SONIC FOUNDRY INC - Quarter Report: 2020 December (Form 10-Q)

 

 

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

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

For the Quarterly period ended December 31, 2020

OR

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

 

Commission File Number 000-30407

 

SONIC FOUNDRY, INC.

(Exact name of registrant as specified in its charter)

MARYLAND		39-1783372
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

222 West Washington Ave, Madison, WI 53703

(Address of principal executive offices)

(608) 443-1600

(Registrant’s telephone number including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days

Yes  ☒           No   ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  ☒            No   ☐

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

 

Large accelerated filer		☐		Accelerated filer		☐
Non-accelerated filer		☐		Smaller reporting company		☒
				Emerging growth company		☐

 

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

        Yes  ☐    No   ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ☐            No  ☒

State the number of shares outstanding of each of the issuer’s common equity as of the last practicable date:

 

Class		Outstanding January 31, 2021
Common Stock, $0.01 par value		8,012,279

 

 

 

PART I. FINANCIAL INFORMATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. For a more complete discussion of accounting policies and certain other information, refer to the Company’s annual report filed on Form 10-K for the fiscal year ended September 30, 2020.

 

 

 

TABLE OF CONTENTS

 

		PAGE NO.
PART I	FINANCIAL INFORMATION	2
Item 1.	Condensed Consolidated Financial Statements (Unaudited)	4
	Condensed Consolidated Balance Sheets – December 31, 2020 and September 30, 2020	4
	Condensed Consolidated Statements of Operations – Three months ended December 31, 2020 and 2019	5
	Condensed Consolidated Statements of Comprehensive Income (Loss) - Three months ended December 31, 2020 and 2019	6
	Condensed Consolidated Statements of Stockholders' Deficit - Three months ended December 31, 2020 and 2019	7
	Condensed Consolidated Statements of Cash Flows – Three months ended December 31, 2020 and 2019	8
	Notes to Condensed Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	31
Item 1A.	Risk Factors	31
Item 6.	Exhibits	31
Signatures		34

 

 

 

		December 31,				September 30,
		2020				2020
Assets
Current assets:
Cash and cash equivalents		$	5,845			$	7,619
Accounts receivable, net of allowances of $258 & $236			5,260				6,250
Inventories			1,214				1,167
Investment in sales-type lease, current			217				275
Capitalized commissions, current			373				440
Prepaid expenses and other current assets			1,048				1,065
Total current assets			13,957				16,816
Property and equipment:
Leasehold improvements			1,136				1,128
Computer equipment			8,213				7,960
Furniture and fixtures			1,444				1,366
Total property and equipment			10,793				10,454
Less accumulated depreciation and amortization			7,596				7,295
Property and equipment, net			3,197				3,159
Other assets:
Investment in sales-type lease, long-term			78				76
Capitalized commissions, long-term			72				100
Right-of-use assets under operating leases			1,827				2,081
Other long-term assets			499				397
Total assets		$	19,630			$	22,629
Liabilities and stockholders’ deficit
Current liabilities:
Accounts payable		$	891			$	2,689
Accrued liabilities			2,374				2,565
Unearned revenue			9,053				10,402
Current portion of finance lease obligations			100				119
Current portion of operating lease obligations			1,482				1,425
Current portion of notes payable and warrant debt, net of discounts			1,038				1,104
Total current liabilities			14,938				18,304
Long-term portion of unearned revenue			1,717				1,736
Long-term portion of finance lease obligations			68				89
Long-term portion of operating lease obligations			344				665
Long-term portion of notes payable and warrant debt, net of discounts			2,399				2,673
Derivative liability, at fair value			71				66
Other liabilities			160				144
Total liabilities			19,697				23,677
Commitments and contingencies
Stockholders’ deficit:
Preferred stock, $.01 par value, authorized 500,000 shares; none issued			—				—
9% Preferred stock, Series A, voting, cumulative, convertible, $.01 par value (liquidation preference of $1,000 per share), authorized 4,500 shares; zero shares issued and outstanding, at amounts paid in			—				—
5% Preferred stock, Series B, voting, cumulative, convertible, $.01 par value (liquidation preference at par), authorized 1,000,000 shares, none issued			—				—
Common stock, $.01 par value, authorized 10,000,000 shares; 8,012,279 and 7,965,325 shares issued, respectively and 7,999,563 and 7,952,609 shares outstanding, respectively			80				80
Additional paid-in capital			209,283				209,022
Accumulated deficit			(208,887	)			(209,519	)
Accumulated other comprehensive loss			(374	)			(462	)
Treasury stock, at cost, 12,716 shares			(169	)			(169	)
Total stockholders’ deficit			(67	)			(1,048	)
Total liabilities and stockholders’ deficit		$	19,630			$	22,629

