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Falconstor Software (NASDAQ:FALC)

Q2 2013 Earnings Call

August 08, 2013 4:30 pm ET

Executives

Gary Quinn - Chief Executive Officer, President and Director

Louis J. Petrucelly - Chief Financial Officer, Principal Accounting Officer, Vice President and Treasurer

Seth R. Horowitz - Executive Vice President of Legal

Analysts

John Aniblo Zaro - Bourgeon Capital Management, LLC

Ross D. DeMont - Midwood Capital Management, LLC

David Cohn

Operator

Good afternoon, and thank you for joining us to discuss FalconStor Software's Q2 2013 earnings. Gary Quinn, FalconStor's Chief Executive Officer; and Louis Petrucelly, Executive Vice President and 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 the FalconStor's reports on Forms 10-K, 10-Q and other reports filed with the Securities and Exchange Commission contained in the company's press release issued today.

During today's call, there will discussions that include non-GAAP results. A reconciliation of the non-GAAP results to GAAP has been posted on the FalconStor's website at www.falconstor.com under Investor Relations.

After the close of business today, FalconStor released its Q2 2013 earnings. Copies of the earnings release and supplemental financial information are available on FalconStor's website at www.falconstor.com.

Now I'm pleased to turn the call over to Gary Quinn. Please go ahead.

Gary Quinn

Thank you, operator. Good afternoon, and welcome to FalconStor's Q2 Quarterly Earnings Call. One thing before I begin is that I would just like to take a moment to thank Jim McNeil for his more than 3 years of dedicated service to FalconStor, its customers, partners and employees.

And on today's call, we'll be answering all of your questions surrounding recent events at FalconStor. We'll be holding a Q&A post our remarks, and we'll answer as many questions as we can provided we have a definitive answer.

As you can see from our press release, we have some work to perform in order to get the company to a consistent profitable growing and financially healthy entity. We've been busy over the last 40 days at the management team, evaluating the company's current balance sheet, product portfolio, routes-to-market, geographic coverage and human capital.

Earlier results of that work have produced the following: An agreement in principle for an equity investment for between $7.5 million and $15 million from Hale Capital Partners with a final investment amount to be determined before closing based upon, among other conditions, a rebalancing plan for the company.

Secondly, a joint development agreement with Violin Memory, a leader in solid-state disk market, also known as flash memory, to deliver a next-generation product for the flash memory platform based upon our current NSS technology. The license and development services will produce up to $12 million for FalconStor over the next 12 to 18 months.

We additionally have an agreement to sell our investment in Blue Whale, a Chinese joint venture for $3 million. Our original investment in Blue Whale in 2008 was approximately $1 million.

As a result of these transactions above culminating, we have decided to end our investment banking relationship with Wells Fargo. As a public company, we remain prepared for any options that may be presented to the company and its Board of Directors. But at this time, we'd prefer to digest these above alternatives and focus our company around moving ahead.

We believe the above transactions will strengthen our capital structure and will also provide comfort and support to our customers, partners and employees that FalconStor will be able to continue to support that growth in the storage and data protection services area into the future.

As a company, we will match our cash in to our cash out, as well as return to profitability. We'll be refocusing our product portfolio and resources, delivering products which address our current enterprise customers segments with NSS CDP and VTL FDS. We are currently evaluating our routes-to-market in a number of geographies to determine if the presence we currently maintain is the right model for distributing our products. We look to separate ourselves from any unnecessary expenditures that do not produce margins, which are required to operate not only as an in-country presence, but also the associated cost of product development, technical support and the associated general and administrative expenses.

Our goal is to be cash flow positive by the end of Q4 of this fiscal year, not including any onetime extraordinary items. Our goal also is to achieve a breakeven operating income by the end of this calendar year on a run rate basis.

At this time, I'd like to turn the call over to our CFO, Lou Petrucelly, to discuss Q2 in detail and also provide some additional color on the balance sheet strengthening initiatives we have undertaken in the last 40 days. Lou?

Louis J. Petrucelly

Thank you, Gary, and good afternoon, everyone. This afternoon, I would like to discuss a summary of our second quarter, provide you with an update on the progress we have made over the first half of the year regarding our litigation and legal activities and finally discuss how we look at the second half of 2013 and provide an overview of our plans and objectives over the next 12 months.

For the second quarter of 2013, our total revenue has decreased 15% to $14 million, compared with $16.5 million in the same period a year ago. The total revenues fell well below our internal expectations, while total revenues from each of our regions have declined on a year-over-year basis. The declines in product revenues, specifically from how our North America and EMEA regions, as well as decreases in maintenance revenues were the primary drivers of the soft revenue performance in Q2.

We attribute our softness of product revenues to specific significant competitive pricing practices for securing deals throughout the world and customers buying practices moving towards an as-needed or just-in-time model to preserve current cash outflows, which have all contributed to elongated sales cycles and pressure on deal sizes.

In addition, our competitors have encouraged customers to question the company's declining cash balances and to raise concerns about the company's direction over the past 12 months. We believe that we are addressing these concerns by taking the steps Gary outlined earlier.

