Earnings Call Transcript - DTST Q1 2024

Operator, Operator

Ladies and gentlemen, good morning, and welcome to the Data Storage Corporation First Quarter 2024 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alexandra Schilt, Investor Relations. Please go ahead.

Alexandra Schilt, Investor Relations

Thank you. Good morning, everyone, and welcome to Data Storage Corporation's 2024 First Quarter Business Update Conference Call. On the call with us this morning are Charles Piluso, Chairman and Chief Executive Officer; and Chris Panagiotakos, Chief Financial Officer. The company issued a press release this morning containing its 2024 first 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 212-671-100-20. 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 our 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 otherwise including the words, believes, expects, anticipates, intends, projects, estimates, plans or 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 March 31, 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, changed circumstances or otherwise. I'd now like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

Charles Piluso, CEO

Thank you, Ale, and good morning, everyone. We continue to execute on our business growth strategy, including securing new contracts with high-profile clients as well as streamlining our operations for efficiency. As a result of our efforts, we witnessed a 20% increase in revenue to $8.2 million for the first quarter of 2024. Additionally, our gross profit increased 42% with a gross profit margin increasing to 36% from 30%, demonstrating the success and scalability of our business model. Importantly, we achieved profitability for the first quarter and believe that as we continue to execute our strategic initiatives, we will continue to grow revenue and increase profitability. We began the year by consolidating our flagship subsidiary into CloudFirst. This strategic decision combines the unique strengths and expertise of the respective business units, positioning us to optimize operations, leverage technical teams, realize greater efficiencies and improve internal resource allocation. As a result, we expect to enhance our cross-selling and upselling opportunities among our customer networks, ensuring continued delivery of outstanding value. With the experienced leadership teams and combined organizations of both CloudFirst and flagship, we are confident in our ability to establish a scalable organization primed for accelerated growth. Let's discuss these contracts that occurred in the first quarter. First, we expanded our contract with an existing multinational telecommunications company. This is a six-figure contract. We are very proud of our successful collaboration with this multinational corporation, spanning over 12 years. Beyond our existing equipment and services, we developed a custom solution. We are now implementing an innovative disaster recovery backup solution boasting advanced technology. This solution enhances their storage capacity, while reducing tape usage and ensuring compliance across multiple countries. With installation moving smoothly, we eagerly anticipate the continued expansion of our collaboration with this organization. Furthermore, one of the largest insurance companies in the United States has chosen to migrate its data center to the Cloud for one of its divisions. Alongside the cloud migration, we will be delivering hosting and managed services, incorporating a comprehensive suite of advanced security solutions to uphold the utmost standards of data protection and compliance. Following an assessment of numerous providers, the insurance company opted for our services for its critical undertaking. The decision was influenced by our company's exceptionally reliable data circuits and proven track record in delivering data management and cloud services to Fortune 500 companies and top-tier financial firms. We believe this contract underscores our ability to address the requirements of prominent enterprises and our commitment to advancing technology that fosters our clients' growth. Being selected illustrates the significance of our offering and the importance of robust security measures in today's digitally driven and risk-laden business landscape. We are confident that our solutions will deliver exceptional results and pave the way for expanding our solutions across additional divisions and geographies in the future. As I discussed in the last call, part of our strategy is international expansion. There is demand for our solutions globally, and we are proud to report the opening of CloudFirst London office in the second quarter of this year. This strategic expansion marked a significant milestone in our strategy to serve a global clientele and further CloudFirst presence in key global markets while increasing our international footprint and further supporting our current multinational clients. In addition, we recently moved to new and expanded headquarters in Melville, New York. We're excited about our new space, which we increased square footage by nearly 40% without a substantial rise in expenses. These new offices are designed to bolster our growth encompassing accounting, technical teams, sales and marketing initiatives. Further validation of the demand for our solutions is the continued increase in visitors to our website, which was over 43,000 in the first quarter of this year. We also continue to support our nurture list, which contains thousands of organizations interested in potential implementation and education of our services. We intend to take advantage of these avenues to secure new contracts and increase our footprint within the market. Currently, we serve more than 450 companies and strive to expand this impressive client base. Data center firms specializing in Windows-based infrastructure platforms rely on us for our expertise in the IBM platform. Partnering with these infrastructure firms offers a chance to broaden our distribution channels, leverage our talented staff and optimize our deployed assets. And before I turn this over to Chris for a review of our financials, I'd like to discuss our new Board members. First, Cliff Stein returned to our Board of Directors. Cliff is a seasoned entrepreneur, adept executive with over 30 years of experience in establishing and managing a thriving real estate advisory firm. His background as a skilled attorney further enriches his expertise. We are confident that Cliff's skillset will provide invaluable guidance to the company as we pursue growth, whether through organic means or strategic acquisitions. Having previously served on the Board and contributed to numerous strategic growth initiatives, we're excited about his renewed engagement. In addition, we appointed Nancy Stallone and Uwayne Mitchell. Nancy's impressive background in corporate finance, auditing, and accounting will be instrumental as we pursue strategic growth initiatives, including international expansion and exploring potential acquisitions. Uwayne Mitchell's legal efficiency, combined with his expertise in data privacy, cybersecurity and technology will greatly enhance our board and support our growth. We remain committed to upholding the highest standards of corporate governance and look forward to their contributions as we advance our business model. Overall, with continued execution of our strategic plan, we achieved profitability for the first quarter, secured new and expanded contracts, increased our penetration in the domestic market and actively expanded into international markets. We are also exploring potential acquisitions that would assist and support our growth and, more importantly, complement and improve our current operations. We believe that our company has reached a pivotal moment. We are exceptionally well positioned to enter key international markets, leverage upselling and cross-selling potentials for our offerings and secure additional subscription-based contracts. These strategic initiatives set the stage for long-term profitability. At the same time, we've carefully managed our expenses and have preserved a strong balance sheet with over $11.9 million in cash and marketable securities. No long-term debt as of the end of the quarter, which provides us the flexibility to deploy capital efficiently and effectively to support our long-term growth and drive value to our shareholders. With that, I'd like to turn this over to Chris Panagiotakos, our CFO, to discuss our financials. Please go ahead, Chris.

