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Executives

Richard Kenneth Coleman - Interim President and Chief Executive Officer

Jennifer Ray Crane - Chief Financial Officer

Crossroads Systems (CRDS) Q2 2013 Earnings Call June 7, 2013 10:00 AM ET

Operator

Good morning, and thank you for participating in today's conference call to discuss Crossroads Systems' financial results for our fiscal second quarter ended April 30, 2013. With us today are Mr. Rick Coleman, the company's Interim President and Chief Executive Officer; and Ms. Jennifer Crane, the company's Chief Financial Officer.

Following their remarks, we will open up the call for your questions. Before we begin today's call, I will provide the necessary cautions regarding forward-looking statements made during this call. During this call, the company's management will make certain forward-looking statements related to the businesses of Crossroads Systems, Inc., which can be identified by the use of forward-looking terminologies 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. Coleman or Ms. Crane about our expectations regarding future growth, operating and financial results and market demand for our products as well as statements about our business plans and objectives. Such forward-looking statements involve known and unknown risks and uncertainties including uncertainties relating to 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.

These factors may cause actual results to be materially different from our historical results or from the results anticipated by our forward-looking statements. You should review our most recent Form 10-K filed with the Securities and Exchange Commission and our Form 10-Q that will be filed with the Securities and Exchange Commission for a more complete discussion of these factors and other risks. Crossroads Systems is not obligating itself to publicly update or alter its forward-looking statements whether as a result of new information, future events or otherwise.

I would like to remind everyone that a webcast replay of this call 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 Mr. Rick Coleman. Please begin, sir.

Richard Kenneth Coleman

Thank you, operator. Good morning, everyone, and thank you for joining us. I'm Rick Coleman, Crossroads' Interim President and CEO. I appreciate everyone joining the call.

Today, I will provide you a financial update of our fiscal 2013 second quarter that ended in April. I will also provide investors an understanding of the current state of our business, the challenges we face and our strategic and tactical plans to create a profitable business that delivers shareholder value.

Before I share some of these details, Crossroads' Chief Financial Officer, Jennifer Crane, will take you through the fiscal second quarter results and provide details regarding our financial performance. I will then offer more detail on the quarter and on our overall business. Jennifer?

Jennifer Ray Crane

This afternoon, we released our fiscal second quarter 2013 results in a press release. For the second quarter, revenue totaled $2.7 million. This revenue total represents a decrease of $716,000 from the same quarter a year ago, primarily due to a decrease in revenue from RVA offset by modest revenue from StrongBox. In Q2 of last year, we recognized $919,000 in RVA revenue compared to $45,000 in Q2 of this year. As expected, our SPHiNX OEM revenue also declined slightly year-over-year.

StrongBox revenue grew from $136,000 in Q2 last year to $525,000 in Q2 this year. Total revenue from StrongBox units was $188,000. The remainder of the StrongBox revenue at $337,000 is revenue we recognize from our co-development agreement with Iron Mountain as well as another strategic partner. While the gross margin is minimal on our Iron Mountain co-development agreement, we have determined that the revenue potential from such activity justifies the engineering focus and provides other benefits besides margin contribution. We will continue to balance the needs of our broader customer base with our strategic opportunities and apportion resources accordingly. We continue to recognize revenue from the Iron Mountain co-development agreement based on the completion percentage of the co-project. The project was 69% complete at the end of the quarter, and we've recognized $187,000 from the project in the quarter.

While revenues from our mature products were mostly as expected, we experienced delays in revenue recognition from one very large StrongBox customer as well as several other deals we thought we would close in fiscal Q2. While we expect these deals to close in the third quarter, one deal is much larger from a cash and revenue perspective compared to our other revenue expectations. Going forward, we will provide more clarity relative to onetime payments and contribution to our cash flow from partners when they occur.

Gross profit in fiscal Q2 was $1.9 million or 70% of total revenue compared to $3.1 million or 89% of total revenue in the same quarter a year ago. The percentage was lower this quarter due to a higher percentage of lower-margin products and the lower margin associated with the Iron Mountain co-development agreement.

Operating expenses for Q2 2013 increased to $5.8 million from $5.1 million in Q2 2012, mainly due to increases in research and development and sales and marketing expenses around our StrongBox product. The March reduction in force did not reduce our operating expenses in the quarter due to severance-related costs, but we do expect to see a quarterly decrease in operating expenses in the range of $1.1 million to $1.3 million starting in our fiscal Q3.

Our net loss was $3.9 million versus a net loss of $2.1 million in the same quarter a year ago. The increased loss was mainly due to our debt -- reduction in revenue, gross profit decreases and increased operating expenses.

