Insiders Are Buying Shares Of Crossroads Systems - Should You?

| About: Crossroads Systems, (CRDS)


Crossroads Systems is a micro-cap tech company with huge upside potential, from both its core operating business and through monetization of its 100+ patents.

The company also has a $128 million NOL carryforward that it can use to offset future taxable income.

Insiders continue to buy shares of Crossroads Systems, which signals confidence in the company's business plan and execution.

Crossroads Systems is a global provider of data archive solutions. The company was founded in 1996 and is headquartered in Austin, Texas. Crossroads has over 100 patents and has been honored with numerous industry awards for data archiving, storage and protection, according to the company.

Crossroads Systems (NASDAQ:CRDS)

Share Price: $2.63

Shares Outstanding: 15 million

Market Cap: $39.6 million

52-Week Range: $.69 - $3.71

Credit: Yahoo Finance

Balance Sheet: As of April 30, 2014, Crossroads has $10.7 million in cash and equivalents and $13.6 million in total current assets, compared to $6.25 million in current liabilities, $4.77 million in long-term debt and $396,000 in other long-term liabilities.

Why Crossroads?

I believe that Crossroads Systems presents a compelling buying opportunity at current prices, given the growth potential of the company's core Strongbox product, and the significant monetization potential of its 100+ patents.

Strongbox Upside

Crossroads' Strongbox product is the company's main revenue growth driver going forward. Strongbox is a low-cost device offering storage and data management, with the goal of delivering significant cost savings for businesses. Strongbox starts in price at $21,950, including a complete solution (Strongbox with LTO 6 library and drives) for one petabyte starting at $125,000. Strongbox aims to keep data center power requirements lower, reducing operational costs by up to 95%, according to the company.

Why is Strongbox key for Crossroads? The global market for network-attached storage (NAS) is huge, and expected to reach $7 billion by 2017 according to a report by Global Industry Analysts, Inc.

"Growth will be primarily driven by the increase in the number of home and small business networks, continued data explosion, and the growing need for data backup and archiving," the report said.

While data storage remains an indispensable IT need, the growing magnitude of the importance of this very basic IT function can be put into perspective by the fact that information is currently multiplying at a rate of over 65% each year and total data generated worldwide is projected to reach over 3 million petabytes by the year 2020. Against this backdrop, the critical importance of data storage comes to the fore. As companies seek to overcome data storage performance limits, significant opportunities are in store for storage technologies like NAS devices."

While Crossroads' revenue declined 16% year-over-year in Q2 2014, the revenue from the Strongbox line increased 145% year-over-year to $621,000. Its Strongbox partners include companies such as Adobe, IBM, HP, Dell, Symantec and Quantum.

The company only just released a hybrid disk tape-based NAS solution that costs significantly less than traditional disk-based NAS, and the company's President and CEO Rick Coleman said this is a "game-changer" for the company as it can now aggressively attack the NAS market (Source: Q2 2014 Quarterly Earnings Report).

Strongbox wins in the second quarter include deals with the Texas Rangers baseball team and LionsGate, one of the world's leading entertainment companies. The company also signed a new partnership with Imagine Communications. This should lead to further positive revenue growth in 2014 and in the coming years.

On July 22, Crossroads introduced the StrongBox V80 Tape Library, which features 5.4TB of internal disk, and the new V80 tape library, which includes two LTO 6 Fibre Channel drives. The V80 library can store the equivalent of more than 60,000 hours of HD video content and is geared towards meeting the needs of the media and entertainment industry's massive storage requirements, the company said in a July 22 release.

Patent Portfolio

I believe the company has an even bigger opportunity when it comes to its patent portfolio. Intellectual property revenue increased to $1.1 million in Q1 2014, up from just $188K the previous year. The company is aiming to monetize more of its 100+ patents through litigation against infringers and if successful, the company could see its revenue jump quite a bit over the coming years.

First, the company's litigation tested 972 portfolio has generated $61 million in revenue, but despite that success, the company had not initiated any legal action against some of its largest infringers. Management is now focusing its efforts on the "bigger" fish, announcing lawsuits against company's like Oracle (NASDAQ:ORCL), Cisco (NASDAQ:CSCO), Dell (NASDAQ:DELL) and Dot Hill (NASDAQ:HILL). Settlements can vary quite significantly, often including either a lump-sum settlement on past infringement or a royalty on future sales through the life of the patent.

Here are just a few of the current lawsuits outstanding:

- The company filed a lawsuit on September 11, 2013 against Dot Hill Systems, alleging patent infringement and breach of the Amended Settlement and License Agreement dated June 27, 2006, between Crossroads and Dot Hill. The Markman hearing is scheduled for October 6-7, 2014.

- The company filed a lawsuit on October 7, 2013 against Oracle, alleging infringement. The Markman hearing is scheduled for October 6-7, 2014.