Our support and services revenue, which is comprised of maintenance and professional services, decreased by 14% compared with the same period a year ago. The maintenance portion of this revenue has declined 9% from $7.7 million in Q2 of 2012 to $7.1 million in Q2 of 2013. I will address this topic later in my presentation.

Professional service revenues decreased 59% from $900,000 in Q2 of 2012 to $400,000 in Q2 of 2013. Professional services revenues tend to fluctuate based on a number of end-users who use FalconStor to help deploy the solutions and to complete -- the completion of those deployments.

Next, I will turn to our Q2 non-GAAP results, which exclude legal costs and stock-based compensation. Our product gross margin increased to 85% in Q2 from 77% in the same period last year. The increase of product gross margin was primarily due to a decrease in the number of fully integrated offerings, which include hardware appliances as a percentage of all product sales compared with the same period a year ago.

As we have stated in the past, the mix of our products revenues, for example, the number of software-only solutions versus fully integrated appliances sold during a period and the level of product revenues can impact our gross margins.

Our support and services gross margin decreased to 62% in Q2 from 64% in 2012. The decrease in gross margin was primarily due to the decline of our overall support and services revenues compared with the prior year.

Overall, our total gross margins increased to 73% in Q2 compared with 70% in 2012.

Our operating expenses decreased 9% in Q2 to $14.5 million from $15.9 million in 2012. The decrease in our operating expenses was primarily due to the 20% decline in our sales and marketing cost during the second quarter compared to the same period a year ago. These decreases were driven primarily by declines in personnel-related cost and overall lower commissions. During the second quarter, we incurred approximately $100,000 of costs associated with the settlement of the Class Action and legal fees associated with both the Class Action and derivative action that will not be recoverable through insurance. During the same period in 2012, we incurred $900,000 of legal costs.

In Q2, our non-GAAP operating loss was $4.2 million compared to a loss of $4.4 million in the same period a year ago. Our non-GAAP operating results excludes stock-based compensation of $200,000 in Q2 and $1.1 million in 2012, and $100,000 and $900,000 of legal cost in each of Q2 2013 and 2012, respectively.

Our non-GAAP net loss at Q2 was $4.9 million or $0.10 per share compared to the net loss of $4.7 million or $0.10 per share in the same period a year ago.

On a GAAP basis, our operating loss in Q2 was $4.6 million compared to an operating loss of $6.3 million in 2012, and we had a net loss of $5.2 million or $0.11 per share compared to a net loss of $6.6 million or $0.14 per share in 2012.

On a year-to-date basis, for 2013, total revenues declined by 18% to $29.3 million compared with $35.8 million for the same period a year ago. Product revenues declined 23% to $14.3 million from $18.5 million in the prior year, and support and service revenues declined 14% to $15 million from $17.3 million in the prior year.

Turning to our year-to-date non-GAAP results. Product gross margins increased to 84% in 2013 from 79% in the same period in 2012. Our support and services gross margins decreased to 61% from the 64% in 2012.

Finally, our gross margins increased 73% in 2013 compared with 72% in 2012.

Our operating expenses, excluding stock-based compensation expense and legal-related cost, decreased 12% from $32.1 million in 2012 to $28.3 million in 2013.

Turning to the '13, our total maintenance revenues have been adversely impacted by various factors within our OEM and non-OEM businesses. We continue to see our legacy OEM business decline first from our product revenue perspective commencing in 2009 and more recently with the wind down of the related maintenance revenue. We anticipate that our OEM maintenance revenues will continue to decline as these historical OEM customers wind down their partnerships with us. And we look to continue to replace these lost OEM maintenance revenues with revenue from our channel and strategic partners. We are focusing our efforts on minimizing the impact of declining maintenance revenues by expanding our market penetration within our installed base and for new customers in verticals where we have been more successful implementing our -- in implementing our best practices for many single processes and the regions where we have lower renewal rates.

Turning to our balance sheet. As of June 30, we have $21.9 million in cash, cash equivalents and marketable securities, which is equivalent to 46% per basic share. These numbers do not include any of the anticipated debt as we've previously discussed.

Our cash used in operations was $5 million for Q2. Our deferred revenue was $22.7 million compared with $24.1 million at the end of 2012. The decline was largely due to the wind down of maintenance revenues from certain legacy OEM customers and to deeper discounts provided of securing deals in the competitive environment over the past year.

Additionally, we continue to see more customers opting to purchase 1-year of maintenance agreements at the original point-of-sale versus the multiyear maintenance agreement in response to tightening budgets and cash flows.

As we have discussed over the past several years, the impact of our legal issues have cost the company significant time, effort and resources, which adversely impact both our financial position, and more importantly, the perception of the company in the marketplace.

However, over the past 12 months, we have achieved significant resolutions surrounding our outstanding legal issues. We settled our government investigations with both the Department of Justice and Securities and Exchange Commission back in June of 2012. In January of 2013, we reached an agreement in principle with the parties for the Class Action to settle the Class Action for $5 million.

