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Falconstor Software (NASDAQ:FALC)

Q3 2013 Earnings Call

October 29, 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

David Cohn

John Aniblo Zaro - Bourgeon Capital Management, LLC

Operator

Good afternoon, and thank you for joining us to discuss FalconStor Software's Third Quarter 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 will then open the call to your questions.

The company would like to advise all participants that today's discussion may contain what some consider forward-looking statements. These forward-looking statements involve risk and uncertainties that could cause actual results to differ materially from the forward-looking statements. These risks and uncertainties are discussed in FalconStor's reports on Forms 10-K, 10-Q and other reports filed with the Securities and Exchange Commission, and in the company's press release issued today.

During today's call, there will be discussions that include non-GAAP results. A reconciliation of the non-GAAP results to GAAP has been posted on FalconStor's website at www.falconstor.com, under Investor Relations. After the close of business today, FalconStor released its third quarter 2013 earnings. Copies of the earnings release and supplemental financial information are available on FalconStor's website, at www.falconstor.com.

I'm now pleased to turn the call over to Gary Quinn. Go ahead, sir.

Gary Quinn

Thank you, operator, and good afternoon, everyone, and thank you for joining us. I want to say that I'm truly excited about the future of FalconStor, and that since being named the CEO in July, the FalconStor team has evaluated all the company operations, and we are in a much better position to generate sustainable top and bottom line growth in the future.

Even though we still have a lot of work ahead of us as we embark upon this journey, I would like to recap the activities we have completed during Q3 so that you know what we have done. First, we executed a joint development agreement with Gartner's #1 flash array market share leader that should bring the company a cash infusion of $12 million. So far we have achieved milestones 1 and 2 of that agreement, which delivered $3 million in Q3, and we expect an additional $3 million in Q4. The final 2 milestones will be achieved in 2014, most likely by the end of the summer of 2014.

The project will position the company for its next generation of technology and the ability to address the current needs of the marketplace for cloud, mobility, business continuity and recovery with greater performance, flexibility, and management.

Next, we completed a private equity placement of $9 million with Hale Capital to enhance the viability of the company for our customers, partners and employees. We've rebalanced the company portfolio of assets, consisting of engineering efforts, geographic coverage, need for back-office operations, and the use of funds for only the most essential requirements to the business, which consists of building products and selling them.

We're still committed to being in a breakeven situation on a non-GAAP basis, at the end of Q4, 2013.

We filed suit against the Huai estate. We decided that pursuit of recovery from the Huai estate through the court system is the best way to drive to conclusion what is possibly due to the company.

In addition, just yesterday, the court gave preliminary approval to the settlement of the securities class action against us. We are one step closer to getting that behind us.

We conducted 3 products summit reviews with the best and brightest from FalconStor to develop the updated product roadmap to ensure that we are more competitive, delivering what our customers want and producing enterprise products on a more nimble and timely basis.

We delivered the long-awaited 7.5 release of our premier products NSS and CDP. We conducted the first sales and marketing summit with the sales organization along with a new marketing strategist, a creative director and a public relations firm. The goal will be to reposition and relaunch FalconStor in Q1 of 2014.

We instituted a company-wide employee rewards program for 2014, consisting of company-performance-based bonus plans for all non-commissionable employees. We believe this will align our non-commissionable employees with our business and shareholder objectives.

Finally, we began the planning for regional profit and loss plans for geographic regional management along with country management for our 2014 year. In addition to that, our horizontal budget stakeholders also will be responsible to our P&L for engineering, technical support and corporate G&A. The company will have a full 360-degree profit and loss statement across all business units.

The many calls that I have received and delivered to staff, customers, partners and industry analysts reaffirms our position that FalconStor has the ability to deliver what the marketplace needs in this ever-changing world of technology. We will continue to look for improvements in our cost structures while we look to grow the company in the areas in which we excel. We must be realistic, though, in our efforts and ensure that the foundation upon which we are moving forward is solid and verified. Our results still require improvement, and we are committed as a FalconStor team to delivering on those necessary results for our shareholders.

I would like to turn the call over to Lou, who is going to review those results for the quarter ended September 30, 2013.

