Sphere 3D Corp. (ANY) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Kirsten. And I will be your conference operator today. At this time, I would like to welcome everyone to the Sphere 3D Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. I will now turn the call over to Lauren Sloane, Investor Relations for Sphere 3D. You may begin your conference.

Thank you, operator, and good afternoon everyone and thank you for joining Sphere 3D's earnings conference call for the third quarter of fiscal year 2017. 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 Q3 earnings release over the wire service and we have 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 making forward-looking statements regarding future events and expectations. We caution you that such statements reflect our judgment as of today, November 9, 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 the risks and uncertainties affecting our future results, we refer you to our filings with the SEC including the Form 6-K, which is expected to be on file later today, which contains our Q3 fiscal year 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 discuss 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. With that, I will turn the call over to Eric. Please go ahead.

Thank you, Lauren, and thank you everyone for joining our third quarter earnings call. I'm excited to be able to share with you an update on our corporate strategy, provide a brief overview on our financial results and discuss the strategic and financial progress we have made. Our corporate strategy has been and continues to be to focus on driving both profitability and revenue growth for our overall businesses. And we have made great progress towards that goal. This quarter, we saw revenue growth from both our storage and virtualization groups, while also dramatically improving our adjusted EBITDA. Some of our financial results are as follows:. Revenue grew 17% to $21.7 million when compared to $18.5 million in the third quarter of the previous year. And when compared to the previous quarter, revenue grew 12% from $19.4 million in the second quarter of 2017. Our adjusted EBITDA showed significant improvement year-over-year and quarter-over-quarter. Adjusted EBITDA improved by 84% to a loss of $629,000 from a loss of $0.4 million in the third quarter of last year. When compared to the previous quarter, adjusted EBITDA improved by 77% from a loss of $2.6 million in the second quarter of 2017. I would also like to note that our results for the first nine months of this year were also strong and demonstrated our execution to driving revenue growth while continuing to improve our adjusted EBITDA. We view these financial achievements as an indication that we're having the right corporate strategy, the worldwide team is executing the plan and the growing market adoption of our storage and virtualization solutions. While our market penetration and the growth of our pipeline in virtualization is on track, I want to provide a little more insight into the data protection and archive portion of our storage group also called DP&A. DP&A consists of our RDX platform, our automation portfolio, media and related services. On a pro forma basis, DP&A revenue was over $18 million for this quarter as well as a positive adjusted EBITDA. In fact, on a pro forma basis, DP&A has shown a positive adjusted EBITDA for every quarter since 2015. I am pleased with the key milestones we and I'm excited to see the commitment and dedication that our worldwide team continues to make towards implementing our strategic plan, which is now showing up in our financial results. I believe we have the building blocks to continue to execute on our strategy for growth while maintaining our focus on the path to profitability, to drive long-term shareholder value and stability for our company. To further illustrate the progress we have been making, I would now like to hand the call over to Peter, who will highlight some specific achievements in the quarter. Peter?

