Mediasite technology is definitely succeeding and definitely very valued. Our high-end recorders to be able to capture 4 concurrent sessions, our ability to stream and play back those sessions, both live and on demand, all of that is getting great uptake in the general medical education world.

Our newest activities in medical, in general, are where we integrate Mediasite's video technology into an offering that our partner customers sell to the customer. In the past, the only way we've really reached customers has been through AV partners, which are basically resellers of video technology, and we still have to make the case for our particular Mediasite technology; or direct to customers in the case of higher education in North America.

The tactic with Noordhoff Health has been to let them take the front-end selling activity, and we provide our technology integrated into their offering. That also is progressing, but like anything else where you're dependent on a third-party to invest the time and energy into making it successful, that is -- that can be a gating factor. So yes, we're progressing with it. Is it going as fast as we like? No, but we're still very encouraged about the potential result.

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [5]

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Okay. Here's one about sales reorganization. How is the sales reorganization performing? Is it executing as planned?

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [6]

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Let me make a little bit of comment to define sales reorganization. I think in the past 1.5 years, we have really spent energy on focusing the sales organization on pure sales and carving out more of the operational aspects of sales like customer care and like customer experience and putting that into a separate organization. That is not changing how we sell or who sells, but rather trying to free up the sales management and sales resource to focus purely on generating additional billings and to reach new customers. That's going well, very well.

Our focus on customer experience just began at the start of this calendar year, really, and that work is still under development. But one thing we've learned is that our top-end customers, those customers that have demonstrated their loyalty to Mediasite are continuing to buy new products and services on a very reliable basis. They buy when they have money to afford to buy. They don't look for other options, they buy Mediasite if they're already committed to Mediasite as their video management or video capture solution.

The challenges we faced in the past is on more entry-level customers. How do you take a customer and grow them from having 2 or 3 or 4 recorders and getting started with video? How do you grow them into the next tier of customers that are going to become strategically committed to video and strategically committed to Mediasite? That's really what the reorganization focused on, is managing that evolving customer experience to make sure that we help those customers get more value out of Mediasite. That too is progressing, but we're just not as far along in doing what we need to do there.

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [7]

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This question is about customer conversions. I saw that some customers started decommissioning plans of Mediasite to other platforms. Do you see this as a problem?

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [8]

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Well, let me pick a minute about what I think the question is, and I'll try to answer it. We coexist with a variety of video solutions in most large universities. And when I say that, here's what I mean: Typically, in the professional schools like the business schools, the medical schools, the science and education, engineering, that area, Mediasite becomes the dominant technology.

In less intense curricula or schools, the customer is really looking for a more casual video solution. There's a variety of ways they can satisfy that. They can satisfy that with composition tools like TechSmith, they can satisfy that with some of our direct competitors but generally, the customers that really value our capabilities are willing to pay for them, and they tend to be the business schools. If you look at the other schools, liberal arts and science or the less intense video value schools, they want a lower-cost solution and those lower-cost solutions tend to be driven by -- up until now, anyway -- other providers.

This year, with the advent of Catch, we have that capability. I'll go back now and answer the question, do I think that's a problem? No, I don't, for 2 reasons. Number one, Catch will enable us to do what any of our more casual video competitors might do and since it's a software-only solution, we can price it to meet whatever is required to keep or win business. The cases where we have had customers who have decided to focus more on software-only solutions, those decisions are usually made by the IT community inside schools, and it's usually made for cost reasons.

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [9]

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Is competition the reason Sonic Foundry can't more steadily grow its revenue? If not, what is the reason?

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [10]

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It absolutely is a factor, but we fundamentally believe the reason we can't grow faster is the market itself is just not growing as fast as we need it to grow. I can tell you that I've talked to some of our competition, I think they see it in the same way we do, that the market is growing slowly. We are frustrated by that, so don't think that we accept it. I've talked earlier today about other things we're doing to compensate for that, but Sonic Foundry, or our competitors, is not in of ourselves going to cause the market to grow faster.

We really believe that once a customer is convinced of the value of video technology to its students and once they integrate video technology into a policy-based educational system in their schools like North Carolina State, like Leeds, like any of a number of other of our large customers, we win and we keep those customers. The problem is that the growth of customers who are doing that is just not fast enough or speedy enough for us to grow our portion of the business faster. We still are the leading provider. We don't believe we have lost market share to competition. We believe we simply can't grow because of the market.

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [11]

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There are a lot of players in this space, what steps is management taking to do some sort of acquisition?

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [12]

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We're exploring all possible opportunities to improve shareholder value. I think we've demonstrated in the past that some acquisitions make sense, and I think you can see that the 2 that we made 4, 5 years ago are paying off very nicely for us. I think it would be naïve to think that acquisitions in the space we're in are necessarily the secret to faster growth or better results. I think you have to be very careful about that. But the flip side of acquisitions is considering the possibility of business combinations with other players as well.

All of those things are on the table. We are not at all suggesting that the path to our shareholders' increased value is just by keeping Sonic Foundry as an independent standalone entity. We're looking at every possible way to improve shareholder value.

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [13]

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Okay, final question. Does Sonic have to raise additional cash this year? And will it be done by dilution to shareholders?

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Kenneth A. Minor, Sonic Foundry, Inc. - CFO & Secretary [14]

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No. The transactions we just announced are what we believe we need for the next year and beyond. I mean, so we've put together a transaction that has a small combination of equity common stock that we announced, I think, about 3 weeks ago. And then today, we announced the $2.5 million debt facility, $2 million that was drawn yesterday, and $500,000 that's additional that's available to us, and we believe that, that's sufficient.

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [15]

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And I would add to what Ken said is that -- and you've heard this before so it's nothing profoundly new. Our expense structure now is very leveragable for future growth. Our biggest challenge is getting the top line to grow. If we can do that, we'll do it with, never say 0 additional expense, but a very, very small additional -- addition to expense, and that will provide improved profitability and cash flow. That's almost 100% of the management team's focus is what do we have to do from a product and a sales perspective to grow the top line.

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Nicole Wise, Sonic Foundry, Inc. - Director of Communications [16]

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There are no more questions.

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Gary R. Weis, Sonic Foundry, Inc. - CEO, CTO & Director [17]

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Great. Well, thanks for joining us this afternoon. Again, we'd encourage you to connect into the annual meeting on Thursday, and feel free at that time to ask any more questions you might have. Thank you.

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Kenneth A. Minor, Sonic Foundry, Inc. - CFO & Secretary [18]

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Thank you.