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Edited Transcript of FALC earnings conference call or presentation 22-Mar-18 8:30pm GMT

Q4 2017 FalconStor Software Inc Earnings Call

Melville Mar 27, 2018 (Thomson StreetEvents) -- Edited Transcript of FalconStor Software Inc earnings conference call or presentation Thursday, March 22, 2018 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Patrick S. McClain

FalconStor Software, Inc. - CFO

* Robert Todd Brooks

FalconStor Software, Inc. - CEO

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Conference Call Participants

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* Allen Saul Zwickler

First Manhattan Co., Research Division - Research Analyst

* 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 Q4 2017 Earnings Call. Today's call is being recorded.

Todd Brooks, FalconStor's Chief Executive Officer, and Patrick McClain, Chief Financial Officer will discuss the company's results and activities and will 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 risks 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 fourth quarter and full year 2017 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 Todd Brooks.

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

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Thank you, Christie, and thanks to everyone that took your time today to join our Q4 earnings call.

As I discussed last time during our Q3 earnings call, since its launch in 2000, FalconStor has been a leader within what has been known as or what's become known as the software-defined storage industry. Our market that was reported in 2017 by IDC to be sized at approximately $7 billion and predicted to grow at a compounded annual growth rate of over 13% through 2021. Our products and solutions play a valuable role in managing and protecting critical data within large enterprise organizations around the world. Our customers depend on our solutions to effectively, efficiently and securely protect their critical data from unexpected disasters, malicious cyber attacks and unplanned outages. They rely on FalconStor to ensure mission-critical business continuity. We're excited about the progress that we've made in our operating performance during the second half of 2017. And it provides clear support that FalconStor has the opportunity to excel and deliver long-term value to its shareholder base.

During the quarter, during Q4, we focused on 3 key initiatives: one, on continuing to adjust our expense base to ensure we are operating on a healthy and profitable foundation; second, on deepening our global partner and end-user base relationships to reenergize sales; and finally, thirdly, in securing the funding needed to enable the long-term success of the company. So for the balance of today's call, we're going to dive, we're going to elaborate a little more in each of these key initiatives and then at the end, we'll open up the phone line for any questions that you may have.

So first, on profitability. Q4 continues the return to profitability that we first delivered last quarter in Q3 of 2017, empowered the company to an annual profit for 2017, which is actually the first annual profit since 2008. The strategic restructuring that we've launched earlier in 2017 and the additional focus we applied during Q4 allowed the company to generate a non-GAAP net operating income in excess of $1.5 million during the quarter. This is a $2.2 million improvements from the $700,000 net or non-GAAP net operating loss generated in Q4 2016. Our performance during Q3 and then also Q4 of last year allowed us to deliver an annual non-GAAP net operating income of over $1.3 million in 2017. That's a $9 million improvement from the non-GAAP net operating loss of nearly $7.8 million in 2016.

Our work and resultant performance during the last 2 quarters will certainly serve as critical supports for long-term profitable performance and growth. But creating a stable financial foundation is not simply driven by a profitable expense base, it's also a result of stable year-over-year bookings and resultant revenue retention and ultimately, our growth.

In my experience, mature enterprise software companies can only create commercial stability by first focusing on installed base value and growth. This requires spending significant time with decision makers from existing partners and customers to uncover the business value they receive when they utilize our products. As discussed during the Q3 call, we continue to have extensive installed base and our reengagement efforts continue to yield positive results in 2000 -- or in Q4. So to support the statement, let me highlight 3 stats from the quarter. To begin, our largest global partner increased their FalconStor billings by over 60% in the second half of 2017 as compared with the first half of 2017. Secondly, billings for FreeStor, which is our flagship products, increased by 122% in Q4 of 2017 as compared to Q4 2016. And then finally, new customer billings delivered from our partners for our 3-point solution products increased by 21% during Q4 as compared to the same quarter last year. So we're very encouraged by the progress that we delivered in Q4. Next, as a final step to ensure the long-term viability of the company, during Q4, we closed the $3 million financing commitment secured from Hale Capital.

So let me turn it over to Pat McClain, our CFO, now and -- to provide some additional detail on that financing and then also details on the Q4 financial results. Pat?

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Patrick S. McClain, FalconStor Software, Inc. - CFO [3]

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Thank you, Todd.