Hi, thanks, Eric. And I thank everyone for attending today. Starting with the virtualization products, which are sold on the HVE and Glassware brands. We're excited to announce this quarter another customer win in excess of $1 million. This recent HVE win represents just one of the many opportunities we're working on and also have the capacity to become million dollar accounts for us. We continue to see solid results in the education vertical, but are seeing success in other verticals as well. We're making significant progress with verticals that require graphic-intense computing in their operations such as architecture and construction firms as well as healthcare entities. We recently demonstrated the incredible performance of our HVE product line at a series of built conferences and were even asked to provide the virtual workspaces for their GPU labs at the conference. There are some great testimonials from the attendees on the video section of our website, and I encourage you to have a look when you have the opportunity. Additionally, at VMware's Annual VMWorld trade show in Los Vegas held in August this year, we launched our new HVE Datrium-ready certified nodes, a unique architecture for the open software-defined data center. Sphere 3D and Datrium have created a series of HVE bundles that accelerate data center transformation by incorporating proven solution designs. These bundle designs will meet and exceed enterprise future performance and capacity demands. During the show, we held a joint Datrium Sphere 3D VIP partner and customer reception at a full capacity, and our approach was well received. As a matter of fact, that event has already resulted in HVE customer win and several existing over intended resellers adding HVE virtualization solution to their product lineup. The momentum we are building and solid foundation afforded by the HVE acquisition we completed earlier this year is now spilling over to the Glassware product portfolio. We've been working with a number of customers in providing elegant and simple solutions to their legacy application problems. We're seeing an increasing number of opportunities and expect to see these drive revenue going forward. Now turning to the Overland-Tandberg storage group. As Eric mentioned earlier, the storage site has demonstrated that we have some differentiated solutions that can drive user adoption and top line growth. We believe that the data protection archive portion has further demonstrated the opportunity for revenue growth and profitability, and we'll be further focusing our efforts on increasing the velocity of their revenue growth going forward as well. We believe that we will see continuous momentum in 2018 with a number of recent product launches including solutions that address the current global datacenter security threats and regulatory data protection requirements as well as our hybrid cloud capabilities for both our RDX and NEO series product line. I think it's hard not to get excited about the opportunity for growth that the Overland-Tandberg, rdxLOCK and the RansomBlock software offerings represent. These software solutions are built to defend against enterprise software security threats like ransomware, a growing global pandemic that has caught many organizations flat-footed and placed them at risk. Last year, the United States FBI computer crime study reported an average of 4,000 ransomware attacks a day worldwide. And then, this year, many of you may recall the massive worldwide ransomware attack aptly named WannaCry that occurred May 12 of this year. On that day, the first major morning news coverage involved attacks on Telephonica Services in Spain and The National Health System in the United Kingdom. And then many more attacks felt throughout the day. By 7:30 p.m. Pacific Time, a total of 80,975 attacks occurred in 205 countries. The high number of enterprises impacted that they emphasized that conventional backup and antivirus software solutions that most enterprises deploy are not sufficient to protect business-critical company network data and online operations. We believe that rdxLOCK Lock and RansomBlock software is the answer to this problem, in that it provides an additional ransomware-proof layer and can be easily deployed on proprietary RDX platform in less than 15 minutes. The ease of use means that the implementation does not require the expertise of IT data administrators, making it well suited for companies of all sizes and individuals. We've already seen a positive response to RansomBlock offering from partners, as the webinars launched last month to promote the solution have had the highest total webinar attendance that we have ever seen in the last couple of years. Another expected driver of additional growth and profitability are our hybrid cloud architectures of the Overland-Tandberg storage archive solutions. These allow organizations and individuals the ability to automatically synchronize with public cloud to provide an additional layer of data protection. We started this initial hybrid cloud integration offering with Microsoft Azure cloud with plan to support other cloud storage infrastructure targets in the future. With approximately half of our channel business represented in Europe, another key market trend that we expect to drive our overall revenue opportunities is the European Union General Data Protection Regulation Compliance requirement, which is also called GDPR. GDPR goes into effect May 2018 and is the compliance requirement that will need to be addressed by any European Union and multinational companies with business in EU, thus representing CI to market growth driver for that region. Industry analysts have forecasted that GPDR alone will spur the IT security market in Europe to grow over 50% in 2018. This will require many of our channel partners and customers can make changes to their data protection and oversight technologies and processes to prepare for the new rules. The Overland-Tandberg storage offerings are already compliant to GDPR. With this advantage, coupled with our strong and long-standing channel presence in Europe, we're optimally positioned to provide efficient and easy-to-implement solutions that ensure readiness and compliance in the fields of business continuity, disaster recovery planning and long-term archive. And finally, another critical quarter milestone we achieved is our first purchase order and subsequent revenue that was derived from bundled products from both HVE virtualization and Overland-Tandberg storage product portfolios. This demonstrates the synergies and additional combined value that can be achieved for our partner customers as you previously announced, the first of what we hope to be many wins like this was from a European-based FTSE listed company. They selected HVE Virtualization Desktop Infrastructure, coupled with Overland-Tandberg SnapServer All Flash Array for a strategic desktop modernization program and storage expansion project. The customer has a workforce of approximately 80,000 people worldwide and a history of success that dates back over 100 years. We believe that we are well on our way to repeating this type of success with other customers in multiple geographic locales. I'll now hand the call over to Kurt, who will give you more detailed overview of our financial results. Kurt?

