FalconStor Software, Inc. (OTCQB:FALC) Q2 2022 Earnings Conference Call August 3, 2022 5:00 PM ET
Clark Liddell - VP, Strategic Operations
Robert Brooks - CEO and President
Vincent Sita - CFO, Treasurer & Principal Accounting Officer
Conference Call Participants
Good afternoon and thank you for joining us to discuss FalconStor Software's Q2 2022 earnings. Todd Brooks, FalconStor's Chief Executive Officer; and Vincent Sita, Chief Financial Officer, will discuss the company's results and activities. And we'll then open the call to your questions.
The company would like to advise all participants that today's discussion may contain what some consider forward-looking statements. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. These risks and uncertainties are discussed in 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 Q2 2022 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 Todd Brooks.
All right, well, thank you, Clark. Appreciate that. And I'd like to thank each and every one of you for taking your time to participate in our call today. Q2 was certainly an important quarter for FalconStor, as we finalized our new relationship with IBM. It locks sales of our joint solutions together. And we are very pleased by the progress that we are making and the market that we serve and the value that our solutions deliver to our customers every single day.
We are a trusted data protection innovator with well over 1,000 end user customers and an over 1 exabyte of data under management. We enable the world's most demanding managed service providers and enterprises to modernize their data backup and archival operations for the hybrid cloud world, protecting data across on-premise data centers and public cloud environments.
Migration to the cloud, data center rationalization and increased leverage of outsourced managed services are absolutely top priorities for enterprise CIOs and are fundamental macro shifts to which FalconStor technology and market experience are well aligned. Our solutions deliver increased data security and provide for quick data recovery, including recovery from ransomware. And our solutions accomplish these while driving down long-term data storage footprint by up to 95%.
For fiscal year 2022, we implemented four key strategic initiatives as we continued our work to reinvent FalconStor. The first initiative was to generate consistent growth by expanding our industry-leading long-term data retention and recovery product line; and by creating new, flexible and extensible data protection innovations that we believe will drive recurring revenue growth over the next decade.
Number two, on sharpening our commercial and R&D focus related to our business continuity-driven data replication products to ensure that we are focused on those use cases which are most important to our largest strategic enterprise customers; third then, on beginning to generate growth via M&A; and then fourth, on delivering consistent profitability.
So we are excited, as I mentioned earlier, about our growth markets, especially as it relate to hybrid cloud and to managed services. And we are excited about these growth markets because of their ability to drive significant recurring revenue growth as we go forward with FalconStor. Data protection as a service, hybrid cloud and managed IT services are growing quickly and are clear reflections of macro shifts in our industry to which FalconStor technology and experience are well aligned.
In fact, the data protection as a service market is predicted to grow by 31% annually to $104 billion in 2027. The worldwide hybrid cloud market is predicted to grow by 20% annually to $204 billion in 2027. And finally, the managed IT services market is predicted to grow by 8% annually to $355 billion in 2026, so our go-to-market focus on managed service providers and on hybrid cloud partners like IBM will be key drivers for FalconStor to generate recurring revenue growth over the next several years.
To that point: I've mentioned IBM a couple of times already, but we were thrilled back in mid-May and Q2 to have entered into our new hybrid cloud reseller agreement with IBM. And that agreement, through that agreement, we're going to provide several new joint solutions which combine FalconStor software with IBM's Cloud Object Storage and IBM power virtual server cloud infrastructure. And now that we've ended Q2, we're even more thrilled to report that our early sales have already started, as we have secured several new customers with IBM throughout the back half of Q2.
Our new joint solutions migrate and optimize data protection in the IBM power cloud. And these solutions include, first, a cloud-native backup solution where enterprises running their applications in the IBM power virtual server cloud can now utilize FalconStor to securely and efficiently backup to IBM Cloud Object Storage.
The second solution then is a cloud migration solution, and this is for enterprises needing to migrate their existing on-premises power applications to the IBM power VS cloud. FalconStor's StorSafe technology takes a secure snapshot of these on-premise applications; and they restore them inside of the IBM Cloud, maximizing application availability and security.
Third then is an advanced hybrid cloud backup solution for MSPs or managed service providers looking to use the cloud for a secure, air-gapped offside location -- offsite location, I should say. FalconStor and IBM deliver an on-premises virtual tape library solution with a cloud instance for secure and encrypted offsite backups. So this new partnership with IBM is a -- clearly a material step forward for us, and it should be a significant contributor to our 2022 strategic goal to significantly increase hyper cloud recurring revenue.
So let's move on now to some highlights and some key points from our Q2 results. First, as we make the strategic shift from perpetual to recurring revenue, we continued to deliver annual recurring revenue increase, or ARR, during the quarter with a 4.2% year-over-year increase. We expect, though, this ARR growth rate to accelerate further in the coming quarters as additional sales come online with IBM.
Second then, at the end of the -- or at the end of Q2, AR represented -- ARR represented 66.8% of our total GAAP revenue. And while this percentage is probably going to vary a bit quarter in and quarter out with the percentage of our total revenue, we do expect that, that will increase as a percent of our total revenue over time.
