Data Storage Corp Q3 FY2024 Earnings Call

Greetings. And welcome to the Data Storage Corporation 2024 Fiscal Third Quarter Business Update. 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, Alexandra Schilt, Investor Relations. Thank you. You may begin.

Thank you. Good morning, everyone. And welcome to Data Storage Corporation’s 2024 third 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. The company issued a press release this morning containing its 2024 third quarter 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 believe, expect, anticipate, intend, project, estimate, plan and similar expressions or 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 that the expectations reflected in such forward-looking statements are reasonable, it can provide no assurance that such expectations will prove to be 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 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 included in the company’s quarterly report on Form 10-Q for the quarter ended September 30, 2024, 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 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, change circumstances or otherwise. I’d now like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

Thank you, Al. Good morning, everyone. We have made important progress during the recent months, including penetrating strategic markets, forging important partnerships and establishing new regional data centers. Before we get into the detail on those achievements, I’d like to report that we generated $5.8 million in revenue for the third quarter. While this reflects a decline of 3% from the previous year, it does align with our strategic focus on building recurring subscription revenue, rather than relying on one-time non-recurring sales. Equipment sales are not our primary strategy, but as I’ve mentioned in the past, we will continue to support our clients and sell equipment and software. Our primary objective remains the same, securing ongoing service contracts with our enterprise infrastructure platform, which creates a stable revenue foundation and supports our long-term growth and profitability. When we look at a 3% decline in revenue, consider the recurring subscription agreements, their length of agreement, and then our excellent renewal rate. While there is a 3% decline for the quarter, what’s not stated is the increase in baseline revenue for 2025 in monthly subscription billing. We achieved profitability for the three months and a gross profit margin of 43.2% in the third quarter of 2024, up from 38.9% in the same period last year. This improvement is an increase in our infrastructure, cloud-based solutions on our enterprise platform. For the nine-month period, we generated $19 million in revenue and achieved profitability. I’d like to get into some of the developments during the quarter. This quarter, we expanded our presence into high growth, highly regulated sectors, where data security, compliance and reliability are paramount. We expanded our partnerships with a $1 billion insurance firm that selected us to enhance its cloud infrastructure and cybersecurity framework. This reflects the client’s confidence in our reliable security services that we’ve been providing for years. Additionally, it underscores the strength of our enterprise infrastructure cloud-based platform in supporting large organizations that handle sensitive compliance heavy data. Working with such a prominent player validates our focus on the insurance sector, where demand for secure and scalable cloud solutions is increasing and our services are recognized as above industry standard. In healthcare, another highly regulated industry, we signed a contract with a leading medical center that required robust, compliant cloud hosting service. This agreement highlights our capacity to meet stringent industry requirements for data protection and HIPAA compliance. Healthcare organizations are seeking trusted cloud partners to ensure that data is always accessible, secure and protected from cyber threats, and this agreement strengthens our position in this sector. We also secured a significant contract in the education sector, partnering with a music publishing organization. This six-figure agreement emphasizes our flexibility in addressing diverse client needs and our adaptability to data-intensive sectors. With the rise of digital learning and content, education and publishing sectors are now required. They require secure cloud infrastructure for data storage and content delivery, making this an excellent growth avenue for our solutions. Collectively, we believe that these agreements showcase our growing reputation as a trusted provider in industries with stringent data requirements, where reliability, security and regulatory adherence are critical. We are confident that our expanding footprint in these fields will drive long-term value as we continue to innovate and tailor our offerings to meet the needs of our clients. To accommodate our growing client base in the United States, we expanded our infrastructure platform to Chicago. This facility enhances our national coverage. It reduces latency and strengthens our capacity to provide reliable, enterprise-level, high-availability cloud services, especially across the Midwest. With this strategic expansion, we are well-equipped to meet rising demand while ensuring an exceptional client experience. Recently, we provided a letter to our shareholders highlighting achievements within our CloudFirst subsidiary, which achieved $5.5 million in revenue for the third quarter and positive net income. This is a direct result of our progress at CloudFirst, as we continue to be a leader in cloud hosting, disaster recovery and cybersecurity. Currently serving over 425 companies across diverse industries, CloudFirst is on track to reach over $20 million in projected recurring revenue for 2025, given our 12-month term agreements renew. Not only is our renewal rate excellent at over 90%, our clients continue to add and expand their services with us, an excellent vote of confidence. Our recent expansion into the U.K. market and the successful integration of Flagship Solutions further strengthens our global footprint and operational efficiency, setting the stage for accelerated growth and global reach. Recently announced was the appointment of Colin Freeman as Managing Director of CloudFirst Europe, an important step of our strategy to expand across the European market and deliver our solutions to this key market. With Colin’s leadership experience, we are confident he will be instrumental in accelerating our growth in the region. In addition to his appointment, we are establishing infrastructure deployment in data centers in the U.K., positioning us to make a strong entry and enhance our footprint in this key market. These milestones are key steps in our organic growth to capture new opportunities and expand our impact. We are excited to build on this momentum as we continue delivering innovative, reliable solutions and creating lasting value to our shareholders. Over the past nine months, our CloudFirst website attracted more than 65,000 visitors, underscoring the growing interest and engagement we are seeing around the IBM PowerServer Migration. To support this rising demand, we are strategically expanding our technical and business development teams, readying ourselves to sustain both client acquisition and maintain impressive client renewal rates. Additionally, we are focused on nurturing a significant pipeline of potential clients globally. Our nurture list includes thousands of organizations interested in the potential implementation of our services across various industries and regions. By cultivating these relationships and providing tailored support, our aim is to convert this interest into new contracts. Our new, expanded addressable market in Europe and companies doing business cross-border exceeds over 50,000 companies. We have increased our addressable market, positioning ourselves with enterprise-level infrastructure with assets deployed in 11 data centers by January 2025. We are positioned to capture the migration. These initiatives allow us to engage with future clients while capitalizing on opportunities to expand our reach and solidify our reputation as a leading provider in the space. Overall, we are proud of our execution, including expanding contracts, international reach, and rising industry prominence. This foundation allows us to consider targeted acquisitions that complement and enhance our operations, positioning us with the greatest success as new shareholders see our value and our share price becomes reflective of the value of the company. At the same time, we are in strong financial position with a solid balance sheet, holding $11.9 million in cash and marketable securities and no long-term debt. This stability provides flexibility to invest efficiently, ensuring we are ready to seize growth opportunities that create value for our shareholders.

