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Edited Transcript of FALC earnings conference call or presentation 14-Aug-19 8:30pm GMT

Q2 2019 FalconStor Software Inc Earnings Call

Melville Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of FalconStor Software Inc earnings conference call or presentation Wednesday, August 14, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brad Wolfe

FalconStor Software, Inc. - Executive VP, CFO & Treasurer

* Robert Todd Brooks

FalconStor Software, Inc. - CEO, President & Director

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Conference Call Participants

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* Bill Dawkins

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Presentation

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Operator [1]

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Good afternoon, and thank you for joining us to discuss FalconStor Software's Second Quarter 2019 Earnings Call. Todd Brooks, FalconStor's Chief Executive Officer; and Brad Wolfe, Chief Financial Officer, will discuss the company's results and activities, and we'll then open the call to your questions.

The company would like to advise all participants that today's discussion may contain what some consider forward-looking statements. These forward-looking statements involve risk and uncertainties that could cause actual results to differ materially from the forward-looking statements. These risks and uncertainties are discussed in FalconStor's reports on Forms 10-K, 10-Q and other reports filed with the Securities and Exchange Commission and in the company's press release issued today.

During today's call, there will be discussions that include non-GAAP results. A reconciliation of the non-GAAP results to GAAP has been posted on FalconStor's website at www.falconstor.com under Investor Relations. After the close of business today, FalconStor released its second quarter 2019 earnings. Copies of the earnings release and supplemental financial information are available on FalconStor's website at www.falconstor.com.

I am now pleased to turn the call over to Mr. Todd Brooks. Please go ahead, sir.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [2]

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Thank you, Nathaniel, appreciate it. And I'd like to take -- thank everyone for taking your time today to participate in our call. I am very pleased with the progress that FalconStor team has made thus far this year in 2019. As we strive to empower IT professionals and enterprises across the globe master -- achieve mastery over their data. Because we believe data is an organization's most precious asset and, when mastered, enables the organization to responsibly push the boundaries of what's possible in the digital economy in which they operate.

FalconStor's products are appointed at a market reported in 2018 by IDC to be sized at approximately $10.7 billion and predicted to grow at a compounded annual growth rate of 14.7% through 2022. This growth is being driven by 2 factors: first, an explosion in the amount of data generated by various digital technologies, whether it's in the form of traditional e-mail, documents, application databases, digital audio and video or Internet-connected devices; and then second, the dramatic increase in storage -- data storage options, whether they be located in a traditional data center, a private cloud or a public cloud. The ever-expanding capacity of data captured and stored is driving the need for enterprises to cost-effectively, securely and intelligently manage this data. So I'm excited about this market and the business value that FalconStor delivers to its complex enterprise customers.

Before we begin, I would like to highlight the approval that we obtained for our reverse stock split, which took effect this past Thursday, August 8. This is a key milestone, as you probably know, for our shareholders. And Brad will go into detail -- into a little bit more detail here in a few minutes on that.

Diving into Q2. During the quarter, we focused on 3 key initiatives: first, on generating year-over-year billings growth; second, on continuing sales momentum with our backup and archive modernization solution; and then third, finally, on key product innovations. For the balance of today's call we will elaborate on each of these key initiatives, provide a detailed review of Q2 financial results and then open the phone line for any questions that you may have.

So for the first -- for the past 7 quarters, we have focused our attention on improving the company's balance sheet, realigning the company to ensure we are generating positive operating profits and on stabilizing the company's quarterly billings. At the beginning of 2019, we believed we were in a position to begin delivering year-over-year growth -- year-over-year billings growth. And I'm very pleased to announce that we generated 15% billings growth in Q2 of 2019 as compared to the same quarter, Q2, of 2018.

What makes us even more significant though is the fact that we intentionally withdrew from new sales pursuits in China, reducing the percentage of total quarterly billings from China to 2% in Q2, down from 12% in Q2 of '18 and down from 17% in Q2 of 2017. Our Q2 billings growth is an important milestone for our team and shareholders alike. And the major -- primary contributor, I should say, to our Q2 growth was a significant increase in our backup and archive modernization solution, which grew 82% year-over-year in Q2 and 46% in Q1 of this year.