We ended the quarter with a cash balance of $6 million compared to $2.5 million at the end of Q1. Our increase in cash is due primarily to financing activities, which yielded the company $8.1 million.

Now I'd like to turn the call back over to Rick.

Richard Kenneth Coleman

Thank you, Jennifer. As most of you know, I joined Crossroads' Board of Directors on April 29, 2013. I was appointed Interim President and CEO on May 8. I was attracted to Crossroads because the company has significant unrealized value. Although still in its infancy, our StrongBox product is well positioned in a multibillion-dollar market with double-digit annual growth rates.

While we're still very small compared to most industry players, we have impressive marquee partners and customers, a large and growing pipeline of sales opportunities and an extremely talented workforce. StrongBox is a unique product in a growing market receptive to disruptive innovation. Our timing is good because data growth is exploding in our target markets. In short, I'm excited about our products, our intellectual property portfolio and the partnerships we've built with first-class industry leaders.

I want to make a brief comment about the recent leadership change at the company. I agreed to step in because of the value I see here and because changes in leadership provide an opportunity to make adjustments and improvements to a company's direction and focus. Certainly, part of my role is to provide a fresh perspective, but it's also to identify where we can modify our strategy while expanding upon our success, especially as it relates to StrongBox. There is no question that we're doing a lot of things right, but we also need to make some course corrections. My focus is on delivering revenue faster, monetizing our intellectual property and moving the company to profitability, all key components to increasing shareholder value. In a moment, I'll talk about how we plan to do that.

On May 22, we pre-released our second quarter results. Clearly, we were disappointed in our performance, especially for StrongBox, with StrongBox revenue coming in at less than half of last quarter. Frankly, the board thought a $5 million increase in our pipeline would yield more closes in the quarter. The current reality is that it's taking longer than expected to close StrongBox accounts. This begs the question, what can be done to shorten the sales cycle and gain more traction? That's a common question for companies launching new products, and I'm confident we'll find the answers.

One of the reasons it's taking longer to close deals than originally expected is that StrongBox is a powerful new tool in what used to be considered a mature market. The innovations that we bring to the market require potential customers to rethink their architectural paradigms.

StrongBox enhances many different customer storage environments. Some are relatively simple, but others have highly complex data ecosystems. The less complex environments enable StrongBox to behave as a plug-and-play solution. Customers with simple environments typically have a limited hardware and software infrastructure, so StrongBox fits more easily into the customers' existing environment. These types of customers more readily understand StrongBox's capability to quickly integrate into their workflow and add immediate value. The result can be a shorter sales cycle without a formal product evaluation. However, the less complex data environments are also smaller revenue opportunities, usually under $30,000 in initial revenue. An example of a current customer with a simple environment is Cyark. You can watch a Cyark success video on our website and quickly understand how we're helping them achieve their business objectives.

However, when we penetrate larger revenue opportunities and accounts with complex data environments, sales cycles are longer. These customers carefully evaluate the integration of StrongBox into their environments, paying close attention to how we work with their embedded software and hardware architecture. And because StrongBox is a new disruptive solution, the decision-makers at these companies may take more time making a purchase decision.

Initial sales to these accounts may also require a formal product evaluation. While the evaluation's taking place, our engineering team works closely with the customer to ensure StrongBox performs well with the complex ecosystem of hardware and software vendors already present at the customer site. We also take the learnings from each customer installation and use them to build new capabilities into future product releases.

We have evaluations underway with a number of large accounts. Two of our recent sales, FotoKem and Jet Propulsion Labs, are a testament to the quality of our solution and its ability to satisfy highly sophisticated buyers. We expect to win more of these types accounts. However, because of the longer sales cycle, it's difficult to predict when larger deals will close. And because we're working from a small revenue base, delays and closes have a disproportionate effect on quarterly revenues. This makes forecasting a challenge. Until we gain a larger share of the market, win more reference accounts, have steady deal flow from our channel partners and establish predictable sales cycles, our reported revenue will fluctuate quarter-to-quarter. Frankly, it may take several quarters of steady growth to smooth out the lumpiness in our top line.

In the meantime, I want to caution investors not to read too much into the timing of our revenues. Choppier revenue recognition also makes it difficult to provide guidance. Previously, the company provided guidance of $7 million to $9 million in StrongBox revenue for fiscal 2013. After 2 quarters, we have about $2 million towards that goal. Given our current StrongBox growth rate, it seems prudent to suspend guidance until the company has more StrongBox sales history. This is one of the reasons why we've decided to provide you a more granular view of our revenue.

