Sphere 3D Corp. (ANY) Q2 2016 Earnings Report, Transcript and Summary

Good afternoon, my name is Matthew and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Second Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you. Lauren Sloane, with Investor Relations. You may begin your conference.

Thank you and good afternoon everyone and thank you for joining Sphere 3D's earnings conference call for the second quarter of fiscal 2016. With me on the call today are Eric Kelly, Chairman and Chief Executive Officer; Kurt Kalbfleisch, our Chief Financial Officer; and Peter Tassiopoulos, our Vice Chairman and President. Prior to the call we distributed our Q2 earnings release over the wire services and we've posted it on our website at investors.sphere3d.com. This call is also being webcast and a replay will be available on the Investor Relations section of our website for 30 days. Before we begin, I would like to remind you that during today's call, we will be make forward-looking statements regarding future events and expectations. We caution you that such statements reflect our judgment as of today, August 11, based on factors that are currently known to us and our actual future events and results could differ materially due to a number of factors, many of which are beyond our control. For a more detailed discussion of risks and uncertainties affecting our future results, we refer you to our filings with the SEC including the Form 6-K we filed earlier today which contains our Q2 fiscal year 2016 financial results. Sphere 3D disclaims any obligation to update or revise these forward-looking statements to reflect future events or circumstances. During the call, we will also discuss our non-GAAP financial measures, unless we specifically state otherwise, the non-revenue financial measures we discussed today are not prepared in accordance with the Generally Accepted Accounting Principles. A reconciliation of the GAAP and non-GAAP results is provided in today's press release and is posted on our Investor Relations section of our website. With that, I will turn the call over to Eric. Please go ahead.

Thank you, Lauren. Good afternoon and thank you for joining us today to discuss our second quarter results. We continue to make progress on our strategy to deploy a combination of public, private and hybrid cloud solutions that are available and accessible to everyone. We believe the way to do this is to deliver one unified and vertically integrated offering converging our virtualization and storage technologies. We would like to spend some time today providing you an update on our partnerships, customer engagements, and other corporate developments which are driving our progress as we execute on our strategic plan. But before I do so, I'd like to quickly overview our financial results for the second quarter. Second quarter revenue came in at $19.6 million which is an increase of over 6% from Q2 of previous year and equal to our prior quarter’s revenue as we held operating expenses to less than $12 million when excluding shareholder based compensation. Kurt will review all the numbers in detail. We view this performance as a positive indicator of our stabilization of our traditional storage business. Also these results are in line with our previously shared expectations to see a revenue ramp from our integrated solutions in the second half of this year. We continue to be encouraged by our partnerships and deal pipeline, and the strategic progress we achieved last quarter. I would like Peter to provide more details on some of the exciting new developments and progress we continue to make. Peter?