The Joint Motion for Preliminary Approval of the Class Action lawsuit was filed with the courts on June 14 of this year.

On March 5, 2013, a corporative motion made by all the company defendants in a derivative action and dismissed the derivative action as of all company defendants. The stockholders have filed a motion of appeal of a dismissal of the derivative action.

On July 31, 2013, we had entered into an agreement with the carrier of the second layer of the company's D & L insurance. Pursuant to that agreement, the insurer agreed to pay 75% of the company's losses attributable to the Class Action and derivative actions above the first $5.25 million of such losses.

To date, we have reached settlements with the first 2 layers of insurance coverage totaling $10 million of D & L insurance whereby the company can recover between 75% and 77% of the limits.

The recent resolutions of our outstanding legal issues should allow us to move on from the events of the past and focus our efforts on executing all our business plans.

To summarize, there have been various challenges the company has faced over the past 24 to 36 months, including operational issues and legal issues, with customers looking to new and flexible purchasing alternatives. In response, we are addressing the start of our balance sheet. We are focusing our efforts on delivering technology that is relevant, not only in today's market, but has flexibility and the feature set to be the core platform for tomorrow's needs.

We intend to return the company to profitability and generate positive cash flow on a consistent and predictable basis so that we could continue to grow our balance sheet and in the best interest of our businesses for the future.

We are addressing each of these objectives. First, we have reached an agreement with -- in principle with Hale Capital Partners on an equity investment of between $7.5 million and $15 million. We are working with Hale to finalize the terms of the investment amount. We believe that commitment from Hale is a testament to the value of our products today, as well as the value and potential of the company going forward to all of our shareholders, customers, partners and employees.

In addition, we signed an agreement to sell our investment in Blue Whale for $3 million, which we expect to close before the end of the year. This investment was a non-core technology and in the area that is not part of our focus going forward.

Second, we are partnering with Violin Memory on a joint development for our next-generation products. Violin will provide the expertise in solid state drives or flash memory, which we believe will provide us with the next-generation of products optimizing flash memory.

We anticipate that this joint development will position the company as the leader in the market for flash memory and traditional hard disk drives, cloud storage and data protection services.

Finally, we are addressing our financial performance with the goal of returning the company to profitability and a positive cash flow going forward. As we discussed earlier, IT buyers are increasingly looking to new and flexible purchasing alternatives. In order to be more competitive, we are adapting our business model to our customers' purchasing models. We are entering into deals with customers with flexibility in terms of how much capacity is purchased at the point-of-sale versus how much capacity will be purchased in the future.

As we move to more and more of these types of transactions, the timing of our revenue recognition may vary from our historical recognition methods. However, we believe that this is a flexibility required in the industry today, and we believe this will ultimately provide us with more opportunities of securing deals in the future. We are also addressing our existing cost structure, and we intend to take actions in the areas that are not performing today and properly align all of our resources with our current and long-term outlooks and to ensure that we achieve our goal of being cash flow positive and profitable on a run-rate basis by year's end.

We are on our way to executing our plans for the second half of 2013, safeguarding our balance sheet, partnering with Violin Memory on a next generation of products and realigning our business from both the top line perspective and from a cost perspective is the correct path for returning stability to the company and is in the best interest of our shareholders, customers, partners and employees. While there's more work to be done over the next 3 or 6 months, we are excited to focus on executing on our objectives, and Gary and I look forward to updating everyone about our progress on our next call.

And now, I'd like to turn the call over to the operator to open the lines for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of John Zaro with BCM.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Let's see, I guess, the first question is why would you -- I mean, if this is -- is Hale Capital going to be a convert like a pipe? Why wouldn't you just have the board and the current shareholders kick in money as opposed to diluting it all?

Gary Quinn

Lou, do you want to take that question?

Louis J. Petrucelly

Well, John, we evaluated all of our alternatives, and based on what was presented in the best interest is we -- presented to us, that's the route we decided to take.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay -- but so this is going to be a dilutive transaction in a pretty big -- because at one point, we were discussing that you guys were discussing and telling all of us that we were going to recover money from the former CEO's estate and that it would bring cash or reduce the size of the shares outstanding. And so now you've settled part of the -- you've settled the shareholder lawsuits, which was part of the reason that you couldn't do anything before, and you guys haven't mentioned anything about that. So I guess, I mean -- in other words, don't we still have that out there hanging of whether we need money or not, or is this -- you just think you need the money so quickly that you'd rather have it on the balance sheet?

Gary Quinn

Okay, John, it's Gary Quinn. So there was a couple of things, I think, in your question there. One was is this transaction with Hale Capital dilutive? And the answer to that is yes. The second question was -- is I thought you guys were doing something with the estate of the former CEO. As coming on board here, I can tell you that we are making available -- any remedies that we have or options we have to recover what we can. But that is something that was -- is not concluded and is still outstanding. So as far as being additive back, we can't really speculate on what that maybe or what that will be.

John Aniblo Zaro - Bourgeon Capital Management, LLC

So have you filed suit against the CEO's estate?