Chris Panagiotakos, CFO

Thank you, Chuck. Good morning, everyone. Total revenue for the three months ended March 31, 2024, was $8.2 million, an increase of 20% compared to $6.9 million for the three months ended March 31, 2023. The increase is primarily attributed to an increase in infrastructure and disaster recovery cloud services and equipment and software sales. Cost of sales for the three months ended March 31, 2024, was $5.3 million, an increase of 10%, compared to $4.8 million for the three months ended March 31, 2023. The increase of 10% was mostly related to the increase in infrastructure and disaster recovery, cloud services and equipment and software sales. Selling, general and administrative expenses for the three months ended March 31, 2024, were $2.8 million, an increase of approximately $620,000 or 29%, as compared to $2.1 million for the three months ended March 31, 2023. The increase was primarily due to an increase in advertising expense, commission expense, salaries and head count growth. Adjusted EBITDA for the three months ended March 31, 2024, was $680,000, compared to adjusted EBITDA of $336,000 for the same period last year. Net income attributable to common shareholders for the three months ended March 31, 2024, was $357,000, compared to $50,000 for the three months ended March 31, 2023. We ended the year with cash and marketable securities of approximately $11.9 million at March 31, 2024, compared to $12.7 million at December 31, 2023. Thank you, I will now turn the call back to Chuck.

Charles Piluso, CEO

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

Operator, Operator

Our first question is from Matthew Galinko with Maxim Group.

Matthew Galinko, Analyst

Congratulations on the strong first quarter. I guess, firstly, can you touch on maybe the pipeline of Fortune 500 customer opportunities and kind of scope expansion opportunities within your existing customer base?

