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Overland Storage (NASDAQ:OVRL)

Q1 2014 Earnings Call

November 13, 2013 5:00 pm ET

Executives

Jim Byers - Senior Vice President

Eric L. Kelly - Chief Executive Officer, President, Independent Director and Member of Special Committee

Kurt L. Kalbfleisch - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Secretary

Analysts

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Phil Anderson - Pinnacle Advisers, L.P

Peter Bortel - Tiburon Opportunity Fund

Rainerio Reyes

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Overland Storage Fiscal 2014 First Quarter Financial Results Conference Call. [Operator Instructions] This conference is being recorded today, November 13, 2013.

I would now like to turn the conference over to Jim Byers of MKR Group. Please go ahead, sir.

Jim Byers

Thank you, operator and thank you for joining us this afternoon to discuss Overland Storage's First Quarter Fiscal 2014 Financial Results Conference Call for the period ended September 30, 2013.

Before we begin the call, I would like to note that management, during the course of our discussion today, including the Q&A section of this call, will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Management may discuss future plans and prospects for revenue, product introductions, market conditions, competitive conditions, gross profit margins, spending levels and other financial metrics.

We caution you that forward-looking statements relating to these and other subjects we may discuss involve risks, uncertainties and assumptions that are difficult to predict. They're not guarantees of performance, and the company's actual results could differ materially from those contained in such statements. There are many factors that could cause or contribute to such differences. We refer you to the risk factors and cautionary language contained in today's formal press release announcing Overland's results, as well as the company's filings with the Securities and Exchange Commission, including the risk factors, management's discussion and analysis and other sections of the company's periodic reports currently on file with the SEC.

We remind you that our forward-looking statements are based on current expectations and speak only as of this date. The company undertakes no obligation to publicly update any forward-looking statements to reflect new information, events or circumstances after the date of this release and conference call.

Now with that said, at this time, I will turn the call over to Overland's CEO, Eric Kelly.

Eric L. Kelly

Good afternoon, and thank you for joining us today for our first quarter fiscal 2014 conference call. I'll begin by providing an update on our business strategy and product direction. And then hand the call over to our CFO, Kurt Kalbfleisch, so he can review the quarterly results. After Kurt concludes, I will have some closing remarks and then we will open the call for questions.

On November 1, we entered into a definitive agreement to acquire Tandberg Data, a privately-held global leader of data storage and data protection solutions. In combination, that would create a company that had more than $110 million in annual revenue during our last fiscal year and will provide the scale and resources to compete more effectively in the marketplace and deliver substantial cost synergies that are expected to provide a clear path to profitability following the integration.

The Overland-Tandberg combination will offer one of the industry's broadest product lines and service offerings in the enterprise market. With an expanded sales and marketing team and over 16,000 global channel and service partners, we have significantly expanded our market presence to fuel our growth. The combination also created potential new opportunities with global OEM customers and expansion into new regions in Europe, Asia and the Middle East. To illustrate how this combination will have a positive impact on our business, we will expand the product offerings to our respective channel partners and into new regions, accelerate the close rate of our current pipeline and have the capacity to build a new pipeline with the additional channel partners and increased resources in sales and marketing. With the combination, we will also be able to leverage a world-class manufacturing facility in China and our supplier relationships to lower our cost of goods and increase gross margins, allowing us to improve operational efficiencies and create a stable foundation for increased revenue and profitability. To provide more clarity on how the combination will look once integration is completed, we will have a comprehensive product line ranging from our high-availability SnapScale clustered NAS, SnapServer DX NAS and Virtual Tape Library to Tandberg's RDX disk-based solutions through our combination of both tape automation product lines.

The approximate combined revenue mix is as follows: disk-based solutions represent 34% of total revenue; service and royalty represent 23%; and tape accessories, drives and media represent 21%. But the tape automation only representing 22% of the total revenue. Approximately 79% of the combined revenue came from channel sales and 21% from OEM sales.

From a cost synergy standpoint, we believe the savings will be between $10 million to $13 million on an annualized basis, and we expect to achieve sustainable non-GAAP EBITDA-positive results within the first 2 quarters following completion of the integration of the 2 companies. To give more detail on our fiscal expectations for the combined company, for the third and fourth quarter of calendar 2014, which is the first 6 months of our fiscal 2015 year, we would expect the combined company revenue of between $54 million to $60 million, with gross margins ranging from 34% to 38%, operating expenses between $19 million to $22 million and EBITDA from breakeven to $3 million.

