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Crossroads Systems (NASDAQ:CRDS)

Q1 2013 Earnings Call

March 12, 2013 4:30 pm ET

Executives

Robert C. Sims - Chief Executive Officer, President and Director

Jennifer Ray Crane - Chief Financial Officer

Analysts

Christopher Slaymaker

Steve Shaw - Sidoti & Company, LLC

Richard Lewis Feldman

Operator

Good afternoon and thank you for participating in today's conference call to discuss Crossroads Systems financial results for the first quarter ended January 31, 2013. With us today are Mr. Rob Sims, the company's Chief Executive Officer; and Ms. Jennifer Crane, the company's Chief Financial Officer.

Following their remarks, we will open up the call for questions. Then before the conclusion of today's call, I'll provide the necessary cautions regarding forward-looking statements made during this call. I would like to remind everyone that a webcast replay will also be available via the link provided in today's press release, as well as available on the company's website at www.crossroads.com. Now, I would like to turn the call over to the Chief Executive Officer of Crossroads Systems, Mr. Rob Sims. Sir, please go ahead.

Robert C. Sims

Thank you. Good afternoon, everyone and thank you for joining us. So we continue to be very excited about the growth of StrongBox, as it beats our expectation for Q1 by 27% and more than doubled over the last quarter. Now, we've had a bunch of operational activities of recent that we've just announced either through press releases or in Ks. And it feels that it's important before providing details of the quarter to at least provide some context for a broader view of what's going on with the business.

So last Friday, we announced a reduction in workforce of 23%. Most of the reduction affected the research and development of the company. However, I think it's very important, it should be noted, that the company still remains very technically strong and very capable of delivering on our future plans in the StrongBox growth.

Now in 2012, if you guys remember, we started to scale our engineering department up to meet the requirements of Iron Mountain and our other strategic partners. And with the majority of those requirements met, we felt it was the right time to balance our expenses with the current business.

Now prior to this change going into effect, to reach breakeven, we would need to close about $6.5 million to even $7 million of StrongBox revenue per quarter. Now, our estimates show that breakeven is around $3.5 million per quarter. And when you consider the Q1 delivered $1.4 million of StrongBox revenue, in just its fourth shipping quarter, that $3.5 million target is very attainable.

Now additionally as always, we are focused on our cash and cash burn. The reduction on our headcount will decrease our annual expenses by over $5 million beginning in fiscal Q3 of this year. Now, we ended Q1 with $2.5 million in cash, and at the end of February, we secured $550,000 from existing investors. The purpose of this funding was to help us manage through the reduction in our workforce, which comes with additional cash requirements for vacation and severance payments. And we have spoken many times about the company's ability to raise capital from intellectual property, strategic partners and the public market. And all efforts are underway, and we anticipate being able to make an announcement soon, and then have a call with everyone to discuss the capitalization of the business going forward. We'd hope to be able to discuss it on the call today, but unfortunately, the timing is such, that we just can't get into the details right now.

So Jennifer will take you through the fiscal first quarter results now, and as well, she'll provide you more detail around these recent announcements. Then I'll get back on and talk and share with you even more of the excitement we're seeing in the progress all around StrongBox in the marketplace.

Jennifer Ray Crane

This afternoon we released our fiscal first quarter 2013 results in a press release which is available for download via our website at www.crossroads.com. For the first quarter, revenue totaled $3.6 million. This revenue total represented an increase of $1 million from the same quarter a year ago, due to the addition of StrongBox revenue of $1.4 million in the current quarter. StrongBox shipments have continued to increase quarter-over-quarter. StrongBox grew from about $650,000 last quarter to $1.4 million this quarter.

We continue to recognize revenue from the Iron Mountain development service contract, which is based on a percentage of the total project completed. The project was on schedule and about 60% complete at the end of the quarter. Gross profit in fiscal Q1 was $2.6 million or 73% of total revenue compared to $2.3 million or 88% of total revenue in the same quarter a year ago. The percentage was lower this quarter due to the lower margin associated with the Iron Mountain development service revenue.

