Clark Liddell: Hello, everybody. Good afternoon, and thanks for joining us to discuss FalconStor Software's Q2 2021 Earnings. Todd Brooks, FalconStor's Chief Executive Officer; and Brad Wolfe, 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 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. And I would like to thank everyone that's participating in our call today for your time. We have a lot of work in front of us, but we are pleased with the progress that we are making, and we're also excited about the market that we serve and the value that our solutions deliver to our enterprise customers and managed service providers every day.

We are a trusted data protection innovator with over an exabyte of data under management. We enable the world's most demanding enterprises to modernize their data backup and archival operations across data centers and public cloud environments. Our solutions then deliver increased data security and provide for quick data recovery, including recovery from ransomware attacks. And our solutions accomplished these while driving down long-term data storage footprints by up to 95%.

So for fiscal year 2021, we implemented 4 key strategic initiatives as we continue to work to reinvent FalconStor: 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 storage innovations that we believe will drive our growth over the next decade; second, 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 important to our largest and most strategic enterprise customers; third, on beginning to generate growth via M&A; and then, finally, on continuing to deliver consistent profitability.

So how are we doing so far in 2021 against these strategic initiatives? So there's 5 areas that we're going to cover in the next couple of slides. First, our quarterly GAAP revenue growth consist -- or the consistency, I should say, in our quarterly GAAP revenue growth is challenging. And this continues to be challenging for us. You can see in this top table for Q2 of this year, our year-over-year revenue declined by 7%. That follows a significant GAAP revenue increase in Q1. And before that, there was a decline in Q4 and before that, a significant increase in Q3. So to say that it is inconsistent would be an understatement and something that remains a challenge. And we'll talk about some actions that we're taking to improve revenue growth consistency in a few minutes. But this certainly does remain an area that we are in need to continue to focus on.

Second then highlight from Q2 is we continue to make good progress in reducing and optimizing our quarterly GAAP operating expenses. In Q2, we were able to reduce operating expenses quarter-over-quarter despite the fact that we've spent almost $350,000 -- about $349,000 to finally exit the 60,000 square foot office that we had in Melville, New York. So we're able to exit that at the end of April. And that action is very important as we move forward and empower our employees to continue working from home. And this move, this ability to get rid of this facility, will save us approximately $135,000 in monthly lease expenses going forward. So we feel really good about how we've been able to continue to control, optimize and reduce our quarterly operating expenses.

Third, the fact that our quarterly revenue growth is not consistent quarter in and quarter out then drives inconsistency in our bottom line net income. So as you can see, in Q2, we had $340 million, almost a $350,000 loss. Q1, we had a $425,000 profit, et cetera, et cetera. So inconsistency there also. Despite the fact that we've been able to control our costs very, very well and even decrease them, that is inconsistent because we have inconsistency on the top line.

Fourth, we continue to improve our balance sheet. And we did so in Q2, especially as it relates to cash on hand and notes payable. During Q2, our cash on hand increased to $3.7 million, and our notes payable decreased to $2.2 million. Brad's going to go into a lot more details on these here in a few minutes. But we're obviously very pleased with this. Especially, beginning to generate and then raise some additional equities is going to allow us to invest in key growth areas, especially some small M&A acquisitions that we are -- we'll be targeting going forward.

And then, finally, speaking of M&A, we have begun to build a pipeline of potential M&A targets, and we've enlisted the assistance of an external sourcing firm to help us do that. So those are Q2 highlights.

I think it's important though -- as you probably remember, we began these reinvention efforts back in late 2017. So I think if we step back for a minute and look at how is it going over the broader view, I think that's an important viewpoint to look at also.

So starting at the top here, we certainly won't read all these numbers. There's a lot of them. But at the top, net customer revenue retention. And that excludes hardware because we now no longer treat hardware as -- we don't count it as revenue. We treat it as a pass-through. So in 2017, our net customer revenue retention -- so this is a measure of are we keeping our clients, our existing clients. We went from 65% in 2017 to 140% in the first half of this year. Now there's an asterisk here and a note down at the bottom that, that increase was certainly helped, not completely explained but certainly helped by 2 large expansions that we had for existing customers in the first half of the year. But nonetheless, we've done a really good job of being able to increase our ability to retain existing clients and even grow those existing clients.