For the first and second quarter of calendar 2014, we are projecting revenue of $55 million to $65 million, gross margins of 36% to 40%, operating expenses of between $20 million to $23 million and EBITDA of $2 million to $6 million. We are very excited about the opportunity we see for the combined company, including achieving greater scale and significant cost synergies through our combined resources, creating a stable foundation for increased revenue and profitability, and the acceleration of our strategy of becoming a global leader in data management and data protection marketplace.

Now let me turn to an update on our mobility enterprise solution, which will enable us to deliver the full functionality of true native applications securely to any mobile device anywhere as a workforce productivity solution. We plan to roll out these products over the next 12 months, and we're on track to begin the rollout in the first calendar quarter of next year through a substantially expanded channel network from our combination with Tandberg. To give you an idea of how this innovative new product suite will look, we will offer 2 different delivery models, an appliance gateway to be installed on premise and a subscription model provided -- providing access to applications via the cloud. We plan to begin a phased rollout of appliance product first, which would include 3 tiers: an enterprise model, a small and medium enterprise model and an SMB model.

We are well ahead where we thought we would be at this point in terms of both product development and the level of customer interest. Currently, we have beta customers using both the appliance and the cloud offering. We're very excited about the capabilities of the new solution and the opportunities created by the technology and supplier partnership with Sphere 3D.

Our focus will be on key vertical markets where storage, obviously, is growing and mobility is important, which includes health care, government, financial services and education. The demand for cloud computing technologies represents a $40 billion market, with the global market for desktop virtualization at $3.6 billion and estimated to grow to $7.5 billion by 2016. With this one-of-a-kind new workforce productivity offering, we will significantly expand our addressable markets. And we'll have final comments at the end of the call, but now I would like to turn the call over to Kurt, our Chief Financial Officer, to review the quarter.

Kurt L. Kalbfleisch

Thank you, Eric. Let me provide some detail on our first fiscal quarter results. Total revenue for the first quarter of fiscal 2014 was $10.6 million compared to $11.7 million in the same quarter of fiscal 2013 and $12.1 million in the immediately preceding quarter. While the first fiscal quarter historically is a seasonally down quarter for us, the decrease as compared to the immediately preceding quarter of $1.5 million was less than half the seasonal decrease we experienced during the first fiscal quarter of each of the 2 previous years. Total product revenue for the first quarter of fiscal 2014 was $6.1 million compared to $6.6 million in the same quarter of fiscal 2013 and $7.6 million in the immediately preceding quarter. Warranty and service revenue in the first quarter of fiscal 2014 totaled $4.5 million or 42% of total Q1 revenue compared to $5.1 million or 43% of revenue in the same quarter last year and $4.5 million or 37% of revenue in the immediately preceding quarter. The decrease in revenue from the same quarter in the prior year was primarily due to decreased service revenue from our extended service contracts related to lower tape-based product sales.

EMEA is historically a down quarter in fiscal Q1, reflecting a seasonality from the summer months. Revenue from EMEA in the first quarter of fiscal 2014 decreased 11% or approximately $300,000 compared to the immediately preceding quarter. However, on a year-over-year basis, the EMEA revenue in the first quarter of fiscal 2014 was up 6% or $150,000.

Now let me walk you through more detail on the product categories that make up the branded product revenue. Tape revenue in the first quarter of fiscal 2014 decreased 30% worldwide, approximately $1.2 million, compared to the immediately preceding quarter and was down 27% or approximately $1 million compared to the first quarter of fiscal 2013. This was primarily related to the decrease in sales of our add-on tape drive. EMEA tape revenues decreased 34% from the immediately preceding quarter and 21% year-over-year.

Americas tape revenue decreased 27% for the immediately preceding quarter and 39% year-over-year. We, however, continued to see increased traction in growth in our disk products. Total disk revenue worldwide in the first quarter of fiscal 2014 was up 4% or $100,000 sequentially and up 26% or $550,000 year-over-year compared to the first quarter of fiscal 2013. Revenue in the first quarter of fiscal 2014 from the SnapServer DX Series worldwide was $1.9 million. This was a 19% increase from the immediately preceding quarter and when compared to the first quarter of the prior year, SnapServer DX Series product was up 34%.

