Data Storage Corp Q2 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to the Data Storage Corporation Second Quarter 2022 Conference Call. All lines have been placed on a listen-only mode, and the floor will open for your questions and comments following the presentation. At this time, it is now my pleasure to turn the floor over to your host, David Waldman, Investor Relations. Sir, the floor is yours.

Thank you. Good morning, everyone and welcome to Data Storage Corporation's 2022 second quarter ending June 30, 2022 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 2022 financial results, which is also posted on the company's website. If you have any questions after the call 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 future or conditional verbs such as will, should, would, may and could are generally forward-looking in nature and not historical facts, although not all forward-looking statements include the foregoing. Although the company believes the expectations reflected in such forward-looking statements are reasonable, it can provide no assurance that such expectations will prove to have been correct. 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 other cautionary statements including the company's quarterly report on Form 10-Q for the quarter ended June 30, 2022, and annual report on Form 10-K and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statements speak only as of the date on which they were 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 we achieved solid revenue growth in the second quarter of 2022, with total revenue increasing by $1.3 million or 37% compared to the same period last year. For the six months ending June 30, 2022, our revenue increased 121% over the same period last year. As stated in our press release this morning, the higher increase in revenue for the six-month period relates to the timing of equipment sales, which were front-loaded in the first quarter. Equipment sales by nature are very lumpy and can cause large swings in our revenue from quarter to quarter. While we are continuing and will continue to take advantage of opportunities to sell equipment to enterprise-level customers, our primary focus is on high margin, recurring subscription-based cloud and managed services, which increased 47% in the second quarter of 2022 compared to the same period last year. Ultimately, this is where we see the future of the company and the future of our industry, as more companies seek to migrate their IBM power infrastructure to the cloud. Over the years of our experience providing data storage and disaster recovery services, this has helped us establish a leading reputation in this market. As we've discussed in the past, while Intel and Windows services have been undergoing this migration to the cloud, the IBM server market has only begun to transition in the last few years. This is a very limited competition marketplace, and our timing is excellent to tap into this rapidly growing multi-billion dollar market opportunity. More importantly, businesses are increasingly under pressure to improve their applications, disaster recovery and storage systems, accelerating the migration from self-managed, on-premise technical equipment to fully managed multi-cloud technologies to reduce costs and compete effectively. In today's environment, capital preservation is also an incentive to move from capital-intensive on-premise technology to a pay-as-you-go model. Basically, customers are moving from a CapEx to an OpEx model, which will continue to support growth in our subscription cloud model. Toward this end, we have built a robust sales pipeline, while at the same time, we are increasing our sales force, expanding our marketing initiatives, as well as investing in highly skilled personnel and infrastructure. Heading this initiative is Tom Mitchell who joined us from Flagship as our new Vice President of Sales. Tom brings more than 26 years of management and sales experience, including 18 years at IBM. He served in IBM's Channel Partner division supporting several of IBM's largest U.S. partners. Tom has been with Flagship for over 10 years, serving as VP of Sales and is now responsible for all of DSC's revenue. Given the strong demand for our services, we are also expanding our sales team with plans to hire an additional four sales reps in the coming month, bringing our direct sales team to 20, while continuing to increase our efforts to develop additional channel partners under the leadership of Director of Channel, Steve Romweber. Steve has over 20 years of experience providing services and software to this community. Steve has been with us over two years and continues to build this distribution channel. We're also creating a special services group, working in partnership with IBM, Cisco, and others alongside their sales staff to open joint opportunities with their clients. In addition, we're expanding within the government sector under the leadership of Tom Kempster, the Executive Vice President of Data Storage Corporation, with a particular focus on state, county, and local agencies. Government is one of the largest users of IBM service and storage. It’s a perfect target to migrate our disaster recovery and cloud infrastructure. As a result of these initiatives, the current outstanding contract value on our client subscription services agreements is over $14 million. Moreover, we have proposals outstanding with a combined total contract value of more than $18 million. I’m also pleased to report that despite the lumpiness of equipment sales, we achieved positive EBITDA in the second quarter of 2022. We believe we are well positioned to drive increased profitability going forward, given the scalability of our business model. At the same time, we continue to carefully manage expenses. Following the acquisition of Flagship, we are centralizing data center operations for better utilization of staff and a reduction in contractors. Overseeing this initiative is our Chief Technology Officer, Chuck Paolillo, who brings more than 20 years of industry experience. We have already identified cost savings that we are implementing across the organization by further integrating our business units. Given these initiatives, let me break down the numbers a little further so you can see where we are today and why we are optimistic going forward. Our three subsidiaries, CloudFirst run by Hal Schwartz; Flagship run by Mark Wyllie and John Camello, President of NEXXIS, combine to make up our subsidiary leadership. Combining CloudFirst's infrastructure and disaster recovery services with Flagship's managed services, our recurring subscription revenues increased by 47%. Cloud subscription is typically priced at a 50% gross profit margin. In contrast, our equipment, software, and hardware sales increase approximately 27% with gross profit margins estimated at 25%. On a standalone basis, CloudFirst, which includes DSC, is profitable and growing. Flagship will continue to fluctuate based on its heavy reliance on equipment and software sales. But as we continue our annual recurring revenues, which are currently running at an estimated $4.3 million, and with centralized operations in the organization, we expect this business to become consistently profitable from quarter to quarter. Based on contracted annual recurring revenue, we expect Flagship to enter 2023 with a baseline recurring revenue of more than $5.2 million. NEXXIS has historically been a slow and steady business with consistent gross profit margins of around 35% and is near breakeven on a standalone basis. As we continue to grow NEXXIS, it should consistently contribute to profitability. So, to wrap up, we are pleased with our progress, especially on subscription cloud-based services. DSC solutions built by DSC represent the future of the company. As I mentioned earlier, while we are prioritizing these services, we are not abandoning equipment and software sales and see these sales as an opportunity for additional cash and add-on services to these large clients. Moreover, we were able to remain positive despite significant investments in our business and sales initiatives, which has always been our strategy. Corporate expenses have grown due, in part, to our focus on government sales, as well as new personnel and professional expenses. We expect that as revenue grows, corporate expenses as a percentage of revenue will decrease. At the same time, we continue to carefully manage expenses and see opportunities for additional cost savings. We also ended the quarter with over $11 million of cash and cash equivalents, and no long-term debt. We have a strong team, a robust proposal pipeline, and limited competition. As a result, we believe we are well positioned to drive increased profitability, given our highly scalable business model. We're excited about the outlook for the business and look forward to providing further updates as developments unfold. With that, I'd like to turn it over to Chris Panagiotakos, our CFO, to discuss our first quarter of financials. Please go ahead, Chris.

