Data Storage Corp Q2 FY2021 Earnings Call

Good day ladies and gentlemen, and welcome to the Data Storage Corporation Second Quarter 2021 Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host David Waldman of Investor Relations. Sir, the floor is yours.

Thank you, Holly. Good morning, everyone and welcome to Data Storage Corporation second quarter 2021 business update conference call. On the call with us this morning are Chuck Piluso, Chairman and Chief Executive Officer, and Chris Panagiotakos, Chief Financial Officer. The company issued a press release this morning containing second quarter 2021 financial results, which is also posted on the company's website. If you have any questions after the call or would like any additional information about the company, please contact Crescendo Communications at 212-671-1020. Before we begin, I'd like to remind listeners that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended, that are intended to be covered by the safe harbor created thereby. Forward-looking statements are subject to risks and uncertainties that could cause actual results, performance, or achievements to differ materially from any future results, performance, or achievements expressed or implied by such forward-looking statements. Statements preceded by, followed by, or that otherwise include the words believes, expects, anticipates, intends, projects, estimates, plans, and similar expressions are forward-looking in nature, not historical facts, although not all forward-looking statements include the foregoing. Although the company believes that the expectations reflected in such forward-looking statements are reasonable, it can provide no assurance that such expectations will prove to be incorrect. Important factors that could cause actual results to differ materially from the company's expectations include, but are not limited to the company's ability to leverage the scalability and performance of Flagship Solutions. The company's ability to benefit from the IBM cloud migration underway, the company's ability to position itself for future profitability, and the company's ability to maintain its NASDAQ listing. These risks should not be construed as exhaustive and should be read together with the other cautionary statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2020, subsequent quarterly reports on Form 10-Q and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statement speaks only as of the date on which it was initially made. Except as required by law, the company assumes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances, or otherwise. I'd now like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

