Sphere 3D Corp. (ANY) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Kirsten and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Sphere 3D First Quarter Fiscal Year 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] I would now like to turn the call over to your host Mr. Mike Bishop of Sphere 3D Investor Relations. You may begin sir.

Thank you, Kirsten, and good afternoon everyone and thank you for joining Sphere 3D's earnings conference call for the first quarter of fiscal year 2017. With me on the call today are Kurt Kalbfleisch, our Chief Financial Officer; Peter Tassiopoulos, our Vice Chairman and President; and Eric Kelly, Chairman and Chief Executive Officer. Unfortunately, Eric has laryngitis today and he will be making opening comments, but we may have others do the majority of the speaking. Prior to the call, we distributed our Q1’s earnings release over the wire services and have posted 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, May 11, based on factors that are currently known to us and that 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 Q1 fiscal 2017 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 non-GAAP financial measures, unless we specifically state otherwise, the non-revenue financial measures we discussed today are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the GAAP and non-GAAP results is provided in today's press release and is posted on the Investor Relations section of our website. And with that, I will turn the call over to Eric. Please go ahead.

Thank you, Mike. Welcome to our first quarter 2017 conference call. We drove many significant developments since our last call and we would like to provide an update on the progress we’ve had in executing our corporate strategy and a significant improvements we continue to make towards our financial and operational efficiencies. Before I lose my voice completely, I will pass the call over to Peter.