Operating expenses for Q1 2013 increased to $5.7 million from $5 million in Q1 2012, mainly due to increases in sales and marketing efforts around our StrongBox product. As Rob discussed, we completed a reduction in force last Friday, and due to severance and vacation payments, we do not expect to see a significant decrease in our operating expenses during our second fiscal quarter which ends on April 30, 2013, but we do expect to see a total decrease in operating expenses of $1.3 million with $1 million in research and development starting in our fiscal Q3. In addition, we'll continue to see our research and development expenses fluctuate over the next few quarters, depending on the amount reclassified to cost of goods sold, relating to Iron Mountain development.

Our net loss was $3.1 million or $0.27 loss per share versus a net loss of $2.7 million or $0.25 loss per share in the same quarter a year ago. This is mainly due to gross profit increases being offset by increased operating expenses. We ended the quarter with a cash balance of $2.5 million compared to $6.9 million at the end of the previous quarter, due to the timing on the receipt of payments and the impact from operations. In addition, we paid back $1.5 million of our bank debt during Q1.

Robert C. Sims

As I said at the start of the call, StrongBox revenue more than doubled quarter-over-quarter. Even what I think is even more important is the overall steady growth we are seeing in the uptake of the solution. Not only are the end customers growing, but the opportunities continue to grow as well. Our funnel grew from $14 million in Q4 2012 to $17 million at the end of Q1.

So Q1 was really a quarter of firsts. Our first studio, Stars, was closed. StrongBox is being used as an active archive for their generated content. And now Stars, they not only just produce shows for their future films for their network, but they are also producing content for other networks. And all of this content is, in fact, their intellectual property. And just like us in the technology sector protecting that property as top of mind and a priority for their business, and StrongBox is that protection.

Another first was the closing of Focus on the Family, one of the nation's leading Christian ministries headquartered in Colorado Springs, Colorado. And I've spoken briefly before about how faith-based ministries surprised me, it's just amazing in how much data they are generating. In fact, last week, we were able to attend the National Religious Broadcasters show in Nashville, which had attracted over 4,000 attendees. Many of those churches and organizations generate content in excess of 500 terabytes. When we've got our market analysis and assessment, there are over 1,600 mega churches in the U.S. So it fits this size and category of data growth. And if you think through that, that half a petabyte and depending on the different configurations that are available to them, a single mega church could drive 100,000 to 300,000 in just StrongBox business alone.

Another first was the closure of end customers brought by Hitachi data systems. Last year at the National Association of Broadcasters or NRB show in April, we were invited to present our technology in their booth. Their seamless migration of files between different storage tiers makes the StrongBox archive tier a very viable, long-term storage strategy for the end users, basically giving them a cradle-to-grave storage architecture. And these types of relationships always, always take time, and it's difficult to see the fruition of the effort put in by the long hours of business development and the different sales organizations. However, Q1, the first, being that viable, tangible measurement is now being seen as a success. Three of the closed deals came as a direct reference from HDS. And we, on the other side of the table, on the product side, have just completed full certification and testing with their 2 major product lines called HNAS and HCP. And we are working together now on rolling out the processes and the message of combining our sales efforts, which at this time, a kind of model evolves, what we call meet in the channel. And this where both groups share the opportunities, and then they combine to make sure that our joint value-added resellers, the guys that are actually implementing, are fully up to speed on how to sell and implement a complete package type of a solution.

So while this is being -- and has taken great progress, I do want to caution everybody to understand, these efforts will continue to take time and they will ramp slowly until it all becomes a very well-oiled machine, but we are certainly thrilled with the results of this. And I do want to mention that at this year's NAB, which starts in the 2nd week of April, we, again, are in the Hitachi booth. But this time, we are the archive solution in the booth, there is no other option and no other solutions. And while I'm at it, I should make sure to invite everybody. If you wish to come to NAB, we also have a very big presence there this year as well.

So Iron Mountain, being another factor, is installing their first beta customer this week, so we're seeing continued good progress there. If those of you might recall, this program was initiated with a $5.2 million investment. And together, we have been developing this program over the last 8 months. We've agreed to let them tell you all about their services and offerings, and I know that they're excited about that when it comes time. But of course, StrongBox is front and center to how all of this is being rolled out. We do know that they have a planned rolled out for their beta program, with the first one starting, as we talked about, and understand that their general launch will be later in the summer.