Our gross margin percentage in the first quarter of fiscal 2014 was 33.7%, which was the same as the first fiscal quarter last year and compared to 36.5% in the immediately preceding quarter.

Total operating expenses including stock-based compensation for the first quarter of fiscal 2014 were $7.7 million compared to $8.6 million in the same quarter last year and $9.4 million in the immediately preceding quarter. The decrease in operating expenses is primarily related to the steps we have been taking to reduce expenses over the last 2 quarters. As part of our continued focus on reducing expenses, we have resized our footprint in our San Diego facility from just over 91,000 square feet to 51,000 square feet and extended our lease another 5 years, which after February of next year will result in a cash savings of about $300,000 per quarter or a $1.2 million savings annually.

Share-based compensation expense included in the operating expense for the first quarter of fiscal 2014 was approximately $0.9 million, compared to $1.1 million in the immediately preceding quarter and $1.2 million in the first quarter of fiscal 2013. We expect stock compensation to be in the range of $1 million to $1.3 million per quarter throughout the remainder of the fiscal year.

Depreciation and amortization was approximately $300,000 in both the first quarter of fiscal 2014 and the immediately preceding quarter as well as the first quarter of fiscal 2013. The net loss for the first quarter of fiscal 2014 was $4.6 million or a loss of $0.15 per share compared to a net loss in the same quarter of fiscal 2013 of $4.9 million or $0.17 per share, and net loss in the preceding quarter of $5.4 million or $0.18 per share.

On the balance sheet. Total cash and short-term investment at September 30, 2013 was $5.8 million compared to cash of $8.8 million at June 30, 2013. At the end of the first quarter of fiscal 2014, we had $3.5 million outstanding under our credit facility, which remains unchanged from the preceding quarter, and $13.25 million outstanding under our convertible notes. Since quarter end, $10.7 million of the convertible notes which were issued in February of this year were converted to equity at $1.30 per share, and we've received $3 million under the amended note purchase agreement entered into earlier this month.

Net accounts receivable is $6.4 million at the end of the first quarter of fiscal 2014 compared to $6.2 million at the end of the first quarter last year and $6.6 million at the end of the preceding quarter. Operating cash used in the first quarter of fiscal 2014 was $4.3 million compared to $4.8 million in the preceding quarter.

With that, I will turn the call back to Eric.

Eric L. Kelly

In closing, we believe the combination of Tandberg will provide expanded scale and market reach that will enable us to fully realize the growth potential of our innovative and award-winning products, which includes our SnapScale clustered NAS, our SnapServer NAS DX Series and, soon to be introduced, our enterprise mobility solution. By creating a stable foundation for increased revenue and profitability, we will be able to accelerate our strategy of becoming a leader in end-to-end data management and data protection marketplace.

I would now like to open the call up for questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Krishna Shankar with Roth Capital.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Eric, can you talk about the outlook for the December quarter in terms of what you're seeing in each of the regions and also by product line relative to the September quarter?

Kurt L. Kalbfleisch

Krishna, this is Kurt, I'll go ahead and take that one. The December quarter is usually a better quarter. The September quarter is usually pretty soft over in Europe. We expect to see some pickup on the tape side compared to what we have last quarter. And we do expect to see some moderate growth over the prior quarter. The regions right now, so far this quarter, are operating as would expect.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Okay. And then, can you give us some OpEx guidance for the December quarter? How they would trend relative to the September quarter?

Kurt L. Kalbfleisch

We would expect to see a slight uptick in the OpEx, nothing significant, but the uptick because of the other activities that are ongoing, we're going to see some increased spending primarily in G&A.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Okay. And Eric, in terms of the process for the deal with Tandberg, is everything on schedule and you still expect the regulatory, proxy and shareholder approval sometime in December.

Eric L. Kelly

Krishna, that's the plan. As you know, we filed the proxy with the SEC and it's under review. And our anticipation is that will be completed, we'll have the final proxy out to the shareholders requesting them to have a positive vote and then, hopefully, close the deal by the end of December.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Great. And then, final question. You sound a little more optimistic about the mobile cloud and mobility products. Can you talk about whether that will start contribute to -- or when that will start to contribute to revenues and whether it will be the appliance product or the cloud service product which will first contribute to revenues?