Louis J. Petrucelly

Thank you, Gary, and good evening, everyone. Because our results are included in our earnings release, I would like to provide just a brief summary of our third quarter results, and provide color where appropriate. Additionally, Gary mentioned some of the near-term initiatives and objectives that we began to take, and I will provide you with a brief update on the progress we have made and update of our plans and objectives heading into Q4 from a financial perspective.

For the third quarter of 2013, our total revenues decreased 14%, to $14.7 million compared with $17.1 million in the same period a year ago. However, total revenues increased 5%, from $14 million compared with the previous quarter. We're pleased that we are able to improve on our revenue results from the previous quarter in light of our various corporate initiatives that were undertaken during the quarter. However, we recognize that there is still work to be done and our goal will be to continue to improve our results every quarter.

Total revenues from each of our regions declined on a year-over-year basis. The declines in product revenues, specifically from our Asia Pacific and EMEA regions, were the primary drivers of the soft revenue performance in Q3 compared with the same period in 2012. Our support and services revenue, which is comprised of maintenance and professional services, decreased by 5% compared with the same period a year ago, while increasing by 10% compared with the previous quarter. The maintenance portion of this revenue declined 4% to $7.5 million in Q3 from $7.9 million last year, which was a result of our decline in our OEM maintenance of approximately $500,000. However, our non-OEM maintenance increased by approximately $200,000 during the same period. Sequentially, our maintenance revenues increased 7% compared with the previous quarter, with our non-OEM maintenance increasing by $600,000 or 9%.

Next, I will turn to our Q3 non-GAAP results, which exclude restructuring expenses, legal costs and stock-based compensation. I will discuss our restructuring efforts specifically in a few moments. Our product gross margin remain unchanged at 82% year-over-year. Our support and services gross margin increased to 69% in Q3 from 62% in 2012. The increase in gross margin was primarily due to the declines in our overall support and services expenses compared with the prior year. Overall, total gross margins increased to 74% in Q3 as compared with 72% in 2012 and 73% in the previous quarter.

We reduced our total operating expenses by 18% year-over-year and by 13% compared to the second quarter of this year. We had an overall operating expense reduction of $2.8 million compared with 2012, and a reduction of $1.9 million compared with the second quarter of 2013. The decrease in our operating expenses was primarily due to the restructuring efforts we commenced during the quarter.

As a result of our restructuring efforts and tighter expense controls, we narrowed our non-GAAP operating loss by 48% to $1.6 million from $3.1 million in 2012. Our non-GAAP operating results exclude restructuring costs of $2.3 million for Q3, and $800,000 in 2012; stock-based compensation expenses of $200,000 in Q3, and $1.1 million in 2012; and expenses of $100,000 and a benefit of $1.4 million of legal costs for each of Q3 2013 and 2012, respectively. Our non-GAAP net loss for Q3 was $1.8 million, or $0.04 per share, compared to net loss of $3.1 million, or $0.07 per share, in the same period a year ago.

On a year-to-date basis, total revenues declined 17% to $44 million compared with $52.9 million for the same period a year ago. Our total non-GAAP expenses declined 15% as the result of our restructuring efforts and the tighter expense controls we have implemented since the close of the second quarter. And our operating loss has decreased by 7% compared with the same period last year.

On our last call, we discussed initiatives that we began to undertake after the close of the second quarter to help strengthen our balance sheet and to improve our overall business operations. One of those initiatives we discussed was an investment of up to $15 million in the company by Hale Capital Partners. After considerable analysis of our business, we decided that an investment of $9 million was the appropriate amount. And on September 16, we closed on this investment with Hale Capital Partners and formed a newly-created series A convertible preferred stock. The common stock equivalents of approximately 8.8 million shares represented an investment of approximately 18.2% from Hale Capital.

