Q1 2023 FalconStor Software Inc Earnings Call

Participants

Clark Liddell; VP of Strategic Operations; FalconStor Software, Inc.

Robert Todd Brooks; CEO, President & Director; FalconStor Software, Inc.

Vincent Sita; CFO, Treasurer & Principal Accounting Officer; FalconStor Software, Inc.

Presentation

Clark Liddell

Good afternoon, and thank you for joining us to discuss FalconStor Software's Q1 2023 Earnings. Todd Brooks, FalconStor's Chief Executive Officer; and Vincent Sita, 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 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 Q1 2023 earnings. Copies of the earnings release and supplemental financial information are available on FalconStor website at www.falconstor.com.
I'm now pleased to turn the call over to Todd Brooks. Todd, I believe you're on mute.

Robert Todd Brooks

Thank you, Clark. I appreciate that. And thanks for everybody for joining our call today. I appreciate you taking your time. Q1 was obviously a very important quarter for us as we increased our annual recurring revenue, we added new hybrid cloud customers through our partnership with IBM. We expanded our MSP business, and we improved legacy customer retention. We are a trusted data protection innovator, and we enable the world's most demanding managed service providers and enterprises to modernize their disaster recovery and data backup operations for the hybrid cloud world, protecting data across on-premises data centers, public cloud and private cloud environments.
Migration to the cloud data, center rationalization and increased leverage of outsourced managed services are top priorities for enterprise CIOs and are fundamental macro shifts to which FalconStor technology in our 20-plus years of market experience are well aligned. Our solutions deliver increased data security and provide for quick data recovery, including recovery from ransomware attacks. And our solutions accomplished these while driving down long-term data storage footprints by up to 95%.
Our hybrid cloud data protection solutions excel in 4 key areas: first, is scalability as our solutions enable customers to protect their mission-critical enterprise workloads; second, in offsite protection as our customers have flexibility to leverage any storage medium from legacy tape to modern cloud-based object storage; third, in cost savings as our industry-leading patented data deduplication technology empowers our customers to decrease their backup data storage by up to 95%; and then fourth, in hardware vendor flexibility as our solutions integrate with IBM's Power System hardware or commodity Intel-based hardware. Packaged together, these advantages give our solutions competitive differentiation, especially within IBM-centric enterprise IT environments and managed service provider IT environments.
We are -- we talk about this almost every earnings call, but we are really excited by the growth markets in which we operate and our -- and those markets' ability to drive significant recurring revenue growth for FalconStor. Data protection as a service, hybrid cloud and managed IT services are growing quickly and are clear reflection of macro shifts in our industry, to which FalconStor technology and experience are well aligned. In fact, the data protection as a service market is predicted to grow by 31% annually to $104 billion in 2027, the worldwide hybrid cloud market is predicted to grow by 20% annually to $204 billion in 2027, and the managed IT services market is predicted to grow by 8% annually to $355 billion in 2026. Our go-to-market focus on hybrid cloud partners, like IBM, and managed service providers will be key drivers for FalconStor to generate consistent and meaningful recurring revenue growth over the next several years.
As mentioned during our last earnings call, for fiscal year 2023, we have implemented 3 key strategic initiatives, and we'll go through these each time during our earnings calls in 2023. First, the initiative is generating consistent recurring revenue growth by expanding our differentiated hybrid cloud data protection leadership position for the tens of thousands of companies that operate IBM Power System environments. Second, on accelerating our recurring revenue growth by extending our IBM-centric hybrid cloud data protection position into Microsoft Azure, Google Cloud and AWS public cloud environments. And then finally, by continuing to aggressively control our operating expenses, deliver consistent profitability, limit our risk while we accelerate our hybrid cloud-focused recurring revenue base.
To this point, we are excited by the hybrid cloud resell relationship we launched in late Q2 of last year with IBM to provide several new joint solutions, which combine FalconStor StorSafe VTL software with IBM Cloud Object Storage, IBM Power hardware and IBM Power Virtual Server cloud environments. And we're very happy to report that our sales continue to increase through this relationship with IBM Q1. And our customer satisfaction has remained very high with IBM customers using these solutions.
And these joint solutions really fall into 3 categories to migrate and optimize data protection for IBM customers. And these include the following 3 solutions: first, an optimized backup and restore solution, where enterprise running their IBM applications on premises or in the IBM Power Virtual Server cloud can utilize our joint solution to securely and effectively back up or efficiently back up to IBM Cloud Object Storage. Second, within cloud migration solutions, for enterprises needing to migrate their existing on-premise applications to the IBM Power Virtual Server cloud, our StorSafe software takes a secure snapshot and restores it to the cloud, maximizing application availability and security. And then finally, an advanced hybrid cloud backup solution for MSPs looking to use the cloud for a secure air-gapped offsite location.
FalconStor and IBM deliver an on-premises solution with a cloud instance for secure and encrypted off-site backups. This partnership with IBM is obviously a material step forward for FalconStor and should be a significant contributor to our long-term strategic goal to significantly increase hybrid cloud recurring revenue.
Right. Let's move on now to our Q1 results. We have seen material recurring revenue growth since launching sales of IBM and IBM partners in the second half of last year. And that growth continued, as I mentioned, in Q1 as the ARR run rate of our hybrid cloud business increased 81% compared to the previous quarter. Within that hybrid cloud total revenue, our MSP ARR run rate increased by 23%. And clearly, we're very pleased with this continued validation, this early validation of our hybrid cloud focus with IBM. But we believe that we can increase these growth rates even further in coming quarters.
As aid to this hybrid cloud growth and MSP ARR run rate growth, we retained 100% of our hybrid cloud customers in the second -- in Q1 and had storage capacity used by our installed base customers increase by 0.3% on average each month. In addition to that -- to strong customer retention and installed base capacity growth, we also saw wins again across all 3 of our major regions, the Americas, Asia Pacific and EMEA. We won 14 new hybrid cloud customers during the quarter, and we have received industry recognition from IT Jungle on -- which is an IBM-centric online publication, which I've actually shown a screenshot here. Clearly, I'm not going to read this, but this article and several customer references that we've received over the last couple of quarters are available on falconstor.com and we leverage these consistently within IBM in FalconStor-related marketing material.
So with that, I'm going to, at this point, turn it over to Vince, who will provide a more detailed overview of our Q1 2023 financial results. Vince?