Thank you, Peter. Good afternoon, everyone. Let me provide some detail on our financial results for the third quarter of 2017. Please note the following financial highlights include results of the HVE/UCX acquisition on January 27, 2017. Total revenue for the third quarter of 2017 was $21.7 million, up 11.9% from $19.4 million in the second quarter of 2017 and up 17.3% from $18.5 million in the third quarter of 2016. OEM revenue was $3.9 million for the third quarter of 2017, up 14.7% from $3.4 million in the preceding quarter and up 21.9% from $3.2 million in the third quarter of 2016. Branded product revenue was $15.7 million in the third quarter of 2017, up 14.6% from $13.7 million in the preceding quarter and up 18% from $13.3 million in the third quarter of 2016. Regionally, the branded product revenue for the third quarter of 2017 was 13% in APAC, 38% in Americas and 49% in EMEA. Warranty and service revenue was $2.1 million in the third quarter of 2017, down slightly from $2.3 million in the preceding quarter and up from $2 million in the third quarter of 2016. Total product revenue for the third quarter of 2017 was $19.6 million, up 14.6% from $17.1 million in the preceding quarter and up 18.8% from $16.5 million in the same quarter last year. Disk systems revenue was $14.1 million in the third quarter of 2017, up 22.6% from $11.5 million in the preceding quarter and up 27% from $11.1 million in the same quarter last year. Tape automation, tape drive and other related revenue remained relatively steady at $5.5 million for the third quarter of 2017 compared to $5.6 million in the second quarter of 2017 and $5.4 million in the third quarter of 2016. Our gross margin for the third quarter of 2017 was 31.1%, up from 27.7% in the preceding quarter and 28% in the third quarter of 2016. Gross margin includes the amortization of intangible assets and cost of goods sold in the amount of approximately $600,000 for each of the quarters. When excluding the amortization related to the intangible assets, the gross margin was 33.7% in the third quarter of 2017, up from 30.6% in the preceding quarter and 31.1% in the third quarter of 2016. Please see today's press release for a reconciliation of this non-GAAP gross margin to GAAP gross margin. Total operating expenses for the third quarter of 2017 when excluding share-based compensation were $9.3 million, down from $10.1 million in the preceding quarter and down from $45.1 million for the third quarter of last year. During the third quarter of 2016, it included a non-cash impairment of goodwill and acquired intangible assets of $34.4 million. When compared to the third quarter of 2016, operating expenses excluding share-based compensation and the non-cash impairment charge were reduced by 13.1%. Deprecation and amortization expense was $1.5 million in each of the second and third quarters of 2017 as well as the third quarter of 2016. The net loss for the third quarter of 2017 was $3.5 million or $0.59 per share. This compares to a net loss of $7.5 million or $1.81 per share for the preceding quarter and a net loss in the third quarter of 2016 of $43.3 million or $21.10 per share. All per share information is reported after giving effect to the 1 for 25 reversal split that occurred on July 11, 2017. Adjusted EBITDA was negative $629,000 for the third quarter of 2017, improved from adjusted EBITDA of negative $2.6 million for the second quarter of 2017 and negative $4 million for the third quarter of 2016. This is an improvement of 77% from the previous quarter and an improvement of 84% from the third quarter of 2016. Adjusted EBITDA excludes share-based compensation expense, impairment, warrant revaluation gain in addition to interest taxes, depreciation and amortization. On the balance sheet, total cash and cash equivalents at September 30, 2017, was $3.9 million compared to $5.1 million at December 31, 2016. Cash used in operations was $1.6 million during the third quarter of 2017 compared to $3.1 million in the second quarter of 2017 and $1.8 million for the third quarter of 2016. Cash used in operations was $8.6 million for the first nine months of 2017, a reduction of 44.9% from the $15.6 million for the first nine months of 2016. At September 30, 2017, we had $18.2 million outstanding under our third-party debt, $24.5 million outstanding under our related party convertible note and $769,000 outstanding under our related-party term loan. With that, I will turn the call back over to Eric.

Thank you, Kurt. Overall, we see investments, we have made in technology and our hybrid cloud strategy over the last two years are gaining traction, and we believe the work we have done has provided a solid foundation and has positioned the company for an even better 2018. Our solutions are ready to take advantage of the current and future market dynamics. And although the success is never in a straight line, we believe our results for this quarter and the last nine months show that we are making significant progress. Lastly, because of our strategic options that we continue to explore with Ernst & Young, we will not have the Q&A portion of the call today. However, I hope we have conveyed to you that our strategy is working, and we are executing our plan. We believe we have built blocks to continue executing our plan for growth while maintaining our focus on the path to profitability, to drive long-term shareholder value and stability for the company. We'd like to thank you, again, for joining us today. We wish, everyone, a happy holiday season. We're working hard to continue to improve upon our financial performance throughout the balance of the year and throughout 2018. And we look forward to updating you in the New Year.

This does conclude today's conference call. Thank you for your participation. You may now disconnect.