Charles Piluso, CEO

Good morning, Matt, and thank you for your question. I can't specifically separate the Fortune 500 companies from others in our base. However, I can share that our current pipeline has a total contract value of around $10.8 million. On average, the contract term is approximately 31 months, with the nonrecurring portion estimated to be around $220,000. The recurring monthly amount is roughly $340,000, which indicates a strong pipeline for recurring revenue. This figure pertains only to recurring revenue, excluding nonrecurring, which can vary due to budgetary constraints or readiness issues. In the past, we combined nonrecurring and recurring figures, but now we're concentrating on subscription-based revenue. We also have ongoing installations and related numbers, along with our remaining contract value. I believe your focus is more on the pipeline, right?

Matthew Galinko, Analyst

Correct. Yes.

Charles Piluso, CEO

Yes. I mean the work in process is also pretty good as well. That number will increase because with work in process, and not having to increase your technical teams and with subscription gross profit margins at 50%, it's a full contribution essentially to profit. So our work in process numbers are pretty good. I haven't given you that. I don't know if you're interested in that.

Matthew Galinko, Analyst

Yes. If you have it, I'd love to have it here.

Charles Piluso, CEO

Yes. It's approximately executed contracts that are being installed of approximately, I believe, $100,000, of which we'll see some of that in the second quarter, and we'll see some of that in the third quarter. The sooner it goes up, the more months of revenue we get and the more profit. But with a 50% margin typically, and we don't believe we have to add technicians for that. So, it's a nice contribution to profit.

Matthew Galinko, Analyst

I wanted to discuss one of the major deals you mentioned this quarter. You referred to developing a custom disaster recovery solution, producing tape, and possibly ensuring compliance with multinational regulations. Did I correctly grasp the scope of this project? Was there a significant amount of custom work involved, or is this something that could be adapted for other potential clients?

Chris Panagiotakos, CFO

On the IBM systems, depending on the size of the client, we estimate the marketplace for infrastructure servicing on the IBM platform to be $36 billion. We believe that 40% of this amount will migrate over the next few years, roughly between 3 and 8 years. This translates to about $400 million in annual recurring revenue. Considering the remaining 60%, which consists of very large companies that we estimate will maintain 50% of their current infrastructure—taking into account that about 10% may migrate away—these companies are substantial and possess their own equipment, requiring them to invest in new hardware, tape libraries, and maintain software renewals and hardware upkeep internationally. When we examine these major accounts, they might utilize either virtual or actual tape libraries. Consequently, we need to create custom systems to support their unique requirements and find ways to speed up their file transfers. Most of our engagements with this 50% are tailored builds, where we provide support for clients who prefer to manage their own equipment. This approach results in fluctuating revenue from equipment sales, software renewals, and hardware maintenance, which we find appealing. Additionally, we assist them with various managed services related to disaster recovery and storage applications involving these tape libraries. It's important to distinguish between clients who will migrate and those who remain with significantly larger infrastructures, such as Deutsche Bank and Citibank, which are more substantial than others. For the large clients we collaborate with, we provide equipment sales as an IBM high-level partner, leveraging our technical expertise to drive revenue growth in these areas. However, most of this revenue isn't consistent, aside from software renewals and hardware maintenance.

Matthew Galinko, Analyst

Sorry, last follow-up and I'll jump back in the queue. So for something like that, where you're working on a disaster recovery, but it's not recurring. How do you flow that through your the kind of line item buckets that you normally break out on the queue? Would that hit the disaster recovery and infrastructure line? Or would that hit the software and equipment line or still mix across both?

