Palladyne AI Corp. Q2 FY2024 earnings call

Management Statement and Operational Highlights

• Software Business: Continued shift towards cloud offering with subscription services revenue growth driven by customer migrations to cloud and new customer wins. Cloud contracts booked in Q2 were the strongest single quarter bookings to date. Showcased MicroStrategy ONE with AI at MicroStrategy World User Conference in May 2024, unveiling Auto Express and availability on Google Cloud Marketplace.
• Bitcoin Strategy: Actively accumulating bitcoin, being the largest corporate holder of bitcoin globally. Attended Bitcoin 2024 Conference, seeing strong support for bitcoin ecosystem. Announced target to achieve a bitcoin yield of 4% to 8% per year for the next three years (2025, 2026, 2027) using organic excess cash flows, proceeds from equity offerings when accretive, and responsible use of Intelligent Leverage Framework.
• Capital Markets: Raised $800 million through 2032 maturity convertible notes in June, called for redemption of $650 million 2025 convertible notes, announced 10:1 stock split, and filed a new shelf registration for $2 billion At-The-Market (ATM) equity offering program.

Segment Performance

• Software Business: Total revenues for the second quarter were $111.4 million, down 7% year-over-year. Subscription services revenue was $24 million, an increase of 21% year-over-year. Non-GAAP subscription billings grew by 45% to $33.4 million, marking the fourth straight year of quarterly double-digit growth. Subscription services revenues now make up approximately 22% of total revenues and are larger than product license revenues. Software business revenues in Q2 were $111 million, cost of revenues were $31 million (up 14% year-over-year), and operating expenses were $99 million (up 4% year-over-year).
• Bitcoin: MicroStrategy remains the largest corporate holder of bitcoin in the world, holding 226,500 bitcoins with a total market value at $15 billion as of yesterday. In Q2 2024, the company acquired an additional 12,222 bitcoin for a total purchase cost of $805 million, an average price of $65,882. As of July 31, 2024, the company held 226,500 bitcoins with an aggregate cost of $8.3 billion or approximately $36,800 per coin. 175,721 unencumbered bitcoins were held at MacroStrategy, representing 78% of total holdings.

Guidance

• Target to achieve a bitcoin yield of 4% to 8% per year for the years 2025, 2026, and 2027.
• Anticipate short-term decrease in total recognized revenue due to transition from on-premise to cloud, but long-term growth in subscription services revenue will offset this. Cloud contracts booked in Q2 were the strongest single quarter bookings, with initial benefits of strong cloud migrations expected to flow through revenue starting next quarter.
• Expect total revenues to start growing again exiting the next 12 to 18 months as the transition to cloud continues.

Risks

• Bitcoin Price Volatility: Fluctuations in bitcoin price can significantly impact the market value of the company's bitcoin holdings, affecting the overall financial position.
• Capital Markets Uncertainty: Changes in capital market conditions, such as difficulty in raising debt or equity financing at favorable terms, could hinder the company's ability to acquire more bitcoin or fund its operations.
• Software Business Transition Risks: Delays or issues in transitioning customers to the cloud could slow down the growth of subscription services revenue and impact the expected revenue recovery in the long term.

Question and Answer

Q: MicroStrategy's equity premium to its bitcoin holdings has remained healthy over the past few months despite the bitcoin price swings and Board directions. Would you attribute this to your ability to achieve a positive BTC Yield?

A: Yes, I think that long-term bitcoin holders and bitcoin really is the longest duration asset. People that believe in bitcoin are thinking this is apex property, that you do not sell your bitcoin. When you have an investment in bitcoin you're not thinking about holding it for a short period of time and flipping it. We think the bitcoin strategy is the way to go. What we're doing is taking advantage of digital capital. The market is going to value our equity based upon their assumptions about the risk and their assumptions about the bitcoin market, and their holding period. And they'll make assumptions about what kind of BTC Yield we can generate and how important that is.

Q: On the software side, how did you feel about the Q2 cloud conversions relative to your expectations? And how should we think about the rest of the year with respect to your cloud migrations and the AI-related partnerships?

A: We had in Q2, the largest cloud bookings quarter, including conversions that we've had in the history of the company, and by about twofold, a little bit more than twofold. So, the conversions are accelerating, which is great. It's going to help our long-term ARR and our long-term recognized revenue. But as Andrew mentioned, it depresses short-term recognized revenue because it doesn't show up and get recognized in a quarter. It gets recognized readily over the course of the year. So, we had a really good quarter in terms of Cloud conversions. Of course, that helps with the overall health of the business. But the other thing it does is it accelerates the adoption of AI, because our AI products are only available in the cloud. And so, we also saw a big uptick in the purchase and the use of AI in the second quarter. And I think that's going to start to accelerate also. And so, we'll see nice adoption and usage of our first-to-market AI products. So, both of those are positive trends in the business and bode well overall.

Q: How does management decide between raising proceeds from debt or equity issuances and whether to use the convertible debt or ATM equity issuances? And how do we think about different options?

A: We have lots of options. We have options including cash purchases, straight debt, convertible debt, equity, or other types of operational measures that might generate income that we can use to acquire bitcoin. We're continually evaluating the capital markets and the relationship between the options market, the futures market, the bitcoin spot market, our equity market, and then developments in our business and then opportunities we have from various counterparties all go into the mix. This year we did acquire bitcoin with equity issuance, and we thought that that was extremely accretive. Then we did a debt offering and a convertible debt offering. That was extremely accretive. It turns out that the next week, the bitcoin market surge and the convertible market surge and the equity market surge, and we could do another convert offering. That was literally a decision-making process that took place over a matter of days. And so, sometimes in days we'll move when the market offers an opportunity. Then we went ahead and redeemed the 25 note that was in response to the capital markets. The next debt deal in Q2 was a response to the capital markets. We're always going to consider things like the duration of the deal. We consider the nature of the pricing of the deal. We didn't really choose to pursue equity so much in Q2 as we did in Q4 of last year or early Q1 just because the markets are shifting. And the relationship between bitcoin, the options market, the convertible debt market, the fixed income market, the equity market, those are all changing. They literally change. To say they change every quarter is a reasonable statement, but sometimes they change week-by-week and month-by-month. So, I think the great situation we're in is that we don't have to do anything quarter-by-quarter. We can afford to take a quarter off, but we can also, like in Q1, we can do an ATM deal, a convertible debt deal, a second convertible debt deal, and a cash purchase and we can use all four different things and we can do that in a hurry. So, we tend to let the capital markets drive our decision-making by keeping an open mind and being flexible.

Q: How do you think about the incremental leverage capacity and interest expense capacity given the increased overall interest expense related to the operating cash flows from software business?

A: I guess I'd start by saying we actively manage and forecast our cash. And at the moment we forecast adequate cash to service our existing debt based on the overall software revenues, which continue to remain durable. And as we mentioned before, we're building stronger ARR as we transition to the cloud. We also manage our cash after taking into account a fully funded software business as well as our debt service needs. So, we take the full picture when we're thinking about incremental debt and interest expense. And I just would say we manage it extremely carefully. And keep in mind too, we also have additional sources of liquidity available to us, as Michael mentioned, via the capital markets if needed. And we continually assess various liability management opportunities across the debt stack. That kind of gives us a profile of our needs as well as our capacity. So, overall, I'd say we feel very comfortable with our ability to service the debt. And we'll continue to be active in ways that will continue to generate that BTC Yield KPI that we announced earlier today.