Data Storage Corp Q4 FY2022 Earnings Call

Greetings and welcome to the Data Storage Corporation 2022 Fiscal Year Business Update Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow a formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Alexandra Sheltz. Please begin.

Thank you, and good morning, everyone. 2022 was a year of assimilation for Data Storage Corporation, especially as it relates to our Flagship subsidiary. And while we are proud to report achieving a 60% increase in revenue to 23.9 million for 2022, we have also implemented meaningful business initiatives during the year that we believe will enable us to further accelerate growth and streamline the organization with the goal of long-term profitability. Additionally, this is the first reporting period that we have broken out our revenues by business segment, which we believe allows us to paint a better picture for each of our business units. While each of our subsidiaries addresses important aspects of information technology and provides solutions and services to a broad range of clients across various industries, our primary focus is targeting long-term contracts with subscription services that provide meaningful recurring revenue streams, allowing us to maintain long-term growth and profitability. The day of waiting for that one large equipment or software sale in order for a subsidiary to be profitable for a quarter is over. The objective is recurring revenue. However, we are not turning away from equipment and software sales. We are instead basing profitability each month on recurring revenue. Our revenue objective is to have 80% of our annual revenue recurring. While we are not 100% there at Flagship, Tom Kemps, the new President of Flagship since November 2022, is highly focused on the strategy and vision. An example of how the strategy is working is our CloudFirst subsidiary. We achieved profitability on a standalone basis with net income of $1.9 million and an EBITDA margin of 27% or $3 million with revenue of 11.5 million for 2022. Hal Schwartz, President of CloudFirst has positioned the subsidiary as a leader in the market and is taking advantage of the cloud migration on IBM Power Service, which is currently underway. We have only begun to scratch the surface of this market, a $36 billion annual addressable market in the United States and Canada. Turning to Flagship. When we acquired Flagship, we understood and still believe today that Flagship's brand and reputation is highly regarded. However, given the current economy, companies are being more cautious in terms of large equipment purchases and the timing of the purchases. While we'll continue to pursue these opportunities, we are focusing Flagship on subscription-based services, which typically provide a higher margin. The strategy is aligned with the overall market and economy as customers are working to outsource and migrate to cloud-type services and solutions, where CapEx moves to OpEx and customers can pay as they grow. Flagship will continue to provide equipment to their client base. However, we will not base the business health on a one-time equipment sale. As a result, after reviewing proposals outstanding for 2023 for equipment sales, we felt it prudent to reduce goodwill by $2.3 million. Today, Flagship is positioned with IBM and is working closely with IBM on cybersecurity solutions and software. Moving forward, we'll be making an investment with IBM to accelerate cybersecurity revenue. Additionally, to further assist in the success of Flagship, we are refreshing the Flagship website, hiring new business development personnel, and expanding distribution channels through key marketing programs. We believe these steps will assist in reaching profitability for Flagship on a standalone basis as well as aid in the overall profitability of Data Storage Corporation. Furthermore, we intend to deploy capital effectively and have outlined several objectives that we expect to execute throughout 2023. First, we plan on hosting high margin revenue-driven events during the year in various cities around the United States. Second, while we provide solutions to government agencies, we are building out a government-focused business unit. Third, we intend to expand internationally as our products and services are applicable worldwide. There are many large markets we can penetrate. Fourth, we are already underway with the consolidation of the technical teams of CloudFirst and Flagship under our CTO, Chuck Paolillo. One positive outcome expected should be an improvement in gross profit. Fifth, we will expand our channel partner program in the United States and Canada. Channel partners are a great way to grow quickly, since these MSPs are the trusted advisers to their client base. And finally, as I have touched on before, we plan to expand the sales force with dedicated sales representatives and teams, aligned with the business segments and departments so we can then focus both on growth and profitability. With the realignment of management and refocused efforts on business initiatives, along with a growing sales team, we believe the value of the activities we undertook in 2022 will become apparent in 2023. Importantly, we expect these steps will be reflected in our first quarter 2023 results, which are shaping up extremely well. Overall, we remain committed to growth. And with limited competition in several of our core services and solutions, we believe our sales teams and our proposal pipeline will aid in advancing our service delivery teams and assist in long-term profitability. With approximately $11.3 million of cash and short-term investments and no debt, we expect to deploy capital effectively and efficiently, including expanding our distribution channels, increasing marketing activities, and exploring accretive acquisitions. We believe we are well on our way towards becoming a multi-billion-dollar leader in this growing market. With that, I'd like to turn it over to Chris, our CFO, to discuss the 2022 financials.