 

		Three Months Ended December 31,
		2020				2019
Revenue:
Product and other		$	2,161			$	2,055
Services			7,004				5,960
Total revenue			9,165				8,015
Cost of revenue:
Product and other			813				831
Services			1,598				1,348
Total cost of revenue			2,411				2,179
Gross margin			6,754				5,836
Operating expenses:
Selling and marketing			3,010				3,396
General and administrative			1,198				1,441
Product development			1,741				1,590
Total operating expenses			5,949				6,427
Income (loss) from operations			805				(591	)
Non-operating expenses:
Interest expense, net			(29	)			(263	)
Other expense, net			11				15
Total non-operating expenses			(18	)			(248	)
Income (loss) before income taxes			787				(839	)
Income tax (expense) benefit			(155	)			19
Net income (loss)		$	632			$	(820	)
Dividends on preferred stock			—				—
Net income (loss) attributable to common stockholders		$	632			$	(820	)
Income (loss) per common share
– basic		$	0.08			$	(0.12	)
– diluted		$	0.08			$	(0.12	)
Weighted average common shares
– basic			7,963,775				6,736,643
– diluted			8,336,028				6,736,643

 

		Three Months Ended December 31,
		2020				2019
Net income (loss)		$	632			$	(820	)
Other comprehensive income (loss)
Foreign currency translation adjustment			88				(8	)
Comprehensive income (loss)		$	720			$	(828	)

 

																		Accumulated
										Additional								other
						Common				paid-in				Accumulated				comprehensive				Treasury
		Preferred stock				stock				capital				deficit				loss				stock				Total
Balance, September 30, 2019		$	—			$	67			$	203,735			$	(209,340	)		$	(546	)		$	(169	)		$	(6,253	)
Stock compensation			—				—				52				—				—				—				52
Foreign currency translation adjustment			—				—				—				—				(8	)			—				(8	)
Net loss			—				—				—				(820	)			—				—				(820	)
Balance, December 31, 2019		$	—			$	67			$	203,787			$	(210,160	)		$	(554	)		$	(169	)		$	(7,029	)

																		Accumulated
										Additional								other
						Common				paid-in				Accumulated				comprehensive				Treasury
		Preferred stock				stock				capital				deficit				loss				stock				Total
Balance, September 30, 2020		$	—			$	80			$	209,022			$	(209,519	)		$	(462	)		$	(169	)		$	(1,048	)
Stock compensation			—				—				119				—				—				—				119
Issuance of common stock			—				—				142				—				—				—				142
Foreign currency translation adjustment			—				—				—				—				88				—				88
Net income			—				—				—				632				—				—				632
Balance, December 31, 2020		$	—			$	80			$	209,283			$	(208,887	)		$	(374	)		$	(169	)		$	(67	)

 

		Three Months Ended
		December 31,
		2020				2019
Operating activities
Net income (loss)		$	632			$	(820	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Amortization of other intangibles			19				94
Depreciation and amortization of property and equipment			268				227
Provision for doubtful accounts - including financing receivables			22				9
Stock-based compensation expense related to stock options and warrants			119				52
Deferred loan interest to related party			—				123
Remeasurement loss on derivative liability			5				2
Changes in operating assets and liabilities:
Accounts receivable			1,079				1,137
Inventories			(42	)			(351	)
Investment in sales-type lease			63				33
Capitalized commissions			95				87
Prepaid expenses and other current assets			45				216
Right-of-use assets under operating leases			285				289
Operating lease obligations			(295	)			(289	)
Other long-term assets			(91	)			5
Accounts payable and accrued liabilities			(2,053	)			(136	)
Other long-term liabilities			12				(6	)
Unearned revenue			(1,431	)			(1,090	)
Net cash used in operating activities			(1,268	)			(418	)
Investing activities
Purchases of property and equipment			(287	)			(59	)
Net cash used in investing activities			(287	)			(59	)
Financing activities
Payments on notes payable			(368	)			(250	)
Proceeds from exercise of common stock options			142				—
Payments on finance lease obligations			(41	)			(70	)
Net cash used in financing activities			(267	)			(320	)
Changes in cash and cash equivalents due to changes in foreign currency			48				13
Net decrease in cash and cash equivalents			(1,774	)			(784	)
Cash and cash equivalents at beginning of year			7,619				4,295
Cash and cash equivalents at end of period		$	5,845			$	3,511
Supplemental cash flow information:
Interest paid		$	20			$	253
Income taxes paid, foreign			44				81
Non-cash financing and investing activities:
Property and equipment financed by finance lease or accounts payable			—				36

 

1.	Basis of Presentation and Significant Accounting Policies

 

Financial Statements

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared on a basis substantially consistent with the Company's audited financial statements as of and for the year ended September 30, 2020 included in the Company's Annual Report on Form 10-K.