So while government opportunity isn't really a first, since we closed both the Department of Health and Human Services and Jet Propulsion Labs in Q4, we have seen continued success in Q1 with the closing of a growth size opportunity, [indiscernible]. And we've talked briefly about our new Federal Advisory Board during our last call, our Q4 call. And just a week ago, I was able to go visit the National Reconnaissance Office, or the NRO, which controls the federal government's satellite activity. In this meeting, along with other agency meetings, of which, of course, they cannot be named, are direct results of our new advisers. There's no way we would have ever gotten to any of these types of meetings without them getting involved and making sure that our technology was brought to bear there and having these types of meetings. Now, on a personal level, besides being in the NRO, and seeing some of the initial satellites and different things that were ever launched and all that being very cool, I think the best thing I got out of this is one of -- the director of one of the programs, which is going across the agencies, looked at me after he had a chance to review the StrongBox, and after we had about 1.5 hours of discussion, and he said, "We are going to have a whole lot of fun." And I'm certainly looking forward to having that kind of fun.

So during our last call, I also spoke about how every one of our StrongBox deals had pulled a tape library and new tape drives along with it. Now, in some cases, these were the larger systems in Spectra Logic, or IBM sales, and in the bar integrates the solution at the customer site. However, there are other opportunities that require smaller capacity, and that's a smaller library. Additionally, the customer would like to see a more simple process. Instead of producing 2 different purchase orders and dealing with 2 different vendors, they would prefer a complete single vendor type solution, and I think we all know the nomenclature, "One throat to choke." So that's all they want to deal with is Crossroads in this particular case. So therefore, we have decided to now offer the smaller tape libraries along with the StrongBox clients through the channel and address these specific type of opportunities. And like the StrongBox itself, I want to be clear that we don't carry inventory. We develop software, SuperMicro white box servers, distributors to build and ship. And the same thing exists in the case of the library, the manufacturer will drop ship the library and the drives to the customer directly. So we're not going to be trying to hold on to inventory and become a hardware type of a company.

Now, this will have an effect on our higher overall revenue. Obviously, because there's more included in the deal, and the margin dollars that we receive will be greater on the business as well as, and I think this is very key, we believe this will shorten the sale cycle for these types of opportunities. Because obviously, if they don't have to go to 2 different vendors and 2 different purchase orders and get those approved, things should approve there and aid our overall business. We will be launching this at the NAB show in April again. And again, if you're able to attend, we'd love to see you there.

And there were some opportunities in this quarter, everything's happening in Q2. But the reality, our quarter ends in April. We're not going to really see too many library-type opportunities this quarter, but most of the benefit will start to occur in the fiscal third quarter, okay.

So the development of our reseller channel is obviously very important, and it continues to grow through our team's efforts as well as the opportunities of partnership from folks like Spectra Logic, Fujifilm and Hitachi, as we go out and start driving this product into the market place. The channel or the value-added resellers in this case, is the best vehicle to expand our market reach and drive our pipeline growth, as now our sales resources, which are out in the field, will switch from primarily trying to drive initial interest, say, at the end-customer end-user area, and now be able to better focus on those relationships with the various channel partners, helping to drive their sales forces and their sales efforts.

Now, one of the mechanisms to enable the adoption of StrongBox and really get this into the market, is to create as quickly as possible, market-leading examples of customers that are in the different types of verticals and industries. For instance, Major League Baseball now is just a great example of what StrongBox can do, but they're in the sports broadcasting arena. While you go to oil and gas type of customers, and of course, they know who MLB network is, but they would like to see examples from their own specific industry.

So in many startups, a channel-earned end-user seeding program is used to where we can get units out into the process and stimulate all of this growth process. Now, this kind of a program is generally very capital-intensive. And since we've had initial great success with StrongBox, we really don't feel the need to go to that kind of a level. So instead, we're implementing an aggressive, what we call first-unit type of campaign, starting at NAB, where we'll be launching it again, and going through the effective end of our fiscal year, which is October. So this program, provides aggressive pricing on the StrongBox for the first 75 terabytes of capacity. So think about it, if you buy first unit, you get a great deal for that first unit into the club, if you will. All subsequent capacity purchases, all subsequent systems will be at the full normal rate.