Chris Panagiotakos, CFO

It's tricky on that. We maintain classes of each of the products that are sold. So when you look at subscription recurring revenue, it's typically annual recurring revenue which is software renewals, hardware maintenance, subscription services for disaster recovery and hosting. And then on the equipment and software line on the financial statements, that's where you'll see equipment and equipment that's sold with the software. We also keep that software equipment and software, anything that is software, that's annually recovering in the equipment and software chart of accounts. So it is bifurcated. It is in the financials and it is separated. But if you want to further break down, we are able to break down equipment and the different types as well as the software and whether that's new software or recurring annual recurring software. So we do break it down. But you would be looking at equipment and software as all those things that are one-time typically.

Operator, Operator

Our next question is from the line of Adam Waldo with Lismore Partners.

Adam Waldo, Analyst

So I want to explore a few different topics, if we may, annual recurring revenue, new business development activities and then sort of what we think the ongoing incremental margin structures of the business will look like, now that you've consolidated CloudFirst and Flagship during the first quarter. On the ARR side, can you give us the dollar value of ARR as you exited the March quarter?

Charles Piluso, CEO

You have that, Chris?

Chris Panagiotakos, CFO

I don't have it handy. We're going to have to get back to you on that.

Charles Piluso, CEO

Yes, just if I could. So in our annual recurring revenue where we have subscription-based business and then software renewal and hardware maintenance is typically in our annual recurring revenue. And we keep track of that from a forecasting point of view because it continues to add to the baseline for the next year. I think, Chris, it was somewhere between $17 million and $18 million, something like that?

Chris Panagiotakos, CFO

$18 million.

Adam Waldo, Analyst

You're right about what you were targeting. That's great. On the new business development side, the number of inbound inquiries through your websites is increasing significantly. What strategies are you implementing from a corporate business development perspective to turn those indications of interest into proposals? Are there new initiatives following the redesign of the websites or new efforts in business development? Please give us an overview of what you are pursuing to enhance conversions into proposals.

Charles Piluso, CEO

Certainly. It's quite challenging. The issue is that the individuals responsible for monitoring and maintaining this equipment are reaching retirement age. There has been an investment in the applications that are currently in use. Graduates can enter the workforce with knowledge of these applications. However, as the maintenance staff retires, CFOs and CIOs are becoming increasingly concerned about ensuring these applications keep operating. As a result, a migration is occurring. Many have already transitioned a significant portion of their Intel-based systems to providers like Amazon and Google. Now, the question becomes what to do with the IBM equipment. To illustrate, over a decade ago, I was in contact with sales representatives from international banks in Manhattan that still utilize IBM systems. Recently, I overheard Jill, a member of our business development team who's been with us for some time, speaking to one of those banks. She discovered my name in Salesforce because I had visited that bank 12 years ago. This migration is indeed taking place, and they remember us from that visit. Hal Schwartz, our President of CloudFirst, is doing an outstanding job with search engine optimization and collaborating with our marketing partners to drive lead flow. This results in phone calls and conversations that enter our nurture list. We then reach out to those on the nurture list to gauge their interest and current status. It's difficult to simply hire 30 people and invest heavily in a direct sales force without the risk of it failing. A robust team is essential, but replicating a direct sales force from 30 years ago isn't feasible. Success depends heavily on inbound leads, networking, trade shows, and relationships built over the last 15 years. Many who have migrated their platforms are now reaching out to us, and we have few competitors, with us being one of the leaders. While we do have Intel infrastructure in our data centers, our advertisements and marketing efforts are primarily focused on our niche, the IBM platform. We also handle any ongoing Intel business. Therefore, business development relies significantly on inbound marketing programs. While my response was lengthy, it highlights the need for longevity and credibility. You must implement inbound strategies to maintain high rankings, which we do. Additionally, having a strong team supported by a proficient business development team and technical team is crucial for bringing in business, and we are managing this efficiently.

Adam Waldo, Analyst

Very helpful. And then as we go forward, obviously, having consolidated CloudFirst and Flagship now, what do we think the sort of steady state approximate range on services gross margin is going to be? And what do you think the incremental or variable EBITDA margin on new revenue looks like as you consolidated those operations?