Thank you, Chuck. Total revenue for the three months ended June 30, 2022 was $4.8 million, an increase of $1.3 million or 37% compared to $3.5 million for the three months ended June 30, 2021. The increase is primarily attributed to the additional sales from the Flagship merger and an increase in monthly subscription revenue. Cost of sales for the three months ended June 30, 2022 was $3 million, an increase of $1 million or 47% compared to $2 million for the three months ended June 30, 2021. The increase of $1 million was most related to the Flagship merger and the variable nature of costs incurred to produce and sell our products and services. Selling, general, and administrative expenses for the three months ended June 30, 2022 were $2.6 million, an increase of $1 million or 62% as compared to $1.6 million for the three months ended June 30, 2021. The increase is primarily attributed to the increase in salaries as a result of the Flagship merger, new sales and marketing staff, and increased marketing expenses. Adjusted EBITDA for the quarter was $33,000 compared to adjusted EBITDA of $249,000 for the same period last year. The net loss attributable to common shareholders for the three months ended June 30, 2022 was $857,000 compared to net income of $136,000 for the same period in 2021. We ended the quarter with cash and cash equivalents of $11.2 million at June 30, 2022, compared to $12.1 million at December 31, 2021.

Thanks, Chris. I'd like to open up this portion to any questions that listeners have to ask.

And our first question comes from Matthew Galinko from Maxim Group.

Chuck, you mentioned, you described the future as a pay-as-you-go model, and we've talked about the opportunities there in the past. How is the macro environment that we're sort of looking at today between inflation and some concerns about growth in the economy impacting how your customers and prospective customers are engaging with that scenario of moving from an on-prem type deployment to a cloud?