 

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, 2020 are not necessarily indicative of the results that might be expected for the year ending September 30, 2021.

 

Impacts of COVID-19

 

On March 11, 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which has resulted in authorities implementing numerous measures to contain the virus, including travel bans and restrictions, quarantines, shelter-in-place orders, and business limitations and shutdowns.  While we are unable to accurately predict the full impact that COVID-19 will have on our results from operations, financial condition, liquidity and cash flows due to numerous uncertainties, including the duration, severity and impact of the pandemic and containment measures, our compliance with these measures has impacted our day-to-day operations and could disrupt our business and operations, as well as those of our key business partners, vendors and other counterparties for an indefinite period of time.  To support the health and well-being of our employees, business partners and communities, a vast majority of our employees have been working remotely since mid-March 2020 and continue to do so for the foreseeable future. 

 

COVID-19 has had negative impacts on our operations and the future impacts of the pandemic and any corresponding economic results are largely unknown and rapidly evolving.  Beginning in March 2020 and continuing through today, the in-person events portion of our business was and continues to be significantly impacted by cancellations and/or postponements due to social distancing protocols enacted to stem the spread of the virus.  In response to the cancellations, the Company introduced a new virtual events platform as an alternate solution for our customers. In addition, the closure of educational institutions globally and the negative financial impact on their funding, could impact sales in the upcoming quarters.  While the virus has increased awareness of the need for distance learning tools and the adoption of video as a necessary communication medium, it is impossible for us to predict with confidence the long-term financial impact on our business including results of operations and liquidity.

 

Restructuring and exit activities

 

The determination of when the Company accrues for involuntary termination benefits under restructuring plans depends on whether the termination benefits are provided under an on-going benefit arrangement or under a one-time benefit arrangement. The Company accounts for on-going benefit arrangements, such as those documented by employment agreements, in accordance with Accounting Standards Codification 712 ("ASC 712") Nonretirement Postemployment Benefits. Under ASC 712, liabilities for postemployment benefits are recorded at the time the obligations are probable of being incurred and can be reasonably estimated. The Company accounts for one-time employment benefit arrangements in accordance with ASC 420 Exit or Disposal Cost Obligations. When applicable, the Company records such costs into operating expense.

 

During the quarter ended December 31, 2020, the Company expensed involuntary termination benefits of $101 thousand under ASC 420 compared to zero in the same quarter last year.

 

Investment in Sales-Type Lease

 

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

 

Investment in sales-type leases consists of the following (in thousands) as of December 31, 2020:

 

 

 

Inventory

 

Inventory consists of raw materials and supplies used in the assembly of Mediasite recorders and finished units. Inventory of completed units and spare parts are carried at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. An obsolescence reserve has been established to account for slow moving inventory.

 

Inventory consists of the following (in thousands):

 

 

Asset Retirement Obligation

 

An asset retirement obligation (“ARO”) associated with the retirement of a tangible long-lived asset is recognized as a liability in the period in which it is incurred or becomes determinable, with an associated increase in the carrying amount of the related long-term asset.  The cost of the tangible asset, including the initially recognized asset retirement cost, is depreciated over the useful life of the asset.  As of December 31, 2020 and September 30, 2020, the Company has recorded a liability of $138 thousand and $134 thousand, respectively, for retirement obligations associated with returning the MSKK leased property to the respective lessors upon the termination of the lease arrangement. Asset retirement obligations are included in other-long term liabilities on the condensed consolidated balance sheets.

 

Fair Value of Financial Instruments

 

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

 

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

    

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

 

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

 

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

 

Financial Liabilities Measured at Fair Value on Recurring Basis

 

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

 

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

 

 

 

 

The gain or loss related to the fair value remeasurement on the derivative liability is included in the other expense line on the condensed consolidated statements of operations.