Thanks, Eric. I appreciate you being able to get out a couple of sentences. Before expanding on those topics, I think it's important that your recent financial results against the backdrop of the transformation plan, which started 24 months ago, in the first quarter of 2015, which represents the first full quarter after the merger with Sphere 3D and Overland Storage. I believe this 20 months view gives a full perspective on the depth and breadth of improvements we have made as a business. To summarize, first our adjusted EBITDA is showing significant improvement since the first quarter following the merger with Overland. In Q1 2015, we reported an adjusted EBITDA loss of $6.1 million. Compared that our adjusted EBITDA in Q1 2017, which was a loss of less than $1 million, represents an 84% improvement compared to Q1 2015 and 60% improvement quarter-over-quarter when compared to the Q4 2016 adjusted EBITDA loss of 2.4. Our revenue for Q1 2017 was $21.7 million, which represents a 60% sequential quarter-over-quarter increase. The HVE and UCX ConneXions acquisition we completed in January. This focuses virtualization and convert solution represented $2.8 million of this Q1 revenue. In addition since the Q1 2015 fiscal year, we have made consistent improvements in operational efficiencies and the modification of the product mix to achieve a higher gross margin. We achieved this progress while maintaining a consistent revenue stream to position us for growth in 2017. We're seeing improved outlook and we will continue to drive the organization to achieve adjusted EBITDA positive results. Kurt will share more details on our financials shortly, but I hope this brief overview shows you the progress that we've achieved today. From a strategic perspective and moving on in our update, I would like to spend some time reviewing a little history on where we have been and enumerate the steps we have taken and are still taking to put the company on a footing to ensure future growth. When we look at the developments of the company, we firmly believe the strategy we've been executing is the right one, delivering unique converged and hyper-converged infrastructure platforms to private public and hybrid cloud environments. The definition of converged infrastructure as it brings together that typically disparate infrastructure elements that power the data center including servers, data storage devices, networking functions, virtualization, management software orchestration and applications. We believe we offer unique and differentiated full range of solutions and technologies for this market that includes software defined storage, server and desktop virtualization, application containerization coupled with data backup in archival. The industry experts are now agreeing with the strategy we began implementing in the beginning of 2015. Gartner was reporting that by 2019 approximately 30% of the global storage capacity in enterprise data centers will be deployed on software defined storage or hyper-converged integrated systems, up from less than 5% today. As another industry data point, the converged infrastructure market is expected to grow approximately 24% annually to markets and markets research. Well the storage market, which has historically provided the majority of our revenue, the past 24 months have been a challenging environment with worldwide enterprise storage declining by 6.7% year-over-year for March 2017 IDC report. However, despite these circumstances, the company continued to maintain their market share as the overall market suffered turbulence. And now with our acquisition of HVE and UCX as well as the investment in our roadmap, we see a path for growth. Over the past 24 months, our efforts in virtualization and containerization have also been challenging, but in a different way. The adoption of our proprietary virtualization and container technologies, V3 and Glassware, has been slower than originally anticipated when the Overland merger was completed. We spent the last two years working closely with a number of the leaders in the industry as we’ve mentioned in the past such as Microsoft, VMware and NVIDIA to help us drive market awareness by educating the market and customers on the unique benefits of our technologies. While our containerization technology has some very unique attributes that we believe are ahead of their time, the market was not adopting them as quickly as we needed. We recognized the importance of a skilled professional services team to effectively architect and deploy our solutions for customers. With these learnings that led us to move forward on acquiring a full team that can support our unique technology and deliver a broader hyper-converged solution with which these virtualization and container technologies could integrate. As you maybe aware at the end of the January, we acquired HVE and UCX ConneXions. HVE ConneXions is the hybrid cloud technology company focused on converged and hyper-converged infrastructure and its sister company Unified ConneXions has the requisite architect engineering and IT expertise that can deliver the support functions for successful pre and post sales of virtualization solutions with a historical focus on corporate government and educational institutions. These were successful companies able to close outside deals relative to their size and we saw their technology and skill set as a perfect set to bolster our virtualization portfolio and fill the gaps to address the rapidly growing converged infrastructure markets. We needed a team that could drive our strategy into the market and HVE and UCX provided these capabilities, but they were already deeply versed in our market and familiar with our products. Once aboard they benefited from our scale and immediately became more effective through the synergy achieved from our co product offering. Furthermore, the UCX and HVE acquisition was accretive from day one. And I'd like to touch on some of the other milestone in this quarter. For our virtualization offerings, initial results have been very strong. Since our acquisition in January, we've been selected by Biloxi Public School system, Beck Group, GMP accounts, Alcorn State, Texas Spine and Joint Hospital and a $3 million deal with an ISV in Texas. Lastly, we announced a partnership with Datrium where we now provided HVE Datrium ready node bundles for simple, blazing fast virtual server and desktop performance. Datrium is considered in what they call Open Convergence for private clouds. They are led by the founders and early top architects of VMware and Data Domain. With the HVE servers are preconfigured with Datrium DVX and host-local flash, we are able to deliver a turnkey cost effective implementation without sacrificing performance and advanced features. We successfully deployed the solution and build the funneled opportunities together. With the containerization field, we created a very simple way to deploy virtual appliances that utilize Glassware for the delivery of applications when coupled with the new technical skill sets from the acquisition of HVE and Unified ConneXions, we have all the ingredients necessary to successfully deliver to customers with first truly differentiated approach for Application Virtualization. We're also working towards integration of V3 technologies such as our proprietary desktop cloud Orchestrator software into the HVE product line. With a significant performance capability and install footprint of HVE, we believe that the addition of the technical capabilities of the DCO will give us an even greater competitive advantage and drive additional growth within this product line. We anticipate to be able to introduce the new capabilities in the next few months that they will also be backward compatible to the existing HVE deployments in many cases. We believe this momentum demonstrates we're beginning to move the needle for growth and is evidence of the inflection point that I mentioned earlier. On the storage side, as mentioned, our storage business has been strong in the face of an adverse environment and it continues to be a bedrock part of our business. This year marks the ten year anniversary of our proprietary RDX removable disk technology. The expansion of this technology continues with partnerships with our OEM such as HP, IBM, Lenovo and Dell as well as solution partnerships with backup recovery software vendors like Veritas, Veeam and Symantec. Recently we announced that we have opened up a whole new market segment for RDX with the release of RDX utility for Mac with new plug and play solution that appears as a standard hard drive to a Mac and is also integrated with Mac time machine tools and Mac backup will give us significant opportunity to grow revenue in this product category. Despite the strong headwinds in traditional storage, we're able to not only maintain our market share, but see the potential for a number of new product introductions over the second half of this calendar year to drive additional growth. I will now pass the call over to Kurt, who will give you an overview of the financials. Kurt?