As previously announced, on November 17, we entered into a $500,000 secured short-term loan with Hale Capital and announced their financing commitment to the company. With the closing of this $3 million financing commitment on February 26, 2018, we received an additional $2.5 million with the $3 million loan rolled into a maturity, a longer-term maturity note. It matures June 30, 2021.

We are also pleased to report that Hale Capital has agreed to postpone the date of the mandatory redemption of the Series A preferred stock from August 5, 2017 to July 31, 2021 and waived all prior breaches of the terms of the Series A preferred stock. The continued support of Hale Capital and specifically, the closing of this financing, provides the company with a solid financial foundation for the future.

As Todd mentioned, the financial highlights of the quarter was the delivery of $1.1 million in non-GAAP operating income, which represents a 24% operating margin. Although we've delivered a 3% increase in revenues versus 3Q, third quarter, our revenues continue to decline versus 4Q 2016 as we closed the quarter at $6.3 million, representing a year-over-year quarterly decline of approximately 16%.

Bookings exceeded third quarter by 63% but primarily due to our large maintenance renewal base in Q4. Although this did -- although we did show a significant decline of 32% in comparison to Q4 2016, our expectation is that bookings and resulting revenues will stabilize over the next few quarters as we continue to reengage our customer base and implement our reforecast commercial strategy.

Gross margin continues to trend higher, increasing to 83% from 80% for Q3 and 74% for Q4 2016. This increase is attributable to cost reductions and product mix. As a result of our cost control and our realignment initiatives, our non-GAAP operating expenses continue to trend lower at $4.7 million, represented a decline of 5% over Q3 and 41% over Q4 2016.

Moving to our annual results. We experienced a year-over-year revenue decline in 17% with full year revenue coming in at $25.2 million versus $30.3 million in 2016. Gross margin increased from 73% to 78% on product mix and cost reductions during the second half of 2017. To reemphasize Todd's earlier statement, we are pleased to report the first profitable full year results since 2008 with non-GAAP net operating income of $1.3 million.

Turning now to balance sheet. We ended the quarter with a cash balance of just over $1 million, down from $1.8 million at the end of Q3. However, net working capital, excluding deferred revenue, ended at $584,000 which was up by $900,000 from the previous quarter, primarily on the strength of December billings of $3.4 million. We closed the year with accounts receivable at $4.2 million, up from $2.2 million at the end of Q3. Accounts payable and accrued expenses ended at $5.5 million with over $1.3 million coming due in Q1 2018.

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

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

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Thank you, Pat. I appreciate that.

So in summary, we are very pleased with the progress that the team has made in Q4 at FalconStor. And we still have significant work ahead of us, but we do believe the company's performance in Q3 and Q4 marked an important pivot point for FalconStor. So to our shareholders and loyal customers who maybe -- who have joined this call today or that might listen to the recording later, we are committed to delivering value, and we look forward to exciting days at FalconStor.

So at this time, I'll ask Christie to begin the question-and-answer session. Christie?

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Operator [5]

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(Operator Instructions) We'll take our first one from Allen Zwickler from First Manhattan.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [6]

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Just two numerical questions. If one were to -- and I'm then just use this term, fully dilute the share count at this point, could you -- do you guys have an estimate as to how many shares are outstanding currently?

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Patrick S. McClain, FalconStor Software, Inc. - CFO [7]

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Well, based on the -- yes, absolutely. This is Pat McClain. Yes. Based on the commitment that is funded so far, which is just the $3 million of the $4 million potential offering, we would have roughly $500 million, about $550 million with the option pool, with the management pool.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [8]

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So you had $50 million before, right? Or roughly?

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Patrick S. McClain, FalconStor Software, Inc. - CFO [9]

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Yes. We had $100 million authorized. Fully diluted, we have $55 million, roughly.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [10]

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Okay. So -- I'm sorry, so you had $55 million fully diluted. And if all of Hale shares, you're going to go to $550 million, is -- did I hear that right?

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Patrick S. McClain, FalconStor Software, Inc. - CFO [11]

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That's right. There'll be an offering that will come out where our current shareholders can participate alongside Hale and purchase units. I think that's been disclosed in our 8-K filings. So that -- it could be as much as 700 million shares when we get -- could get to -- if the offering is fully funded.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [12]

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And this -- and Hale would own what percentage of those shares if that was the case?

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Patrick S. McClain, FalconStor Software, Inc. - CFO [13]

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It depends on...