Seth R. Horowitz

This is Seth Horowitz, the General Counsel, John. The answer is that all material litigation is disclosed in our filings.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay. So when the Q comes out, we'll know whether you filed suit against him or not?

Seth R. Horowitz

Yes. I'll tell you that there's no disclosure of any litigation against the estate in the Q.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay. So I -- you see where I'm going on this? I'm just trying to figure out why -- like the whole idea of -- the negotiations on this originally were that you would settle the Class Action suit, and then you would settle it with them. And you didn't sue them because you had some standby agreement with them. Now I'm...

Seth R. Horowitz

John, I just wanted to clear. We have never made any public statements about actions against the estate because we don't discuss specific circumstances that are not public events. As Gary said, in general, without referring to the estate in the specific, we are pursuing all opportunities to recover money that could owed to the company.

John Aniblo Zaro - Bourgeon Capital Management, LLC

So I guess the question is -- I mean, we all know that you're going to sue the estate if they haven't settled. So the question is why haven't you sued the estate? Because -- in other words, we're going to be diluted because you haven't -- you either haven't sued the estate yet, or you haven't settled with the estate. Do you understand? What I'm saying is I'm not complaining, I'm just trying to figure out why ...

Seth R. Horowitz

Well, John, first of all, you're linking 2 activities in your mind, which we have not made any linkage. And you're saying that [indiscernible].

John Aniblo Zaro - Bourgeon Capital Management, LLC

Well, the fact of the matter is the guy was convicted or was accused.

Seth R. Horowitz

Okay, John. Do you want me to answer the question, or do you want...

John Aniblo Zaro - Bourgeon Capital Management, LLC

Yes, yes, yes. Okay.

Seth R. Horowitz

Okay. So let me answer the question, okay? You're linking 2 things which we -- the company has made no linkage on. In terms of the estate, as I said, we don't comment about any particular actions that we might or might not take, but we are aware of all the money that we can recover, and we're going to take all the means to recover those monies.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay. My last question for now is you guys didn't make any mention of the Hewlett-Packard and IBM deals. The IBM deal in particular, is that deal still on?

Gary Quinn

That deal is still on. The -- this is Gary Quinn. That deal is still on. The shipment of the IBM solution from FalconStor is shipping later on this month. It is available for business partners to finally order, okay? And we are currently working with business partners globally to drive demand for that solution to the midmarket.

Operator

Our next question is from the line Ross DeMont, Midwood Capital.

Ross D. DeMont - Midwood Capital Management, LLC

On this Violin Memory deal, did I hear you mention some revenues associated with that, or maybe I missed that specific numbers?

Gary Quinn

Okay. So Ross, I'm going to -- there is a total value of the agreement is $12 million in total. I can't comment on the specifics of what we're developing and how we're developing it [indiscernible].

Ross D. DeMont - Midwood Capital Management, LLC

No. I just want to know is that $12 million over the next 12 months? And is that -- that'll be -- that'll go through revenues that's -- I mean, that's cash to us, revenues to us?

Gary Quinn

Okay. So I'm going to have Lou answer the accounting side of that, so he can be in detailed and let you what you want to know.

Louis J. Petrucelly

So the recognition, Ross, is dependent upon obviously the terms of the agreement, which we haven't discussed. But it will be taken over a period of time based on terms of how the agreement is laid out right now. So it's not a -- you're not going to see the $12 million to tip the revenue number in our next quarter. Okay?

Ross D. DeMont - Midwood Capital Management, LLC

Okay, okay.

Gary Quinn

Just so you understand, Ross. There's a license component to that and then there's an engineering services component to that, of which then Violin will remit to us $12 million over the period.

Ross D. DeMont - Midwood Capital Management, LLC

Okay, that's helpful. I know you -- in the press release and on the call, you've talked about the reached agreement in principle with Hale subject to or somewhat to be determined based on what you, you used a term, the rebalancing plan. What is -- what do they need to observe in this rebalancing plan, or what is it that you need to show? And when will we all know whether it's $7.5 million or $15 million? I was a little confused by that.

Gary Quinn

Okay, so this is Gary Quinn. Hale Capital has agreed to a range of investment they will make in the company. As part of that investment, we are required to produce a plan that they will accept based upon a number of items, such as revenue, cash flow, operating income, that we have to achieve and execute against. And once we get that approval from them, then that was one of the conditions of the actual transaction finalizing. At that point in time, we will then be able to determine what that final amount will be between that range of $7.5 million and $15 million.

Louis J. Petrucelly

One of the big things that you see out there today is, and I think many of you guys know, all right, is that when we're selling many of our -- our customers or potential customers are usually not really aware of where FalconStor currently is at from a financial perspective, but our competitors make them aware. And so one of the things that gets in our way a lot of times is the fact that the company's balance sheet is not healthy. The company's income statement is to be desired sometimes. And so therefore, we need to take that off the table for us. We have good technology. We win many times on the technical side of a transaction. When it comes down to the actual financial consummation of the deal, we fight this headwind. So we believe by coming up with a business plan that will be executed as a condition of this investment, we'll be able to achieve profitability, positive cash flow and be able to grow the business again.