FalconStor has historically been an industry leader in backup and archive modernization with our VTL or Virtual Tape Library solution. However, what has historically been viewed as simply a backup tape replacement option as it evolves into an even more powerful solution for our complex enterprise customers. Today, those customers are able to leverage this solution to completely modernize their routine backup and archive operations by ensuring they are able to meet the most stringent backup windows, materially reduce the amount of data that needs to be stored and easily leveraging new, flexible and lower-cost storage options, such as AWS, the Attaché content platform and the IBM cloud.

IDC reports that 75% of the data stored by an enterprise is in the form of routine data backup and archives. Our solution is the best in the industry and that isn't just our opinion here at FalconStor. In fact, Russ Fellows is senior partner and analyst from Evaluator Group, an independent information management and data storage analyst firm, has this to say about our solution: "The performance of the tested FalconStor VTL was the highest-performing single node system Evaluator Group is aware of to date at nearly 40 terabytes an hour."

In fact, our solution is 25% faster than our leading competitor, which is Dell EMC's Data Domain product. It is architected to run on commodity hardware that is 1/3 of the cost of EMC hardware. So we are obviously excited about our backup and archive modernization solution and its importance within our complete suite of data protection technology and as a result, we will continue to increase product, marketing and sales efforts in this area. Our pipeline for the balance of 2019 has continued to improve and our expectation is that we will deliver year-over-year billings growth for 2019.

Moving on to key product innovations. The FalconStar store product suite delivers tremendous business value across 3 key solution categories. Those being backup and archive modernization, disaster recovery and high availability. As already discussed, the backup and archive modernization category is powered by our VTL technology and is targeted at modernization and optimization of existing backup and archive operations. This category is the foundation of daily routine data protection strategies for our complex enterprise customers. Next, the disaster recovery category is targeted at delivering superior application-aware protection via advanced continuous data snapshot and journal-based replication and then automated recovery. Finally, the high-availability category delivers superior business continuity via continuous active-active availability of mission-critical production data. Each of these solution categories is built upon a foundation of hardware and cloud vendor-agnostic technology, which allows our customers to leverage existing hardware investments and intelligently utilize the best target storage environment for each of their specific data protection use cases, and finally, allows them to eliminate vendor lock-in and the need to rip and replace hardware.

Our full-spectrum data protection solutions enable our complex enterprise customers to virtually eliminate potential data loss. As we continue moving or as we continue innovating within our data protection space, we will place the majority of our focus on intelligent data storage leveraging the full array of potential storage environments for our enterprise customers, whether those storage environments be on-premise, within one of the customer's data centers or located within one of many public cloud data storage vendors. I look forward to some exciting and innovative product announcements over the next several quarters.

FalconStor is unique. Over nearly 2 decades of technology innovation is unmatched by newer entrants in the data protection space, and we'll continue to build upon this advantage. Our customers know that our solutions are powerful and comprehensive.

With that, I'll turn it over to Brad to provide a more detailed overview of our Q2 financial results. Brad?

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Brad Wolfe, FalconStor Software, Inc. - Executive VP, CFO & Treasurer [3]

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Thank you, Todd. We closed the 3 months ended June 30, 2019, with $3.5 million in billings as compared to $3.1 million for the same period of the previous year. This 50% growth in billings year-over-year was driven by record sales in the Americas, where billings increased 114% as compared to the prior year. On a product-specific basis, as Todd highlighted, this also reflects impressive progress with VTL, where our Q2 billings grew by 82% as compared to the previous year.

Year-over-year, we have also reduced our China-specific risk exposure significantly. China now represents just 2% of our total sales as compared to 12% in 2018.