Thank you, Peter. Good afternoon everyone. Let me provide some detail on our financial results for the first quarter. Please note the financial highlights include results of UCX and HVE for February and March of this year following the acquisition in January. Total revenue for the first quarter of 2017 was $21.7 million, up from $18.7 million in the fourth quarter of 2016 and up from $19.6 million in the first quarter of 2016. OEM revenue for the first quarter of 2017 was $3.4 million, up from $3.3 million in the preceding quarter, and compared to $3.9 million in the first quarter of 2016. Branded product revenue was $16 million for the first quarter of 2017, up from $13.4 million in the fourth quarter of 2016, and up from $13.4 million in the first quarter of 2016. Regionally, the branded product revenue for the first quarter of 2017 was 14% in APAC, 36% in the Americas, and 50% in EMEA. Warranty and service revenue was $2.3 million in first quarter of 2017, compared to $1.9 million in the fourth quarter of 2016, and $2.3 million in the first quarter of 2016. Total product revenue for the first quarter was $19.4 million, up from $16.8 million in the preceding quarter and up from $17.3 million in the same quarter last year. Disk systems revenue was $15 million for the first quarter of 2017, up 29% from $11.6 million in the preceding quarter, and up 23% from $12.2 million in the same quarter last year. Tape automation, tape drives and other related revenue was $4.4 million in the first quarter of 2017, down from $5.2 million in the fourth quarter of 2016 and $5.1 million in the first quarter of 2016. Our gross margin for the first quarter of 2017 was 31.4%, up from 28.9% in the fourth quarter of 2016, and 30.4% in the first quarter of 2016. Gross margin includes the amortization of intangible assets and cost of goods sold and the amount of approximately $600,000 for each of the quarters. When excluding the amortization related to the intangible assets, the gross margin was 34% in the first quarter of 2017, up from 31.9% in the fourth quarter of 2016 and 33.3% in the first quarter of 2016. Please see today's press release for reconciliation of this non-GAAP gross margin to GAAP gross margin. Total operating expenses for the first quarter of 2017, when excluding share made compensation, were $9.5 million, compared to $9.2 million for the fourth quarter of 2016 and down from $11.3 million in the first quarter of last year. When compared to the fourth quarter of 2016 – for the first quarter of 2016 operating expenses excluding share based compensation were down 16%. The small increase in operating expenses when compared to the fourth quarter of 2016 was primarily due to the additional operating expenses from the acquisition in January of 2017, but was partially offset by other cost cutting measures implemented by the company. Depreciation and amortization expense was $1.5 million in the first quarter of 2017 and fourth quarter of 2016, compared to $1.6 million in the first quarter of 2016. Net loss for the first quarter of 2017 was $7.8 million or loss of $0.10 per share. Included within the now loss was $1.1 million non-cash purchase price adjustment for revaluation of investment. This compares to a loss of $7.5 million or $0.14 per share in the fourth quarter 2016 and net loss in the first quarter of 2016 of $8.1 million or $0.18 per share. Adjusted EBITDA, which excludes share-based compensation expense, warrant revaluation gain, acquisition costs and loss on revaluation of investment, in addition to interest, taxes, depreciation and amortization, was a negative $966,000 for the first quarter, compared to an adjusted EBITDA loss of $2.4 million in the fourth quarter of 2016 and a loss of $3.1 million in the first quarter of 2016. The improvement in the adjusted EBITDA loss during the first quarter of 2017 was largely due to the increase in gross profit during the quarter and operational efficiencies implemented in the second half of 2016. On the balance sheet, total cash and cash equivalents at March 31, 2017, was $6.9 million compared to $5.1 million in December 31, 2016. Cash used in operations was $4 million which reflects increases in accounts receivable and inventory during the first quarter, compared to $1.9 million for the fourth quarter of 2016 and $5.2 million for the first quarter of 2016. At March 31, 2017 we had $18.2 million outstanding under our third-party debt, $24.5 million outstanding under our related party convertible note and $1.9 million outstanding and our related party term loan. With that, I will turn the call back over to Peter.

