FalconStor Software's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.29.14 | About: FalconStor Software, (FALC)

FalconStor Software Inc. (NASDAQ:FALC)

Q1 2014 Earnings Conference Call

April 29, 2014 16:30 ET

Executives

Gary Quinn - President, CEO

Lou Petrucelly - CFO, EVP

Analysts

John Zaro - BCM

Operator

Good afternoon, and thank you for joining us to discuss FalconStor Software's Q1 2014 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 can cause actual results to differ materially from 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 Web site at www.falconstor.com, under Investor Relations. After the close of business today, FalconStor released its Q1 2014 earnings. Copies of the earnings release and supplemental financial information are available on FalconStor's Web site, at www.falconstor.com.

I'm now pleased to turn the call over to Gary Quinn.

Gary Quinn

Thank you, operator, and good evening to everyone, and thank you for joining us on this first call of the 2014 fiscal year. I continued to be very pleased and excited with the FalconStor teams’ efforts in this new fiscal year. And what clearly is an atmosphere of increased intensity. Throughout the quarter, there were many positive milestones supporting FalconStor’s turnaround and reinforcing our belief that we are on the right track for the future.

We started off the quarter in January with worldwide sales kick-off that rolled out three key changes for 2014. We introduced the company’s new bookings model by which our sales teams are now compensated, reintroduced a number of new sales programs to drive customer acquisition, to grow and expand our footprint with existing customers and to reward the behavior that the company is looking to capital [lies] (ph) upon. And we also introduced our new branding messaging and updated product roadmap.

The management team consisting of myself, Lou Petrucelly, Rob Zecha, Seth Horowitz and Alan Komet were able to deliver the message in person for all the FalconStor field representatives in Japan, Korea, China, Singapore, Europe and the Americas.

In a moment, I will provide some details on how we are continuing to improve our leadership and structure within each region to maximize sales performance. We followed those meetings up with a new product releases in February for our VTL NAS 8.0 and NSS/CDP 7.6 offerings.

In addition, we provided a sneak preview of the upcoming FalconStor branding and messaging with the mini site named falconstor.com/befree in support of those new releases.

As of this evening, FalconStor’s updated corporate site, which demonstrates the new positioning of FalconStor in the marketplace has gone live. We hope you take a chance to take a look at that site after the call.

In the past several months, I had the pleasure of meeting with and reconfirming FalconStor’s commitment to many of our global strategic alliances as well as our top regional value added resellers and top revenue contributing FalconStor customers.

During those meetings, I provided an overview of our company and where we are positioning ourselves for the future regarding many opportunities such as cloud, software defined storage and storage virtualization. In addition, how FalconStor can help customers eliminate vendor walk-in from proprietary platforms while optimizing their storage portfolios total cost of ownership.

These are just a few of the many challenges that our customers are facing. FalconStor has real opportunities to address these customer challenges in the marketplace. I will provide you with a little more color in my regional round up by geography.

On the product side, as I mentioned previously, we delivered two new releases for our portfolio in February and as of this call tonight, we have released – we will have released two more from engineering, which we expect will be out to the general public in the next thirty days. I believe our engineering machine is just warming up and we are excited about what the team and the Rob Zecha’s leadership has been accomplishing.

Additionally, we continue to execute superbly with our joint development project, we should have more updates by our next quarterly call. Just for clarification though, we did not add any additional cash or deferred revenue from our joint development relationship, which as you know is based upon milestone achievements and Lou will address those more in his comments.

On expense control and cash utilization, you can see that we have been able to maintain our positive momentum throughout Q1 2014 from Q4 2013. I will have Lou elaborate more on all the numbers but our metrics are moving in the right direction and we are pleased with our current quarter bookings performance.

So now a few highlights on the quarter from a bookings perspective. Our APAC business excluding the Japan business exceeded the first quarter’s internal bookings target with the strong performance once again led by our China business.

As I mentioned above we have been reaffirming our strategic alliances, partners and customers with commitments from FalconStor. We are working with Huawei to expand our business and to make available our VTL NAS 3.0 product for the second half of their sales year. In addition, our Korean business which we changed to a more flexible business model to address the requirements of that line performed quite well on a year-over-year basis.

Once again, these regions have seasonality which is quite different from the United States, Korean business is typically stronger in Q2 and Q4 versus Q1 and Q3. The year-over-year performance was encouraging. Our southeast Asian business which consist of Singapore, Malaysia, Indonesia and Australia also had a good performance to start off the new year and their year-over-year performance was solid.

Finally, our Japan business did not perform to our expectations even with Q1 2014 being the last quarter of the Japanese fiscal year. As a result, we have experienced some personal changes at both of Japan Country Manager position and the APAC Vice President and GM position.