Second then, gross margin has gone from 78% in '17 to 85%. Adjusted EBITDA has gone from 7% to 19%. Free cash flow has gone from a $2.9 million burn in 2017 to a $300,000 surplus in the first half of the year. Our Rule of 40, which is simply you take your revenue growth rate percentage and you add that percentage number to your EBITDA percentage, and you come up with a 2-digit number. We're targeting at least 40 for that number. In 2017, we were at negative 14 and for the first half of this year, so far, we're at the positive 25. So that's obviously much better. That's, I think if we do the math, a 39-point increase on Rule of 40. Again, we've got a little ways to go. We're going to -- our goal is to get and maintain at or above 40 of Rule of 40.

And then last, but not least, I think it's important to understand that when we first started, the company was operating in many, many, many markets. And we recognize that it was probably going to be smart for us if we did not attempt, given our size, given our scale, to operate in China and Hong Kong. And so we decided -- we made a strategic decision to begin to not focus on new sales there. We still have customers and they still renew, but it's certainly a small percentage of our business now. In 2017, a little over 23% of our total sales came from those noncore markets or what we call now noncore markets. In the first half of this year, that number dropped to 5%. So while that hurts, short-term revenue certainly was the right decision to make as it makes us much, much, much more efficient and allows us to focus in markets, like the Americas and EMEA and Japan and Southeast Asia and Korea, where we know that we can win, right? And it's not extremely difficult or expensive to operate in.

So we feel good about that broader view. But as I said earlier on the previous slides, we still have a lot of work to do to drive consistency. And on that topic, I mentioned that there are a few things that we've put in place to further drive consistency. And primarily, it revolves around demand generation and sales pipeline expansion. And those 2 actions, we can categorize them in 2 ways.

One is talent expansion, so adding -- we added a new industry seasoned VP of Marketing to improve our demand generation. We've also added a dedicated or, I should say, a product executive that is dedicated to expanding our go-to-market paths. Where, historically, our product lead and our engineering lead has been the same person, we now have broken that apart. And we have one engineering executive and one product executive, and that helps us to focus on identifying those go-to-market paths that are going to be important for the company going forward and identifying those areas and those solutions that customers will be excited to purchase products from FalconStor for.

The second category then is on market expansion. So continuing the focus, number one, on our long-term data retention products and especially as it relates to companies and managed service providers that focus on data that is captured within IBM i environment. So as you probably know, the IBM i operating system is analogous to Windows, but it's developed by IBM i -- or by IBM, I should say. And it is used by a lot of companies to operate their mission-critical applications. It's very important to -- over 100,000 customers still use IBM i. And our solutions interface with IBM i environments very, very well. And so we've used that historically as a beachhead to grow. And it's worked, but we think it can work even better. And so we'll put a lot of attention in that.

And I bring up MSPs because not only are companies using our solutions to help them then manage data that resides in IBM i environments but also, there's a growing segment now of managed service providers, or MSPs, that are providing outsourced backup as a service or disaster recovery as a service to these companies that have mission-critical systems on IBM i. And so we're investing and targeting those MSPs also.

And then, finally, our overall goal of helping companies to modernize their data backup and archive operations across multiple sites and public clouds. If you look at a typical company today, there are various stages of migrating data to the cloud. There's certainly some cost benefits from doing so, but if there's work involved and there's expertise involved and there's risk involved, and so various companies are at different stages of that migration. Some will have the majority of their data still in-house. Some of them will have some more of the data that's in the cloud. We want to help our clients efficiently control their data, manage their data and securely manage it where they have it stored, whether it's on-premise or in the cloud. And then when they are ready to make that shift to the cloud, to help them do so in a very streamlined way.

So those are the things that we've put in place recently to begin to drive additional demand generation in sales pipeline. But that's an important fact, right? We've -- and if we're going to create consistent growth, we've got to dramatically increase our sales pipelines as we go forward.