Some of the more significant terms and conditions of this deal are as follows: Dividends are paid quarterly at a rate of prime plus 500 basis points. The rate is capped at a maximum of 10%. Preferred shares are convertible at any time to common stock at the option of the holders. Also, preferred shares are convertible by the company after 1 year if the volume-weighted average price of the company stock is trading at or above 250% of the conversion price for 60 consecutive trading days. The holders of the preferred stock can redeem at stated value plus accrued interest after August 5, 2017, whereupon certain triggering events that could result in some or all of the preferred stock to be redeemed at the stated value plus accrued dividends or market price. As long as preferred holders hold at least 85% of preferred stock outstanding, they're entitled to 2 board seats; if less than 85% but more than 15% of the stock remains outstanding, the holders are entitled to 1 board seat. Currently, Martin Hale is the only board member that has been elected to the current Board of Directors, and Hale Capital has the right to add another director at their discretion. Finally, there are various financial and operational-based covenants that must be met by the company.

The net proceeds to the company from the $9 million invested were approximately $8.7 million at the transaction cost. We are excited to have Marty and his team working with us, and we look forward to leveraging his experience and his network of resources.

And another initiative we undertook after the close of the second quarter was a comprehensive rebalancing of our business with the primary objective of lowering our cost structure to align our operating expenses with the company's capital resources and the size of our business. As a result of our rebalancing efforts, we have identified approximately $17 million of annualized expenses that we can eliminate from our existing cost structure. Of this amount, approximately $11 million is associated with personnel expenses. We have also done a comprehensive review of all of our non-personnel expenses around the world, and we have identified approximately $6 million of expenses that can be removed from our business through tighter expense control management, elimination of non-core activities and elimination or consolidation of our physical presence in certain geographical locations.

As we discussed on our previous call, the main objectives of the rebalancing plan was to align the resources and assets necessary for our core business objectives and to eliminate any expenses that did not meet that criteria. As we worked through our plan, one of the major non-personnel expenses we looked at was the cost associated with our physical presence in locations around the world. Our plan is to implement the most cost-effective ways to service our installed customer base for new coverage miles in certain regions. These new coverage miles include servicing customers from other regional locations or through exclusive arrangement with partners, resellers or distributors. We believe this model is not only cost effective, but will also be seamless for our installed base.

Finally, after a comprehensive review of all of our assets as part of our rebalancing efforts, we have or will be reducing our headcount by approximately 30% once all the plans are finalized by the end of this year. During this process, we look at all of our personnel at every level in every region and in every function to analyze which functions are vital pieces of our core business moving forward. While this is never an easy process or decision, we need to staff our business in a way that supports our core business plans and strategies and make the best use of our resources.

As you can see from the slide, we reduced positions from every department in every region globally. We ensured that we reduce our headcount in a way that will not negatively impact our existing customers or our ability to execute on our plan. We substantially removed the majority of personnel cost during the quarter. However, there are still employees who will exit the company during the fourth quarter, who have remained with the company either to transition their roles or due to local labor law requirements surrounding separation of employees, specifically within our European locations.

Our total restructuring charges during the quarter were $2.3 million, and we paid approximately $1.4 million of those charges during the quarter. We anticipate that we will have additional restructuring charges in Q4, as we continue to wind down various locations, facilities and personnel during the remainder of the year.

Turning to our balance sheet, as of September 30, we had $29.5 million in cash, cash equivalents and marketable securities, which includes the $9 million preferred stock investment net of transaction cost, and $3 million payment from our joint development agreement which we announced last quarter, and $1.4 million of payments associated with our restructuring efforts.

Our cash use in operations was $700,000 in Q3, compared with the cash used in operations of $5 million in the previous quarter and cash used in operations of $7.1 million in Q3 of 2012. Our deferred revenue was $25.3 million compared with $24.1 million at the end of 2012. As we discussed, we raised $9 million during the quarter in the form of redeemable convertible preferred stock, and we continue to carry no debt. Finally, we discussed on our last call that we signed an agreement to sell our investment at Blue Whale for $3 million, which we still expect to close before the end of the year.

To summarize, as you see from our results, and from the actions we have taken during the quarter, we are taking steps in the right direction by addressing the size of our balance sheet, reducing operating expenses, solving our cash burn, and by focusing on our path to stabilize and to grow our business model moving forward. We believe we're on the correct path of executing our plan of being cash flow positive and profitable on a run rate basis by year end. While there's still more work to be done over the next quarter or so, we are excited and focused on executing on our objectives, and Gary and I look forward to updating everyone about our progress on our next call.