So we've already pre-launched this program into our current channel. It's only been active for about a week or so, and we've already seen 23 quotes for the program, which equates to an over $1 million in pipeline, so we feel pretty good about the program. So this kind of new program with the lower margin, along with the reduction of over $5 million in annual expenses, has an effect on us as we look at our 2013 fiscal year revenue outlook. We had initially given a $9 million to $11 million type of a guidance, and we feel that it's important to look at that and say it'll be a little closer to $7 million to $9 million. Now, and of course, this still represents a massive growth year-over-year, but it's more reflective of this lower margin type of a program we're implementing, as well as the fact that we have less resources with the reduction in our ability to go to market in the same manner.

So intellectual property has always been a source of revenue as well and cash for the company. And if you recall from the last earnings call, we talked a lot about how last year was challenging. As a single lawsuit took the whole year to conclude, and really prevented us from monetizing the IP as we expected. Since then, we had filed a small case, and it has already come to a successful conclusion, so a little bit more like our normal process. And so we are well positioned to continue along our IP campaign. And as I stated earlier, we are actively pursuing monetization options that I look forward to speaking with you about very soon. So cash, as always, again, remains a focus for management and the board, and I know it is top of mind for our investors, and we are very confident in our ability to profitably capitalize this business and drive it now towards profitability. So with that, we'll now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Chris Slaymaker with JMP Securities.

Christopher Slaymaker

So I was just wondering if you could possibly give us a little bit more detail as to what your outlook for IP licensing revenue is going to be for the remainder of 2013?

Robert C. Sims

So we always have a standard quarterly. I'm assuming you're talking about any additional elements.

Christopher Slaymaker

Yes.

Robert C. Sims

So unfortunately, it deals with litigation, as always, and it's just impossible to necessarily tell you what that is. There's a couple options that we're looking at as well that may make it quicker or others that might make it bigger. So all I could say is just, I think we'll be talking about it very soon in the next weeks and give you guys some more information on that.

Christopher Slaymaker

All right. And I know you mentioned you launched that pilot program for -- it gave the discount for the first several terabytes of capacity for the StrongBox about a week ago, you said, I think.

Robert C. Sims

Well, no. It's the week or so ago. Couple of weeks ago...

Christopher Slaymaker

Yes, so it just -- does that have an effect on the margins for file in the quarter?

Robert C. Sims

On Q2? Nothing on Q2.

Christopher Slaymaker

No, no, for Q1.

Robert C. Sims

It has nothing to do with Q1, no.

Christopher Slaymaker

Okay, that's why I say -- yes, that makes sense, now that I think about it. And then -- yes, sorry. So one more question. What -- the financing that you announced this afternoon, did that -- is that something that was motivated? Are you doing anything to keep from being delisted? Was that what motivated the financing at all?

Robert C. Sims

It's not the primary motivation. Obviously, that delisting and the effect on that is something that we're very focused on. And equity -- and the equity position of the company will solve that. So as I said, kind of at the beginning, we have the reduction and we wanted to make sure that it was really primarily focused onto that kind of arena. I was making sure that we just capitalize properly to do the right thing, so we need to do it at the right time, okay?

Christopher Slaymaker

But you said you saw an uptick in large deals of the StrongBox product in the quarter.

Robert C. Sims

I wouldn't think Q1 was a big uptick in large deal a quarter. We've certainly seen -- we are seeing big uptick in quotes, and deals flow and funnel. A lot more larger deals have started to come in. As we outlook into the year and then go forward as to where some of those deals are coming from, the Q1 is pretty average. What we have been seeing in terms of -- we're averaging around 65K-ish a deal, right now. But there are a lot of big deals that they were certainly getting quoted into and our advisor request for information, request for quotes, those types of things.

Christopher Slaymaker

Are you -- so you are seeing a big uptick in quotes. And is there anything in particular that you're doing to kind of go out and educate the market as to why tape is the best solution?