Thanks, David. Good morning, everyone. I'm pleased to report that during the second quarter, we made progress financially and operationally. In addition, we have listed on NASDAQ successfully and completed our merger with Flagship. First, in terms of our results, we achieved a 76% increase in revenue for the three months ended June 30, 2021, compared to the same period last year. Non-EBITDA revenue increased, reporting growth across all product lines, and we expect to maintain strong organic growth going forward. Revenue for Infrastructure & Disaster Recovery, which are our subscription-based cloud solutions, increased 25%. Revenue for Equipment and Software increased 208%, and revenue for Managed Services increased 269%. Revenue for Nexxis VoIP services increased 19%. We attribute this increase to the rise in monthly subscription revenue and additional sales from the Flagship Solutions merger. It's important to note that the second quarter results only reflect the month of June, since we completed the merger on May 31, 2021. I'd like to highlight that on a pro forma basis, for the three months, revenue would have been over $7.8 million, and looking back on a pro forma basis for the full year of 2020, revenue would have been over $18 million. During the call today, I'd like to discuss several items in greater detail: our accomplishments to date, the importance of the Flagship merger, and finally, our organic growth strategy. I'll start by providing a brief background on the company; some of you may be new to us following our recent NASDAQ uplisting. The company overall, since completing several acquisitions, has been a 25-year veteran providing business continuity services such as Disaster Recovery, Infrastructure as a Service, and cybersecurity. We provide the solutions and services to a broad range of customers across several industries and maintain our own internal business development team. In addition to the business development team, we also have distribution channels that we refer to as channel partners. For the past two decades, our mission has been to protect clients' data, ensure business continuity, and assist in the compliance requirements of our clients, typically providing better management and control over our clients’ digital information. Since the company's establishment in 2008, we've completed some meaningful acquisitions focused within the IBM AI space, the latest being Flagship. We have limited competition, and it's important to note that we do not compete with Amazon Web Services or Microsoft in this space. There has been a massive migration from Intel Windows servers to the cloud. From on-premise or off-premise, we are now seeing that same migration in the IBM Power market. This transition to the IBM Power market is just beginning, and we are at the forefront of this transformation. Let's discuss Flagship and why this is so exciting and highly synergistic for us. Flagship is a provider of IBM solutions, managed services, and cloud solutions, which are extremely complementary to our own IBM business. We anticipate meaningful operational efficiency and have begun to realize the synergies and advantages of the combined companies this quarter. By combining Flagship with Data Storage, we are now a comprehensive, one-stop provider with the ability to provide each other's solutions, allowing us significant cross-selling opportunities that we intend to leverage. In connection with the merger, we are pleased to welcome Mark Wiley, who continues to serve as the CEO of Flagship subsidiary and has also joined the Board of Directors of Data Storage Corporation. In total, we have added 15 Flagship employees, increasing our headcount to over 44 full-time employees. The Flagship merger followed our successful uplisting and capital raise. The public offering resulted in proceeds of $10.8 million, and subsequent to the Flagship merger, we received approximately $3.4 million from the voluntary exercise of a portion of our warrants. Additionally, we recently completed a registered direct offering that resulted in approximately $8.3 million in gross proceeds, or $7.6 million in net proceeds. As a result, we have significantly strengthened our balance sheet, enabling us to execute on our organic growth strategy as well as explore opportunistic and creative acquisitions. Given our expanded offerings following the acquisition, we have positioned our sales and marketing organization to focus more heavily on four key verticals where we have particular sector experience and have seen significant growth opportunities. Our new core marketing verticals include sports, banking and finance, healthcare, and the government sector. We already have a number of well-recognized customers within each one of these sectors, which provide us with immediate credibility as we target new customers. That said, we will not neglect other industries; we believe this new strategy will accelerate organic growth. With respect to the sports division, Flagship brings the knowledge and experience of working with $1 billion sports franchises that understand the requirements. The solution can deliver key insights for sporting entertainment venues, helping to enhance fan engagement and drive breakthrough revenue. Today, stadiums require a sophisticated mix of hardware and software wireless connectivity to establish communications between stadium operators and fans. Sports arenas require breaking down audience data into relevant actionable insights, including data from cameras, infrastructure sensors, historical databases, information systems stored at the team stadiums, ticketing systems, and more. They are using these insights for marketing and programming strategies or to optimize and personalize the fan experience. This is a large market, and we intend to focus on continuing sales in this space, with capable executives spearheading these opportunities. As for banking and finance, technologies are truly changing the way banks operate, and the rise of financial technology solutions require a new approach to information technology and banking. We are proud to have served customers within this sector who rely on us to help them through these transitions. Over time, our strategies involve assisting them in transforming financial data into actionable insights, as well as optimizing customer experiences and operations. We plan to introduce new tools and capabilities, such as artificial intelligence, implementing quality cybersecurity programs, and leveraging all the benefits that modern cloud infrastructure has to offer. There is a large market opportunity and an untapped customer base that we intend to aggressively penetrate. Regarding the healthcare sector, it has the largest IBM user community next to government. Many providers are turning to digital innovations to respond to the COVID-19 pandemic and the new normal. Our goal is to provide solutions that make real-time data-driven decisions and optimize healthcare asset availability and performance with tools such as predictive analytics and proactive maintenance. With our dedicated division comprised of knowledgeable employees, we intend to strengthen our marketing within this industry and leverage our existing contacts to gain additional traction. Lastly, the government represents the largest community of IBM users, which provides significant opportunities to deploy products and services and deliver smart technology solutions that help mitigate risk, reduce costs, and increase productivity. The total marketplace for infrastructure as a service and disaster recovery globally is estimated at over 1 million virtual IBM services. Yet, we have barely scratched the surface. The latest survey shows that globally, only 15% of the community is using any type of cloud-based solution. Our strategy is to build with our customers and establish long-term contracts to supply monthly subscription-based solutions. The total value of these recurring contracts we have in place with our clients exceeds $10 million and is growing, with a renewal rate of over 94% on our term subscription agreements. Our subscription-based model is highly scalable and provides a high return on capital. For example, a platform custom built under our design can serve 20 clients averaging $3,000 per month per client, equating to $60,000 per month or $720,000 of revenue per year at a cost of $365,000. Our average term typically spans 36 months. This is an attractive model; however, it’s important to note that for each additional client we onboard, the incremental cost is $10,000 in CapEx versus over $18 per client on the initial bill. This represents a 55% reduction in incremental cost, and our payback period is less than four months. Clearly, the return on capital under this model is attractive and should contribute to our margin expansion as we continue to capture new clients. This does not include technical support and networking levels, where the return is also excellent. We have seen a strong uptick in client interest in sales proposals: from January to July alone, we had over 26,000 visitors to our website, illustrating the growing interest among the IBM community to find solutions for migrating to the cloud. We're also expanding our distribution channels through new partnerships, as well as relationships with cable companies. We're looking at opportunities internationally, working with local partners. While a significant portion of revenue has been subscription-based, we also generate revenue from the sale of equipment and software, cybersecurity, data storage, IBM Power Systems equipment and software, and managed service solutions. Moving forward, we intend to shift customers to subscription-based services for predictable higher-margin recurring revenue. Equipment sales generate meaningful dollars but can be less predictable, subject to seasonality and refresh, yielding lower margins. To wrap it up, we achieved several significant accomplishments in a short amount of time. Revenue for the quarter increased 76% over the same period last year. We uplisted to NASDAQ, completed the acquisition of Flagship, and significantly enhanced our balance sheet. As a result, we believe we are well positioned to execute on our organic growth strategy and explore synergistic acquisitions. Overall, I'm pleased with our performance and truly believe the best is yet to come. With that, I’d like to turn this over to Chris, our CFO, to discuss the second quarter financials. Right, Chris?