I believe that the recession, although it hits us all personally, is excellent for this business. People will preserve their cash, and the expression 'pay as you go' is more as 'pay as you grow.' If you look at it that way, people will preserve cash and they'll look to optimize their staff, where we take care of infrastructure. It's one expense they don't need on the payroll side, along with disaster recovery with being able to have backups that are done after hours. Our backups are done on the target side and continue to ensure companies receive information on how successful those backups are. So through automation, through our 24-hour monitoring, they can literally, if they want, reduce their staff and capital expenditures and then move with us. I think, from a recession or the threat of a recession, it’s good for our business, Matt.

Could you provide more detail on whether government customers, who are among the heaviest users of IBM power infrastructure, differ from non-government customers in their response to the current environment?

It's interesting that, I've been dealing with some government-type sales throughout my career, and with this, it becomes difficult to a degree. But what's happened now is Tom Kempster, who originally was with ABC and we merged with or acquired back in '16 and '17, is running this right now and knows it really well. He's responding to RFPs, which is great, and I believe we just took a sale with a local township in New York state. So, I think it is heating up. It's seeing the advantages of it; whether they'll move the cloud infrastructure completely, I think that might be a bit protective for a little while. But on the disaster recovery side, I think we'll see some acceleration in that way. Tom is responding to RFPs, and I believe we just took an order. We're fairly new at what we call GovNet, which are websites being developed for that right now. It’s directly targeted to government services for cybersecurity, infrastructure as a service, cloud infrastructure, and disaster recovery. We believe that it will pick up in a short period if Tom is working on it, I believe we received a good order.

Very good. Maybe my last question for me before I jump back in the queue: I think you've talked in the past a little bit about international expansion of the services business. How is that going for you to date?

We've been so busy looking at where we can consolidate in the U.S. We also have two data centers in Canada with our partner, Able-One. I will say that we have our eye on it. We know exactly where the data centers are, where there’s heavy bandwidth globally. We have designed a particular plan, and Chuck Paolillo, as our CTO, where we can put a rack in a specific country and open that up. We are looking at that. We just need to see who we would assign to run with international. I believe that we can probably put up two cities in 12 months and work with IBM partners in those countries, giving them the opportunity to leverage what we've built over 10 years with this platform. So, we do have our eyes on it.

Our next question comes from Bill Jordan from TA Investments. Go ahead, sir.

Good morning, Chuck. I was wondering if you could provide some color on how Flagship is doing on a standalone basis?

Sure. I'm going to turn that over to Chris, but before I do that, I will say that when we acquired Flagship, they had a baseline of recurring annual recurring revenue, which they've been growing over the years to decrease their dependency on equipment. They have a very experienced sales team that has been selling equipment and software for as long as they've been in business. So, there's a lot of pressure essentially on Flagship with cross-selling and their customers. We're working really hard to not lose anything on the equipment and software sales, but at the same time build into DSC, Data Storage Corporation, CloudFirst data centers with infrastructure and disaster recovery. So, we're working together with training. Tom Mitchell is overseeing all sales and has it as a priority for cross-training and compensation. It's a little bit of a transition, but at the same time we don't want to lose some fairly large accounts that Flagship has. There are also additional sales that come along with those equipment and software sales. But actually, the actual numbers, Chris, I'll turn it over to you.

So Bill, to further answer your question, if you remove the stock-based compensation, the amortization expense, and the corporate allocation, Flagship did show a slight profit for the six months ended June 30, 2022.

And that appears to be our last question at this time. I would now like to turn it over to management for any closing remarks. Thank you.

Well, thank you. Thank you for the questions. It's always good to drill down a little bit, and we appreciate it, Bill and Matt. As we continue to generate solid year-over-year growth while continuing our focus on monthly recurring subscription-based revenue and managed services, this is what our mission is. We have a great leadership running the company, the subsidiaries, and the offices, and management underneath that. We believe we are extremely well positioned to capitalize on the growing opportunities, as more companies seek to migrate their IBM power systems and infrastructure to the cloud. In addition, we're well positioned to drive increased profitability going forward, given the scalability of our business model. We ended the quarter with $11 million in cash. We have no long-term debt. We have a solid foundation to accelerate our business model. Thank you all for joining today. It's appreciated, and we look forward to further updates from us with press releases. Thank you.

Thank you. This does conclude today's conference. We thank you for your participation. You may disconnect your lines at this time and have a wonderful day.