Robert C. Sims

Well, we're actually not even talking tape, believe it or not. What we're talking about is the simplification of the workflow for the user, where today they create things as a file. And with StrongBox, they get to retain it as a file all the way through into its long-term archive and access. It just happens to be that the tape is the construct of medium being used. So they're really latching onto the value of an online accessible file system that has all the built-in data protection and data reliability. And the fact that tape is almost secondary, cause they really like the cost and the performance and everything else. So we're really not marketing tape, we're marketing long-term archive, fully protected archiving. And they're really starting to get it. And the other thing is just as any new product in the market, it's saying -- I always talk about, it's a 2-year overnight sensation. It just takes a while for folks to fully grasp the integration, where it fits in the market, where it goes in the infrastructure, get the partners engaged where they get comfortable with where it goes, and all of that starts to occur as we roll out.

Christopher Slaymaker

And so you -- and you're at least saying you're reaping some sort of reward from your investment and marketing in this area, right?

Robert C. Sims

Yes, we're starting to see that. Obviously, the good news is it says if we do more of it, we should get more on the other side, and that's our focused efforts that we're doing with what the company size and position is. Part of the change, what's mostly impacting engineering is that this company does need to turn the corner and drive towards profitability in sales and marketing, and that is a lot of our focus.

Christopher Slaymaker

Did you add any heads in your sales organization in the quarter?

Robert C. Sims

A few. Sales field -- I'm looking at Jennifer...

Jennifer Ray Crane

We did. Inside sales and then our channel sales also. Yes, we did.

Christopher Slaymaker

Okay. And can you give us, just some idea as to how much do you plan on growing that over the course of 2013?

Robert C. Sims

We don't have a big intention of growing the actual internal resource. What we're focused on now is to scale out of our partners, national buyers and regional buyers, and we've got a lot of activity there. And so what we've done is we've covered regionally, the U.S. and Western Europe. And then if they can take 5 hours and just do simple math, it's obviously not the total amount. But if you did 5 hours and each of those had 10 sales people, then you're one guy, have got 50 people selling for it.

Operator

Your next question is from Steve Shaw with Sidoti & Company.

Steve Shaw - Sidoti & Company, LLC

Just to confirm, you said the new breakeven point was $3.5 million?

Robert C. Sims

Of StrongBox revenue, yes.

Steve Shaw - Sidoti & Company, LLC

And then also, in regards to the labor force reductions, what sort of made you guys do this now or why wasn't it done previously? And then you talk about the good things that will come from it. In terms of cutting expenses, what happens -- what might happen to R&D or development of products as a result?

Robert C. Sims

Well, obviously, you won't get as much out and you won't get it as quickly as that -- that's just in the concept of that. Now, the difference in the timing is that we've gotten a lot of functionality developed, it's released. We need to now go a bit slower as far as let's go out and consume the results of what we've already developed and the great technology that we produced, and it's clear that customers are buying it. And that it is -- got all a lot of the functionality, if not, all that they need for certain industries. And then we focused now into our strategic partners, like Iron Mountain and Fujifilm, and those to make sure that their programs and elements are developed but the StrongBox itself, has clearly entered the market in a big way. It's solving significant problems and it's capable of delivering against the needs of the customers. And so at any time in a process of the program, you got to look at things and adjust where are you spending your money on [indiscernible] or are you spending your money on taking advantage of what you already built? And that was the decision.

Operator

Your next question is from Dick Feldman with Axiom Capital.

Richard Lewis Feldman

I have a couple of questions that relate to financial guidance. The $3.5 million to $4 million in StrongBox revenue that you said you needed to reach breakeven, does that take account of the promotion, low pricing strategy that you just announced? And also, is that what's needed to make the whole company profitable or just the StrongBox segment? And if it's just the StrongBox segment, does the other part of the company, what does it have to do to reach profitability?

Robert C. Sims

Okay. Yes, that's a good question. Now, let me start from there. It would be the whole company. And $3.5 million of StrongBox revenue when attained, we believe, will make the whole company break even. The rest of the company, while it's -- think of it more as a cash cow. We're not putting any real R&D efforts into that stage. And so the analysis that's done is the whole company on what the StrongBox revenue needs to be. And I'm sorry, but I forgot the first part of the question.