During the 3 months ended June 30, 2019, we recognized revenue of $4 million as compared with $4 million in the prior year period. Revenue recognition on sales is driven by several factors. First, the volume of new product licenses and maintenance sales both for expansion of our existing installed base and the acquisition of new customers. Second, customer retention, which sustains maintenance renewal revenue over long-term sales arrangements. Total cost of revenue for the 3 months ended June 30, 2019, increased 105% to $1.3 million compared with $0.6 million in the prior year period.

Total gross profit decreased $0.7 million or 20% to $2.7 million for the 3 months ended June 30, 2019, compared with $3.4 million for the prior year period. Total gross margin decreased to 68% for the 3 months ended June 30, 2019, compared with 84% for the prior year period. The decrease in our total gross margin and total gross profit in absolute dollars was primarily due to product mix as a result of higher-than-anticipated hardware and application sales during the current period, which yields significantly less profit margin as compared to our key propriety software license offerings. Generally, our total gross profit and total gross margins fluctuate based on several factors including: one, revenue growth; and two, changes in personnel headcount and related costs; and three, our product offerings and mix of sales.

Overall, our total operating expenses for the 3 months ended June 30, 2019, declined $0.4 million or 10% to $3.7 million as compared to $4.1 million for the same period of the previous year.

Turning now to the balance sheet. We ended the quarter with cash -- with a cash balance of $2.4 million. Net working capital, excluding deferred revenue, contract receivables, but including redemption value of our term note ended at a $1 million deficit. We closed the quarter with accounts receivable of $1.7 million, accounts payable and accrued expenses of $3.4 million and deferred revenue of $8.7 million.

As Todd mentioned, we completed our 100:1 stock split as approved by the shareholders on 8/08/2019. This reduces our shares outstanding from approximately 544 million to 5.4 million increased -- and increased our stock price to, as of the close of today, $10.75. This is the first step in our plan to potentially relist on NASDAQ and reinvigorate our investor participation as we move FalconStor toward being a key platform company in our space.

Todd, I'll now turn it back over to you for final comments.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [4]

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All right. Thanks, Brad. In summary, we are very pleased with the progress made thus far in 2019 and we do believe the company's performance over the last 8 quarters has set up a fantastic opportunity for FalconStor and its shareholders. The fact that we were unable to generate an operating profit for an eighth straight quarter was disappointing for our team, I won't lie. However, as Brad highlighted, our Q2 operating loss was primarily driven by an increase to cost of goods sold from several large wins we secured in the quarter.

At the beginning of Q3, we made several changes to ensure we deliver cash flow-positive operations in Q3 and in Q4. Our decision to dramatically reduce our physical presence in China is a good example of the targeted changes we have made while continuing to focus on delivering not only billings growth but cash flow-positive operations each and every quarter.

Finally, I'd like to take this opportunity to highlight the experienced team we have assembled at FalconStor. First, our dedicated and loyal employees base has an impressive amount of domain experience in our industry and average tenure of over 9 years with the company. Second, the leadership team we have built is unique at a company like FalconStor and has proven experience in growing mature software companies and delivering shareholder value.

I'd like to take a minute to highlight 2 of our leaders. The first, our new VP of Product and Marketing, David Morris, is a seasoned innovator within the data storage industry. And then the second, our VP of Engineering, Mark Delsman, was just accepted into the Forbes Technology Council. So congratulations to both David and Mark. And then finally, our Board of Directors is seasoned and includes top minds from our industry and complementary disciplines. We recognize the opportunity we have, and we are excited to be part of the FalconStor story. To our shareholders and loyal partners and customers who have joined the call today or that will listen to its recording, we are committed to delivering value, and we look forward to the future of FalconStor.

So at this time, I will ask Nathaniel to begin the question-and-answer session. Nathaniel?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Bill Dawkins with Burleson Dawkins, Inc.