Thank you Kurt. I’d also like to give everybody a little bit of an update on what we’ve been doing with corporate link, including our Board of Directors. In our business update in March of this year we highlighted that we are actively seeking additional directors for our Board. I would like to welcome our two new Board members Dr. Cheemin Bo-Linn and Duncan McEwan. We are honored they have joined our Board and we look forward to them sharing their many years of extensive experience of working with technology companies. Dr. Bo-Linn has had a successful career in both the private and public markets and we believe her knowledge of strategic growth transformations and proven technology expertise in cloud software and enterprise storage will strengthen our Board. Dr. Bo-Linn’s corporate leadership experience has included serving as Vice President of IBM Corporation, as well as serving as Chief Marketing and Revenue Officer of NetLine Corp., a digital marketing firm. She also has a broad range of board governance experience where she has served on the boards of both public and private technology companies. Dr. Bo-Linn is currently President and CEO of a consulting services firm, focused on assisting companies to identify opportunities to increase shareholder value. Duncan McEwan’s experience working with technology companies specifically cloud-based software will also argument the strength of our Board and his insight will be instrumental if the company works to drive growth. He’s been a senior executive of some of the largest communication firms in Canada, including Call-Net and Sprint Canada. He’s currently the President of a consulting firm specializing in M&A and strategic advice for technology based clients. Now in closing, we have already put in place a concrete roadmap to improve the financial performance of the company and we are seeing results in the form of new and larger deals at our converged and virtualization offerings. Moving forward, we are focused on the following priorities: first, we must continue the new deal wins, improve revenue; second, we must achieve adjusted EBITDA breakeven, provide financial stability and third, continue to strengthen our balance sheet, all of which would increase shareholder value. We believe we have made the necessary and appropriate moves to set the foundation to rebuild this company and we are excited to tell the story. In the coming months we're planning to host and participate in a number of investor events. Starting with LD Micro on June 6 and additional events that are planned between now and through the fall. I'd like to thank all of you for joining Sphere 3D Q1 2017 earnings call update. And I would now hand the call to the operator who will now facilitate taking any questions you may have. Operator?

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

Thanks. Since you guys have completed the re-org can you talk about how your pipeline has built? Maybe just give some color in terms of the size of the deals that you're seeing and how that’s evolved since before to post your re-org? That would be very helpful.

Sure Hubert, hi it’s Peter here. I'm filling in for Eric today as you know. So I’ll fill in as many questions as I can. So that like a three-part question. On the pipeline, obviously the pipeline continue to build we had some stall last year in our pipeline in the sense that we were still lacking some of the expertise needed I can't stress enough how important it was to bring in technical skills that we needed to drive the deals through the pipeline. But at the time to the second part of your question, there are much larger opportunities than we traditionally were seeing predominantly because we have the ability to move into additional parts of the portfolio, as well as the deal with customers on the larger implementations. As evidenced by the fact that we signed a $3 million deal not that long ago here just a few weeks ago. Something that we would have had trouble executing on in the past is really something that we now welcome the opportunity to go after. So the deals are getting bigger the pipeline obviously is natural because the deal size is bigger, I mean, it gets bigger. And then on the execution side, we're much more capable today to actually pull this through the pipeline out to the other side and book it as revenue.

Okay. And then related to that, with some of these larger deals, obviously, it's going to take some time here to close. So how do we think about your operating cash flow or at least moving toward positive EBITDA like do we expect that like this year or is that something that's a little bit further out?

Hubert this is Kurt, I’ll take that one. We're targeting more of the short term in regards to getting that positive number. I think the progress we showed this quarter was a pretty significant step in that direction. And we’ll be targeting that in the short term. I don't want to give a specific quarter in regards to that, but we do have that in our shorter term plan.

Okay. And then just on the balance sheet. I actually don't have the numbers at least it’s now on the press release, but in terms of outstanding debt what's the situation there? Is there any update you can give? I missed the part when you guys spoke about it.

As far as the amount of outstanding debt they're down a bit from last quarter due to the payments associated with the related party term note. But they still stand at $18.2 million under our third-party debt with the $24.5 million on the convertible note and $1.9 million under the related party term loan.

Okay thanks. I’ll pass the line.

At this point there are no further questions I would now like to turn the call over to management for closing remarks.

Again…

Sorry, Eric, I'll take it. I know you're still struggling. Thank you. Well this concludes our first quarter 2017 call. We like to thank everybody for joining us. We’re back on our normal schedule in terms of conference calls and we look forward to giving you guys an update again at the next call as well as along the way through our public disclosure. Operator?