Thank you, Chuck. Good morning, everyone. Total revenue for the three months ended September 30, 2024 was $5.8 million, a decrease of approximately $178,000 or 3% compared to $6 million for the three months ended September 30, 2023. The decrease is primarily attributed to lower one-time equipment and software sales during the current period and a decrease in managed services partially offset by increases in all other revenue sources. Total revenue for the nine months ended September 30, 2024 was $19 million, an increase of approximately $184,000 or 1%, compared to $18.7 million for the nine months ended September 30, 2023. The increase is primarily attributed to the increase of 29% in infrastructure and disaster recovery cloud services, offset partially by a decrease in one-time equipment sales and managed services during the current period. Cost of sales for the three months ended September 30, 2024 was $3.3 million, a decrease of approximately $359,000 or 10%, compared to $3.7 million for the three months ended September 30, 2023. The decrease of 10% was mostly related to the decrease in one-time equipment and managed services related cost of sales. Cost of sales for the nine months ended September 30, 2024 was $11.1 million, a decrease of approximately $703,000 or 6%, compared to $11.8 million for the nine months ended September 30, 2023. The decrease of 6% was mostly related to a decrease in one-time equipment sales. Selling, general and administrative expenses for the three months ended September 30, 2024 were $2.5 million, an increase of approximately $221,000 or 10%, as compared to $2.3 million for the three months ended September 30, 2023. Selling, general and administrative expenses for the nine months ended September 30, 2024 were $8.1 million, an increase of approximately $1.2 million or 17%, as compared to $6.9 million for the nine months ended September 30, 2023. The increases were primarily due to an increase in professional fees, salaries, stock-based compensation and travel as a result of our international expansion efforts. Adjusted EBITDA for the three months ended September 30, 2024 was $515,000, compared to adjusted EBITDA of $486,000 for the same period last year. Adjusted EBITDA for the nine months ended September 30, 2024 and 2023 was $1.4 million. Net income attributable to common shareholders for the three months ended September 30, 2024 was $122,000, compared to net income of $179,000 for the three months ended September 30, 2023. Net income attributable to common shareholders for the nine months ended September 30, 2024 was $235,000, compared to $456,000 for the nine months ended September 30, 2023. We ended the period with cash and marketable securities of approximately $11.9 million at September 30, 2024, compared to $12.75 million at December 31, 2023.

Thanks, Chris. Let’s open up the call for questions. Do we have any questions? Operator?

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

Hey. Thanks for taking my questions. Can we start on the services renewal? I think you mentioned $20 million or maybe it was a bit more. What is your outlook for services revenue in 2025 at this point? Just so I can get that right.

Thanks for the question, Chris. It's good to hear from you. Regarding service renewals, if you’re referring to managed services, our average monthly revenue is between $175,000 and $200,000. I’m not certain if you’re also inquiring about software renewal and hardware maintenance, but I wanted to share those figures. Typically, our managed services revenue falls within that range, which also includes professional services related to the implementation of our subscription services. For instance, if we assess our sales funnel, implementation services usually account for around 10%. So, when considering those figures, you can derive insights into our numbers. On the software and hardware renewals, we see an annual range of about $5 million to $6 million, which can sometimes lead to fluctuations in our revenue. One large client contributes approximately $2.9 million to $3 million. When does that occur?

In March.

You will notice an increase. It's not just equipment that contributes to the fluctuations. If we consider our baseline and look ahead to 2025, for instance, our annual agreements, which include software renewals and hardware maintenance, are around $5 million to $6 million. We need to look at what that amounts to against the $21 million figure.