In order to improve our revenue streams, we're examining a number of tactical actions. One of these is to focus on accounts with less complex or clearly understood environments. These types of accounts have environments where StrongBox easily integrates, users can see immediate functionality, make faster decisions and do not expect an evaluation. These accounts can deliver higher throughput with fewer resources needed to close the sale.

We're also focusing more on selected initial target markets. Because of the StrongBox's wide range of capabilities and functionality, it can solve a lot of problems in a lot of different markets. Based on our market experience to date, we have a deeper understanding of the optimal solutions for buyers in our target markets and are strengthening our StrongBox messaging. This should improve sales, ensure customer satisfaction and increase the number of customers willing to recommend us to others.

Our initial studies and early successes tell us the media and entertainment, government and research markets present some of the strongest opportunities in our pipeline. We have experienced and proven sales partners addressing each of these markets and are working aggressively to help them be successful. As we attract more channel partners with more diverse customer sets, we'll expand our reach into other markets where StrongBox can excel.

In March, we announced the 23% reduction in our workforce, mostly affecting engineering. While a difficult decision, it made sense to streamline the company at this point in our history. As the company previously discussed, the reduction should save us about $5 million annually.

Also in March, we announced the closing of an $8.1 million preferred equity round primarily led by current investors. We're encouraged by the confidence our investors have in our business. The capital infusion is enabling us to continue to deliver StrongBox to the market.

In the second quarter, we closed a follow-on order from Jet Propulsion Labs and continued to make inroads into the defense space by winning an order from another well-known defense manufacturer. Our European team developed -- delivered London Loft, a post-production studio, and the British Museum, home to some of the world's finest historical treasures.

One thing we did not announce in the quarter was our strategy for IP monetization, something that many of you are wondering about. Despite the lack of news, be assured that we expect to monetize what we believe to be a highly valuable asset. I can't give you a time line or more information, but we are addressing this is a fundamental part of our strategy.

Our strategic partners continue to provide us with validation and a growing pipeline of opportunity. The Iron Mountain relationship continues to mature. As the company has stated many times, we can't say much about Iron Mountain's plans for StrongBox. That communication will be driven by Iron Mountain. At the end of the quarter, we were 69% complete with our co-development project, slightly behind schedule as a result of changing development priorities.

Fuji, another of our key partners, continues to make strategic moves that are good for StrongBox. We expect to receive some meaningful revenue from them in Q3 as they expand their marketing efforts.

Hitachi also continues to help position StrongBox as a valuable way to drive the overall cost per petabyte down in large storage environments. Our solution complements Hitachi's offering and delivers exceptional value to their customers.

In April, we exhibited at the National Association of Broadcasters Show. We had our own large booth staffed by our sales team. But just as important, we were invited to help staff the booths of 2 important partners, Hitachi and Dell. Both of these companies highlighted StrongBox as a solution complementary to their own storage offerings. Our team had the opportunity to work jointly with Hitachi and Dell counterparts and made sales presentations to their current and prospective customers. Our presence in the Hitachi booth and in the Dell booth made a powerful statement to the market that StrongBox is highly valuable as a shared storage solution, able to integrate with the industry's leading providers. Partnerships like these speak volumes about the quality of the StrongBox solution.

Today marks 1 month since I joined this team. It's an exciting time to be at Crossroads, and we're addressing our opportunities with a sense of urgency and renewed commitment. Nonetheless, in the next few quarters, our revenue from mature products will likely continue to decline, possibly faster-than-anticipated increases in StrongBox revenue growth. However, we believe in the path we're on. We've resourced and directed the company based on our faith in StrongBox and will continue doing so. We are focused on monetizing our IP portfolio and believe there is significant value to be realized. We are reviewing a number of strategic options.

We do have challenges to overcome. The sales cycle must be shortened, and we have to have more reference accounts. One of the benefits of the StrongBox model is that our customers make an initial purchase of capacity. Then as their data needs grow, we expect them to make follow-on capacity purchases. As our customer base grows, our models project repeat purchases from existing customers at high gross margins. These purchases will be driven by the rapidly expanding data market and also by customers who understand how StrongBox enhances their operations. The realization of these revenue streams is what we're working toward.

In the meantime, I am directing our efforts at tactical improvements designed to close more accounts. Strategically, we're retooling our marketing approach and digging deeper into our key verticals. These activities should position the company to better serve our value-added resellers and increase our partner participation. While we have challenges, I see a path to better operating results. We're quickly taking the actions necessary to achieve our potential and maximize shareholder value.

Now we'll open it up for any questions.

Question-and-Answer Session

Operator

[Operator Instructions] Sir, at this time, there are no questions.

Richard Kenneth Coleman

Thank you, operator. Thanks for joining us today, and we look forward to the next update.

Operator

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

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