So today, we have approximately 600 active customers that manage over -- those customers manage over 1 exabyte of data using our technology. And that technology is protected by 45 patents or patent applications. Over the last 4 quarters, there are a few things I'll highlight here that we've been able to accomplish from a commercial perspective.

First, we launched our newest long-term data retention and recovery product, StorSafe, which significantly improves the ability for enterprise customers to optimize their data storage and reduce related data storage cost by easily leveraging AWS, Microsoft Azure, IBM Cloud or the Wasabi public cloud storage.

Next, we expanded our global partnership with Hitachi Vantara to deliver a new hybrid cloud data protection architecture powered by StorSafe and Hitachi's HCP object storage platform.

Third then, we deepened our integration with AWS cloud data storage tiers to further enable storage reduction for our customers -- or storage cost reduction, I should say, for our customers.

Fourth then, we gained market share by accelerating replacements of IBM's end-of-life ProtecTIER solution.

Next then, we continue to demonstrate the ability of our data protection solutions to scale with several expansions of multi-petabyte deployments across multiple data centers for large enterprises and government institutions. And I actually referred to that above -- when I was talking about some of the expansions that we've seen so far in the first half of 2021, those fall into this scale -- or into this ability to scale.

And then last, we've expanded our solution functionality for our managed service provider partners, these MSPs. And these include folks like Blue Chip, a leading IBM i-focused U.K.-based MSP. They now serve over 300 customers and 70 petabytes of data under management with our technology.

So going forward, we will focus in 7 key areas as we continue to push for consistent growth. First, on increasing our subscription-based recurring revenue. Now as you probably realize, when we say we're shifting to more of a subscription base, that's from kind of your old-school perpetual base, when our customer pays for it one time and they have a limited -- unlimited license for it. Subscription is an annual subscription and it's much healthier for our business. And it does have the downside, in the short term, of reducing revenue slightly, but it's much, much, much more healthier for the company going forward.

Second then, and especially since we're moving to subscription-based revenue deals for new customers, we've got to generate new customer growth and we have to continue to improve customer retention. We've done a great job over the last 4 years improving that, but we still have some ability to improve in that area.

Third then, generate consistent quarterly revenue growth while maintaining profitability growth. It's really important to pair these 2 together, right? You can't have one without the other. And that will allow us to reach our target of at least an R score of 40.

Fourth then, continue to innovate with our long-term data retention and recovery products.

Fifth, on then selectively expanding our business continuity-driven data replication products to meet the needs of our most strategic customers.

Sixth, on actually executing a disciplined M&A strategy.

And then, finally, on continuing to improve capital structure and our liquidity profile.

So as I mentioned at the start of the call, we are very excited about this market. And maybe even more so by the fact that we now, since last year, actually, since 2020, have begun to attack the cloud data storage market, which is estimated to grow, between 2019 and 2027, by 22% a year. So it's a massive market, relatively new in the last couple of years with FalconStor and one where we're putting in a lot of focus.

So with that, let me pause, and I'm going to turn it over to Brad to go through the detailed financials. Brad?

Brad Wolfe: Thanks, Todd. We closed the 3 months ended June 30, 2021, with $3.3 million GAAP revenue compared to $3.5 million for the same period of the previous year, a decrease of 7%. GAAP total gross profit for the quarter was $2.8 million compared to $3.1 million for the previous year, a decrease of 9%.

GAAP total operating expenses were $3 million compared to $2.6 million for the second quarter of 2020. The increase is due to the personnel-related costs related to our reinstatement of the workforce that was reduced as part of the 2020 restructuring plan implemented in response to COVID-19 and the closing down of our Melville facility, which was approximately $350,000. We generated GAAP operating loss of $183,000 in Q2 2021 compared to income of $550,000 in Q2 of 2020, a decline of 133%; and a GAAP net loss of $350,000 for the quarter compared to net income of $407,000 in Q2 of 2020, a decline of 186%.

So the year-over-year quarterly comparisons are not positive. We would like, and we feel because of COVID-19, a first half 2021 versus first half of 2020 is more meaningful comparison. We had dramatic expense cuts in Q2 of 2020 in response to COVID-19, which helped Q2 2020 profitability but was not sustainable. The first half comparison to the same period are much more telling.