Thank you, Chuck. Total revenue for the year ended December 31, 2022 increased by approximately 60% to $23.9 million compared to $14.9 million for 2021. All of our subsidiaries saw increases in revenue. The primary increase in revenue relates to the acquisition of Flagship. At CloudFirst, revenue grew from $10.2 million to $11.5 million, an increase of approximately 13%. At Nexxis, revenue grew from $817,000 to $931,000, an increase of approximately 14%. The Company saw increases from mostly all of its revenue sources; cloud infrastructure and disaster recovery, equipment and software, managed services, and Nexxis' VoIP services all grew from the prior year. Cost of sales for the year ended December 31, 2022 was $15.8 million compared to $8.5 million for the year ended December 31, 2021. The increase of $7.3 million was mostly related to the increase in sales, which resulted from the Flagship acquisition. Selling, general and administrative expenses for the year ended December 31, 2022 were $9.8 million, an increase of approximately $2.7 million compared to $7.2 million for the year ended December 31, 2021. The increase is primarily attributed to the Flagship acquisition. We also saw increases in salaries as a result of new sales and marketing staff, increased marketing expenses, and increases in professional fees associated with being on NASDAQ. Adjusted EBITDA for the year was $4,384 compared to adjusted EBITDA of $824,583 for the same period last year. Net loss attributable to common shareholders for the year ended December 31, 2022 was $4.4 million compared to net income of $204,161 for the year ended December 31, 2021. For further detail on the $4.4 million loss, we had a goodwill impairment at Flagship of $2.3 million. We had approximately a $400,000 expense in one-time equity compensation. We had $127,000 in one-time offering cost and approximately a $1.5 million loss, mostly attributed to Flagship and our public company and corporate expenses. We ended the year with cash and short-term investments of $11.3 million at December 31, 2022, compared to $12.1 million at December 31, 2021.

Thanks, Chris. I'd like to open it up for questions. Rob, if you can take over at this point.

Absolutely, thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from Matthew Galinko with Maxim Group. Please proceed with your question.

Nice job on 2022 results. So Chuck, I think you touched on aligning Flagship with subscription being consistent with how I think macro is shaping how investors or how customers want to consume services. They want to go more towards the rental model than the capital purchase model. Did I understand you correctly? And can you go a little bit more into how this environment is resulting in some changes to customer conversations? Is that having a material impact on that shift?

Hey, Matt, it's a little difficult. First of all, I think that very large clients, which Flagship has many, might take an approach of delaying or being more cautious on the large equipment sales. So, you have very large customers that might not be moving over to what we call infrastructure cloud, but folks are looking at software-as-a-service and cybersecurity-as-a-service. So, instead of just purchasing and running it on their own systems, you have a couple of things going on. One is possibly delaying equipment sales, putting those off a little bit, and others evaluating whether they should move onto infrastructure-as-a-service. We know that several large government agencies have moved onto infrastructure-as-a-service. So, I would say for the most part it's according to the size of the accounts; however, there is a delay just based on the economy with people putting off decisions on equipment sales. It can easily roll over to the next quarter. I think we should be expecting decent results when we look at the first quarter, but folks are consuming on a monthly subscription basis. Overall, when we talk about the overall business environment, instead of making big capital purchases or licensing software for an entire year or for three years. I don't know if that answers your question, Matt. Does it?

Yes, that was helpful. I understand you don't provide guidance, but considering how 2022 unfolded, you had strong Flagship revenue in both the first and fourth quarters. Can you share any insights on what we might anticipate based on those high points from 2022? Does that create a high standard for us to consider for 2023? Is the subscription growth aligned with the equipment purchases you reported in 2022?

When you take a look at the first quarter of 2022, we have some very large accounts, and there are some software renewals within that. That's why we see the lumpiness when we look at quarters. Our press release from last year showed there was a large equipment sale and a large software renewal in that same period. These software renewals and hardware maintenance revenues occur in various months throughout the year. In some cases, clients put them out for competitive bids, which adds to the unpredictability. Our goal is to transition more towards predictable, straight-lined growth, but outside factors can contribute to that lumpiness. The software renewal and hardware maintenance occur annually, but equipment sales can shift quite easily to the next month or quarter. We are here to provide proposals to clients looking to move to infrastructure-as-a-service. Therefore, it's tough to predict equipment sales and that’s why we took the goodwill impairment on Flagship—to be conservative.

I'm going to ask one more question and then jump back in the queue. You touched on international expansion. It's definitely a topic that's come up over the last few quarters. Can you talk a little bit more about how those plans will shape up for 2023? What's new in that strategy and what can we expect to see?

I still consider Canada to be international. We have a partnership with ABLe Communications, which was purchased by a much larger MSP, and we now have our equipment in two data centers in the Toronto metro area. We are looking to do much more in Canada. Additionally, we have been in talks with MSPs in Europe and will continue exploring those opportunities. We want to ensure that, especially in Europe, we partner with MSPs in the same manner as CloudFirst in the U.S. and Canada. We’re also enhancing the MSP channel partner program in both Canada and the U.S. so we can expand our reach.

Our next question comes from Adam Waldo with Lismore Partners. Please proceed with your question.

Yes. Good day. Thank you very much for taking my questions. I'd like to explore two areas, the new business pipeline and then the outlook for cash generation and capital deployment. So, on the new business pipeline, I know, as the prior question said, you don't like to give specific financial guidance in terms of revenue, net income, cash flow, and so on. But can you give us a sense of some granularity or quantification of what your new business pipeline looks like at this time on a value basis in the recurring revenue side of the business? And how that would have compared, let's say, six months or a year ago? And related to that, can you give us some quantification of where your close rates are trending? Then I'll hold my second question.