 

Financial Liabilities Measured at Fair Value on a Non-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 Mr. Mark D. Burish ("Mr. Burish") warrant was measured at fair value using a Black Scholes model and the remaining fair value was allocated to the related Mr. Burish note purchase agreement (see Note 4) which management believes materially approximated the fair value based on calculating the present value of expected future cash flows (Level 3). The non-recurring fair value measurements were performed as of the date of issuance of the note purchase agreement and warrant. The discount was being amortized over the life of the related debt until May 2020, at which time the debt was extinguished and exchanged for the Company's common stock.

 

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, debt instruments and capital lease obligations. The book values of cash and cash equivalents, accounts receivable, investment in sales-type lease, and accounts payable are considered to be representative of their respective fair values due their short term nature. The carrying value of 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.

 

No legal contingencies were recorded or were required to be disclosed for the three months ended December 31, 2020 or 2019.

 

Stock Based Compensation

 

The Company uses a lattice valuation model to account for all employee stock options granted. The lattice valuation model is a more flexible analysis to value options because of its ability to incorporate inputs that change over time, such as actual exercise behavior of option holders. The Company uses historical data to estimate the option exercise and employee departure behavior in the lattice valuation model. Expected volatility is based on historical volatility of the Company’s stock. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogeneous groups for valuation. The expected term of options granted is derived from the output of the option pricing model and represents the period of time that options granted are expected to be outstanding. The risk-free rate for periods the options are expected to be outstanding is based on the U.S. Treasury yields in effect at the time of grant. Forfeitures are based on actual behavior patterns. The expected exercise factor and forfeiture rates are calculated using historical exercise and forfeiture activity for the previous three years.

 

 

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

 

 

A summary of option activity at December 31, 2020 and changes during the three months then ended is presented below:

 

 

A summary of the status of the Company’s non-vested options and changes during the three month period ended December 31, 2020 is presented below:

 

 

The weighted average grant date fair value of options granted during the three months ended December 31, 2020 was $1.55. As of December 31, 2020, there was $510 thousand of total unrecognized compensation cost related to non-vested stock-based compensation, with total forfeiture adjusted unrecognized compensation cost of $394 thousand. The cost is expected to be recognized over a weighted-average remaining life of 1.9 years.

 

Stock-based compensation recorded in the three months ended December 31, 2020 was $119 thousand. Stock-based compensation recorded in the three months ended December 31, 2019 was $52 thousand. There was $142 thousand in cash received from exercises under all stock option plans and warrants during the three months ended December 31, 2020 and zero during the same period in 2019. There were no tax benefits realized for tax deductions from option exercises in either of the three month period ended December 31, 2020 or 2019. 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 300,000 common shares may be issued. The board passed a resolution in December 2020 to increase the share count by an additional 100,000 shares. A total of 106,710 shares are available to be issued under the plan as December 31, 2020. The Company recorded stock compensation expense under this plan of less than $1 thousand for each of the three month period ended December 31, 2020 and 2019.

 

 

Preferred Stock and Dividends

 

A total of zero shares of Preferred Stock, Series A were issued and outstanding as of December 31, 2020 and 2019.

 

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:

 

 

Liquidity

 

At December 31, 2020, approximately $3.1 million of cash and cash equivalents was held by the Company's foreign subsidiaries.

 

The Company believes its cash position plus available resources is adequate to accomplish its business plan through at least the next twelve months. We will likely evaluate lease opportunities to finance equipment purchases in the future and support working capital needs. We may also seek additional equity financing but there are no assurances that these will be on terms acceptable to the Company.

 

Recent Accounting Pronouncements

 

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

 

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

 

 

 

 

 

 

 

2. Related Party Transactions

 

During the three months ended December 31, 2020, the Company incurred fees of $32 thousand to a law firm, a partner of which is a director and stockholder of the Company. The Company incurred similar fees of $110 thousand during the three months ended December 31, 2019. The Company had accrued liabilities of $10 thousand and $36 thousand for unbilled services to the same law firm at December 31, 2020 and September 30, 2020, respectively.

 

On May 13, 2020, the Company entered into a debt conversion agreement with Mr. Burish to convert all outstanding debt owed to Mr. Burish into common stock at a conversion price of $5.00 per share. The total debt amount, including accrued interest and fees, of $5.6 million was converted into 1,114,723 shares of common stock. The transaction was recommended by the Company's Special Committee of Independent and Disinterested Directors, unanimously approved by all disinterested directors of the Company, and ratified by shareholders at the Company's most recent shareholder meeting. Silverwood Partners, the Special Committee's financial advisor, issued a fairness opinion in connection with the transaction.