Ross D. DeMont - Midwood Capital Management, LLC

Can you provide any more details on this convert in terms of where the conversion price might be, or any of the other terms?

Gary Quinn

I'll let Lou answer that question.

Louis J. Petrucelly

Yes, I mean, so the conversion prices will be based upon a 20-day average or the stock price immediately preceding the closing of it -- of the transaction.

Ross D. DeMont - Midwood Capital Management, LLC

So based on a 1:1 -- a parity or some multiple of that?

Louis J. Petrucelly

Yes, it's on a 1:1 right now. Yes.

Ross D. DeMont - Midwood Capital Management, LLC

Okay. I mean, at some sense, we don't really have a deal that we've got -- we don't have a convert deal. I mean, we have something they said that they'll do subject to a plan from us, and they may put in a range of $1 -- I mean, I'm almost a little surprised we press release this because we lose all our negotiating leverage with these guys. I mean, is not -- we're not a done deal here. It's just an indication of something they might do. I mean, is that a fair characterization?

Gary Quinn

Well, we...

Louis J. Petrucelly

I would say that it's more than just a something they might do, Ross.

Ross D. DeMont - Midwood Capital Management, LLC

I mean, but they're not -- they haven't committed [indiscernible].

Louis J. Petrucelly

We have an agreed term sheet that has been executed, that is basically going through some due diligence with Hale at this point in time. And then also, the creation with Hale of a rebalancing plan that meets their terms and conditions, which is primarily positive cash flow, as well as profitability.

Ross D. DeMont - Midwood Capital Management, LLC

But -- so we have a nonbinding term sheet?

Louis J. Petrucelly

Yes, yes.

Gary Quinn

Yes, that's correct.

Operator

Our next question is from the line of David Cohn with Raymond James.

David Cohn

A couple of them for you. Why did you not consider a rights offering? I mean, your shareholders have suffered significantly. Why not have a rights offering to raise the dough?

Gary Quinn

Yes, David, I think we explored all of our alternative and opportunities in front of us. And at -- this decision was made within the best interest that was on the table for us at the time.

Louis J. Petrucelly

No, we have -- we were -- as Gary said earlier, our objective was to shore up our balance sheet. We need to do this from an operational perspective to make sure that our customers and our partners and our employees see that we have the wherewithal to have a strong and healthy balance sheet. It was tough decision [indiscernible].

David Cohn

So is this something where you expect to get the cash imminently?

Louis J. Petrucelly

Yes, there's -- yes, I mean, in the near term.

Gary Quinn

Okay. To add there, the goal is to have a final agreement in the near-term period. Yes.

David Cohn

Still would have been a lot more -- it would have made a lot more sense to do a rights offering, but -- a couple of other questions. I'm a little confused now on what the balance sheet is going to look like. So we've mentioned a bunch of different pieces here. So can you walk me back through what the balance sheet is going to look like with what we know are payments that you are expected to receive and payments that you are going to have to make? So right now, we have a payment due of $1.7 million, I think, somewhere in the mid-part of December related to the final piece of the settlement. We have a $5 million payment due to settle the shareholders suit. Can you walk me through what the incoming revenues are that offset? I wasn't clear on what the insurance amounts that you're going to recover are.

Louis J. Petrucelly

Sure. So as you said, we have $1.7 million due to the government in December and $5 million at some point when the -- if and when the settlement is approved by the courts, right? So the $1.7 million is not covered by insurance. That comes out of our cash balance to date. $5 million we'll still -- we have reached -- so there are 2 layers that we have that -- which should be covered in our insurance. The first layer is for $5 million, we've reached an agreement for 77% of that in October, I believe, after the first $250,000 of a deductible, okay? So you have the first $250,000 is the company's responsibility, and then after $250,000, the first layer of insurance kicks in. We received $3.8 million of that money back in December, okay? So now we have -- on the next layer, we received -- we have reached an agreement with the second layer of an insurance coverage for the next $5 million, and to date, we have a receivable of that that's due to us of approximately $1.3 million, which represents 75% of the expenses we've incurred above the first $5.25 million. So I think what you're trying to get at, David, if I'm correct, is that if we work up -- if the Class Action was settled today and we had to make payments, the amount of cash that would come out of our existing cash balance would be $3.7 million.

David Cohn

$3.7 million, I don't understand. Why not $5 million?

Louis J. Petrucelly

Because we have $1.3 million in receivables that is due to us from the insurance.

David Cohn

Got you, got you. Okay, I got it. I get it. Okay. So essentially, you have $3.7 million plus the $1.7 million, so you have $5.4 million in expected payments between now and year end, assuming the settlement is before year end?

Louis J. Petrucelly

I'm sorry, everything's done. The lawyer's have seen it. Everything's done at this point. It was settled, that's correct.

David Cohn

Okay. And then we had one other item that you mentioned. You have the new joint venture -- joint development agreement with Violin. So can you give us some idea? Do you expect to receive any cash from them in the next 6 months?