Thanks, Eric, welcome everyone. In our last earnings call, we highlighted the introduction of our V3 Virtualization Solutions which provide a workload optimized and distributed approach to Virtual Desktop Infrastructures for VDI. We're pleased that just before the end of Q2 we were able to move to general availability of the new platform and provide the market with an extensive fulsome family of simple, yet powerful solutions that are purpose built for VDI. We believe their simplicity and versatility makes our solution more accessible and affordable to a broader set of customers than what is being addressed by competitors in the market today. Our relationships with VMware [in Video] [ph] stem from our unique approach and specific focus on VDI. Included in the general availability release of our V3 appliance family are a number of proprietary technologies within our Desktop Cloud Orchestrator software and the ability to leverage our patent pending, distributed desktop hyper converged architecture. This GA release represents the broadest launch of product offering that we've ever done at the company. Within the launch a total of ten appliances were introduced, each designed to be workload optimized to meet a number of targeted deployment used cases for both greenfield deployments, as well as extending deployment within the existing VDI customer environments. The V3 family now includes purpose built appliances and architectures that can provide both, business graphics and higher end professional graphics solutions. We've done this in concert and leverage graphics processing technology from our partner, NVIDIA, who is considered the industry leader in visual graphics computing and the inventor of the GPU processor. We also remain committed to our strategy to utilize proof-of-concept or POC deployments as the first stage of engagement to validate V3's value and differentiation in virtual desktop environments. We've mentioned previously that we had multiple POCs and we're pleased to see that some of these have since closed and are moving to the next stage and other POCs are lining up. Our first couple of Elite partners have built healthy pipeline of deals that range in size from as little as $60,000 to over $1 million. We have kicked off additional proof-of-concept efforts in North America and have multiple opportunities in this quarter's pipeline as well. We continue to deepen our strategic relationship with our technology partners by integrating and certifying our solutions with them. Over the next couple of months, we expect to be able to share with you more information on accreditations and certifications that will continue to facilitate the joint go-to-market efforts, already underway with these partners. Now I'd like to take a moment to give you an update on the progress we've made with Glassware 2.0 based products. Just last month, we held a soft launch event in EMEA for Glassware with the UK-based channel partner. The event focused on how to extend the life of the enterprise 16-bit Windows applications, as well as delivered 32-bit Windows solutions on 64-bit Windows10 platforms. Enterprise customers representing over 70,000 end-user seats attended the interactive, thought leadership and demonstration day at one of London's most recognized modern landmarks, the Gherkin. We've already been engaged to provide multiple large-scale Glassware 2.0 POCs and continue to bring on board additional opportunities, in both the U.K. and North America. In addition, we've now successfully built the access to Glassware needed to utilize some traditional virtualization performance testing tools to benchmark our performance and provide industry accepted performance metrics for direct comparison by CEOs, decision makers, and industry analysts, alike. But the very unique way that we managed the underlying Windows serving [indiscernible], just took a little bit of time to do so, with this now complete we can start to provide apples-to-apples comparisons. As we or other third-parties complete these reports, we'll publish them on our site when possible and some of you probably already noticed a new literature that helps describe some of the nuances of the current product version of the Glassware or V3 along with blogs that provide some additional color. We encourage you to follow us on social media for updates when these blogs reports are posts. With the introduction of the Elite and ElitePro certification program that we announced in June, we further empowered our channel partners to succeed in deploying virtualization solutions by reducing the cost and complexity of architecting, deploying, and supporting VDI or virtual application solutions; Elite and ElitePro programs enable our partners to increase their customer base, as well as broaden their offering options to their current customers. The addition of [indiscernible] and iPro as the inaugural partners in the certification program has played an important role in continuing to build a healthy pipeline of potential new customers, as well as increased our scale and reach. We're routinely introducing our Elite programs to both existing pre-qualified channel partners, as well a number of new resellers in concert with our technology partners. Last quarter, we also announced a handful of developments on the storage side of our business. Including that our SnapServer NAS has been chosen as a best of breed by a number of channel partners to ensure reliability and ease of installation and deployment for IP video surveillance applications. We also continue to strengthen the SnapServer and SnapCLOUD on-premise cloud storage products with the proprietary encryption, continuous replication ECR. The Snap ECR technology augments the nearest data replication and collaboration offerings within the Snap family of products, including SnapSync file syncing share. SnapSync facilitates secured private and hybrid cloud management and sharing of data in a simplified and high performance way that we believe differentiates us in the market, gives us access to a larger market to serve. We also continue to expand our partnership with Microsoft which allows us to provide hybrid cloud solution through the Azure cloud infrastructure. One example of this Azure expansion is our work with Microsoft in their Azure Government infrastructure. As we announced previously, we received confirmation from Microsoft that SnapCLOUD storage product are the first virtual NAS storage solutions that have been successfully tested and validated in the Microsoft Azure Government infrastructure. The Microsoft Azure Government is a separate and network isolated instance of Azure cloud that is dedicated to meet U.S. government security, privacy and redundancy demands. We're planning co-marketing efforts with some select resellers that focus on government opportunities and we've been acknowledged on the Azure Gov systems architecture blog form as a designed reference for the deployment of Azure marketplace applications within Azure Gov environment. The building a robust pipeline introduction of this unique product capabilities across the portfolio provides us the tools needed to achieve some growth. And now with that, I'd like to hand it off to Kurt to go through the financials.