Sure. I'll go in reverse direction. Our close rates are around 25%. When we take a look at each company, which is very separate, if we examine Flagship, these are large customers being covered by experienced staff, and the close rate is typically very high, probably higher than 50%. Their sales funnel is somewhat different from CloudFirst. For CloudFirst, you will see a total contract value that exceeds $13 million. Sometimes, it's not that we are losing an account; it's just the clients' decision-making process is delayed. The close rate is around 25% or so, but on CloudFirst, it’s actually a little bit higher. When leads are processed through our sales force, there’s an automated system that rates leads based on their engagement with our materials. The higher-rated leads generally have close rates above 25%. We typically get around 6,000 visitors to our CloudFirst site each month, which has doubled recently due to our marketing programs.

No, that's tremendously helpful. And Chuck, you talked about the $13 million value, annualized value of the current sort of pipeline at CloudFirst. How does that dollar value compare with let's say six months to 12 months ago? If you go back six months, what would that have looked like? If you go back a year ago, what would that have looked like?

Sure, just to clarify, it's the total contract value typically. I just want to make sure that’s clear. We usually sign 36-month agreements, but it averages around $13 million to $15 million and has been consistent with that over the last couple of years.

Okay, that's very helpful. And then turning to you've given guidance sort of qualitatively that your ambition is to be profitable and cash-generative in 2023 and beyond. You've right-sized the organization late last year to be able to do that. So how comfortable are you at this juncture that you should be able to be profitable and cash-generative for all of 2023, although there may be, because of lumpiness in the business, a quarter here or there where it might be a little bit tight?

It's tough to answer that question and not put myself in a corner on it. All of our business plans approved by the board this year for 2023 have the objective of net income profitability. We are not ones to wildly spend cash, but we are searching for experienced sales representatives who need recruiters to help with that. For example, Nexxis is a small telecom voice data company, and we have approvals to hire sales reps. There might be times when Nexxis incurs losses while growing that sales force, but overall, the combined company can absorb some short-term losses. We are highly focused on achieving positive net income and working to size our business for recurring revenue. We do anticipate some short-term losses for parts of the business, but overall, when consolidated, we believe it will be a positive net income.

And then the final topic is capital returns and deployment. Your stock trades at basically net cash. You look to be pretty comfortable that you can be at least somewhat profitable and cash-generative this year and beyond. Hopefully, it's scaling beyond. So what opportunities are there to try to close the gap in value between the stock price and the sort of private market value in the business, which is much higher? What thoughts do you have currently around stock buybacks, dividends, and so forth?

If we consider a stock buyback, it may seem necessary because of where the price is today. We have $8 million to $10 million in assets deployed in six data centers and more cash in the bank. The current situation is frustrating for management and investors. While we should consider stock buybacks, it suggests there are no better uses for that cash, and I believe we do have better uses for it. However, if prices continue to drop, we will assess buyback options. Our focus is on producing quarter-over-quarter growth and showing profitability, which will hopefully attract investor interest and enhance our market cap. If we find compelling acquisition opportunities, we will explore those as well. Acquisitions can be beneficial, but integration takes time and can be challenging. We are considering all options, but at the moment, the priority is to grow the business and explore capital deployment that supports that growth.

Hey, guys. Again, thanks for my follow-up here. Chuck, I think you mentioned making an investment through Flagship in cybersecurity and your work with IBM. Can you go a little bit further into that? What's the investment look like, and what specifically in cybersecurity? And when would we start to see returns on these investments?

I would expect to see returns over the next three to six months. Tom will ramp up recruiting for sales personnel to enhance business development at Flagship. We will focus first on existing accounts from Flagship, Nexxis, and CloudFirst. IBM is working closely with Tom and the team at Flagship. Cybersecurity is not new for us, as CloudFirst has been offering certain types of cybersecurity. Flagship has also sold IBM software to some high-profile clients. This new initiative is about expanding those existing capabilities and rolling out additional software alongside IBM.

Got it. Thanks. Last question for me is just on the hiring environment. You mentioned adding to the team, particularly in sales, I think. Is it easier today to add? Is the current environment we're in supportive of expanding headcount in the areas where you want to?

Nothing's easy today. Nobody wants to talk on the phone; everyone prefers video calls, which isn’t always ideal. However, I will say there have been layoffs in large companies like Verizon, leading us to interview laid-off staff. I had follow-up interviews for two excellent candidates from Verizon for Nexxis, demonstrating that this environment may provide an opportunity for finding qualified talent. As these layoffs continue, this could be advantageous for us. Thank you, Rob. To wrap up, while we continue to generate strong year-over-year revenue growth and preserve a solid balance sheet, we intend to deploy capital efficiently and effectively to accelerate our growth and remain at the forefront of this industry. We have taken steps to streamline the organization and reduce redundant costs, which should be apparent as early as the first quarter of 2023. We are excited about the outlook for the business and look forward to providing further updates as developments unfold. I'd like to thank everyone for joining us today and have a great day.

This concludes today's conference. You may disconnect your lines at this time, and we thank you for your participation.