FalconStor Software, Inc.
Q4 2021 Earnings Call Transcript

Published: 9 Mar 2022

[Clark Liddell:]

Thank you for joining us to discuss FalconStor Software's Q4 2021 and full year 2021 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 then the company's press release issued today. During today's call, there will be discussions that include non-GAAP results. A reconciliation of 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 Q4 2021 and full year 2021 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.

[Robert Brooks:]

All right. Well, thank you, Clark. Appreciate that. I'd like to thank each of you for taking your time to participate in our call today. So we've got a lot of work to do, but I am very pleased by the progress that we are making in the market that we serve and the value that our solutions deliver to our main service provider partners and enterprise customers every day. We are a trusted data protection innovator. We have well over 1,000 end user customers, and an exabyte of data under management. We enable the world's most demanding managed service providers and enterprises to modernize their data backup and archive 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 top priorities for enterprise COOs, and they are fundamental macro shifts to which our technology here at FalconStor and our market experience are very well aligned. Our solutions deliver increased data security and provide for quick data recovery, including recovery from ransomware attacks. And our solutions accomplish these while driving down the cost of long-term data storage footprints by over 95%. For the fiscal year 2021, we implemented 4 key strategic initiatives. And if you've attended our calls before or reviewed our quarterly materials, you've seen these each and every quarter over the last 4 quarters. But these 4 strategic initiatives that we executed against last year were, first, generating 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 our growth over the next decade. Second, then on sharpening our commercial and R&D focus related to our business continuity or data-driven replication products to ensure that we are focused on those use cases which are important to our largest and most strategic customers. Third, on beginning to generate growth via M&A. And then finally, on delivering consistent profitability. So how did we do, well, against those 4 key initiatives throughout 2021? Well, first thing we're going to do here is go through our Q4 2021 results. So first, we increased our GAAP subscription revenue year-over-year by 20% in Q4. And for the entire year, we had actually increased our subscription-based revenue year-over-year by 40%. So these are certainly solid increases in our GAAP subscription revenue, and we're very pleased about that. But we think we can accelerate that even more as we continue to focus on growing our subscription-based recurring revenue. Second then, our quarterly GAAP total revenue consistency remains one of our top focus areas. And as you can see, Q4, we were -- we delivered a 4% year-over-year increase in total GAAP revenue, but it's inconsistent. So if you look over the last 4 quarters prior to Q4, in Q3, we were down; in Q2, we were down; Q1, we delivered 20% increase year-over-year; but in Q4 2020, we were down. So inconsistency remains an opportunity that we are focused on driving very consistent quarterly total GAAP revenue. Third then, we continue to focus on tightly managing our operating expenses. And for Q4 of 2021, we -- our operating expenses were down 7% year-over-year. So that's great. So this is an area that we continue to focus on, we continue to do well in. And then last, fourthly, our GAAP net income consistency remains an opportunity. And that's largely driven because obviously, our total GAAP revenue is inconsistent, that growth, I should say, the total GAAP revenue is inconsistent. So for the year of 2021, Vince, well go through these details here in a minute. But for that year of 2021, we delivered a net income, a GAAP net income of about $200,000. But for the quarter, we delivered a loss of about $191,000. So consistency in this area of total GAAP revenue and total GAAP net income remains one of our top priorities. So when we -- I should say you guys probably know, we've been working on reinventing FalconStor now for about a few years. And so I think it helps if we look at a few key metrics over that period of time to see how we progressed. So first, our net customer revenue retention. So that excludes hardware because we no longer treat hardware a revenue, we now treat it as a pass-through. And so in 2017, our net customer revenue retention was 65%. That's grown in 2021 to 99%. Our gross margin in 2017 was 78%. That has grown to 86% in 2021. Our adjusted EBITDA was 7% in 2017, that has grown to 25%. Free cash flow, while it's improved, and we're pleased that it's improved, it's certainly not delivering positive cash flow every year. So we've improved it from a $2.9 million burn in 2017 to a $1.1 million burn in 2021. You can see that we delivered positive cash flow in 2020. But we need to make that consistent, right, year-in, year-out, positive free cash flow, so that remains one of our focus items. Fifth, then our R score, and R score, as you probably know, is simply defined as annual revenue growth percent plus annual EBITDA percent. So when you look at that metric in 2017, we were at an R score of negative 14. And then in 2021, that had grown to an R score of 21. So that's an increase of 35 points over that period of time, which we're very pleased with. Because it's a reflection both of maintaining or growing revenue and increasing our EBITDA. And then finally, the last metric that we've been tracking in reviewing each quarter is our percent of sales from noncore markets, as an example, China. Back in 2017, our sales from those markets was about 23%, just a little over 23% of our total sales. In 2021, that has shrunk to 4%. As we continue to focus on those markets that are efficient for us to operate in and that we believe where we have