Thank you Chuck. Total revenue for the three months ended June 30, 2021, was $3.5 million, representing a 76% increase compared to $2 million during the same period last year. The increase was primarily attributable to additional sales from the Flagship merger and an increase in software and equipment sales, as well as infrastructure and disaster recovery cloud services. Cost of sales for the three months ended June 30, 2021, was $2 million, an increase of 77% compared to $1.1 million for the same period in 2020. The increase was mostly related to variable costs incurred to produce and sell our products and services. For the three months ended June 30, 2021, selling, general, and administrative expenses were $1.6 million, an increase of 62% compared to $1 million for the same period last year. This increase was primarily attributed to higher salaries related to increased headcount, professional fees related to the merger, and advertising expenses due to additional Flagship marketing campaigns post-merger. Net income before provision for income taxes for the three months ended June 30, 2021, was $135,561 compared to a net income of $183,259 for the same period last year. Cash and cash equivalents at June 30, 2021, amounted to $3.1 million. Subsequent to June 30, 2021, investors exercised 465,390 warrants into 455,390 shares of common stock for $3.4 million. Additionally, on July 21, 2021, the company completed an equity offering, selling 2,375,000 shares of common stock and 1,031,250 warrants for net proceeds of $7.6 million. The warrants have an exercise price of $6.14 and are valid for five and a half years. Thank you. I will now turn the call back over to Chuck.

Thanks, Chris. I believe we can move into the Q&A if we could, David.

Yes. Holly, if you could provide the instructions.

Ladies and gentlemen, the floor is now open for questions. Your first question is coming from Sam Husker. Please announce your affiliation, then pose your question.

I'm from Boulder Capital. Congratulations on your quarter, by the way. My first question is regarding your recent announcements of your agreement with Able-One. Would you be able to walk me through your marketing programs in Canada and any updates you have regarding your business there?

Sure. Thanks for the question. We did have a press release that went out on Able-One. Able-One is a provider in the Toronto metropolitan area with two data centers in that region. They are considered a channel partner. In this particular case, we placed our model and equipment in their data centers, allowing us to serve the Able-One clients. Able-One typically sells equipment and software, providing IBM solutions, and through our collaboration, they now have the ability to offer Infrastructure-as-a-Service and disaster recovery off our platform in Canada. They have an existing customer base, so for their prospects and customers, they can either recommend them to Able-One or come directly to us for that, since this migration is underway right now. We have a great relationship with Able-One. We fully support them, and our tech teams work closely together to assist in the migration.