And now I will turn the call to the operator to open the lines for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from David Cohn with Raymond James.

David Cohn

I had a couple of questions about the operating expenses, for the quarter. They were approximately $13 million, and I'm not sure -- so on an annualized basis you are at about $52 million. So I am not clear from the commentary, how much more is going to come out of your OpEx from where you are today?

Louis J. Petrucelly

David, we spent a great deal of time evaluating our business during the quarter, and with the objective to remove all the expenses not associated to support our core business going forward. We don't give guidance, as you know, so it's tough for me to give you exact numbers where our run rate is going to be in Q4 and going forward...

David Cohn

I'm just confused between -- obviously, you have taken some action within the quarter and you plan to take some additional action in the following quarter. So I'm at an OpEx right now of about $13 million a quarter. And so I'm just wondering what do I have left to cut in what you said? That's essentially my question.

Gary Quinn

So David, as Lou mentioned, there's -- we still have some people in a few areas of the world that due to local law we were unable to separate with during Q3, so we still have some of those personnel costs to come out in Q4. We additionally needed some people to help us transition the business, and they will be separating after Q4 is also over. So there are some personnel costs that are out. And then I would imagine that there's a couple of regional offices that have an undetermined status yet as to whether or not we will be subletting that to someone else or we would actually think it's the best thing to basically just wind down the lease. So I don't believe, Lou, there's anything much more than those 2 areas left. But those typically take time due to local regulatory rules. And then, obviously, when you're looking at leases, we want to do the best thing for everyone and try to have minimal costs associated with separating from a facility where we conducted business before.

David Cohn

All right. I have just a couple of other brief questions and then I'll get back in line. So you expect in Q4 you're going to get the Blue Whale revenue, you're going to get another $3 million from your deal with Violin Memory. And then you have -- it's a $4.2 million payment for the remaining piece of the settlement, correct?

Louis J. Petrucelly

No, no. So we -- a couple of -- Blue Whale is just a cash basis. That's investing --- it will be a below the line item, a gain on sale but it's not revenue.

David Cohn

No, no, no. Yes, I'm just talking about with the cash that's coming in, in Q4 versus what's going out?

Louis J. Petrucelly

Yes, that's that. The settlement was $5 million that we have [indiscernible] $5 million. And keep in mind also on December 27, we wrap up our deferred prosecution agreement with a final payment of $1.7 million.

David Cohn

Okay. So $6.7 million going out. That was the number that I was looking for. Okay. And then the Violin Memory...

Gary Quinn

Yes, one other thing, David, to your Violin Memory question, we did reach the second milestone, and we're just awaiting payment for that in this quarter, which is worth $3 million. And as Lou mentioned, there is a number associated with Blue Whale, so that's coming.

David Cohn

Okay. And then with respect to when you actually are able to recognize the revenue from the Violin Memory, you expect that will be in the back half of '14?

Louis J. Petrucelly

Yes, so based on the contract we have with them, the $12 million will begin to be recognized as revenue over a period associated with the services that are required with that. And that we expect to begin when we finish the fourth milestone, which as Gary indicated, which we anticipate would be by the end of the summer next year.

David Cohn

Excellent. Any 10% customers in the quarter?

Louis J. Petrucelly

One.

David Cohn

Can you name them?

Louis J. Petrucelly

Hitachi Data Systems.

David Cohn

Excellent. And was there any business from Huawei in the quarter?

Louis J. Petrucelly

Immaterial.

Operator

And your next question is from John Zaro with BCM.

John Aniblo Zaro - Bourgeon Capital Management, LLC

I have a couple of questions. Just one thing just on the immaterial on Huawei, this has been kind of a struggle. Are we in the penalty box like every other company that's out there? Or is this just we're just starting to get back into Huawei?

