Data Storage Corp Q2 FY2023 Earnings Call

Greetings, and welcome to the Data Storage Corporation 2023 Fiscal Second Quarter Business Update Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Waldman, Investor Relations. Please go ahead.

Thank you. Good morning to everyone, and welcome to Data Storage Corporation's second quarter 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. So, here we go. The company issued a press release this morning containing its second quarter 2023 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 and 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 or future 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 that the expectations reflected in such forward-looking statements are reasonable, they 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 the other cautionary statements included in the company's quarterly report on Form 10-Q for the quarter ended June 30, 2023, annual reports 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 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.

Thank you, David, and good morning, everyone. We are beginning to witness the benefits of the business initiatives I discussed on prior calls which are focused on accelerating our growth with the goal of achieving long-term sustainable profitability. I am proud to report that we have achieved solid financial results for the second quarter with revenue increasing 22% to $5.9 million. Importantly, we achieved profitability for the second consecutive quarter, which we believe demonstrates our ability to execute our business growth strategy and the strength of our business model. We also improved gross profit by 11% for the six-month period. Furthermore, we are continuing to simulate our Flagship business unit. And we are actively exploring ways to increase our gross profit margin on subscription revenue within Flagship and move closer to the 50% margin that we attained at CloudFirst. Additionally, our equipment and software group generated $2.4 million in the second quarter compared to $1.9 million for the second quarter of 2022. Notably, CloudFirst as a standalone achieved $3.2 million in revenue for the second quarter, with net income of over $550,000 and $800,000 in EBITDA, which is a 25% margin. We plan to continue to drive revenues by executing on our business initiatives, including expanding distribution channels, increasing our digital and direct marketing programs, continuing our lead generation program, hosting additional revenue-driven sales events and exploring strategic M&A opportunities to assist with the overall growth of our company. Importantly, there is significant need for our innovative solutions on a global basis, as expanding internationally and increasing our geographic footprint and addressable market are priorities for us. Another validation of our growing presence in the marketplace is the fact that we had over 45,000 visitors to our websites year-to-date. We also have over $9 million in total contract value and proposals to potential clients. In addition, we have what we refer to as a nurture group of companies, with over 25,000 organizations that receive our information that do not opt out and receive marketing and technical information they have continued to send over the years and interface with them on an ongoing basis. Companies on this list have expressed interest in implementing our solutions and could provide meaningful revenue should we secure new contracts. In particular, and perhaps more importantly to note, are the secured contracts announced recently, which we believe demonstrates our contract momentum during the second quarter and into the third quarter of 2023. Many of these are high-margin subscription-based contracts. Let me touch on these contracts quickly, and I'd like to highlight that we continue to maintain a 94% renewal rate with an average term of 29 months, validating that we continually meet or exceed our clients' needs. First, we secured a multimillion dollar contract with a leading business process solution provider that has customers around the world. We are implementing cloud-based infrastructure to support their large data sets while providing 24/7 dedicated support and data recovery services. Our solutions allow for the client to run at full performance during planned maintenance or unplanned outages. This contract provides an avenue to penetrate international markets, and we intend to pursue the opportunities. Next, we secured a large subscription-based contract with a promotional products company. This contract specifically came through our Flagship subsidiary, and we believe illustrates we are executing on our goal of increasing Flagship's recurring subscription-based revenue contracts. This customer sought us out following an unpredictable natural disaster. Unfortunately, following this event, the customer quickly realized that they are unable to recover and resume operations within the required timeframes, making it a costly and an extended outage. As a result, we were a contract to provide cloud-based disaster recovery and cloud-based infrastructure to allow them to move from legacy hardware to running all of their critical applications on our fully managed, highly secure enterprise cloud with dedicated support teams, ensuring seamless and rapid recovery. Furthermore, we secured a multimillion dollar project with one of the nation's leading sports and entertainment companies. For this project, we built a custom solution and are providing cloud storage infrastructure to improve response times to files, recovery of files and increasing their storage capacity. We believe this contract demonstrates our ability to address each client's needs and build out specific solutions to assist in reaching their goals. In addition, the sports and entertainment industry has been increasing the adoption of data storage and security solutions. And as a result, we are gaining traction in this industry. And most recently, we were contracted by one of the largest food distributors in the United States to provide managed disaster recovery solutions. This is another subscription-based contract and increased our reach within the vertical while enhancing our recognition within the food industry. We have the opportunity to expand these contracts and provide additional services, which we will explore and execute accordingly. We are securing large, high-margin contracts and have been focused on subscription-based services, providing recurring revenue as we add these important companies to the list of 450 companies we currently serve. I'm proud to report that CloudFirst and Flagship achieved profitability on a standalone basis for both the first and second quarters. We are targeting large market opportunities and continue to secure contracts and believe we are better positioned to penetrate the market as well as expand our geographic footprint, which should assist in accelerating our growth. We also continue to explore strategic acquisitions that complement and improve our current operations, including companies leading a technology trend or may increase our distribution channels or they’d add important technical staff and create economies of scale. Through all these initiatives I have highlighted, I am confident we can continue to grow revenue, improve our gross profit margins and net income. To wrap up, as mentioned at the start of the call, we are effectively executing on our business initiatives and achieved profitability for the second quarter. At the same time, we maintained a solid balance sheet with over $10.6 million in cash and short-term investments and intend to deploy capital efficiently to assist in the growth of the company while continuing to secure meaningful contracts. We believe our growth strategy will support long-term profitability and create long-term value for our shareholders. With that, I'd like to turn the call over to Chris Panagiotakos, our CFO, to discuss the second quarter financials. Please go ahead, Chris.