Charles Piluso, CEO

We aren't disclosing the specifics of our outstanding nonrecurring proposals because some are quite substantial and involve existing clients. While we have a $10 million proposal for current customers, we can't predict when it will materialize. The margins you see at 38%, 35%, or below 50% indicate that they stem from equipment sales or significant software and hardware renewals, making predictions challenging. Traditionally, Flagship focused on managed services, a domain where CloudFirst was previously more active. Now, we're shifting to equipment sales, which is slower as we transition clients. For example, if a customer wants to purchase $2 million worth of equipment, our business development team encourages them to consider hosting instead, offering a trial to experience it. This approach may result in losing an equipment sale initially, but we could then transition them to a 60-month hosting and disaster recovery subscription. Predicting margins is difficult, but if we see margins over 45%, that usually means high recurring revenue for that quarter. Ideally, we aim for 80% of our revenue to come from subscriptions and 20% from one-time equipment and professional services. However, if we encounter a 60-40 split due to a large account, margins may be lower, but we still strengthen our cash flow and continue to benefit from annual software renewals and hardware maintenance related to that equipment, which adds a recurring aspect to it.

Adam Waldo, Analyst

Okay. Last question, if you'll allow me. You opened the new office in London during the quarter. How does that align with your previous initiatives regarding value-added resellers or distribution partners in the U.K.? Will the London office be part of a new initiative, or have you decided to establish your own sales and distribution efforts in the U.K.?

Charles Piluso, CEO

What our plan is, is to build a distribution channel. So the folks that are working there right now, the individuals, their objective is to get distributors. And those distributors hopefully have clients that have IBM platforms. Once that's up to a certain level that Hal Schwartz and myself are comfortable with, we'll deploy equipment in two data centers. So these folks are working with data centers today and folks that already sell Intel side platforms. So we're pretty confident. We spent a little time over there. It's going well early on. The company is being registered there. We're not registered yet. We signed the lease and all. We've hired a firm that's working on registration of the company, but there's some very good activity. We're happy about it at this particular point, but I'll continue to update everybody as it moves along.

Chris Panagiotakos, CFO

Adam, this is Chris. The ARR for the quarter was approximately $3.1 million.

Adam Waldo, Analyst

$3.1 million booked in the quarter?

Chris Panagiotakos, CFO

In the quarter, correct.

Adam Waldo, Analyst

Okay. Is that just a straight line annualization, Chris, or are there some timing considerations?

Chris Panagiotakos, CFO

It's timing. It's not a straight line.

Adam Waldo, Analyst

Is that still annualized out to the $17 million to $18 million that Chuck and you spoke about earlier?

Chris Panagiotakos, CFO

Yes.

Operator, Operator

Our next question is from the line of Matthew Galinko with Maxim Group.

Matthew Galinko, Analyst

Just a follow-up. I guess given your comments on the go-to-market and then how you sort of go after that pipeline of IBM customers that are transitioning or could transition to cloud. How does that inform your M&A strategy? And what sort of assets would you look at today sort of throwing dollars at a building, a bigger and bigger sales force isn't necessarily the strategy you're looking for to grow that business?