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Bill Dawkins, [2]

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Your story sounds awesome, it always sounds great, and you all have done a great job on getting the operations it seems like really tied together and tight and everything. But I'd just say, once again, when will we see some growth? I mean I want to, like, revenue growth -- year-over-year revenue growth. When do you all think that's going to begin to kick-in? Because your story is wonderful. It always has been. And your technology has always been wonderful. But where are the sales? When will that happen?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [3]

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Well, billings as you saw in our review, Bill, billings were up 15% for the quarter, and that's obviously step number one. Those billings, as Brad mentioned in his review, are always a combination of some perpetual license, some subscription license, some maintenance renewals, and that varies from quarter to quarter. So how that then manifests itself into actual revenue changes. So a $3.5 million billing quarter doesn't mean a $3.5 million revenue quarter. It could be anywhere from $4 million to more than that. And so it's equally likely that we'll have a quarter where we'll increase billings by 15% and we'll increase revenue by 15% or more. So it's just -- it's totally a combination of the type of deals that are secured during the quarter as to the revenue recognition that then comes out of that billings. But meeting a -- achieving a 15% billing growth in the quarter is huge in my perspective. The company hasn't done that in -- good lord, I don't even know how many years. And so that was a tremendous first step.

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Brad Wolfe, FalconStor Software, Inc. - Executive VP, CFO & Treasurer [4]

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I would just add, Bill, sustained billings growth will result in sustained revenue growth. So as long as we can sustain year-over-year billings growth, the revenue will come. The revenue recognition, it is a matter of mix, but as long as we continue to grow billings, revenue growth will come.

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Bill Dawkins, [5]

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And does this product have the characteristics of a product that can actually ramp? Or is this the kind of thing that we're going to see 15% year-over-year growth? Is that the kind of marketable plan? And I know it's huge. But what kind of ramp can this product have?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [6]

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Yes. I don't believe, Bill, that we have a product set at least today. We're working on some things that are really interesting that we're not ready to announce today but our current product set and how they've evolved over the last couple of years are really interesting but they're not going to be 200%, 300% -- 200%, 300%, 400% super high-growth type technology that you might have when you're starting from 0. But, a healthy 20% to 30% organic growth rate and then as we've mentioned numerous times before then beginning to add in acquisitions will absolutely take the company to an interesting growth rate. But we're in a mature -- we are a mature company, been around for 20 years, as you very well know, and being able to turn a company like FalconStor to where you can have 20%, 30% growth organically is just tremendous.

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Bill Dawkins, [7]

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Okay. And so -- and then on the gross margin side, would this kind of be a range of your gross margins, maybe the mid-60s to the mid-80s? Or could we actually see gross margins drop into the 50s?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [8]

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No. You'll actually start to see those go up, Bill. One of the things that we're working on internally is actually moving a portion of our cost of goods sold, the hardware piece to just be a pass-through. And so as we do that and as we get more of our hardware to just be a pass-through, what you'll see is those gross margins actually go up, not down.

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Bill Dawkins, [9]

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Okay. And one last thing just for the people on the call because I'm having a hard time too, but how do we get a quote on your stock? What's the symbol, is it FALC. D?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [10]

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Yes. Brad, you want to review that real quick on how that works?

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Brad Wolfe, FalconStor Software, Inc. - Executive VP, CFO & Treasurer [11]

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Yes. Sure would be happy to. We did the 100:1 stock split and what we're required to do after we do the stock split is the company will trade under FALC. D for 20 days and then after that, it will go back to regular trading. So that's why you -- if you go look at it today, there's that FALC. D out there. But that will be removed after 20 days and then it will just be normal trading from there forward.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [12]

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Yes. That's a regulation, Bill, that we have no control of. That's something that's imposed on us.

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Operator [13]

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(Operator Instructions) And we have no further questioners at this time. I would now like to turn the conference back to Mr. Todd Brooks for closing remarks.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO, President & Director [14]

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All right. Thanks, Nathaniel. Thanks to everybody once again for attending, and we appreciate your time, and we look forward to chatting again soon.

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Operator [15]

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Ladies and gentlemen, this concludes today's presentation. You may now disconnect.