Thank you, Chuck. Total revenue for the three months ended June 30, 2023 was $5.9 million, an increase of $1.1 million or 22% compared to $4.8 million for the three months ended June 30, 2022. The increase is attributed to an increase in all of our revenue streams during the current period. Cost of sales for the three months ended June 30, 2023 was $3.3 million, an increase of $56,000 or 2% compared to $3.3 million for the three months ended June 30, 2022. The increase was mostly related to an increase in equipment-related cost of sales. Selling and general administrative expenses for the three months ended June 30, 2023 were $2.5 million, a decrease of $122,000 or 5% as compared to $2.6 million for the three months ended June 30, 2022. The decrease was primarily due to a reduction in salary expenses, a reduction in advertising expenses, offset by an increase in professional fees and commission expenses. Adjusted EBITDA for the three months ended June 30, 2023 was $530,000 compared to an adjusted EBITDA loss of $259,000 for the same period last year. Net income attributable to common shareholders for the three months ended June 30, 2023 was $227,000 compared to a net loss of $1.1 million for the three months ended June 30, 2022. We ended the quarter with cash and short-term investments of approximately $10.7 million at June 30, 2023 compared to $11.3 million at December 31, 2022. Thank you. I will now turn the call back to Chuck.

Thanks, Chris. I'd like to open it up for questions, if any.

Thank you. Our first question comes from Matthew Galinko with Maxim Group. Please go ahead.

Good morning, and thank you for taking my questions. Can we start with the recent trend? It seems like the pace of large deals has been increasing slightly over the past few months. Am I observing that correctly? Is there a specific reason for this in terms of your go-to-market strategy and execution? Is it related to an unpredictable timing for securing large contracts? Please help me understand how this developed.

Good morning, Matt. Let me start off by saying that we've been preaching that the migration is underway for these large powerful IBM systems. We know that it's kind of plateaued, maybe even declined slightly on Amazon, Google or Microsoft, and a lot of those systems, Azure, whatever, are in play and have been in play for 10-plus years, but this migration on the IBM side is happening, and it's accelerating. So, companies that are midsized as we know that most of these systems on the IBM side are enterprise level and mid. And so, with that, the migration is underway. And that's why when you see 45,000 visitors, and that's combined for all three companies, but I believe it's over 38,000 just CloudFirst alone. It could be a little higher than that, but we'll just assume around 38,000. So, this we could see by the number of visitors to the site, how many times migrating your IBM systems to the cloud has been downloaded off of our site. So there's a very high awareness to it. There's limited competition in this area at this particular point, and we're taking advantage of it. But it's about the migration now, Matt.

That's helpful. I think you mentioned a pipeline number of $9 million in prepared. Please correct me if I'm mistaken. Do your pipeline figures generally include large multimillion-dollar opportunities that are in progress? Or what does the composition look like in terms of size for that $9 million?