Next then, as we make the shift to recurring revenue, growing total GAAP revenue and short-term is clearly an important goal, but at this time, quarterly GAAP total revenue growth consistency continues to be our biggest focus area and challenge. And you can see that we've only grown total GAAP revenue -- and here again this is all revenue together, not just recurring, but we've only grown total GAAP revenue in one of the last 5 quarters. So we've got a lot of work to do there, but we've got -- we're certainly going in the right direction.
Next then. In fact, when we look at the total GAAP revenue that decreased in Q2 by 27%, most of this is actually caused by, and you can see in that last line, a reduction in nonrecurring revenue, especially as compared to like 4 or 5 quarters ago. So here again, like I said, we've got work to do for total revenue but are very excited by the growth that we're now beginning to see in our ARR.
All right, when we look next at expenses, we continually tightly manage our quarterly operating expenses to better align with our current quarterly revenue level. Q2's GAAP operating expenses decreased actually to $2.5 million, which represented a year-over-year decrease of 17%; and a quarter-over-quarter, so from Q1 to Q2, about 9% decrease. And so we continue to work hard on managing those and finding ways that we can be more efficient with our operating expenses and we will continue to do that in Q3 and in Q4.
Finally, due to our decrease in total GAAP revenue, we incurred a $0.9 million GAAP net loss during the quarter, so we've got work to do, mainly here again on the top line total GAAP revenue area, to maintain that level as we continue to build our recurring revenue. All right, at this point, I'm going to turn it over to Vince. And he is going to give us a more detailed view of our Q2 financial results. Vince?
Thanks, Rob. So if we look at the summary, income statement summary, on Slide 9. This summarizes the quarter and versus previous quarter and Q2 versus Q2 of last year. So our revenues for Q2, as mentioned, we were in total $2.4 million versus $2 million in Q1 of this year and versus $3.3 million in Q2 2021. Gross profit was $2 million compared to $1.6 million in previous quarter and $2.8 million in Q2 of previous year.
Total operating expenses. As Rob highlighted, overall expenses did drop this quarter over prior quarter, so $2.5 million in total operating expenses versus $2.7 million in Q1 of this year and versus $3 million in Q2 2021. So that's a 9% drop quarter-over-quarter Q2 over Q1 and 17% drop over prior year same period.
We incurred an operating loss of $0.5 million in Q2 versus an operating loss of $1.1 million in Q1 and compared to a net operating loss of $183,000 in Q2 2021. At the net income level, Q2 generated a net loss of $0.9 million versus a net loss of $1.1 million in previous quarter and a net loss of $0.4 million in Q2 of the prior year.
If we move on to the balance sheet, look at some key figures. We ended the quarter with a cash balance of $1.8 million compared to $3.4 million on March 31, 2022, and compared to $3.7 million when we look at June 30, 2021, therefore a decrease of $1.6 million from Q1 2022 and a decrease of $1.9 million over Q2 2021.
Looking at net working capital cash. So we include -- we exclude in this contract assets and deferred revenues, though we do include the redemption value of our terms notes. And still we ended at $0.7 million, a decline of $1.1 million from Q2 2022 and a decline of 2.2 million from Q2 2021. We closed the quarter with $1.7 million in accounts receivable. This is gross of any reserves. Accounts payable and accrued expenses of $1.6 million and deferred revenues of $5 million.
If we move to the next slide. So given our Q1 and Q2 results, we are reducing and revising our full year 2022 guidance. The revised guidance does reflect continued sequential quarterly GAAP total revenue growth and GAAP net income positive results in Q3 and Q4 2022.
So our revised calls for total revenues in the range of $10 million to $12 million, adjusted EBITDA of minus $0.5 million to $1.2 million and net income of minus $1.8 million to minus $0.5 million.
Rob, I'm going to turn it back to you for some final comments.
Yes, thank you, Vince. Yes, thank you, Ben. So, one thing I want to point out: We're going to be very intentional, especially over the next several quarters as we continue to build our annual recurring revenue with our new relationships, to show how the quarter-over-quarter trends are going because we feel like we have finally gotten ourselves to a point where we can begin to grow total revenue even as we're growing our -- because we've gotten our ARR to a level now where we think we can begin growing total GAAP revenue quarter in and quarter out. We look at our pipeline that we have now for Q3.
We look at our pipeline that we have now for Q4. And we believe that, over the next couple of quarters, we're actually going to be able to see growth on each one of these dimensions. And so we'll be sure in our earnings calls to follow that trend and show how quarter-over-quarters are going because it is important that we look at that very tightly and then show how we're doing against that -- against those metrics. So with that, let me pause and, Clark, turn it back over to you to see if there's any questions.
A - Clark Liddell
Yes. Thanks, Todd. If anyone has any questions. Like just tight them and local Operator Instructions] question not seeing any yet. Okay, well then I'm looking to see if there's any hands raised. I'm not seeing that either. Todd I'm going to pass it back to you for final comments.
All right, well, thanks again, everybody, for your time. And as Vince and I both mentioned during the call, we are super excited about what we've been able to do, especially with our relationship with IBM and where that's going and just kind of how that started. So we'll be very excited to get back together here again in 90 days or so to tell you how we're doing, but thanks for your time once again for your investment and your interest in FalconStor. Thank you.
Thank you, everyone.