Richard Lewis Feldman

Yes, it's just the breakeven revenues...

Jennifer Ray Crane

[indiscernible]

Robert C. Sims

Okay. I'm sorry, I apologize for that, Dick. So it's kind of yes and kind of no. The discount is a great discount. And customers are liking it, but it's not kind of 0. But I think, yes, more likely we do the analysis. Does it have to be higher than $3.5 million? Maybe a little bit over that, and so it's going to be breakeven with the full discount program. But remember a couple of things here. That's just the first system. And for the first 75 terabytes of that first system. We have reorders coming from specific customers, those are at full rates. We have second systems for replication of sight to sight, those kind of things, and those are at full rates. So it's not as if all of our revenue in the next quarters are going to be just those first system discounts. And so I think if you were to try to model that, it would have some impact. But I don't think, if it is, it's just a bit more than the $3.5 million, $3 million to $7 million kind of range -- kind of [indiscernible], okay? And remember the program's only going through the end of the fiscal year.

Richard Lewis Feldman

You raised a point that you're getting reorders. And I wondered if you could give us some color there as to the mix between the 2 sources, new business from customers you haven't had before and other customers expanding their use of the product.

Robert C. Sims

Yes, I don't have statistics directly, but let me kind of give you some color around it, I guess. So for instance, JPL, which closed in Q4, has already had the second and third follow-on order. Major League Baseball, has a follow-on order. The interesting thing is the follow-on orders are bigger than the initial orders, which is nice. I don't think we have enough runway under it to really -- to give you a model, per se. For this year, when we did our own modeling, we didn't actually have any reorders in it, so we're actually doing better than what we thought. And then we kind of modeled it more like a 20% in a 30% of prior year reorders as we go forward. So we just honestly don't have enough runway underneath us. But what we do see is as the customers get the product, they sniff it out, they test it, they use it for a smaller world and smaller environment. They quickly then turn and start talking about how to leverage it into other environments. So we think, for the first year here, this next year, we're going to see a lot of that kind of modeling. First year, it's in smaller kind of environment, kick the tires, start doing programs to move from there, that's kind of how we see it.

Unknown Analyst

Okay. So in a sense that you talked traditionally repeat business, but it's repeat business, do you get any maintenance revenues or is it just outright sales?

Robert C. Sims

Yes -- no, we have a 12% maintenance standard. We have increased maintenance from there for different packages. But we definitely have maintenance for every system and full capacity.

Unknown Analyst

But over time, that could build up to a nice number.

Robert C. Sims

Over time, software companies live and breathe off of that, right?

Operator

[Operator Instructions] And there are no further questions at this time.

Robert C. Sims

Okay. Well, thanks everybody for joining us today, as always. If you have a chance, and you want to come to NAB, let us know. I would love to see you there. And if not, I know we're going to be talking throughout this time, and I look forward to speaking with you again.

Operator

Before we conclude today's call, I would like to make -- take a moment to read the company's Safe Harbor statement. During this call, the company's management made certain forward-looking statements related to the businesses of Crossroads Systems Inc., which can be identified by the use of the forward-looking terminology such as believes, expects, plans, intends, anticipates and variations of such words or similar expressions. But their absence does not mean that the statement is not forward-looking. Statements in this announcement that are forward-looking include, but are not limited to, statements made by Mr. Sims that the company looks forward to generating accelerating growth as it progresses through 2013. Such forward-looking statements involve known and unknown risks and uncertainties, including uncertainties relating to the product development and commercialization, the ability to obtain or maintain patent and other proprietary intellectual property protection, market acceptance, future capital requirements, regulatory actions or delays, competition and general and other factors that may cause actual results to be materially different from those described herein. Certain of these risks and uncertainties are or will be described in greater detail in the company's public filings with the U.S. Securities and Exchange Commission. Crossroads Systems is not under obligation to and expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

Thank you, ladies and gentlemen, for joining us for today's presentation. This concludes today's call. You may now disconnect.

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