Yeah. It’s over $20 million.

Yeah. So, it’s over $20 million that we create a baseline from that. And with the degree and the amount that existing customers add to storage and compute power, on that alone, we have growth demands on it. So you’ll see this lumpiness that goes on. So what ends up happening is, if we take someone that’s got software renewal and hardware maintenance and they’re an on-premise customer, obviously, but we’re most likely doing disaster recovery for them as well. If we move them to cloud hosting, well, then we’re going to lose that revenue. They could move off the platform to another platform, not an IBM Power platform, let’s say to Intel, whatever. You would lose that. But typically, they’ll move to our hosting and they’re currently using disaster recovery. So, on baseline, you’re looking at around $21 million, which includes $5 million to $6 million of software renewal and hardware maintenance. You’re also looking at around, let’s just call it, $2 million to $2.4 million of managed services that’s part of that number.

Got it. That’s very helpful. Sorry, go ahead.

No. That’s it. I just want to make sure I’m answering that.

Oh! Gotcha. Okay. So, I guess that number includes any assumptions regarding the 90% renewal rate or more than 90%, so will there be some churn factored into that number? How should we interpret that figure? Is it before or after expected churn?

When we analyze our churn, it’s approximately 92%. I’m providing an estimate here, with 92% related to client revenue and 94% concerning actual clients. Considering we have four to six competitors, with two of them having been acquired by private equity firms, often when companies are purchased, some leadership may depart. However, while some personnel may leave, customers generally remain because there is sufficient business available, and they prefer not to transfer their data again. Therefore, I estimate a 94% renewal rate that shows customers continue to stay. The real challenge lies with larger companies; I don’t believe organizations like Deutsche Bank or Citibank will transition to the cloud in the coming years as they have substantial, existing platforms. Consequently, the expected revenue of $5 million to $6 million might decrease as our hosting services increase. We won't see a significant boost from the $2.9 million, which comes with a 15% gross profit margin. Transitioning to cloud hosting, we’re discussing margins exceeding 50% today, with our cloud services margins around 60%. In terms of managed services, we continue to monitor and manage clients' infrastructure. Our primary focus is support, and many clients use Intel and IBM platforms with us for cybersecurity and monitoring, creating a bundle that’s challenging to leave unless a company is acquired. Most clients are not facing bankruptcy; they are mid-sized or enterprise-level, though they could be bought and shifted to another platform. Thus, our services tend to be quite sticky.

Helpful. Very much appreciate it. And I’ve got one more and then I’ll jump in the queue. So if we could go a little bit deeper into that. So if we take just the cloud subscription renewals, is it reasonable to say that those really sticky customers that have already migrated to cloud subscriptions are north maybe like 95%, 96%. And are they on a revenue basis generally growing? So like, are the renewals generally bigger than the prior contracts as they, if they push more into the cloud or their cloud services come under higher demand?

It’s an interesting question because the first thing I want to approach is the years ago, we would always say we would have an automatic renewal on most of our term contracts for 36 months. We have 12 months as well and we have 60 months, but most of them are 36 months. And what we were doing in the past is we had an automatic renewal and the automatic renewal was just for a year. So if they had a three-year term, it was one year. So we picked up on this from a competitor, I think, and I’m going back a bunch of years. And now what we do is we actually, they renew for the actual term that was the original term. So we’d go for three years and then renew for three years. But what ends up happening is our account management team is in constant touch with these clients. And Chris, our CFO, puts out a weekly report of KPIs. And I keep looking at that and it’s actually like a 3:1 ratio that our clients continue to add storage and compute power, other services, whether they were on IBM Power or Intel or now Intel moving to IBM Power or different levels of disaster recovery or cybersecurity. So what ends up happening is that we’re in constant touch and it’s growing. It looks like a 3:1 ratio. I’m not saying on the revenue side, but on the actual contract side addendums. The other thing is Harold Schwartz, who’s the President of the company, Harold put in place that when it renews, we can increase up to 10%. We have the right to increase up to 10% on their actual monthly term, which is good. So we can go back and increase that. We’re not stuck with keeping that because years ago, I mean, we have clients for over a decade and they were maintaining the same price and other services that might be software would continue to move up. So with that, we have a built-in 10% on top of that, along with, if you remember that whole model years ago, it’s a data grows. That’s what we’ve been doing. We’ve been doing data vaulting since 2002 and it’s only really since raising the money and all of that and moving on to NASDAQ that has given the opportunity to really get very aggressive and get smarter.

Great. Thank you.

Thank you. Mr. Piluso, we have no further questions at this time. I’d like to turn the floor back over to you for closing comments.

Thank you. Since our NASDAQ uplisting and capital raises in 2021, we have developed a business strategy that we believe will accelerate our growth, drive long-term profitability and maximize value to our shareholders. We are optimistic about the potential of our initiatives and we are executing. We remain committed to providing our shareholders with meaningful updates, and I would like to thank everyone who joined our call today. We appreciate it. Thank you. Have a great day.

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.