Hal Schwartz, President of CloudFirst, evaluates the level of proposals scientifically. Everyone provides a probability percentage for their proposals, whether it's 5%, 10%, 20%, or 50%. The $9 million reflects total contract value from individuals and companies that have engaged with our technical and sales teams for proposals. We generally do not include very large deals in this figure. When a proposal reaches a 90% probability, it usually indicates that terms and conditions are being negotiated. The $9 million can be analyzed based on our average contract duration of 29 months, even though many contracts last 36 months, to estimate monthly recurring revenue. The duration of contracts can vary, with some at 12 months and others at 60 months. These figures represent clients who have actively sought proposals from our technical team. However, for significant deals, which Flagship sometimes handles, we tend to exclude these or adjust their probability to 5% or 10%, as we adopt a conservative approach in our assessments.

No, that's very helpful. I have one last question for now. I notice that your SG&A spending tends to vary quite a bit. How would you describe or approach your go-to-market spending for the rest of the year, considering the momentum you have experienced so far this year?

When analyzing SG&A expenses, it's important to note that equipment sales can lead to significant commissions for sales representatives. A portion of the gross profit is allocated to these commissions, which can cause noticeable fluctuations. Additionally, stock compensation, associated with stock options and grants, also contributes to changes in SG&A. For example, in 2022, Flagship incurred over $400,000 in stock compensation, while in 2023, this amount was $52,000. This compensation was given to Flagship executives despite not meeting performance targets, allowing them to remain engaged with the company. Overall, stock compensation for Flagship was around $460,000 in 2022.

Got it. All right. Thank you. I'll jump back in the queue.

Next question comes from Adam Waldo with Lismore Partners. Please go ahead.

Good day, everyone. Chuck, thanks very much for taking my questions again this quarter. I want to really drill down again on the new business pipeline and backlog metrics, which certainly, as we met last quarter and when you reported fourth quarter results back in the winter, we're illustrating what you sort of qualitatively termed a migration acceleration, right, in customers to the IBM platform. So, when we met last quarter, you reported 19,000 inbound inquiries over the three divisions websites year-to-date, and that compared with 6,000 back in the winter. Now, today, you're reporting 45,000. So, I think that really puts a fine point on it, right? How do we think about how those kinds of inbound inquiries compared with a year ago, keeping in mind that you have also been upgrading your websites this year relative to last?

Good morning, Adam. Let me clarify the questions. Regarding the new business, pipeline, and migration, I want to emphasize that while the platform is growing by approximately 9% compared to the previous period, it's not that people are specifically moving to IBM. Instead, those who already have these systems installed are realizing that it might be more beneficial to conserve capital and adopt a pay-as-you-grow model, enabling them to upgrade to the latest systems and ensure optimal disaster recovery. While there is some growth in IBM Power, it mainly involves existing customers. IBM typically retains its client base. With respect to the increased inquiries, when I mentioned 45,000, that encompasses all three sites. This acceleration includes the two other subsidiaries as well. Specifically for CloudFirst, I believe we have had around 38,000 inquiries so far this year. When I shared the previous number, it was during the April-May timeframe. We're indeed seeing a good close rate with these inquiries since inbound leads often indicate that something is happening in their environment. This could stem from the CFO advising a review of potential benefits or from IBM technicians who may be aging and nearing retirement. Additionally, there are custom applications built on this platform that continue to be developed by new graduates, but the individuals maintaining the older hardware pose a risk for these companies. Given these factors, businesses are exploring their options, which is why we have a substantial nurture list, with ongoing inquiries. The migration is in progress, and our pipeline, currently at $9 million, is healthy. Though this pipeline was once higher due to closed deals, we remain optimistic about the opportunities ahead. We're considering using some of our cash reserves to pursue growth in the U.K. and to expand in Canada with our partners at the two data centers there. We anticipate further growth in our pipeline as the migration continues with minimal competition. Returning to Flagship for a moment, cross-selling is finally showing results, with deals coming in from Flagship. They are engaging with about 25 well-known accounts interested in the cloud-based solutions offered through CloudFirst. Concurrently, they are successfully selling equipment and provisioning services. I am genuinely excited about this progress, more so than before, although I tend to have a bit of a personality that never feels fully satisfied. Nonetheless, it is moving in a positive direction. If we consider the challenges that CloudFirst faced, things are improving, and I believe that Tom Kempster is enhancing our gross profit margins by actively visiting these accounts and elevating the margins there. I hope this answers your question comprehensively.