 

Mr. Burish beneficially owns more than 5% of the Company’s common stock. Mr. Burish also serves as the Chairman of the Board of Directors. An affiliated party beneficially owns more than 5% of the Company's common stock. All transactions with Mr. Burish and with the affiliated party were approved by a Special Committee of Disinterested and Independent Directors.

 

 

 

3. Commitments

 

Inventory Purchase Commitments

 

The Company enters into unconditional purchase commitments on a regular basis for the supply of Mediasite product for hardware inventory, as well as services to support our hosting environment, which are not recorded on the Company's condensed consolidated balance sheet. At December 31, 2020, the Company had an obligation to purchase $199 thousand of Mediasite product and $237 thousand of services during fiscal 2021, and $422 thousand during fiscal 2022 and 2023.

 

Leases

 

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

 

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

 

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

 

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

 

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

 

Right-of-use assets and lease liabilities are recognized for our leases. Right-of-use assets under finance leases are included in property and equipment on the condensed consolidated balance sheets and have a net carrying value of $191 thousand at September 30, 2020 and $152 thousand at December 31,2020.

 

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

 

As of December 31, 2020, future maturities of operating and finance lease liabilities for the fiscal years ended September 30 are as follows (in thousands):

 

 

 

Adoption of ASC 842

 

Supplemental information related to leases is as follows (in thousands, except lease term and discount rate):

 

 

Variable lease costs include operating costs for U.S. office lease based on square footage and Consumer Price Index ("CPI") rent escalation and related VAT for office lease in the Netherlands.

 

Supplemental cash flow information related to operating and finance leases were as follows (in thousands):

 

 

Other information related to leases was as follows:

 

 

 

 

4. Credit Arrangements

 

Partners for Growth V, L.P.

 

On May 11, 2018, Sonic Foundry, Inc., entered into a Loan and Security Agreement (the “2018 Loan and Security Agreement”) with Partners for Growth V, L.P. (“PFG V”).

 

The 2018 Loan and Security Agreement provides for a Term Loan ("Term Loan") in the amount of $2,500,000, which was disbursed in two (2) Tranches as follows: Tranche 1 was disbursed on May 14, 2018 in the amount of $2,000,000; and Tranche 2 in the amount of $500,000, was disbursed on November 8, 2018. Each tranche of the Term Loan bears interest at 10.75% per annum. Tranche 1 of the Term Loan is payable interest only until November 30, 2018. Thereafter, principal is due in 30 equal monthly principal installments, plus accrued interest, beginning December 1, 2018 and continuing until May 1, 2021, when the principal balance is to be paid in full. Tranche 2 of the Term Loan is payable using the same repayment schedule as Tranche 1. Upon maturity, Sonic Foundry is required to pay PFG V a cash fee of $150,000. The principal of the Term Loan may be prepaid at any time without penalty as of May 14, 2019. The Term Loan is collateralized by substantially all the Company’s assets, including intellectual property.

 

Coincident with execution of the 2018 Loan and Security Agreement, the Company entered into a Warrant Agreement (“Warrant”) with PFG V. Pursuant to the terms of the Warrant, the Company issued to PFG V a warrant to purchase up to 66,000 shares of common stock of the Company at an exercise price of $2.57 per share, subject to certain adjustments. Pursuant to the Warrant, PFG V is also entitled, under certain conditions, to require the Company to exchange the Warrant for the sum of $250,000. All warrants issued in connection with PFG V expire on May 11, 2023.

 

At December 31, 2020, and September 30, 2020, the estimated fair value of the derivative liability associated with the warrants issued in connection with the 2018 Loan and Security Agreement, was $71 thousand and $66 thousand, respectively. Included in other expense, the remeasurement loss on the derivative liability during the three months ended December 31, 2020 was $5 thousand compared to remeasurement loss of $2 thousand during the three months ended December 31, 2019.