Gary Quinn

So the answer to that is that there is a cash installment of $3 million that should happen before the end of this month, which was a part of the actual signing of the agreement and deliverable of a few items. And then the next deliverables of cash occur on achievements of certain milestones, which occur at certain times. So they could be dated 3 months, 6 months, or it could be just by actually delivering it before then with a final deliverable that has to be done before the end of next calendar year 2014.

David Cohn

Okay. And did you give up the right to any product in that licensing agreement, or have you given up the right to resell any product?

Louis J. Petrucelly

So we have not done anything like that, and I can't really comment anymore than that. But we have not given up any rights to any of our products to resell them, distribute them in any way, shape or form.

Operator

[Operator Instructions] The next question is a follow-up from the line of John Zaro with BCM.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay, so we're on for the IBM shipment at the end of the month. So that seems to have stabilized. From the standpoint of -- I'm still a little confused and, I'm sorry to go over this again. So I guess, I'm confused on what we're doing about this -- about the family? I don't know why that's so difficult for you guys to say. Your -- I mean, you're either going to go after them or you're not. At one point, you were trying to settle with them, so [indiscernible].

Gary Quinn

John, I'm going to let Seth respond to that question again about what we're doing to recover anything that the company is entitled to, to the fullest extent available.

John Aniblo Zaro - Bourgeon Capital Management, LLC

I mean, all I really care about is that you're doing something. That's all you have to say as opposed to doing nothing.

Seth R. Horowitz

Well, John, first, I want to correct something you said when we said [indiscernible]. We have never made a statement about something like a settlement with the family. So you may be speculating that, but I just want to clarify for everyone on the call that's not a statement the company ever made. And I'll repeat what I said before, John. We don't talk about potential litigation or non-litigation or what those actions. When we have something to publicly disclose, we will. But as I've said and as Gary said, we intend to pursue all remedies we have to recover any monies that could be due to the company. That goes for anyone who's out there. I'm not referring specifically to any particular person. But any monies due to the company, we intend to pursue.

Operator

Our next question is from the line of Ronald Markowitz [ph], private investor.

Unknown Shareholder

Yes, I have a question. It's not a huge issue in comparison to the ones that have been discussed, but it has really gotten me curious. I had read a statement some months back that the company had paid Jim McNeil $20,000 for his office furniture. Why did we do that?

Gary Quinn

Ron, this is Gary Quinn. As part of Jim's separation from the company, that was one of the items that was included in that separation agreement, and that was just part of that agreement. I was not part of that agreement, but all I can say is that was something that was included in there. I mean, it's something that the board and Jim had agreed upon.

Operator

Our next question is a follow-up from the line of Ross DeMont with Midwood Capital.

Ross D. DeMont - Midwood Capital Management, LLC

A couple of more things. Over the course of this strategic alternatives process, which is, I guess, roughly 8 months in length at this point. Did we have any overtures by anyone to buy the entire company outright?

Gary Quinn

Ross, could you just say that one more time, please?

Ross D. DeMont - Midwood Capital Management, LLC

Sorry. I was just sort of saying we've been through this 8 month strategic alternatives process, which we're now -- it's now come to a close. But I was wondering if at any point over the -- during that process, did we have any overtures by any parties to buy this entire company outright?

Gary Quinn

Okay. So Ross, we typically do not come out and disclose if we received any bids formal or informal or otherwise, but the options that we've taken were the ones that were deemed to be best for the company at this point in time.

Ross D. DeMont - Midwood Capital Management, LLC

I guess I'm just asking -- I mean, we've -- this is our first and only sort of ragout de forme to learn about what happened during this process, and why we've achieved this result as opposed to something else. And I'm just wondering if anyone made an overture to buy the whole company? I don't -- I mean, any reason why we can't talk about that?

Gary Quinn

I mean, we're -- it's not something that we actually are talking about whether they're formal or informal. As I mentioned, we went through a process to look at strategic alternatives. There has been many things that fall under alternatives. It could be an acquisition of the company. It could be to take private of the company. It could be [indiscernible].

Ross D. DeMont - Midwood Capital Management, LLC

I know, but did either of those 2 come up?

Gary Quinn

The result of what has occurred is what is we felt was the best thing for the company at this time.

Ross D. DeMont - Midwood Capital Management, LLC

I know, but you keep saying we had a menu of options. I wondered if one of those options was someone buying the entire company?

Gary Quinn

These are the options that we basically chose from what we had.

Ross D. DeMont - Midwood Capital Management, LLC

Sorry, let me try this again. So basically you're not going to talk about any of the other options other than the ones you settled on. Is that a fair way to put it?

Gary Quinn

That's correct.

Ross D. DeMont - Midwood Capital Management, LLC

Okay. I hope you guys will keep your mind and eyes open for a potential deal because we're at -- the stocks are at 20-year lows. The go-it-alone strategy has not served us particularly well, and our competitors are orders and orders of magnitude larger than we are. So to me, what you come up with is not enough to change this company in the eyes of all of its customers and shareholders. I hope we -- I hope the stock recovers a little bit here, but I think most people would have hoped you just sell the whole company and recognize that being this size, competing in this space is probably not a good strategy, but I'll -- that's all I [indiscernible].