We have decided to elevate our China Country Manager, John Yang to be the Regional Vice President and GM for Asia, which now includes China, Hong Kong, Taiwan, Singapore, Malaysia, Indonesia and Australia. He is a seasoned veteran of the geography, has spent almost seven years in addition in Singapore where I knew off him from a past relationship. We are bullish on his ability to get FalconStor progressed both inside and outside of the China geography. And at this point in time, our Korean manager and our Interim Japan Country Manager will report directly to me as will John, the Vice President and GM of Asia.

Our EMEA business also overachieved this quarter on a bookings basis compared with our internal targets. We continued to get a solid performance from the German and Eastern European geographies as well as our northern region which consist of the U.K., Ireland and Scandinavia. The southern region which is being rebuilt by one of our more seasoned individuals in Europe still has some more work to perform before we see a significant contribution from that territory.

We are confident in our newly appointed Vice President and General Manager, Guy Berlo for Europe since the many approaches to the business in Germany and Eastern Europe are now beginning to get adopted in the rest of the territory.

During my trips to Europe this past quarter, I visited a number of customers to reaffirm our commitment to the team as well as received their confirmation as FalconStor is on the right path. I had the pleasure of meeting with our largest value added reseller in EMEA and confirmed we were looking to expand our business with them and target new opportunities around private cloud computing.

In addition, I also was able to meet with the Fujitsu Technology Services team in Germany to reinforce our relationship and to continue to grow and support Fujitsu platforms, initiatives and future business.

Our Americas business just missed their internal bookings targets by a few deals which were attributed to our new GM was making some great progress and a few new over anxious sales staff that were added to the team starting in January.

Under this new leadership, the Americas team which has been recharged and is generating a lot of new activity in the territory, I had the pleasure during Q1 of meeting with our leading value added resellers in United States as well as Canada both in Toronto and Quebec.

All of the meetings were positive and we came away with a renewed commitment to FalconStor and continuance of business and expansion. I also met with a lot of numerous large customers in the regions once again provide them with an update on the company, the direction in which we are heading and the stability we are achieving.

I had the pleasure of meeting with our joint development partners Head of Engineering and some of their new management team to reinforce our commitments to each other, discussed the dynamics of the marketplace. Continuing my efforts to engage our strategic partners, I met with our liaison to the Hitachi FalconStor strategic alliance, we compared company objectives, share technology roadmaps committed to delivering go to market plans for the coming year and how to work cooperatively to attack common competitors.

Finally, as you can see by the Google Searches of FalconStor, we are making progress in the marketplace and the perception of the company. We are pleased to see references to the FalconStor turnaround. As I said, please check out our new Web site at www.falconstor.com, we will be delivering localized versions throughout the year to ensure that our international customers and partners feel our commitment to them as well.

To summarize, we met with industry analysts, strategic global alliances to update them on FalconStor activities and directions as well as reaffirm our plan with our strategic joint development partner, we have met with leading VARs around the globe as well as top revenue generating customers to deliver the FalconStor message and future direction.

We have heard from our customers and partners, marketplace demands are constantly evolving and changing the way data management technology is being used. We still have a lot of work to perform in this exciting world of technology, you likely have heard from our competitors how changes driven by cloud computing and other shifting paradigms are presenting major challenges to their businesses.

At FalconStor, we believe we have the technology to enable customers and partners to be free. Our technology today and its future is not platform specific. We give customers the freedom to migrate, optimize, recover and provide continuity for the heterogeneous stores portfolios of which many customers possess today. We will have cloud providers to incorporate the private storage platforms into their infrastructure offerings while the deployment is occurring.

We allow customers and partners to choose the right storage, whether that is today’s spindle technology, emerging storage, flash and SSD technology or historical tape solutions to meet their SLAs with their customers. We allow partners and customers to focus on their business.

So in closing, before I turn it over to Lou, FalconStor is on the road to recovery. There are many milestones to achieve throughout this journey. We must be realistic in our expectations and our results, if we are to establish the foundation for our future as a company. We are in an exciting marketplace. We have a major opportunity before us and as I hope, you can tell, I’m still excited to be leading the FalconStor team.

Now, I’d like to turn the call over to Lou, who will take you through the financial results for the quarter ended March 31, 2014. Lou?

Lou Petrucelly

Thank you, Gary, and good evening everyone.

As we pointed out during our last call, we believe its most appropriate to measure our results on a sequential basis which will better highlight the progress we are making during the transition of period stabilizing our business. And as a result, the rebalancing efforts which commenced during the second half of last year.