 

The proceeds from the 2018 Loan and Security Agreement were allocated between the PFG V 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 $2.3 million and $156 thousand, respectively. The warrant debt is treated together as a debt discount on the PFG V Debt and will be accreted to interest expense under the effective interest method over the three-year term of the PFG V Debt and the five-year term of the Warrant Debt. During the three months ended December 31, 2020, the Company recorded accretion of discount expense associated with the warrants issued with the PFG V loan of $6 thousand compared to $5 thousand in the same periods last year. In addition, $14 thousand amortization of the debt discount was recorded in the current three month period compared to $14 thousand in the prior year. At December 31, 2020, the carrying value of the PFG V Debt and the Warrant Debt (inclusive of its conversion feature) were $417 thousand and $178 thousand, respectively. In addition, the Company agreed to pay PFG V a cash fee of up to $150,000 payable upon maturity (the “back-end fee”), which will be earned ratably over the three year term of the PFG V loan. During the three months ended December 31, 2020, the Company recorded interest expense of $13 thousand associated with recognition of the back-end fee compared to $13 thousand during the three months ended December 31, 2019.

 

The non-cash effective interest expense is calculated on the net balance of the PFG V Debt, debt discount, back-end fee and related loan origination fees, on a monthly basis. During the three months ended December 31, 2020, non-cash interest expense of $18 thousand related to the effective interest rate on the PFG V loan was recorded compared to $3 thousand in the three months ended December 31, 2019.

 

On March 11, 2019, Sonic Foundry, Inc. entered into a Consent, Waiver & Modification to the 2018 Loan and Security Agreement dated May 11, 2018 (the "Modification") with Partners for Growth V, L.P. ("PFG"). Under the Modification: PFG waived the Company's default on the Minimum EBITDA financial covenant for the quarterly reporting period ending December 31, 2018; modified the existing financial covenants to be as follows: (i) Minimum Coverage Ratio (as defined), which requires, as of the last day of each month on or after the closing date, to be equal to or greater than (x) 0.7: 1.00 for the December through May calendar months, and (y) 0.9:1.00 for the June through November calendar months; (ii) Minimum Qualifying Revenue (as defined), which requires, as of the last day of each calendar month, on or after December 1, 2018, on a trailing twelve-month basis, to be no less than $13,000,000; and modified the negative covenants to be as follows: the Company (x) shall not cause or permit (a) Japanese subsidiary indebtedness under its revolving line of credit facility to exceed at any time $1,000,000 outstanding, or (b) aggregate subsidiary indebtedness to exceed $1,200,000 at any time. At December 31, 2020, the Company was in compliance with all covenants per the 2018 Loan and Security Agreement, as modified.

 

 

 

 

The existing terms of the PFG loan in terms of amortization, interest rate, payment schedule and maturity date are unchanged.

 

At December 31, 2020, a gross balance of $417 thousand was outstanding on the term debt with PFG V with an effective interest rate of sixteen-and-six-tenths percent (16.60%). At September 30, 2020, a gross balance of $667 thousand was outstanding with PFG V.

 

Initial Notes of the February 28, 2019 Note Purchase Agreement

 

On January 4, 2019, Sonic Foundry, Inc. and Mr. Burish entered into a Promissory Note (the "Promissory Note") pursuant to which Mr. Burish purchased a 9.25% Unsecured Promissory Note for $1,000,000 in cash. Interest accrued and outstanding principal on the Promissory Note was due and payable on January 4, 2020. The Promissory Note may be prepaid at any time without penalty. The Promissory Note was later included in the Note Purchase Agreement, dated February 28, 2019, as detailed below.

 

On January 31, 2019, Sonic Foundry, Inc. and Mr. Burish entered into a Promissory Note (the "January 31, 2019 Promissory Note") pursuant to which Mr. Burish purchased a 9.25% Unsecured Promissory Note for $1,000,000 in cash. Interest accrued and outstanding principal on the January 31, 2019 Promissory Note was due and payable on January 31, 2020. The January 31, 2019 Promissory Note may be prepaid any time without penalty. The note may be paid by the Company by issuing common stock to Mr. Burish, with each share valued at $1.30 per share. The January 31, 2019 Promissory Note was later included in the Note Purchase Agreement, dated February 28, 2019, as detailed below.

 

On February 14, 2019, Sonic Foundry, Inc. and Mr. Burish entered into a Promissory Note (the "February 14, 2019 Promissory Note") pursuant to which Mr. Burish purchased a 9.25% Unsecured Promissory Note for $1,000,000 in cash. Interest accrued and outstanding principal on the February 14, 2019 Promissory Note was due and payable on February 14, 2020. The February 14, 2019 Promissory Note may be prepaid any time without penalty. The note may be paid by the Company by issuing common stock to Mr. Burish with each share valued at $1.30 per share. The February 14, 2019 Promissory Note was later included in the Note Purchase Agreement, dated February 28, 2019, as detailed below.