Gary Quinn

And Ross, I hear you, and I hear you regarding continuing to keep ourselves open. We are a public company, okay? If someone would come forward and present a transaction to us, which includes one of the ones you're talking about, whether it was acquisition of the firm or whether it is a take private of the firm, we have a responsibility to the stockholders as a public company to respond to those offers as they come along, should they come along, and we are still open to those offers should they come along. We just felt that it was time to part ways with Wells Fargo at this time. The opportunities that were presented to us, we took those that were there. But as you know, we are public, and if someone would come forward, we are more than willing to entertain any options that are presented to us.

Ross D. DeMont - Midwood Capital Management, LLC

One thing you could do to placate those of us who lived through this pain is to take this Hale deal that you're doing with them and come out and offer to the rest of us. I mean, there's no reason you shouldn't let your long-suffering shareholders avail themselves of an at-market convert deal rather than letting that firm do it on a one-off basis. So I'd encourage you to at least think about that.

Gary Quinn

Okay, thank you.

Operator

Our next question is a follow-up from the line of David Cohn with Raymond James.

David Cohn

Could we get back to business for a minute? So we're going to get breakeven in Q4. Could you tell me whether or not you expect to get to breakeven through additional cost cuts or through improvements in revenue, or maybe a combination thereof? As you stand right now, your breakeven looks like it's closer to the $20 million level. So you are either going to have to continue to restructure the business somewhat or dramatically increase the revenue? So how are we going to get to that breakeven in Q4?

Gary Quinn

So David, the question is are we looking for an increase in revenues, of reduction in costs, changes in our business plan or all of the above? And at the moment, we've gone through looking at our product portfolio and focusing that portfolio on how we can drive the most revenue that's possible with that current product line, as well as looking at the routes-to-market where we're currently focused. And that includes different customer segments. We're approaching the marketplace from medium, small, large enterprises, potentially SMBs, OEM relationships in certain geographic locations around the world. Some are performing, some are not. The coverage model that we have in those locations could be possibly modified to drive more revenue at a reduced cost rate. So all of that is currently being put together as part of this plan. And we will be sharing that with you, the results, either on the Q3 call or before if there's something that we need to tell you that's materially important.

David Cohn

Okay. A couple of years ago, Violin was slated to come public. It was probably 3 or 4 years ago, and they had, had a major deal with Hewlett-Packard. And I believe Hewlett-Packard had walked away from the deal just prior to them coming public. Will the opportunity that you've recently announced with Hewlett-Packard be negatively impacted at all by your agreement with Violin?

Gary Quinn

No. Actually, the Hewlett-Packard agreement is the opportunity for FalconStor to provide a virtualization layer with its NSS technology for those customers that Hewlett-Packard is entertaining into their cloud matrix offering that are not utilizing Hewlett-Packard storage and servers. So for those customers that are non-HP that they are trying to bring into their cloud matrix, they will be using FalconStor's NSS technology in its current format to allow those customers to participate in cloud matrix. So we don't envision impact by this transaction with Violin. If anything, it will permit that type of technology to participate in a greater way because it we'll be optimizing flash memory versus today, where we are currently compatible with it, but we do not exploit it.

David Cohn

Excellent. And then just one other question. Who was the buyer of Blue Whale?

Louis J. Petrucelly

That we -- we didn't disclose that, David.

David Cohn

Will that be disclosed in the Q?

Louis J. Petrucelly

No. It's not -- no, we will not disclose in the Q. We're not filing that agreement with the Q, I mean, if that's the question though.

Operator

I have no further questions at this time. I would like to turn the conference back to management for any closing remarks.

Gary Quinn

Operator, there's -- you can -- I think some people are going to go back in the queue based upon that last call. I don't think anybody was on, so somebody I think has gone back in.

Operator

I'm showing no questioners in queue, sir.

Gary Quinn

I thought David Cohn was jumping back in.

Operator

He has just jumped back in. Do you want to continue?

Gary Quinn

Continue on.

David Cohn

Are there any geographic regions then that you're considering exiting? For example, is there a consideration to exiting China, or one of the other regions in its entirety?

Gary Quinn

No. Actually, in looking at the geographic territories, most territory that FalconStor operates in today has in-country presence. And what I mean by that, it's not only people on the ground. It's typically an office space and all the associated cost that go with that of operating an entity. So the question becomes is if you look at the amount of revenue that you're generating -- and probably not actually the people cost, but the ability to operate the entire entity there. It may not sometimes make sense to carry all that additional G&A cost with you. So we're evaluating each country today. There's no specific region that we are currently targeting at this point. We're looking to put a distribution model in place that makes the most sense for the company whether that's FalconStor representatives on the ground distributing product on their own, working directly with a partner or a 2-tier distribution model. Maybe setting up an exclusive distribution right for a particular partner to serve that country, so there, in that case, we are not incurring the additional G&A cost associated with that, or in some places where we were historically there, or we started out recently in the last few years and it never really materialized, to cut our losses because nothing's really come out of there, whether it's historically or a recent investment. So that's kind of what we're looking at doing. But at the moment, there is no specific country or region that we are targeting as a whole. And as far as exiting any region or a country, we'll still maintain a distribution right presence whether it's from the company or from a partner.