Gary Quinn

Okay. So John, as you know, we recorded, I want to say for probably 2 consecutive years, probably a decent amount of business with Huawei for our APAC territory. I was just there a couple of weeks ago. Going into the new -- into 2013, Huawei was looking to do some different things with us related to their deal with us, and we accommodated them. They were also bringing the division that we were originally doing business with underneath, let’s say, the mother ship, as some of their own refocusing internally kind of slowed them down in the first couple of quarters. At this point in time, we are engaged with them. We're looking to do more business with them. But as Lou mentioned, at the moment the number is very immaterial, and we're looking to do things as we move ahead.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay. And then, I'm a little confused on the -- this is sort of a 2 part question -- on the movement of the cash just from the standpoint of where you are -- where you were at the end of the quarter, what you got from Hale, and what you used in the quarter. So I guess, the question is, didn't you start the quarter with $29 million?

Louis J. Petrucelly

Let me -- I'll kind of break out -- I will kind of do an apples-to-apples for you, John, okay? So if you recall last quarter, we ended the quarter with $21 million -- roughly $21.9 million in cash, and had a cash burn of about $6.3 million compared to Q1.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Which took you to $21 million?

Louis J. Petrucelly

It was $21 million, that's correct, yes. So we ended the quarter were $29.5 million. So if you kind of back out the items that we did during the quarter to look at what our cash burn was...

John Aniblo Zaro - Bourgeon Capital Management, LLC

I got it. I got it. That explains it, nevermind. I got it.

Louis J. Petrucelly

So our cash burn was $2.7 million during the quarter, if you take everything out, compared to $6.3 million. So we -- solved the cash burn.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay. And then you guys, for lack of better thing, you had -- for a way of putting it, you had 3 businesses, 3 "core" businesses before. And at least one of them didn't make a lot of sense. And I guess the question is, in this restructuring, have we gone to 2? Have we gone to 1? Or are we still at 3?

Gary Quinn

So I don't know exactly how we get the 3, but I'll give you a little synopsis of how I see it. The company had 2 product lines. One of them was the VTL and FDS product line, which revolved around virtualization of tape and file deduplication. The other side the NSS and CDP side, which was around storage virtualization as well as replication and snapshot technology. So those are all -- both built on a common foundation from a long time ago, although they were split on something called IPStor. I think where you're driving at -- and that business is enterprise business, enterprise class. The VTL business was the OEM business that we used to have, which we don't have any more of. And there was an effort to take that technology and look to move it to a different customer segment in the SMB space, but that never materialized. I mean, that product never came out of engineering. It was still quite some time away. It was a customer segment that would have required significant investment on both on awareness, a marketing and a go-to-market strategy to take on new partners and more potentially through a -- to a Web-type environment or e-commerce engine. In evaluating the business, considering that, that was at a minimum a year away from a delivery perspective from the engineering team, and considering that we had built our business on enterprise class technology with enterprise customers, both medium and large and mega-large, we felt that it was the best thing to refocus all of our assets around the enterprise. And in that path, there was the first creation of this one product for an SMB market. There was a second deliverable that was for the enterprise. And what we decided to do is to invest in accelerating that enterprise class technology for delivery. And the reason why that came about is our ability to do the joint development work, as well as go to some incremental engineering deliverables every 90 to 120 days to speed up that actual realization of the second step along the strategy that the company had. And so we believe that we need to focus on the enterprise, go after the opportunities in the enterprise around business continuity, around recovery, around cloud and data mobility. And that's really where the heritage of FalconStor comes from, and we believe we can leverage that and move forward and grow.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Okay. No, I think that's great. You had too many divisions before that did too little and too wide of a universe. You can't focus.

Gary Quinn

Yes. I mean, yes, you're right.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Yes, I mean -- has Hale helped you in looking at this restructuring and going through this? Or they at this point, they weren't that -- that much involved yet?

Gary Quinn

I don't know if you know Martin Hale, but I mean, Martin Hale has been a great addition to our team here at FalconStor, not only at the board level but to us on a day-to-day, with myself and Lou and the team. He brings some different perspectives on how to grow a business and how to measure a business and make the right decisions. So if you are asking if Marty is in here every day and turning on spreadsheets, I have to say the answer is no. But I would have to say that we probably talk to Marty and his team and his portfolio of company management probably at least every couple of days here, bouncing off ideas, sharing contacts, sharing opportunities and ways to actually run your business. So I value his addition to the team, and he has been a really good sounding board for me as we've gone to this transition over the last 90 days.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Great. That's fantastic. I have 2 more, if that's okay. One, what have your customers -- how have your customers been responding? I know you personally, Gary, were concerned about that at one point along this road in the last 5 months.