Thank you, Peter. Good afternoon everyone. Let me provide some detail on our financial results for the second quarter. Please note following financial highlights reflect the addition of the RDX products acquired in August 2015. Total revenue for the second quarter of 2016 was $19.6 million compared to $19.6 million in the first quarter of 2016, and up from $18.4 million in the second quarter of 2015. OEM revenue for the second quarter of 2016 was $3.6 million compared to $3.9 million in the preceding quarter, and up from $2.7 million in second quarter of 2015. Branded product revenue was $13.9 million in the second quarter of 2016 compared to $13.4 million in the first quarter, and up from $12.9 million in the same quarter last year. Regionally, our branded product revenue for the second quarter of 2016 was 15% in APAC, 24% in the Americas, and 61% IN EMEA. Warranty and service revenue was $2.1 million in second quarter of 2016 compared to $2.3 million in the first quarter of 2016, and $2.8 million in the second quarter of 2015. Total product revenue for the second quarter was $17.5 million compared to $17.3 million in the preceding quarter and up from $15.6 million in the same quarter last year. Disk systems revenue was $11.8 million in the second quarter of 2016 compared to $12.2 million in the first quarter of 2016, and up from $8.6 million in the same quarter last year. Tape automation, tape drives and other related revenue was $5.7 million in the second quarter of 2016, up from to $5.1 million in the first quarter of 2016 and down from $7 million in the second quarter of 2015. Our gross margin for the second quarter of 2016 was 29.6%, compared to 30.4% in the first quarter of 2016, and 31.5% in the second quarter of 2015. The gross margin includes the amortization of intangible assets and cost of goods sold and the amount of approximately $600,000 for each of the comparable quarters. When excluding the amortization relating to the intangible assets, the gross margin was 32.6% in the second quarter of 2016 compared to 33.3% in the first quarter and 34.9% in the second quarter of 2015. Total operating expenses for the second quarter of 2016 when excluding share-based compensation were $11.8 million compared to $11.3 million in the first quarter of 2016, $13.8 million in the same quarter of last year. When compared to the second quarter of 2015, operating expenses excluding share-based compensation were down $2 million or 14.5%. Depreciation and amortization expense in each of the first two quarters of 2016 was $1.6 million compared to $1.9 million in the second quarter last year. Net loss for the second quarter of 2016 was $9.6 million or a loss of $0.19 per share, compared to a loss of $8.1 million or $0.18 per share in the first quarter of 2016, and a net loss in the second quarter of 2015 of $8.9 million or $0.25 per share. Adjusted EBITDA, which excludes share-based compensation expense and warrant liability revaluation, in addition to interest, taxes, depreciation and amortization, was negative $4.6 million for the second quarter, compared to an adjusted EBITDA of negative $3.1 million in the first quarter of 2016 and negative $5.3 million in the second quarter of 2015. The increase in the loss during the second quarter of 2016 was largely due to the impact of foreign currency fluctuations in a one-time expense including G&A. On the balance sheet, total cash and cash equivalents at June 30, were $4.3 million compared to $8.7 million in December of 2015. At June 30, we had $8.2 million outstanding under our credit facility, and $10 million outstanding under our term loan along with $24.5 million outstanding in our convertible note. With that, I will turn the call back over to Eric.

Thank you, Kurt. In summary, the progress we have made this quarter on our partnerships along with the growth of our Certified Virtualization Solution Elite Partner Program allows us the scale as our portfolio of products become recognized through our commercial validation. We continue to focus on growth and believe the foundations we have set through executing on our strategic initiatives, including leveraging our existing partnerships and increasing marketing awareness of our superior architectures and features of our products will yield growth in the second half of 2016. At this time I would like to turn it over to the operator and open the line for questions.

[Operator Instructions] Your first question comes from the line of Hubert Mak with Cormark Securities. Your line is open.

Thanks guys. So it sounds like you guys have a number of PoCs are hovering in the background right now. How do we think about those coming through in the back half of this year? Are those expected to lead to revenue ramp coming into the second half of this year or is that more in the 2017 timeframe? And then along with that question, I think last quarter it was suggested that the second half would be higher than the first time. I believe it was [50%] [ph]. I think that was the number here but can you sort of give us sort of a revised guidance how that -- is that still the same thinking in the context of the seasonality as well. I think Q3 is probably weaker I believe in Europe. So if you can just sort of give us some color on that?

Hi, Hubert, how are were doing? This is Eric.

Good.

Good. Good to hear from you. So just -- I'll answer the first part and then I'll pass it over to Peter and Kurt. So how the development of our virtualization solution go is that we have a POC and the customers do a proof-of-concept and then they expand from that to a pilot and then from that to full production. And so as you see the POCs that we started the first half of the year and as Peter mentioned, some of those has already moved into pilot, and then we see those moving to full production. So that's where you'll see a bit of the revenue ramp happening in the second half of the year. Second question, Kurt, I'll pass that over to you.

Yes, Hubert, happy to go over that. You had brought this up last quarter and what we stated yes there is some seasonality in Q3 that we hoped to offset with opportunities in other regions because of the -- our strength in Europe, obviously we do see that impact in the third quarter. However, we are still comfortable with stating that the second half of the year we believe will be -- will show upside for the first half. However, I don't recall giving any percentages on that and I'm not prepared to do so at this time.

Okay. And then just to follow-up on the POCs, can you talk about sort of the magnitude of these POCs that came through from first half and into pilots? How do we think of that in terms of the revenue coming through -- like how fast the ramp versus like -- is it going to be a one-year timeframe from -- to full production or is it a longer timeframe?

So I can answer that. I mean POCs can run from literally as little as a week to a quarter, right. Traditionally they run somewhere in that two to four week's period of time. And then at that point they usually ask you to look to a pilot or they didn't like their POC obviously, but they don't take that long. Now some of the POCs are bigger just because of the magnitude, so look at it as a percentage, you're going to POC a very small subset of your organization. You're going to pilot a larger subset and you're going to go full production. So if you're looking at a user with 10,000, their pilot might be 300 to 400 users and their POC maybe a single box; by the same token if they have VDI experience and they've already deployed a 1,000 their pilot may be another 1,000. So it does vary from opportunity to opportunity. Again, we've mentioned before, we'll mention again, the way we've designed and the way we've built it is we plug into existing opportunities so much of our pipeline is not just POCs, it's actually existing VDI deployments where they are actually using us for the problems they've already encountered and this goes around our distributed approach to what we do, usually its performance based. So you're plugging into someone who already has VDI budget, already has a plan they failed at what they were doing, and they are looking for somebody who can actually deliver what was originally promised and that shortens the sales cycle dramatically.