Eric L. Kelly

Yes, Krishna. I'm excited about both our enterprise mobility solution as well as the combination between ourselves and Tandberg. I think as I've stated, the combination gives us a solid foundation. We'll be north of $100 million business and expanding our channel globally. And that actually will help us in terms of when we roll out our enterprise mobility solution in the first calendar quarter of next year. So, excited about both. I mean, we are on schedule in terms of both development and the customer feedback. And the technology is performing as we expected, and in some areas, much better. So pretty excited about how things are shaping up for 2004 -- or 2014, excuse me, on both sides. A lot of work to do ahead -- a lot of work ahead of us but we have all the plans in place. We have our channel partners that we're working with. We have our beta customers we're working with on enterprise solution. And the customer feedback is just outstanding in terms of what we're hearing relative to the acceptance of the product.

Operator

[Operator Instructions] And our next question comes from the line of Phil Anderson with Pinnacle Fund.

Phil Anderson - Pinnacle Advisers, L.P

Eric, it's been a couple of weeks now since the acquisition/merger has been announced. I'm curious what type of reaction there has been in both the Overland customer base and the Tandberg customer base to the merger, not only of existing customers but prospective customers, which you may have been pursuing, independent one another over the years, but now that the company has larger scale, maybe more responsive to your sales efforts.

Eric L. Kelly

Phil, thanks for the question. I mean, I've been on the road over the last 1.5 weeks talking to a lot of our channel partners, our customers and as well as our suppliers. I have to tell you the combination of doing -- of the 2 businesses is from our customers' and suppliers' standpoint, they are extremely happy. We're having telephone calls and meetings from suppliers and customers that, previously, weren't really interested in talking to us, they were concerned about the viability of the company. They think it's a great move. So if the indications over the last couple of weeks are consistent with what happens going forward, I think, it's a deal and a structure that they definitely appreciate. I mean, I was just -- I just flew back last night from Houston visiting one of our key customers. They're excited about not only just the stability of the company, but also the breadth of products we're going to be able to deliver to them as well. So all great news from both our suppliers, our customers. So that is great, great feedback and a great signal in terms of we are doing the right thing.

Phil Anderson - Pinnacle Advisers, L.P

That all sounds good. Kurt, in your prepared remarks, you mentioned that there is less seasonality this quarter than there had been -- there was less of a down draft due to seasonality this quarter than there had been in the year ago period. Was that due to anything in particular that you could shed some light on?

Kurt L. Kalbfleisch

It was based on the strength of our primarily the SnapServer DX product in the European in channel. We had -- we continue to show growth there both quarter-over-quarter and year-over-year. And that kind of bucked the trend a little bit to what we have historically seen. Over the last 2 years, we saw north 20% reduction in this quarter compared to the prior. And we were able to buck that trend by better than half in Europe.

Operator

And our next question comes from the line of Peter Bortel with Tiburon Opportunity Fund.

Peter Bortel - Tiburon Opportunity Fund

I was hoping to touch on the Sphere 3D opportunity. It seems the market has been pretty excited about the Canadian company. What was Overland's initial investment in the company and what's that worth now? And as a second part to the question, can you kind of quantify the opportunity? I think, I'm not sure, it was online or offline you mentioned it was something like a $10 million opportunity in 2014. Can you give us some color as investors on what sort of top line contribution you expect from the mobility investment?

Eric L. Kelly

Okay, sure. Let me kind of take -- there's a couple of questions there. I mean, the first one, I mean, our investment in Sphere 3D was about $250,000 in cash. If you look at kind of the closing price of the stock today, we have about 770,000 shares and that represents close to $4 million, about $3.9 million. And it's doubled since the end of the quarter, which we reported in our filings. So I think it was a great investment from an investment -- from an investor standpoint. But I think, even more importantly, the supplier agreement that we have with them, which identifies that they have to acquire and buy their infrastructure from us only, and also the technology agreement we have, which we have the right to license and develop our products for the market outside of the consumer space. So we're pretty excited about the partnership we have with them. The equity side is obviously proving to be very important to us in terms of a balance sheet standpoint. And the technology and the supplier partnership is something that's very strategic to us as well. And I think there is a follow-on question?

Peter Bortel - Tiburon Opportunity Fund

The opportunity for top line from the relationship going forward, can you quantify that for our models?

Eric L. Kelly

I think the number we identified was about $10 million to $13 million for the year.