Gary Quinn

Yes. So I'd actually have to say, John, that the biggest response has been that as we went through this quarter, and albeit we had a lot to do and I really appreciate the efforts of the FalconStor team in helping us getting it done, I also spent a lot of time, as I mentioned, talking to customers and partners and industry analysts and the biggest thing that I saw go away based upon the long list of over 6 bigger deals that we had this quarter, I didn't have to do any viability calls. So I think by shoring up the company in August with the joint development actions, with the commitment from Hale Capital, and with the actual commitment to deliver on rebalancing our assets, I think that set many customers and many partners at ease. And if you look at where we are today in our financials that we just published, I think we're in a really good spot. I mean, we've got some work to do, don’t get me wrong. But I will tell you this, I feel really good about it, and I think we're on our way.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Great. And then last but not least, the question that I just have to ask is, you guys have been restricted for, I'll just say 2 years, and to your most senior board members, who hopefully are on this call, we've been repeatedly told that you would love to buy the stock if you possibly could. Are we going to actually see some people step up and buy some stock to support the company? I mean, and are we also going to have this call that we were supposedly going to have to talk about all this?

Louis J. Petrucelly

Well, John, as far as when people buy stock or not, obviously that gets known when -- if and when a filing is done. We just can't -- we're not going to comment on if they can, if they can't; when they are, when they're not. I mean, that itself, by giving that information out is obviously inside information that we don’t share. So it's hard for us to answer.

John Aniblo Zaro - Bourgeon Capital Management, LLC

That's not really the question. I don't want to know any of the specifics, and you and I both know that when they say that they're going to support the company, and they have been telling everybody that for 2 years, and so far they haven't been able to because they've been restricted. That basically if you want to say that one side is restricted -- is insider information, then the other side is. The fact of the matter is, if you guys -- if they say they're going to support the company and they believe in it and they would love to buy stock, and they have been saying that since it was $2.50 and they've been using the excuse of being restricted, the question seems pretty normal that since all these restrictions are finally being lifted, that they would be investing. Yes, or no? It's pretty simple. That's not inside information. That's just...

Gary Quinn

So to your point, all right. If this, obviously...

John Aniblo Zaro - Bourgeon Capital Management, LLC

I mean, let's not bulls*** around, okay? We've all been in this a long time. We've put up with a lot of s*** from these guys, and they kept saying that they would stand up and support everyone, okay? And we think you guys have done a great job, but the fact of the matter is that so far they haven't put up a nickel, and we have all lost a ton of money. So now that they can do something, that's the question. I don’t think that's an unfair question.

Gary Quinn

Okay. So all I can say is, like you said, there are a number of things that have gone on over the last couple of years. As of this call, we're unable to comment on what people are going to do or what they will do. I think we need to just see it as it goes as -- there's a lot of clouds have been lifted off the company.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Right. But they will not be restricted in 10 days or whatever the restriction is, correct?

Gary Quinn

I can't answer that.

Louis J. Petrucelly

We can't answer that question.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Well, you have a blackout period. You have a blackout period. So is the blackout period going to be lifted or not? Are they still going to be restricted? There's nothing bad about that.

Seth R. Horowitz

John, it's Seth Horowitz. You and I have had this conversation before. And it's the company's position -- I know you are saying that they said they were restricted. I'm not sure where you're getting that from, but our position is that we don't comment whether...

John Aniblo Zaro - Bourgeon Capital Management, LLC

Well, you either have a restriction period...

Louis J. Petrucelly

Our position is that we don’t comment on whether any officer or director is or is not allowed to sell stock for internal reasons. That is our position.

John Aniblo Zaro - Bourgeon Capital Management, LLC

That's not what -- just so you know, that's not what your guys on your board have said in the past. What they have said is, that you guys -- that they've been restricted all the way along. And that what they've also said is, is now that it's earnings period, they're really restricted, okay. So you can say whatever you want, Seth. I have been doing this a long time, that's not accurate, okay? It's not. I talked to them, okay? So the question is, I'll ask you again, do you guys have a blackout period from earnings, for earnings, and will they be free to buy after that blackout period? It's not a question of whether they will. It's a question of whether they're free to buy afterwards.