Okay, thank you. Another question; you mentioned earlier in the call your selling distributors or channel partners. I'd like to get a better idea of how they do their prospecting and selling?

Very interesting question. We believe that the best way to approach this marketplace is by collaborating with companies that sell software and hardware to the IBM community, particularly the IBM i community. We provide them with marketing programs and templates to generate awareness. Following that, we conduct programs to educate their client base on the ability to move to disaster recovery in the cloud, or from on-premise to off-premise. When it's time to refresh their equipment, they understand that they have the option to move to our subscription-based solutions. The channel partners have the customer base, and they act as trusted advisors, making it a very successful program for us.

Okay, thank you for answering my questions. And congrats again on the great quarter.

Thanks.

Your next question is coming from Evan Greenberg. Please announce your affiliation and then ask your question.

LegendCap Opportunity Fund. How are you, Chuck?

Good, Evan, how are you?

Good. Two questions. Number one, I saw that the gross margins really started to expand quite a bit. I don't know how substantial it is, but I would anticipate as the mix grows, and as you get more recurring revenue, that gross margin will continue to be incremental. Is that part of the plan?

Yes, first of all, we value equipment sales; it puts cash on the balance sheet. However, every new month is a fresh start. We continue to grow subscription-based services. We don’t turn away equipment sales, but the more that mix shifts over time—if you look back a few years, 65% of our revenue prior to Flagship was from equipment, and 35% was from subscriptions. Now that mix has changed to approximately 80% subscription and 20% equipment. Flagship has large clients that may not transition off-premise as quickly, but they are working on data analytics and other programs with sports franchises and other large customers. We’ll see how that mix turns out over the next year, but the businesses are collaborating to build more subscription services.

The second question I had to do with depreciation and amortization. What is your EBITDA? It's a lot greater than your earnings because of the D&A. I wanted to understand what the D&A was from and whether that's going to be a continuing situation for the company, though declining as a percentage of sales?

We have capitalized leases, so we're not showing the full amount on the depreciation side because we're concentrating on gross profit margin. Overall, prior to our NASDAQ uplisting, as we raised capital, we've been reinvesting earnings back into sales and marketing programs. Companies like Flagship focus on purchasing the latest IBM equipment, deploying millions in assets in those data centers. We're aiming for the companies to be cash flow profitable, using new cash for organic growth strategies. I believe we’ll see a difference now in profitability since we no longer need to continually reinvest into sales and marketing programs.

Great. The final question is about working with IBM. Are you integrated into their Linux UX business and their Red Hat business, and do you do joint sales and presentations with those businesses?

Flagship is very involved with IBM, and we work closely with them. We have purchased all of our equipment from IBM, deploying millions in assets in their data centers. Our joint efforts with Flagship focus on co-marketing programs and solutions. Flagship is heavily engaged with IBM, including Red Hat.

Okay, thanks a lot for your time.

Thanks, Evan.

There are no more questions in queue. I would now like to turn the floor back over to management for any closing comments.

Okay, a few closing points. Overall, we believe we’re well positioned in the IBM Power Systems space to assist companies in their migration, which is clearly underway. Let’s also keep in mind that the company provides our clients the ability to migrate their Windows applications, Office 365, and everything in the Intel Cloud environment, including disaster recovery, cloud hosting, cybersecurity, and data analytics. Our marketing strategies are primarily focused on serving the IBM buying community. As mentioned, our goal for the remainder of 2021 is to increase our presence in the IBM Power Infrastructure cloud and business continuity marketplace while continuing to grow our position as a leader in our market. We are highly encouraged by the activity and the outlook for the business. I would just like to thank everyone for joining today. Have a great day.

Thank you, ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.