Vincent Sita

Thanks, Mark. So if we look at the income statement, we closed Q1 of this year with $2.3 million in revenues, operating expenses of $2.3 million, net operating loss of $421,000 and a net loss of $448,000. So how did this compare to prior year, Q1 of 2022? So revenues represent an increase of 11%. Operating expenses were 16% lower or $400,000 lower than the previous year, Q1 2022. So as a result, net operating income was $0.7 million higher in 2023 versus 2022.
Net income in Q1 2023 was a net loss of $448,000 versus a net loss of $1.1 million last year, Q1 2022. If we look at our -- the balance sheet on the next page, we ended the quarter with a cash balance of $1.8 million compared to $2 million at December 31, 2022, compared to $3.4 million as at March 31, 2022 so, therefore, a decrease of $0.2 million from Q4 of 2022 and a decrease over Q1 2022 of $1.6 million.
Looking at net working capital. So net working capital cash, which we exclude contract assets and deferred revenues, but include the redemption value of our term notes, ended at $872,000, a decrease of $0.3 million from Q4 2022 and a decline of $0.9 million from Q1 2022. We closed the quarter with $1.8 million in accounts receivable -- accounts payable and accrued expenses of $1.7 million and deferred revenues of $5 million. So Todd, I'll turn it back to you if you have any other final comments.

Robert Todd Brooks

Well, thanks, Vince. I appreciate that. And clearly, we're encouraged by the progress that we're making with IBM and our every cloud focus. We've got a lot of work to do. We're going to clearly continue to work hard to manage our expenses, make sure that we are profitable or very close to profitability every quarter. Clearly, we fell short of that a little bit in Q1. Although we did dramatically improve, our net income still was a loss for the quarter, so we've got a little bit of work to do there. But nonetheless, we're excited by the increase in hybrid cloud sales and just engagement in general with IBM and that partnership and the IBM partners.
So with that, let me pause and, Clark, you can open up the floor for questions.

Clark Liddell

Absolutely. Thanks, Todd. (Operator Instructions) And if you want to type a question in that box, then I will read it to Todd and/or Vince, and they'll be glad to answer it for you. So we'll just give you a few seconds here to type a couple a question or 2 in. Okay. Todd, I'm not seeing any questions as of this time. So I'll turn it back to you.

Robert Todd Brooks

All right. Thanks, Clark. Once again, thanks, everybody, for your time. I look forward to connecting again in the quarter and look forward to continue to work hard to grow this business with IBM and business in general with FalconStor. So thanks again for taking your time, and we'll talk next time.