Seth R. Horowitz

The answer, John, is that we have internal company policies that prohibit purchases or sales during the particular periods near the end of quarters related to earnings.

John Aniblo Zaro - Bourgeon Capital Management, LLC

Well, and I'm asking what that is.

Seth R. Horowitz

Our company policy is that no one who is affiliated with the company can buy or sell until the third business day after the -- after earnings are announced -- or made, excuse me.

Gary Quinn

Okay. All right. Thank you, John. As always it's a pleasure.

Operator

And we have a follow-up question from the line of David Cohn.

David Cohn

Tell us what happened in the quarter with respect to advancing your relationship with the project with IBM?

Gary Quinn

Okay. So just to give you a little color on that, David, as you know we announced a transaction to go to market with IBM's business partners along with their server and storage division back in June. We have made some progress in the fact that we signed up a number of partners, not a huge amount, but we're trying to be careful in how many we have. It's not about how many, it's how good. We've been able to do that in the U.S. as well as in Brazil and in Canada. We have preliminary activities going on in EMEA and APAC. At the moment, though, we have not signed up any business partner there. We have built a small pipeline that we are currently tracking as we speak. And we look forward to closing some transactions as soon as possible. As you know for us, typically our sales transaction is somewhere in the 9- to 12-month range, in the larger transactions. The smaller ones are somewhere 6 to 9 months. So at the moment, we're encouraged by the pipeline we've built, the partners that we've gotten together with. And we expect to, as I think as said to you guys, it was still early, and I think we would see -- we would start reporting out on that in 2014 as we get more traction.

David Cohn

So thus far, there have been no revenues generated from the agreement, correct?

Gary Quinn

That's correct.

David Cohn

Okay. And then could you give me an idea of what you could expect the ASPs to be on what you considered a smaller deal and then what you would expect ASPs to be on a larger deal?

Gary Quinn

Well, in the case of IBM, we're restricted to selling in the mid-market only, which is in their definition, up to a company with 1,000 employees or less. In addition to that, they've asked us to not run into their high-end large enterprise guys, so there's a limit of a maximum of 192 terabytes in any given configuration. But at the moment, we're currently looking at average deal sizes in the neighborhood of somewhere around $77,000, based upon the pipeline that we have today. And like I said, we'll see where we go with that. I mean, we're encouraged so far by the reception from IBM business partners, the reception from their customers. There was a need in the marketplace for a mid-market appliance of this nature, and we are happy to deliver that for IBM's business partners out there today.

David Cohn

Is the lead generation coming from IBM to you?

Gary Quinn

It's actually as part of that program, okay, we're utilizing as you know, market -- MDF funds to drive demand for the solution, and then we work in conjunction with IBM business partners in actually serving those customers' requirements. [Indiscernible]

David Cohn

Excellent. Will you have some type of a revenue forecast? And when we get to the Q4 call, say, in early February, will you be able to present us with some idea of what you expect the agreement to generate in terms of revenue?

Gary Quinn

Yes, I think at our moment right now, David, we're evaluating some metrics. I know that I've talked to you guys about some metrics, I guess a little more, I guess you would say, color or detail around regions, as well as by products and by customer segments. And we are currently putting that together as we speak, we certainly did that as part of our plan internally. Louis switched over to a new financial system here so it's a lot easier for us to, let’s say, push a button as opposed to consolidate spreadsheets. And we believe that, that reporting capability is helping guide us at the moment as we move ahead. And am not going to commit to reporting out on IBM solely, but I think I will be able to give you some more color by region, by customer segment and by products sometime next year.

David Cohn

Has any other opportunity presented itself in the quarter that is something the company plans to pursue?

Gary Quinn

I don't think I can answer that question right now.