Our earnings release distributed earlier today contains our year-over-year results involving applicable disclosures in accordance with GAAP. As we have discussed as we navigate through this transition period, we anticipate that some of our quarters maybe lumpy and revenues may lag from a GAAP perspective depending on the mix of flexible business we transact.

We have completed our first full quarter of offerings customize the option of a flexible purchasing model and our sales teams are now focused on bookings achievements versus our historical upfront model.

Our near term objectives will continue to focus on driving stability within the business, growing our bookings and increasing deferred revenue and cash flows on a sequential basis.

Now, I would like to provide with you a brief update on some of the key metrics were used to measure the progress we have made during the quarter. For the first quarter of 2014, GAAP revenues totaled $12 million compared with $14.6 million in the previous quarter and $14.7 million in Q3 of 2013.

As we discussed on prior calls, it won’t be more competitive, we introduced a flexible business model that provides our customers the ability to structure their purchases in a manner which best fits their IT budgets. As we move more and more these are the transactions, the timing of our revenue recognition will lag behind our bookings and will differ from historical upfront method.

However, we believe this flexibility will hopefully provide us with more opportunities to securing deals and growing our market share moving forward. From a bookings perspectives, Q1 bookings totaled $14.4 million compared with $16.3 million in the previous quarter as $14.41 million of bookings are in Q3 of 2013.

As I mentioned earlier, Q1 was the first quarter which our sales force internal progress were based upon booking achievement to better align our objectives of securing more deals and growing our market share.

Geographically, Asia Pacific region increased bookings by 25% compared with Q4, while the Americas bookings were down by 7% and our EMEA bookings were [off] (ph) by 39. The differences in our sequential booking rates reflect some of the transitions we undertook in our business over the past two quarters and to some degree, the seasonality in a few of our more matured markets specifically in Central Europe.

Our Asia Pacific region contributed 37% of total Q1 bookings, EMEA contributed 28% and the Americas contributed 35% of total Q1 bookings.

Overall, approximately 10% of our total Q1 bookings were derived from new customers. Finally, we were pleased to exceed our internal bookings targets for the quarter.

Next, I will turn to our non-GAAP expenses which excludes restructuring charges, legal costs and stock-based compensation. As part of our balancing efforts, we reduced our overhead to a level that commensurate with the company’s size and we aligned our operating expenses to the company’s capital resources.

Our Q1 non-GAAP expenses were $13.9 million compared with $13.8 million in the previous quarter and $16.3 million in Q3 of 2013. Our non-GAAP gross margin remains consistent at 7% to 8% compared with the previous despite the decline in our total revenues. And we closed the quarter with 279 employees worldwide compared with 285 employees in the previous quarter.

We are pleased that we have maintained our core structure and during the quarter, we strategically reinvest back into our business both from a sales and marketing and product development perspectives. We anticipate that we may recognize incremental expenses in the coming quarters in support of our near term objectives. However, we will continue to monitor our expense structures closely and continue to drive a bottom-line culture across the entire company.

Turning to our balance sheet, as of March 31, we have $27.9 million in cash, cash equivalents and marketable securities compared with $28.1 million in the previous quarter, and $29.5 million at September 30. Our Q4 2013 cash balances reflected a $3 million milestone payment received from our joint development activities and $3 million of proceeds from the sale of a cost-based investment.

Our Q3 2013 cash balances reflected a $9 million preferred stock invested by Hale Capital and $3 million payment receipt from a joint development activities. During the recent quarter, we did not receive any significant payments that we made $600,000 of payments associated with our restructuring efforts.

As of March 31, our deferred revenue totaled $31.9 million compared to $29.8 million at December 31, an increase of 7%. As I previously discussed, we did not get any deferred revenue during the quarter related to our joint development activities. The increase was attributable to our focus on securing bookings which in some cases utilized our new flexible model and our focus on maintenance and support renewals.

As of March 31, approximately 12% of our deferred revenue balance was related to deferred product revenues compared with 10% at December 31. For the quarter, we generated positive cash flow from operations of $300,000 compared with cash used in operations of $3.6 million in the previous quarter.

On an adjusted non-GAAP basis, for the quarter we generated positive cash flow from operations of $900,000 compared with cash flow from operations on an adjusted non-GAAP basis of $1 million in the previous quarter. The adjusted non-GAAP cash flow from operations excludes payments made in connection with our legal settlements, restructuring activities and any proceeds received from joint development activities as applicable.

Finally, we continue to carry no debt. To summarize, we are part of the progress we are making and remain fully committed to the execution of our turnaround strategy. Many of our internal metrics were positive for the quarter including booking achievements, preserving cash, generating positive cash flow from operations and growing our deferred revenues. Our new overhead structure shows our commitment to align our cost with activities directly supportive of top line growth.