differentiation and where we can win. Going forward, I expect our sales from those markets will continue to be in that 4% range, maybe a bit less as we move forward. So as I mentioned when we started the call, I'm excited by the growth markets that we are focused on. Those being data protection as a service, hybrid cloud and managed IT services. All of those are growing quickly, and they are clear reflections of macro shifts that are occurring in our industry, into which FalconStor technology and experience is very well aligned. In fact, the data protection as a service market is predicted to grow 31% annually to $104 billion in 2027. The hybrid cloud market is predicted to grow at 20% annually to $204 billion in 2027. And then finally, the managed services market is predicted to grow 8% annually to $355 billion in 2026. So these are exciting markets for us to focus in. And we believe that our ability to market focus on managed service providers and on hybrid cloud partners will be key drivers for FalconStor to generate growth over the next several years. So today, we have over 1,000 organizations in managed service providers that manage over 1 exabyte of data using FalconStor technology, and that technology is protected by 43 patents and patent applications. 2021 featured some important commercial highlights that I'd like to review and that we're pleased with, that we're able to accomplish in 2021. First of all, we've launched a multitenant version of our long-term data retention and recovery product, a product we call StorSafe, which significantly improves the ability for managed service providers, or MSPs to optimize data protection for the enterprise customers that they serve. Our StorSafe solution improves MSP tenant management, data storage and reduce this data storage cost by seamlessly leveraging public cloud storage, such as IBM Cloud, AWS, Microsoft Azure or Wasabi. Next, we introduced what we believe is a new and disruptive per tenant per month pricing model for our MSP partners, which aligns very well with their monthly OpEx structured business models. And this move has already proven to be working. Not only did we -- were we able to secure several new MSPs toward the end of Q3, but we added 3 more in Q4. So we're excited about the reach -- or the -- that pricing model and how that is being received in the market. Third then, we launched an initiative for our MSPs to be able to leverage either our IBM Power servers or Intel Server platforms. And this flexibility is key for our MSPs that are offered back into the service and migration as a service to customers with diverse operating environments, including environments like IBM i. Next, then fourth, we expanded our global partnership with Hitachi Vantara to provide advanced disaster recovery in cloud-enabled protection for Hitachi flash storage rates with our StorGuard technology, that's data replication, snapshot-based technology. So we were pleased to be able to launch that. And then fifth, finally, we continue to demonstrate the ability of our data protection solutions to scale with several expansions of multi-petabyte deployments across multiple data centers, large enterprises, government institutions and MSPs. So we're excited about what we were able to accomplish in 2021. As I mentioned earlier, we have a lot of work to do, but we're latching into 2022. I'm excited by the progress that we've made. So for 2022, then, we here again, have set 4 key growth initiatives that will then track our progress against every quarter as we have our calls. First, we're focused on generating growth by targeting the market forces that are moving to cloud-based data protection, both as client-led services and by using backup as a service and migration as a service through MSP. So said another way, focused on growing through MSPs data protection that is moving to the cloud, a very important macro shift that is happening in our industry. Second then, we're focused on generating growth by expanding our reach into mid-range storage markets through the bundling the of FalconStor technology with storage market leaders like we've already done with Hitachi Vantara. We'll continue that initiative. Third then, as I mentioned earlier, we've got to become much more consistent on our quarterly profitability and increasing free cash flow every quarter. So we'll focus on that. And then last but not least, working on beginning to generate growth via M&A, which we did not -- we were not able to accomplish in 2021. So we hope to begin that in 2022. So in just a minute, I'm going to turn it over to Vince to go through the detailed financials for both Q4 and 2021. But before I do, I wanted to just address this ongoing crisis in Ukraine. So our thoughts and our prayers, of all FalconStor employees, are with those that have been so tragically -- continue to be tragically impacted. And all this crisis has the potential to cause disruption across the globe and negatively impact our business. We don't have any employees, any contractors or any customers in either Ukraine or Russia. But regardless, we'll continue to closely monitor the situation for any potential impacts to our business. And most importantly, continue to diligently help our customers protect their incredibly valuable data. So I'd like to introduce Vince Sita before turning it over to Vince. He's our -- Vince is our new Chief Financial Officer, and he joined the company back in mid-February. Vince replaces Brad Wolfe, who was a key asset for FalconStor for over 3 years. We wish Brad well in his future and appreciate the dedication that he brought to FalconStor every single day. This is inheriting a solid foundation from which that we can build FalconStor. And I already appreciate the talent and the experience that he is bringing to our team. Vince got a very -- Vince has a very strong operational and strategic planning focus and it's going to be a very important asset to FalconStor as we grow. So with that, let me finally turn it over to Vince for a more detailed overview of our Q4 and full year 2021 financial results. Vince?