Kurt L. Kalbfleisch

Fiscal 2015, Peter.

Eric L. Kelly

And so we're pretty comfortable with that top line revenue number. And I think as you people are starting to realize whether technology can deliver. It's one where we'll have, if not the only, one of the -- only one that we know about today in terms of being able to deliver an integrated storage and mobility enterprise appliance solution as a gateway. So the feedback as I mentioned earlier in the previous question, even the customers are just waiting to get the product, the feedback from our beta customers is just outstanding. And so we're very comfortable with that top line revenue number that we have identified.

Operator

[Operator Instructions] And our next question comes from the line of Ray Reyes with Bridge Street Asset Management.

Rainerio Reyes

I had a follow-on question about Sphere 3D. You talked about different pricing models depending on the customer segment. Could you go into a little bit more detail, on the economics of how it will work, like how much would you charge and then what the margins might be like?

Eric L. Kelly

Well, I can answer part of that question. There is 2 business models that we'll be rolling out. The first one is an appliance or gateway, where they actually would buy our appliance and put into on their premises or on their data center. That will allow them to have concurrent users using the applications on whatever mobile device they choose. The second business model will be a subscription model via a cloud offering where they actually can subscribe to specific applications that they want to use from a mobility standpoint. And we haven't disclosed any of the pricings, but if you look at the appliance side, there's really 3 categories kind of a high-end enterprise solution, a mid-ranged -- what I'd call a mid-enterprise solution and then a small and medium business solution. So those would kind of be the tiered categories and, obviously, there will be different performance and functionality and offerings based on those 3-tier solutions. And then, obviously, the subscription model will again be determined based on the applications that they want to use. So for example, if they're using application A, it would be a different pricing model than if they're using application B or application C. But we haven't rolled out the pricing yet. And we have time, that's what we're going to do through the end of the year, is actually nailing down the pricing and rolling that out at launch. But just to add to that, I mean, we are looking at very healthy margins for this solution. And so I think not just from a revenue standpoint, the margin structure will be on the high-end of what we have been doing with some of our other offerings.

Rainerio Reyes

Are there any constraints to ramping this up? So for example, let's say that demand for next is more than you're forecasting. Are there any physical or personnel constraints attached to meeting the actual demand or...

Eric L. Kelly

No, we've been very, very focused on making sure we can scale. The good news is the products -- the software actually works with our current platforms. So we already have the ability to deliver on our current appliances. So therefore, there is no ramp requirements or new platforms we have to roll out. And we have the manufacturing capacity to scale as needed. So, we have no issues from the appliance side and then, obviously, on the cloud, you already have the infrastructure in place from our beta customers. And that's very, very straightforward to scale from a cloud perspective.

Rainerio Reyes

Okay. Is the relationship -- the distributorship you have in the United States, is that exclusive?

Eric L. Kelly

The -- I didn't follow the question.

Rainerio Reyes

Your relationship with Sphere 3D. My understanding is for the United States, if I understand that correctly, you have a distributorship or licensing arrangement with them, is that exclusive?

Eric L. Kelly

Yes, it's actually broader than that. We have -- outside of the consumer market, we have a worldwide exclusive to deliver the product, yes.

Rainerio Reyes

Okay, and then on the tape products, do you feel that the businesses has stabilized already or do you anticipate further decline next year?

Kurt L. Kalbfleisch

Ray, this is Kurt. We expect that the tape side has stabilized. Obviously, we saw seasonality this quarter, as expected. But we don't believe it will have to drop off in this fiscal year like we did last.

Operator

And at this time, there are no further questions. I would like to hand the call back to management for closing remarks.

Eric L. Kelly

Great. Well, I mean, hopefully, everybody totally feels our excitement in terms of the things that are transpiring with Overland. I mean, the combination between ourselves and Tandberg is a strategic move that we've been looking at for over a year. It gives us the scale and the size and the foundation to be able to -- and the resources to actually start monetizing the pipeline we have and actually start building on that pipeline going forward. The partnership with Sphere 3D allows us to deliver what we believe are technology and solutions that the market can't get any place else. So, we're extremely excited about how we have things laid out going into 2014.

So since there are no further questions, I would just like to thank everyone for joining the call today. And we look forward to updating you as we continue to make progress. So this concludes the call today and thank you, again, for your time.

Operator

And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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