We remain committed to our goal of 2014 of breaking even on a non-GAAP basis and generating positive cash flow from operations on a full year basis. As we mentioned earlier some of the quarters maybe lumpy depending on the mix of flexible business we transact and our revenues may lag behind our bookings achievements in the near term.

Our folks will be on driving stability within the business, capitalizing on areas where we can reinvest to support our growth initiatives and growing our deferred revenues and bookings on a sequential basis.

We believe we are on a correct path to execute our plans while there is more work to be done over the next several quarters, we are excited and focused on executing on our objectives and Gary and I look forward to updating everyone on our progress on our next call.

And now, I will turn the call over to our operator to open the line for questions. Operator?

Question-and-Answer session

Operator

Thank you. Ladies and gentlemen, we will now begin our question-and-answer session. (Operator Instructions) And our first question comes from the line of John Zaro with BCM. Please go ahead.

John Zaro - BCM

Wow. I've been prepared. Hi, guys.

Gary Quinn

Hi, John.

Lou Petrucelly

Hi, John.

John Zaro - BCM

I have a couple of sort of just basic questions. EMEA bookings were off 39% which is part of the -- I mean.

Lou Petrucelly

We're not saying sequential to Q4, John.

John Zaro - BCM

Okay, okay. Got it.

Lou Petrucelly

They were over on plan – internal plans to Q1.

John Zaro - BCM

Okay. Yes, I was just trying to figure out how after I listen to the first part and then that came up, okay. Second, the – you've implemented this new sales plan and this new plan to make it sort of easier in the marketplace, or at least to be more or like other people that you're competing it in the marketplace. And I guess the question is, how is that going? And when I say that, it's – you obviously did it because customers were interested. It's hard to sort of see right up the bat how it's work, but I guess the question is how is it going?

Gary Quinn

So to answer that question John, we actually think it's going quite well. Most customers in an enterprise space are looking for flexible purchasing models, they're looking for multiple year commitments for predictability. They also wanted to know what is it going to cost them to expand in the future as they continue to grow. So before we only allow somebody to buy a license and maintenance associated with a one-year term for the most part, that's how we actually sold things and we could never give anybody any type of additional flexibility.

So it's being received quite well. It was something that we started in the European business last year with a couple of different programs. We roll those programs out globally. Europe had a strong performance this quarter related to those activities. And they started catching on a little bit to United States. On the Asia side, that geography really other than if you look in like Singapore, Hong Kong, Australia. The Japan, Korea and China business is not really doing anything from a flexible model, it’s still pretty much straight forward but that's pretty much customary in those geographies at this point. And we're still trying to find the way if there is one to provide some additional incentives that have territory right now, but that will probably happen over the next quarter or two as I spend more time there.

But at the moment it's been received well, in the United States, Canada as well as in EMEA. And I think what you'll see is, as we roll along with bookings and as you see deferred revenue start to increase more and more, it will only be a positive and that will give the empirical data.

John Zaro - BCM

Great. And then, the second thing you brought in or you've promoted this guy, who was in China to the head of all Asia. It would to us in China to the head of whole Asia. It would obviously be a very daunting task for anyone. That's a lot of countries in space to cover and you're a small company. So I guess the question is, you don't want to have too many people, but can one person really be that – person or you're going to have to get someone else?

Gary Quinn

So to answer to your question, I mean John Yang is not going to cover Malaysia, Indonesia, Singapore, Australia by himself. I mean there are currently sales staff on the ground there. The idea for us is in the most likely scenario, we will have a – John actually spent seven years in Singapore where I know him from. So he is a native Chinese citizen. He was born in China. He spent, like I said seven years in Singapore, he has a tremendous networking contact on Western Southeast Asia, we will be recruiting an individual to put on his management team in addition to the two individuals he has today that are managing the teams across the geography of China.

We also have a leader in Taiwan, as well as in Hong Kong. So he's not as an individual, I mean there is an infrastructure out there in that territory of a pretty decent amount of sales individuals both pre-sales and sales. We're just aligning the geography under him and the fact that he has experience both inside and outside of China, and he has delivered what we've asked him to do.

Once we kind of set down within last year and determine what was going on there for us. We've seen some very nice performance in both Q4 from him as we mentioned on the last call. This call, same thing on Q1 I mean he's gotten the business rolling for us in a big way in China. He recently took over the Hong Kong territory, which was not part of his responsibility last fiscal year. He's turned that around in Q1 quite significantly with a number of programs we put in place there.