[Vincent Sita:]

Thank you, Todd. Okay. So for our Q4 2021, we closed the 3-month period ended December 31, 2021, with $3.8 million in GAAP revenues, compared to $3.7 million for the same period of the previous year, an increase of 4%. GAAP total profit for the quarter was $3.4 million, compared to $3.2 million for the previous year, an increase of 6%. GAAP total operating expenses were $3 million, compared to $3.2 million for the fourth quarter of 2020, a decrease of 7%. And so as a result, we generated a GAAP operating income of $385,000 in Q4 2021, compared to a GAAP operating loss of $47,000 in Q4 2020. However, in Q4 2021, we did -- we had a higher deferred tax expense resulting from a revaluation of our deferred tax asset. And as a result, despite generating an operating income of $385,000, that was in Q4 2021, versus an operating loss in Q4 2020, we ended up with a higher GAAP net loss in 2021 of $191,000, compared to a GAAP net loss of $109,000 for Q4 2020. So for the full year, on Slide 13, we closed total revenues of $14.2 million, compared to $14.8 million for the same period of the previous year, a decrease of 4%. GAAP total profit for fiscal year 2021 was $12.2 million, compared to $12.9 million for prior year, a decrease of 6%. GAAP total operating expenses were $11.6 million, compared to $11.1 million for fiscal year 2020, an increase of 4%. As a result, GAAP operating income for fiscal year 2021 was $634,000, versus $1.8 million for fiscal year 2020. Moreover, 2021 GAAP operating income did include a benefit of $633,000 related to a gain for a legal settlement of a contractual dispute. Without that gain, we would only have produced a breakeven operating income for full year of 2021. So finally, for GAAP net income for 2021 we came in at $203,000, compared to a GAAP net income of $1.1 million for fiscal year 2020. If we turn now to the balance sheet, we ended the quarter with a cash balance of $3.2 million compared to $3.5 million in September 2021 -- September 30, 2021, and $1.9 million at December 31, 2020. So a reduction of $300,000 versus Q3 2021 and an improvement over Q4 of 2020 of $1.3 million. In the second and third quarter of 2021, we raised $4.5 million gross proceeds from 2 public offerings of our common stock at a price of $4.10. We also paid, at the end of Q2, $1.3 million towards our notes payable balance. Net working capital, excluding deferred revenues, contract receivables, but including the redemption value of our term notes, ended at $3.6 million, a decline of $200,000 from Q3 2021. However, an improvement of $4.5 million for Q4 2020. We closed the quarter with $2.9 million in accounts receivable. That's gross of any reserves. Accounts payable on account -- and accrued expenses of $1.5 million and deferred revenues of $6.1 million. So for 2022, we are providing the following guidance

[Robert Brooks:]

All right. Well, thank you, Vince. So a quick summary, we are pleased with our 2021 results. We made a lot of progress commercially, especially as it relates to MSPs, hybrid cloud use cases and with our partnership with Hitachi Vantara. So we'll continue that in 2022 and build upon that foundation that we've built. And we're excited about where we are and looking forward to where we are going here in 2022. So with that, let me -- I'm going to turn it back over to Clark and he will open up the floor for any questions that anyone may have. Clark?

[A - Clark Liddell:]

. Okay. I've got 1 question here, Todd. From Chad, it says with a big market opportunity and traction in the market, guidance for 2022 is flat to up 9% versus 2021?

[Robert Brooks:]

Yes. So that is correct. So the -- if you remember, we're continuing our shift from a perpetual license model to a subscription license model. So that impacts our short-term ability in any way to grow as we continue to work through that shift. And so it's a combination, Chad, of maintaining as much of our legacy revenue base as we possibly can, right, through higher renewal rates, through expansions for our legacy customers and then layering in on top of that a great subscription growth, but through some of these new markets. So when you net it all out, we are targeting total revenue growth for the year. But until we get a little deeper into the higher percentage of our total revenue being subscription-based, that growth rate is going to be diminished a little bit. But great question.

[Clark Liddell:]

Are there any other questions? Okay. Todd, I'm not seeing any other questions at this time. All right.

[Robert Brooks:]

All right. Great. Well, once again, folks, thank you for your time. We really appreciate your time and attention and looking forward to speaking again with you in a couple of months. Thank you.

[Clark Liddell:]

Todd, we just got a question here, if you want to tackle it.

[Robert Brooks:]

Absolutely. Go ahead.

[Clark Liddell:]

It's from Wallace. It says, so what is subscription growth in 2022?

[Robert Brooks:]

Subscription growth in 2022. Great question. I think Wallace that we're -- it's right around the 30 -- between 30% and 40% mark. I don't have the exact number I apologize. I should have that ready. But I think we -- as I mentioned back in one of the slides about the Q4 being a 20% increase year-over-year and then in the year, being a 40% year-over-year. I think we have an opportunity to maintain that or increase some, depending on how we're able to do on some of these go-to-market initiatives. But that remains one of our big priorities, even though as we're making that shift to subscription, it does hurt our ability to grow total revenue a little bit.

[Clark Liddell:]

Okay. No more questions that I see Todd.

[Robert Brooks:]

All right. Very good. Well, once again, thanks, folks, and we will chat you in a couple of months. Thank you.

[Vincent Sita:]

Thank you.

[Clark Liddell:]

Thanks.