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [14]

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Well, assuming nobody, as we sit today.

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Patrick S. McClain, FalconStor Software, Inc. - CFO [15]

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As we sit today if no one participates, Hale would own 73%.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [16]

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73%. Okay. Got it. And secondly, could you disclose who your largest 1 or 2 customers are? If they're not over 10%, we wouldn't get to know that. So could you let us know?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [17]

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Yes. I prefer not to right now. In the future, we probably will begin to discuss that, but not today.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [18]

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Okay. But are these recognizable companies that -- because you talked about them increasing their...

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [19]

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Yes.

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Allen Saul Zwickler, First Manhattan Co., Research Division - Research Analyst [20]

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Okay. Great.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [21]

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Well, I'll give you like several -- I can just give a little bit of color around it. We've got quite a few, a large number of really large global partners.

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Operator [22]

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(Operator Instructions) We'll go next to Bill Dawkins from Burleson Dawkins, Inc.

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Bill Dawkins, [23]

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I know you talked about these next couple of quarters, things really stabilizing. Could you give me an estimate of where you think or the bottom of the revenue line is?

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Patrick S. McClain, FalconStor Software, Inc. - CFO [24]

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Good question. I don't know that we want to tag an exact number, Bill. But I think in general -- there's going to be some and maybe not even perfectly quantifiable right now effects from the Accounting 606 changes. But I think in general, if you just kind of look at it from a generic business perspective, we feel like we're beginning -- with the reengagement that we've had with the customer base, we believe that we've, by and large, arrested the decline. Now we could always be surprised obviously, but we're feeling pretty good that we've got the ship pointed in the right direction again, and we can begin to now focus on where we're going to put our efforts for growth.

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Bill Dawkins, [25]

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And going along those lines of growth, once you all get these things stabilized and hopefully, this company can begin to ramp again, how -- and I think how rapidly can this company ramp once you all get these things stabilized and grow these customers out?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [26]

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We have a lot of it, Bill. It depends upon -- we will likely employ as we go forward kind of a dual strategy of organic and inorganic. So the organic growth with our existing product set and then growth on the back of strategic acquisitions. And so a lot of it just depends on the -- largely on the types of companies that we might go and acquire. And I think on the organic side, the mature software companies like FalconStor, it would be naive to think that you would turn that base products set into a super-high growing product set again. But I do think that we can deliver some modest amount of organic growth while we are also then adding growth via M&A.

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Bill Dawkins, [27]

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The reason for my question is that -- I mean, we talked about the size of this market when we've got this little-bitty company in this big market. But it just never really showed up on the top line with FalconStor, and that's why I asked. Is the product...

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [28]

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Yes.

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Bill Dawkins, [29]

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I mean, as your press release state, I mean, you've got a pretty damn good product. It's just I haven't ever seen the damn product ramp. That's why I'm desperate. I want to know.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [30]

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Yes. Well, we covered this just a little bit, Bill, from -- in the Q3 call. And I agree with you, the products is fantastic. The -- I think where the company struggled historically is just in commercial execution, right? And so I can't speak as we weren't here obviously talking -- exactly where they fell down. But as we look at rebuilding relationships, it's all about discipline, proper account management, keeping in touch with the customers. A lot of customers that we reengage with are hearing comments like, oh, we haven't heard you or heard from you guys in 2 or 3 years is not uncommon, right? So who knows? We might be surprised with what we can drive organically, but I don't want to be naive and think that all of a sudden, the core FalconStor products are going to become the super-high growth products. But they could serve as a fantastic foundation to growth via M&A.

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Bill Dawkins, [31]

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Got you. So it can be the core of something bigger as far as the package is concerned?

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [32]

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Absolutely. And storage, as you well know is centric to a lot of enterprise software applications, right? So I think as we begin to lay out our strategic road map going forward and we begin to think about other areas in which we might go into, there are a lot of interest and opportunities for enterprise software that is storage-centric.

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Operator [33]

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(Operator Instructions) We have no more questions in the queue. I'd like to turn it back to you for any closing remarks.

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Robert Todd Brooks, FalconStor Software, Inc. - CEO [34]

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No. I'm good, Christie. Thank you very much. And once again, thanks, everyone for attending today, taking your time out of your busy schedule to attend our call. We look forward to our call next quarter. Thank you.

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Operator [35]

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And that concludes our call for today. Thank you for your participation. You may now disconnect.