Charles Piluso, CEO

Matt, that's an interesting question. As I mentioned, suddenly acquiring a large number of sales representatives is challenging because people are generally reluctant to meet. Therefore, we need a strong inbound program alongside a good reputation and a proactive outreach strategy. Regarding our pipeline, we've been developing relationships with distributors, which we refer to as channel partners, and they have customer bases prepared for migration. This contributes to our proposals. Some prospects come in through Google AdWords or improve their rankings organically, while others are actively engaging with clients who have previously purchased equipment from Flagship and CloudFirst. In terms of mergers and acquisitions, we are focused on finding opportunities that will enhance our distribution channels. We’ve engaged with various potential partners, including a company boasting 1,000 distributors in a software sector, but we haven’t found a fit that aligns with our objectives. Our search includes companies in the cybersecurity sector with 24-hour operations, not software-focused companies. We aim for companies with revenues between $10 million and $15 million that may be facing financial distress, which we could help stabilize but finding a solid company is quite tough. We are continuously searching for M&A opportunities while also investing in organic growth. We've decided to proceed with both strategies, knowing that organic investments will negatively impact our profit and loss statement, unlike acquisitions that affect our balance sheet. For instance, we've made organic investments in the U.K. and are expanding in the U.S. Although we actively seek firms in the $10 million to $15 million range, this segment is challenging, and we are cautious about depleting our $11 million to $12 million cash reserve on the balance sheet. We value our stable company with excellent margins, customer loyalty, and a high renewal rate. However, we want to avoid situations where we might incur significant losses from entities that have sustained considerable ongoing losses over the years. So, we are analyzing every option available in response to your question, Matt.

Operator, Operator

Our next question is from Bobby Cohen with Merger Monday Capital.

Bobby Cohen, Analyst

Chuck, this is Bobby Cohen. I had one broad-brush question. When do you project $1 from international?

Charles Piluso, CEO

Today, we have international customers and generate revenue from around 8 countries. We have equipment with a partner in France and serve banks there. To answer your question directly, I expect that within the next 90 days, we will have enough information to decide on deploying equipment. We discussed this strategically and should know within that timeframe about the distribution. I anticipate that by September, we will have deployment plans in place. Currently, we serve international clients that are hubbed out of the U.S., but due to some European regulations, we may need to start the process in the U.S. before transitioning them over. Therefore, we aim for a September timeframe to deploy equipment, which would allow for international revenue coming from equipment in the U.K. in the fourth quarter.

Bobby Cohen, Analyst

Okay. Great. One more question. You mentioned it briefly, but could you provide more details on your interest in mergers and acquisitions? I understand you're going to take a careful approach, but are there many opportunities available?

Charles Piluso, CEO

We have been collaborating closely with Maxim, and their team has been actively searching for companies for us. Additionally, we have relationships with about three other firms that are also seeking opportunities for us. Over the past six months, we have probably issued around five term sheets or letters of intent. However, after conducting further due diligence, we decided against proceeding with them. We’ve also had over five additional discussions with companies where we didn’t reach the stage of a letter of intent or a term sheet. We remain very active in our search for the right partner. This is my fourth venture, and I have been trained by two Fortune 10 companies. Many individuals in this industry started from the ground up right after college, and they tend to have a challenging mindset, especially if they have never worked for anyone before. Integrating such individuals can be quite difficult. Although we have managed to successfully acquire a number of companies over the years, it’s particularly challenging in the $10 million to $15 million range. We are hesitant to move beyond that threshold unless a company has manageable bank debt, especially given the current interest rates. We don’t typically favor debt since we are experiencing solid growth and stability in our EBITDA. Speaking of which, Chris, can you provide the EBITDA for CloudFirst in the first quarter? What do you have on that?

Chris Panagiotakos, CFO

I mean it's a big number. Remember, we look at EBITDA, consolidated with headquarters. So the EBITDA number, I think the margin is in the 30% EBITDA margin on CloudFirst. So that gives you a little feel for it. So we're doing fine. So we are looking for it. We have the appetite for M&A. We want to do M&A, but it just needs to be the right thing. Everything starts out right, as we all know. And it's the question of how it ends.

Charles Piluso, CEO

Thank you, and thank you for the questions. We have formulated a robust business strategy that we believe will drive our growth and ensure a sustained and increased profitability over the long term. While delivering maximum value to our shareholders, we're optimistic about our prospects and our efforts and eagerly anticipate realizing the full benefits over time. And we look forward to providing meaningful updates to our shareholders. Furthermore, I'd like to thank everyone who joined the call today. Thank you, and have a great day.

Operator, Operator

Thank you. The conference of Data Storage Corporation has now concluded. Thank you for your participation. You may now disconnect your lines.