 

February 28, 2019 Note Purchase Agreement

 

On February 28, 2019, Sonic Foundry, Inc. entered into a Note Purchase Agreement (the "Note Purchase Agreement") with Mr. Burish.

 

The Note Purchase Agreement provided for subordinated secured promissory notes (the "Subordinated Promissory Notes") in an aggregate original principal amount of up to $5,000,000. Mr. Burish acquired from the Company (a) on the initial closing date, the notes in an aggregate principal amount of $3,000,000 (the "Initial Notes") and (b) two additional tranches, each in the amount of $1,000,000 and payable at any time prior to the first anniversary of the Agreement (the "Additional Notes" and together with the Initial Notes, collectively, the "Purchase Price"). The Initial Notes were previously disbursed in January and February of 2019, as detailed above (the Promissory Note, the January 31st, 2019 Promissory Note, and the February 14, 2019 Promissory Note, collectively referred to as the "Initial Notes"). The fourth tranche was disbursed on March 13, 2019 and the fifth and final tranche was disbursed on April 4, 2019.

 

The Subordinated Promissory Notes accrued interest at the variable per annum rate equal to the Prime Rate (as defined) plus four percent (4.00%). The outstanding principal balance of the Subordinated Promissory Notes, plus all unpaid accrued interest, plus all outstanding and unpaid obligations, was set to mature on February 28, 2024 (the "Maturity Date"). Principal installments of $100,000 were to begin monthly on August 31, 2020, and continue through the Maturity Date. The Note Purchase Agreement dated February 28, 2019 was subordinated to the existing PFG loan.

 

At each anniversary of the Closing, an administration fee will be payable to Mr. Burish equal to 0.5% of the purchase price less principal payments made.

 

 

The proceeds from the Note Purchase Agreement were allocated between the Subordinated Promissory Notes and the Burish Warrant based on their relative fair value on the date of issuance. The warrant was treated together as a debt discount on the Subordinated Notes Payable and was accreted to interest expense under the effective interest rate method over the five-year term of the Subordinated Notes Payable. During the first fiscal quarter of 2020, the Company recorded accretion of discount expense associated with the Subordinated Promissory Notes of $34 thousand.

 

The non-cash effective interest expense was calculated on the net balance of the Subordinated Promissory Notes, Burish Warrant, and related loan origination fees, on a monthly basis. During the three months ended December 31, 2019, $15 thousand of non-cash interest benefit related to the effective interest rate on the Subordinated Promissory Notes was recorded.

 

February 28, 2019 Warrant

 

Coincident with execution of the Note Purchase Agreement, the Company entered into a Warrant Agreement ("Burish Warrant") with Mr. Burish. Pursuant to the terms of the Burish Warrant, the Company issued to Mr. Burish a warrant to purchase up to 728,155 shares of common stock of the Company at an exercise price of $1.18 per share, subject to certain adjustments.

 

On April 25, 2019, Mr. Burish exercised his warrant to purchase 728,155 shares of common stock of the Company at an exercise price of $1.18 per share. A special committee of disinterested and independent directors approved the issuance of the Subordinated Promissory Notes and the Burish Warrant.

 

May 13, 2020 Debt Conversion Agreement

 

On May 13, 2020, the Company entered into a debt conversion agreement with Mr. Burish to convert all outstanding debt owed to Mr. Burish into common stock at a conversion price of $5.00 per share. The net carrying value of $5.0 million, including principal and accrued interest of $5.6 million less debt discount and loan origination fees of $596 thousand, was converted into 1,114,723 shares of common stock. The debt conversion was treated as a debt extinguishment, and resulted in a net loss of $26 thousand.

 

Paycheck Protection Program (PPP) Loan Dated April 20, 2020

 