We closed the first half of 2021 with $7.1 million GAAP revenue compared to $6.7 million for the same period the previous year, an increase of 6%. GAAP total gross profit for the first half of 2021 was $6 million compared to $5.7 million for the previous year, an increase of 5%.

GAAP total operating expenses were $6.2 million compared to $5.6 million for the first half of 2020. The increase, again, was due to the increase in personnel-related costs related to our reinstatement of our workforce that was reduced as part of the 2020 restructuring plan and also related to the Melville lease cost to -- in that lease. We generated GAAP operating losses of $200,000 in the first half of 2021 compared to net income of $146,000 for the first half of 2020, a decline of 237%; and GAAP net income of $76,000 for the first half of 2021 compared to a loss of $313,000 for the first half of 2020, an increase of 124%.

Turning now to the balance sheet. We ended the quarter with a cash balance of $3.7 million compared to $2 million on March 31, 2021, and $1.5 million at June 30, 2020, an improvement of $1.7 million from Q1 2021, an improvement of over $2.2 million to Q2 2020. In Q2 2020, we raised $3.3 million gross proceeds in a public offering for our common stock at a price of $4.10. We also paid $1.3 million toward our notes payable balance.

Net working capital, excluding deferred revenue, contract receivables but including redemption value of our term notes, ended at $3.1 million, an improvement of $2.7 million from Q1 2021 and an improvement of $5.8 million from Q2 of 2020. Q2 marks the fourth quarter in a row that we were free cash flow positive for the quarter. We have generated $1.7 million of free cash flow over the last 4 quarters. We closed the quarter with $3.7 million of cash and cash equivalents, accounts receivable gross of any reserve of $2.3 million, accounts payable and accrued expenses of $2.4 million and deferred revenue of $6 million.

As we mentioned on our last earnings call, we continue to restructure the company to reduce nonoperational costs and streamline our cost structure. We've been working toward becoming a primarily virtual company for several years, but COVID-19 accelerated things as we abandoned large legacy leases from around the world. As of April 30, 2021, our lease in Melville, New York of approximately 60,000 square feet ended, and we did not renew it. The monthly cost of this legacy lease was approximately $135,000 per month. So some of the $1.6 million annual lease has been offset with sublet rent. We anticipate that approximately $1.1 million of the gross savings in 2021 and $1.6 million in 2022 and beyond will be used and redeployed to help us with growth.

On July 27, 2021, we closed a follow-on equity raise of $1.2 million gross proceeds and a public offering of our common stock at $4.10. The support and access to the public market reaffirms the valuation and market approach we've been pursuing for several years and allows us to pursue more aggressive organic growth and potential M&A.

Finally, we want to confirm our 2021 guidance. Our guidance was total revenue of $15.1 million to $16.1 million, adjusted EBITDA of $4.2 million to $5.1 million, net income of $1.9 million to $2.8 million and a Rule of 40 score of 31 to 41. The company's weathered the COVID-19 disruptions relatively well so far, and we believe, especially with our recent equity raises, we're well positioned for growth in 2021 and beyond.

Todd, I will turn it back over to you for final comments.

Robert

Brooks: Thanks, Brad. I appreciate that. And as you can see from the detailed numbers, there's a lot of good things that are going on, and there's a lot of work that remains. And I couldn't be more proud of the team and what we've been able to accomplish over the last 4 years. But make no mistake about it, there's a lot of work in front of us to create revenue growth cost consistency every single quarter while continuing to drive very attractive profitability.

So with that, I'm going to turn it back over to Clark, who will now open up the floor to any questions that you may have. Clark?

Clark Liddell: Yes. Thanks, Todd. [Operator Instructions]

Okay. Todd, I don't see any questions or any hands raised.

Robert

Brooks: Okay. All right. Well, in that case, we'll wrap it up and reconvene next time. But once again, thanks, everybody, for your time and for spending your afternoon with us, and we look forward to chatting again in the future. Have a good evening. Thank you.