No, that's very helpful color, Chuck. I appreciate it and very encouraging. As you look at sales cycles and close rates, are those remaining pretty stable? Or is the large increase in inbound inquiries affecting sales cycle lengths and close rates in any meaningful way?

I believe we are performing well, but there is definitely room for improvement, especially with inbound leads, which are showing positive movement. Flagship is progressing, and changes to the website have contributed to this. We need to focus more on indirect sales through alternative channels and channel partners. Historically, we've targeted companies that sold IBM systems, but that approach is becoming less effective. There is additional revenue potential available, particularly from cable and telecom companies that already have established relationships with customers. We need to explore more non-traditional channel partners. I don't mean to imply that our current efforts are inadequate; we do well in that area, but I believe we can enhance our support for the team focused on these partnerships. Having a channel partner who already has a customer relationship simplifies the sales process, eliminating the need for cold outreach. We should leverage inbound leads and collaborate with trusted advisers in networks like cable companies, which, despite facing challenges, have strong customer connections. That’s the direction we're considering.

As you prioritize, Chuck, you pointed out that trusted partners as channel partners can significantly speed up the sales cycle and improve close rates compared to international expansion, where you might be starting from scratch. Could you elaborate on your plans for the U.K. and Canada? Will you work with channel partners there, or will it be a new start? Additionally, how are you balancing the capital efficiency and returns from channel partners versus the potential returns from expanding internationally if it involves starting from the ground up?

I have a brief background to share. My experience is with International Telecommunications Corporation, where we implemented global switches and formed partnerships internationally. That company eventually went public for $800 million. I have experience working internationally, and I believe partnering is the most effective way to accelerate growth. We have the financial resources to support these partners, which is essential since many companies lack sufficient funding. We already have channel partners in Canada, and we aim to establish similar partnerships in the U.K. By collaborating with them and integrating our equipment according to the standards set by Chuck Paolillo, our CTO, we can quickly roll out our operations in the U.K. We plan to work with channel partners, though we will also have sales representatives and country management focused on supporting these partners, similar to our approach in the U.S. under the guidance of Steve Romweber, our Channel Director. Our strategy will ultimately involve working with partners.

Okay. That's terrific. One last one, if you'll quickly permit me. Last quarter, you mentioned $5.5 million in executed contracts that the service delivery team was in the process of installing and implementing. How does that look here at the end of the latest quarter?

I don't want to provide guidance on this or specify a timeline, but I want to address the question. Often, when implementing infrastructure as a service, it's essential to collaborate closely with the client's technical team. Even if our team is ready, the client's team may not be, making the process slower on the infrastructure front. Therefore, I can't provide a specific timing. Currently, about $160,000 in monthly recurring revenue is being set up. However, I can't indicate when that will be reflected in our results, as there could be client-related delays and shifting priorities, but these are contracts that have been executed.

Right. Okay. And so about $160,000 in process and about 29, 30 months average length or was a little longer than that than the historical averages?

Some agreements may take anywhere from 12 to 60 months to complete. The average duration is about 29 months, but it's difficult to provide an exact timeline. If we had more clarity, I would offer guidance, and this would be the first time we did so. However, we sometimes anticipate events occurring within a month, and then they get delayed due to factors on the networking side or other projects on the client's end. Predicting this is challenging, but these are confirmed agreements.

Okay. Thanks very much.

Thank you. There are no further questions. I would like to turn the floor over to management for closing remarks.

Matt and Adam, thank you for the questions. Overall, we are beginning to witness the benefits of the business initiatives and anticipate realizing the full benefits over time. As we roll out initiatives, we believe we can achieve sustained profitability and increase value for our shareholders. We are very excited about the outlook for the business and look forward to announcing additional milestones in the near term. I'd like to thank everyone who joined today. We appreciate it, and have a great day.

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