Following the approval of the Board of Directors, the Company and First Business Bank entered into a $2.3 million Promissory Note (the "Promissory Note") under the Paycheck Protection Program (PPP) contained within the new Coronavirus Aid, Relief, and Economic Security (CARES) Act. The PPP loan has a term of two years for those companies receiving loan proceeds prior to June 5, 2020, is unsecured, and is guaranteed by the U.S. Small Business Administration ("SBA"). The loan carries a fixed interest rate of 1% per annum. Under the terms of the CARES Act, the Company will be eligible for and intends to apply for forgiveness of all loan proceeds used for payroll costs, rent, utilities, and other qualifying expenses during the eight-week or twenty-four week period ("covered period") following receipt of the loan, provided the Company maintains its employment and compensation within certain parameters during such period, and provided further that not more than 40% of the amount forgiven can be attributable to non-payroll costs. The Company must apply for forgiveness within 10 months from the end of the covered period. First Business Bank will then have 60 days to review the application and submit it to the SBA and the SBA will have 90 days from receipt of the application to review and render a decision back to the lender. If the borrower does not apply for loan forgiveness within the 10 month time frame, or if the SBA determines that the loan is not eligible for forgiveness (in whole or in part), the PPP loan is no longer deferred and the borrower must begin paying principal and interest. If this occurs, the lender must notify the borrower of the amount and the date the first payment is due. The SBA began accepting applications for forgiveness from lenders on August 10, 2020 when the development of its new software-as-a-service platform went live. As of December 31, 2020 the full amount of the loan has been split between short-term and long-term notes payable of $482 thousand and $1.8 million, respectively, as well as short-term accrued interest of $16 thousand. The Company plans to apply for 100% forgiveness in Q2-2021.

 

Other Indebtedness

 

On January 30, 2020, Mediasite K.K. entered into a Term Loan ("Term Loan") with Sumitomo Mitsui Banking Corporation for $460 thousand in cash. The Term loan accrued interest at an annual rate of 1.475%. Beginning in January 2020, principal payments in 12 equal monthly installments, plus accrued interest were made. The principal has been paid in full as of December 30, 2020.

 

At December 31, 2020 and September 30, 2020, no balance was outstanding on the line of credit with Mitsui Sumitomo Bank. The credit facility is related to Mediasite K.K., and accrues interest at an annual rate of approximately one-and-one half percent (1.575%). The available line of credit at December 31, 2020 was $485 thousand and matures on March 1, 2021.

 

On August 20, 2020, Mediasite K.K. and Sumitomo Mitsui Banking Corporation entered into a $379 thousand Promissory Note under an initiative by the Japanese Finance Corporation government institution in response to the Cabinet Decision entitled "Emergency Economic Measures to Cope With COVID-19." Extending financial relief to organizations impacted by COVID-19, the loan has a term of three years and carries a fixed interest rate of 0.46% per annum. Government subsidies provided through the Japanese Finance Corporations will provide interest relief throughout the term of the loan. In addition, the loan agreement includes a three year grace period with principal payments deferred through the end of the loan, which is September 30, 2023. As of September 30, 2020 the full amount of the loan has been included in long-term 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, 2020 or September 30, 2020, and has not recognized any interest or penalties in the Condensed Consolidated Statements of Operations for either of the three or three months ended December 31, 2020 or 2019.

 

The Company’s tax rate differs from the expected tax rate each reporting period as a result of permanent differences, the valuation allowance, and international tax items.

 

 

 

6. Revenue

 

Disaggregation of Revenues

 

The following tables summarize revenues from contracts with customers for the three months ended December 31, 2020 and 2019, respectively, (in thousands) by subsidiary, which includes the parent (SOFO), our Netherlands location (SFI) and our Japanese location (MSKK) :

 

 

 

 

Transaction price allocated to future performance obligations

 

As of December 31, 2020, the aggregate amount of the transaction price that is allocated to our future performance obligations was approximately $4.0 million in the next three months, $9.1 million in the next twelve months, and the remaining $1.7 million thereafter.

 

 

Disclosures related to our contracts with customers

 

Timing may differ between the satisfaction of performance obligations and the invoicing and collection of amounts related to our contracts with customers. We record assets for amounts related to performance obligations that are satisfied but not yet billed and/or collected. Liabilities are recorded for amounts that are collected in advance of the satisfaction of performance obligations. These liabilities are classified as current and non-current unearned revenue.

 

Unearned revenues

 

Unearned revenues represent our obligation to transfer products or services to our client for which we have received consideration, or an amount of consideration is due, from the client. During the three months ended December 31, 2020, revenues recognized related to the amount included in the unearned revenues balance at the beginning of the period was $4.2 million compared to $4.3 million recognized during the  three months ended December 31, 2019.

 

Assets recognized from the costs to obtain our contracts with customers

 

We recognize an asset for the incremental costs of obtaining a contract with a customer. We amortize these deferred costs proportionate with related revenues over the period of the contract. During the three months ended December 31, 2020, amortization expense related to the amount included in the capitalized commissions at the beginning of the period was $215 thousand compared to $203 thousand recognized during the three months ended December 31, 2019.