Okay. And then on the Glassware 2.0, you guys have a number of POCs who are in U.K. and I guess North America, can you talk about the pipeline, how has that grown, can you sort of give us - qualify that –at all from like say last year to this year, or like it would be great if you can just kind of quantify how that's ramping?

Certainly, so what we did in EMEA was the first time we've got outside of North America. It was extremely positive, there is a bunch of blogs, pictures, just some stuff on content actually online and you can see it from the event itself that our partner published, but we had about 70,000 seats represented in that, we had a number of POCs that have already been engaged with us, pretty sizable as POCs and represent some pretty good opportunities for this year. So we see those coming this quarter, next quarter at the latest, in terms of some of the larger stuff for Glassware.

Okay. And then just a couple more here on the partners; can you sort of talk about the partner channel, how that's also ramping and where -- as I know you were sort of targeting a subset of those that make sense to you from maintaining that focus. So can you just sort of just give an update as to where you think you are on the partnerships and how that would drive revenue?

So as you know the GA came in July 19 I believe is when V3 became GA. Since then we've engaged -- I don't have an exact number off the top of my head but quite a few, some of them being our resellers, our partners that we're enabling, others are our technology partners who we grandfathered because of their underlying skillset, to be able to take on a product like this pretty quickly. And so we're definitely seeing a fair bit of ramp as far as that goes and we've got a really good dedicated team that manages that internally. So it's almost running like its own small little team that is committed to it. So we're seeing a lot of activity as far as bringing on partners. The problem we saw -- for those who know VDI, it's pretty immediate and obvious to them what we do that's unique, and it really does boil around performance. At the end of the day no one is going to replace their real desktop with a slower virtual desktop and that's the bottom line. So it's relatively easy to demonstrate that architecture as to why we're different. So it's pretty quick to get them on boarded.

And are you actively seeing deals coming through from the partner channel…?

Yes, absolutely.

Okay. And then just lastly on the cost side, given that you guys are expecting sort of revenue ramp or this revenue coming through here. How do we think about the cost, do we expect there will be some investments here or do you think you can hold the base -- the current base?

Well, I mean I can give it to Kurt but I think you guys have seen with GA came all the back work and not to be underestimated what it takes to bring out an entire family of ten appliances, and keeping in mind that those appliances can be mixed and mashed and used for other purposes as well, not just for VDI but we have something called SmartNotes which is called VSAN, that money was spent starting last year in November leading up to GA, that was a big part of the investment that we made. So you've seen a fair bit of that already get absorbed by the company in terms of that product launch. And beyond that I'd let Kurt answer the rest of the question. Kurt?

Yes, you're right. I don't expect to see any notable increase in operating expenses over the near-term. I think we've committed to the reduction that we put in place and do not expect to see those increases in the near term.

Okay, great, thanks.

[Operator Instructions] Your next question comes from the line of Hoch Cho with Greenlaw. Your line is open.

Hello, I'm just curious about the cash situation. What was the cash used this quarter? And how much cash do you have available for this coming quarter? Thank you.

This is Kurt. The cash burn this quarter was higher than last, primarily to pay down of AP accrued liabilities along with some inventory investment that we made during the quarter, and so the cash used in operations was up. As of June, we had $4.2 million from there. We would look to have -- hopefully, have some additional capacity in our credit facility, as you know, the credibility we signed up with Opus Bank was upto $10 million of capacity based on the company's collateral base. And so that would be the first place we look if we needed additional capital in the future.

Sorry, so what was the cash used?

The cash used in operations was $8.5 million and the entire increase can be viewed as pay down of AP accrued liabilities along with some additional inventory expense that was brought in during the quarter.

Okay. So have you all started talking to OPUS about enlarging the credit line?

At this point I can't go into specific conversations we're having obviously with our lending institution. So as of now the facility is as disclosed in the public record.

Okay. Do you have enough cash to get through the quarter without raising additional debt or equity?

Like I said, at this point we'll take a look at the lines that we have in place. If we feel there is requirement for additional capital for our growth activities, we'll review it at that time.

There are no further questions at this time. I'll turn the call back over to the presenters.

Thank you, operator. I'd like to thank everyone again, for joining the call today and allowing us to share with you our Q2 results. And the progress we continue to make. I look forward to talking to everyone in the future on our next quarter call.

This concludes today's conference call, you may now disconnect.