David Cohn

Okay. And then with respect to the actual business that you did in the quarter end. Q4, you had some pretty decent business out of Huawei, and they were almost a 10% customer. In Q1, you had virtually none, at least that was my recollection. In Q2, did you get any business from Huawei?

Louis J. Petrucelly

No, David, we did not. They're still -- we're still experiencing the disruptions that we talked about from their internal reorganization that happened there. So we have not received any material revenue from them in Q2.

David Cohn

Okay. And then were there any 10% customers in the quarter?

Louis J. Petrucelly

Yes, we had 2.

David Cohn

Could you share who they were? I know I'll see them in the Q, but...

Gary Quinn

[indiscernible], no worries. It's only you [indiscernible] Hitachi Data Systems and Datang Telecom, which is a distributor in China.

David Cohn

Hitachi and Datang. Okay. And I thought Jim had said on one of the previous calls that he had renegotiated some type of an agreement with Huawei. So you did expect to get some higher volume maybe at a lower price. I don't remember exactly what the specifics were, but we did expect to have some business in Q2 from Huawei.

Louis J. Petrucelly

Well, we have a current agreement in place with them. They have an agreement with us -- OEM agreement with us. And yes, we did expect the revenue that we're still being impacted by their -- by their internal situations going on. So we are -- we don't have much insight into what's happening. It's difficult when you're dealing with OEMs sometimes to get real feel for what's going on over there. But yes, I mean, we expect to or hope to have some revenue from them going forward. But we'll see what happens. It's just very hard to predict right now, David, [indiscernible].

David Cohn

Got you. Okay. All right. So you've had -- you guys have had another month. We've had -- the month of July has come and gone. Just could you give us some characterization of what you're seeing in the business? Are the competitive issues accelerating? Are they abating somewhat? Are you losing deals as a result of those competitive pricing issues? Just give us some flavor on what July and the very first part of August look like.

Gary Quinn

So David, I think that as you read reports that are out there regarding the storage marketplace, the economic conditions, they're still very much the same as they were over the previous quarters that I think you have probably been talking to the team here. It's competitive, and you need to win.

David Cohn

Okay. So pretty much status quo?

Gary Quinn

Status quo.

Operator

Our next question is a follow-up from the line of John Zaro with BCM.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Going back to Ross' -- to the issue. I've been -- we've invested through a lot of these, and particularly these converts. And I guess the issue is you're telling us that a dilution of anywhere from 10% to 25% of $1 is better than any price that you potentially could've gotten and put in the company up for sale. That's basically what you're -- if this is your choice. That's what you're telling us. Is that correct?

Gary Quinn

No, that's the assumptions you're making based on what we announced today [indiscernible].

John Aniblo Zaro - Bourgeon Capital Management, LLC

Well, if you could sell the company for $2, which is up 100%, why would you dilute people 7% to 25%? At 1? So I'm just -- it's a mathematical question.

Gary Quinn

John, the board decided that this was the best way to move the company forward.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay, okay. Well, I mean, going back to the -- what we were talking -- what Ross and everybody else was talking about was we are the people that have owned this company for a long time. We're the ones that have lost a ton of money. And I know you guys are limited by what you can say, but you're not really telling us anything related to how this all came about except that we're going to get diluted, which doesn't really help us. And in addition to that, just -- I'd like to say one final comment on this and then let you guys go. This discussion about the family was on, at least, one of these calls, okay? It was publicly talked about on one of these calls. And it was talked about many times since then with Jim. So you guys need to come clean on this and what's going on so that we're all on the same page on this.

Gary Quinn

Okay.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay? Because there was in-depth discussions. I have plenty of notes, and I have plenty of dates and plenty of calls and transcripts.

Gary Quinn

Okay, that's -- John, duly noted, and I understand what you're saying, and I appreciate your comments.

Operator

Our next question is a follow-up from the line of David Cohn with Raymond James.

David Cohn

Last one, I promise. The K -- your last 10-K suggested you still had an open buyback that was 3 million, 4 million shares. Is that buyback still viable? And I recognize in light of the fact that you've announced the convert, you're not buying back stock. But is that buyback still viable?

Gary Quinn

The program still is open, David.

Operator

There are no further questions at this time. I'd like to turn the conference back to management for any closing remarks.

Gary Quinn

I'd like to thank everybody for attending our quarterly conference call tonight. I appreciate your questions and your feedback and your input, and we look forward to giving you an update on our next call in Q3. Thank you very much. Good night.

Operator

Thank you, sir. Ladies and gentlemen, if you'd like to listen to a replay of today's conference, please dial 1 (800) 406-7325 or (303) 590-3030 using the access code of 4630239. This does conclude the FalconStor Software Q2 2013 Earnings Call. Thank you very much for your participation. You may now disconnect.

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