David Cohn

Okay. And then with respect to the Huawei, just to follow up on the Huawei question, was it your feeling after meeting with them that because of the problems they have been having, that you are simply delayed from additional business and the relationship is still intact, so you would expect to get some revenue from them in 2014? Could you just give us some idea of what your take was subsequent to your meeting?

Gary Quinn

Yes, David. I think the issue there really was related to some internal changes that went on within their own organization, basically bringing the vision back underneath the parent and then that parent deciding now they're obviously reporting -- the child is reporting to the parent and there are some business plans that need to be put forward. And so I think that just kind of stalled some of their activities or delayed them. But as far as the temperature on the relationship, I think the temperature is good. And I think that we will be moving forward with them as we go ahead.

David Cohn

Excellent. And then could you -- how will you service them in the future? Because I would suspect that part of the cuts that you made were in Asia. So will there be a change in how you fulfill orders for them?

Gary Quinn

No, actually, I'll answer that question on a little bit broader scale. Huawei was directly serviced by our China operations, and as Lou mentioned in our review of the business, our goal was to not impact any of the current business, whether that was customers, whether that was partners, or whomever was generating revenue at this point in time. We basically evaluated geographies where revenue may not have been at the expectations that we originally had as a company when it started. There was some expansion that had gone on in a number of places and just maybe did not bear any fruit. We decided that we should approach those businesses in a different model, not as resource-intensive or expense-intensive and there's ways to do that. In the case of the APAC territory, at the moment we have decided to cover Australia and New Zealand. And our Hong Kong location, Hong Kong will be serviced through our China operations. And Australia and New Zealand right now will be serviced by a local partner, okay, to cover customers and new opportunities in the territory. So we believe in Asia we have not impacted our revenue streams there from the actions that we've taken. And as I'm sure you know some of the other areas that we had some challenges in was our southern territory in EMEA, which consists of France, Spain, Portugal and Italy. We all know the macro issues that are happening there. And we just think that there needed to be some change in that territory, in addition to some of the sluggish economic conditions that are going on. So we're working through that as we speak. You might have noticed we appointed a long-term veteran here, Guy Berlo, to head up our territory there. He has been running one of the most successful territories within FalconStor over the years in our German and Eastern European region, so we look forward to some good things from him as we move ahead. And I think that in the other areas we had expanded a lot of back-office operations. We don't really need people today to book our orders. We need people to do that in a consistent manner and we have new applications that allow us to do that through the cloud, whereby we don’t have the people in every country booking the orders anymore. So there was a big ramp-up of that in the past. A lot of that operational aspect has been discontinued or is being migrated to more central functions by region with less people with more effectiveness. And so I think we're in a good spot.

David Cohn

Excellent. There was probably quite a bit of fat in that part of the business, so that's fantastic. And then my last question, is with respect to the Huai estate, has there been any overture subsequent to your filing against the estate? Has there been any serious overture to settle?

Gary Quinn

David, we don’t comment on any of that kind of information or share that in a public forum. At the moment, we believe this was the best and simplest way to move ahead in that situation. It's a very difficult situation, as you all know, and we believe this was the best vehicle to actually move ahead there.

Operator

And there appears to be no further questions. I will turn it back to management for any closing remarks.

Gary Quinn

Thank you very much, operator. To all of our shareholders, we've had a very busy third quarter, to say the least. We believe that we still have a lot of work to do and we have some things to tie out on our expense side still, which we've mentioned and Louis' prepared view and some slides, as well as their on our website. We believe that the company still has relevant technology. There is tremendous opportunities, as we all know, in cloud, in mobility, in annuity as well as recovery. We will be looking to take our work from our engineers and put that together, repositioning the company and refocusing the company from a sales and go-to-market strategy by bringing on some experts from the outside. These folks are not current employees but there are some people that we've entrusted before. And we look forward to working with them. And like I said, we will be coming back out with FalconStor in Q1 of 2014. And we all look forward to talking to you then after our Q4 results. And thank you very much for joining us. Good night.

Operator

Ladies and gentlemen, this concludes the FalconStor Software third quarter 2013 earnings call. If you would like to listen to a replay of today's call, please dial (303) 590-3030 or 1 (800) 406-7325, with the access code 464-1577 and the # sign. Thank you for your participation. You may now disconnect.

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