- The company filed a lawsuit on November 26, 2013 against Huawei Technologies alleging infringement of several patents. The Markman hearing is scheduled for October 6-7, 2014.

- The company filed a lawsuit on November 26, 2013 against Dell, alleging infringement of several patents. The Markman hearing is scheduled for October 6-7, 2014.

It is very hard to place a potential dollar amount on each of Crossroads' patents. However, if successful in court, the victories can be quite large - take for example the company Vringo Inc. (VRNG), which settled a lawsuit with Microsoft (NASDAQ:MSFT) on May 30, 2013, paying 5% on any amounts that Google pays for use of the patents it owns. Another example is Virnet X (NYSEMKT:VHC), which won a $368 victory against Apple (NASDAQ:AAPL) in 2013. The results can vary significantly, but can be game-changing nevertheless.

Additionally, the company owns what they call the "non-972" patent family, which consists of 117 patents and pending patents. Nothing had been done to evaluate the potential monetization of this portfolio, but in November, the company said it had taken the first steps towards monetization as management engaged IT experts to perform an analysis of the patents, to give the company an idea of the patents' potential value.

The analysis of the non-972 patent family showed that Crossroads could be entitled to a share of over $82 billion in the estimated industry sales over the life of its patents. The figure is only to provide investors with the potential value of the patents and seems like a pretty generous valuation; however, just a slice of the $82 billion figure could lead to substantial revenues for a $40 million company.

Net Operating Loss Carryforward

Crossroads has a massive $128 million net operating loss that it can use to offset future tax liabilities. This is a huge benefit for the company as it speeds ahead towards profitability, as it can shield future profits from taxation.

Insiders Are Buying Shares

Insiders can have many reasons to sell stock of a company, but when insiders are buying, there is usually just one reason - they think the share price will rise. In the last year, insiders at Crossroads have purchased 914,700 shares, according to documents.

- Jeffrey E. Eberwein, a director and chairman of the company, purchased 2,700 shares on July 10.

- On March 31, Crossroads announced that it had entered into a securities purchase agreement for a private placement of 1.88 million units of Crossroads' common stock and warrants to purchase 943,311 shares of common stock, at units sold at $2.25 per unit, resulting in gross proceeds of $4.3 million.

Affiliates of Lone Star Value Management, of which the Eberwein serves as a managing member, will purchase approximately $2.9 million worth of units, according to the release.

- On July 31, 2014, Don Pearce, a director of the company, purchased 3,481 common shares, according to the SEC Form 4 document.

- On July 31, Galen Vetter, a director of the company, purchased 3,481 shares, according to the SEC Form 4 document.

This could mean that insiders believe at least one of the ongoing lawsuits will be a victory for Crossroads; at the very least, I think it's a sign of confidence in the company.

Ownership Profile

Following the share purchases and private placement, Eberwein now owns 2.22 million shares of Crossroads, which is 14.6% of the company. A number of other insiders also own a substantial amount of shares:

- Thomas Bruce Akin, Executive Chairman of Dynex Capital (NYSE:DX) and Managing Partner of Talkot Partners, owns 4.65% of the company.

- Steven A. Ledger, a director, owns 2.98% of the company.

- Brian Joseph Bianchi, Chief Operating Officer, owns 2.7% of the company.

- David Cerf, Executive Vice President of Strategy and Business Development, owns 2.28% of the company.

- Don Pearce, a director, owns 37,500 shares or .25% of the company.

Full insider ownership can be found at Crossroads Systems website.

Potential Risks

There are a few potential risks that investors need to be aware of before buying shares of Crossroads, which can be found on the company's annual report.

- Crossroads faces significant competition from its peers, which also happen to be some of its largest customers.

- Sales of the top three customers in 2013 represented 45% of total revenue.

- Operating results depend on new product introductions, which may not be successful.

- The company is not yet profitable, with $6.25 million in current liabilities and $4.77 million in long-term debt.

- Crossroads derives most of its product sales revenue from sales of virtual tape servers, so if demand for these systems stagnates or falls, the company's financial position could be threatened.

- The success of the company also depends on its ability to monetize several of its patents, and nothing is guaranteed. Significant legal expenses could occur without any returns.

- Patent enforcement litigation is taking longer due to federal courts becoming more crowded.

Bottom Line: Crossroads Has Huge Potential

Despite the risks, I think an investment in Crossroads Systems is quite compelling at current prices. If the company can monetize just a small fraction of its patents through litigation, and if Strongbox can gain market share in the fast-growing network-attached storage industry, then the share price could rise several fold.

Insiders continue to buy shares, which makes the investment case even more compelling. I own shares of Crossroads at an average cost basis of $2.10, and I will add more shares on any further pullback.

Disclosure: The author is long CRDS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: CRDS is one of the few tech stocks I own.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.