So he is a natural guy, yes, it is a bit more work for him, but once he has the right guy probably out of Singapore covering Southeast Asia, I think same thing like we had in Europe. These are guys who been in the territory for years, they performed quarter in and quarter out, maybe where people have not talked about them. But same thing like [he below] (ph) in EMEA, we feel strongly about their capability and once they bring that discipline to the other territories, I think we're going to see results.

As far as Japan goes, we have some questions about that business at the moment. This was the first final fiscal quarter for Japan, usually this is the biggest quarter for Japan. Our business underperformed and it appears now that I've dug into it and a lot of details post-Tsunami. The business was actually not performing, everybody was doing well during the Tsunami except unfortunately for the people who are hurt by the Tsunami. But as recovery providers and technology space, we all enjoyed a nice bump there for about a year and a half. But, as you pull that back and you look under the covers, you find that we have some execution issues going on.

So we've had some changes in personnel. We think we've the right moves. And out of (indiscernible) on Japan for the rest of the year, but we think I have some work to do there. I don't think you'll see anything significant change there until the end of the calendar year.

John Zaro - BCM

Got it. The Violin joint venture, I can't remember and I have to pull my notes out, is -- was there any plan and did we miss a sort of a stick in the road or we don't necessarily have different markers closer, first quarter?

Gary Quinn

Okay. Just to bring everybody on the call up to speed on Violin. Violin is the joint development project that both FalconStor and they are pursuing to develop some technology together. There are four milestones in the actual work that we're doing together, two of them were met last calendar year. The agreement ends in December of 2014. And no, we did not miss a milestone;, we did not miss a beat. Obviously, you can imagine where hot and heavy in the middle of coding or testing at the moment. Next milestone is based upon deliverable and there was no date for that deliverable it basically last just be done by the end of this calendar year.

So we just wanted to point out to people John that Violin contributes cash and deferred revenue for us. Violin cash comes in at the milestones and the revenues being deferred until the project is completed. So we wanted to make sure people understood the deferred revenue was organic and was not coming out of the Violin work.

John Zaro - BCM

Got it. Perfect. Okay. And then last but not least, have you guys given any more thought to how many quarters it will take before you would have some, what shall I say guidance but not particularly – not I don’t mean hardcore guidance but more of – you obviously have plans as you said you went through each sector, or this plan, or didn’t have plan. At some point, I’m presuming you are going to have a 2015 plan range, is there going to be a point in time, or you feel maybe a couple of more quarters where you will comfortable that you can actually put forward something for say 2015?

Gary Quinn

So I think as I have been very cautious with everyone and conservative, I do know everybody would like to know what we are going to do in the future. I think we still have a few more quarters before we take the training wheels off the bike.

John Zaro - BCM

Yes.

Gary Quinn

With that being said, I also think there is some more metrics that myself and Lou will start to provide to you that you will be able to build a model based upon deferred revenue and have that revenue comes in within a waterfall effect. Okay? And I think once you get to understand our rule better, you will be able to predict what we are going to be doing in the future. And I said, I don’t want to say, I would never do guidance but at the moment its really not something the stage we are in that we need do. But I think, you will able – I think you will be able to build a very predictable model once we give you a little more information regarding how deferred is working and when we expect to bring in what revenue from that bucket as times go on.

John Zaro - BCM

Perfect. Okay. Fantastic. Thanks very much. Congratulations.

Gary Quinn

Thank you.

John Zaro - BCM

Thanks.

Operator

And I’m showing we have no further questions at this time. Please continue.

Gary Quinn

Okay. Operator, we will just wait a minute or two in case anybody wants to get into the queue and if not then we will wrap up.

Yes?

Operator

(Operator Instructions)

Gary Quinn

Okay. All right. Before we close off operator, so – to everyone on the call tonight thank you very much for joining us. I think just a couple of points before we go. I just want to let you know that we are working very hard to get the turnaround of FalconStor to be happening. I think we are making progress against our internal metrics.

One thing, as Lou pointed out, a number of our key indicators are going in the right direction are positive. As we continue to roll out this model – of our bookings model compensate our teams, provide more flexibility for customers to acquire a FalconStor technology. I believe that you will see a lag on the GAAP revenues on the top line. But as the year goes on you will be able to predict where we are going and what’s happening at the company.

So I’m actually very pleased with the performance of the company. It was an exciting quarter. It was a busy quarter. It was the most active quarter since I have been here. And I really look to working with the FalconStor team to make this successful. So thank you very much. And good night.

Operator

Ladies and gentlemen, this does conclude our conference for today. We thank you for your participation. And you may now disconnect.

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