Earnings Call Transcript - DTST Q3 2023

Operator, Operator

Greetings, and welcome to the Data Storage Corporation 2023 Fiscal Third 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, Alexandra Schilt. Thank you. You may begin.

Alexandra Schilt, Host

Thank you. Good morning, everyone, and welcome to Data Storage Corporation's third quarter business update conference call. Joining us today are Chuck Piluso, Chairman and Chief Executive Officer, and Chris Panagiotakos, Chief Financial Officer. The company released a press statement this morning detailing its third quarter 2023 financial results, which is also available on the company's website. If you have any questions after the call or need further information about the company, please reach out to Crescendo Communications at (212) 671-1020. Before we start, I would like to remind everyone that this conference call includes forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, featuring a safe harbor provision. These statements are subject to risks and uncertainties that could cause actual results, performance, or accomplishments to vary significantly from those projected. Statements that use words such as believes, expects, anticipates, intends, projects, estimates, plans, and similar expressions, or future verbs like will, should, would, may, and could, are generally considered forward-looking and not historical facts, though not all forward-looking statements will contain these terms. While the company believes the expectations in the forward-looking statements are reasonable, it cannot guarantee that they will be proven correct. Key factors that could lead to actual results differing from expectations include the company's ability to harness the scalability and performance of Flagship Solutions, gain from the ongoing IBM cloud migration, position itself for future profitability, and keep its NASDAQ listing. These risks are not exhaustive and should be read in conjunction with other cautionary information provided in the company's quarterly report on Form 10-Q for the quarter ending September 30, 2023, as well as the annual report on Form 10-K and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statement is only valid as of the date it was made. Except as legally required, the company does not intend to update or revise any forward-looking statements due to new information, future events, changed circumstances, or otherwise. I will now turn the call over to Chuck Piluso. Please go ahead, Chuck.

Charles Piluso, CEO

Thanks, Alexandra. Good morning, everyone. I'm proud to report we generated a 35% increase in revenue to approximately $6 million for the third quarter of 2023. Importantly, we achieved another quarter of profitability with approximately $158,000 in net income for the third quarter. We believe this is a direct result of our ongoing business growth initiatives, which we have implemented to assist in accelerating our revenue growth and increased profitability. Notably, CloudFirst as a stand-alone business achieved $3.7 million in revenue for the third quarter with a net income of over $800,000 and $1.1 million in EBITDA. In addition, on the equipment and software side, we generated approximately $2 million of revenue in the third quarter, compared to approximately $1 million for the third quarter of 2022, an increase of nearly 100%. While the increase in equipment sales had a slight impact on our overall gross profit margin, we continue to work to assimilate Flagship business unit and have actively implemented strategies to enhance our gross profit margin by increasing subscription revenues within Flagship and moving closer to the 50% margin that we generated for CloudFirst. We have begun the process of bringing together these two excellent companies and their team members to leverage the talent, client bases, assets and management. Across the organization, with the continued execution and further implementation of our growth initiatives, including ongoing expansion of our distribution channels, increased utilization of our digital and direct marketing programs, optimizing our lead generation program, hosting additional revenue-driven sales events, and exploring strategic M&A opportunities, we can continue to increase revenue while maximizing long-term profitability. Furthermore, we plan to expand internationally as there is a significant need for our innovative solutions around the world, and we intend to penetrate these large underserved markets. Today, a program is underway to reach out to over 1,000 managed service providers in the U.K. to build partnerships and create a distribution channel. We'll provide updates on our progress as developments unfold. Validating the demand for our solutions, we have continued to witness an increase in visitors to our website. We also have our nurture list, which I have spoken about in the last quarter that contains over 25,000 organizations interested in the potential implementation of our services. We intend to take advantage of these avenues to secure new contracts and increase exposure within the market. In addition, we recently launched a strategic sales and marketing initiative designed to capitalize on the growing demand for our products and services. We are already witnessing the benefits of these initiatives. This includes onboarding new sales representatives, who are dedicated to driving and securing new customers, which supports and works hand in hand with our ongoing lead generation programs. Our new sales representatives are responsible for attending to our nurture list with the goal of progressing discussions to contract. Concurrently, we launched a new major accounts program. This program is solely focused on increasing our penetration with existing enterprise and middle market accounts to take advantage of upselling and cross-selling opportunities. Today, DFC receives a small segment of the ITC spend for these enterprise-level clients. In fact, our ongoing strategy has been to land new customers and expand our relationships over time as their needs grow. Land to expand enables endless cross-selling opportunities. However, with a dedicated team ensuring these opportunities aren't overlooked, we can truly capitalize on significant opportunities within the market. Demonstrating this effective strategy is our recent contract announcement with one of the nation's leading sports and entertainment companies. We have been working with this customer for a number of years and continue to expand our relationship. We are working to implement our cybersecurity solutions into their security systems to assist with protecting their large infrastructure, as well as aid in response times to certain threats. We believe this expanded contract validates how we grow with our clients and continually address their needs. I'd also like to highlight that this contract follows previously announced contracts as discussed in our last conference call, including a subscription-based contract with a leading promotional company. We were providing fully monitored and managed cloud solutions today. Unfortunately, an unexpected natural disaster happened and following this, they realized they were unable to recover and resume operations within their required time frame. And as a result, we have implemented cloud-based disaster recovery and cloud-based infrastructure, allowing the client to run its critical applications on our fully managed, highly secure enterprise cloud 24/7 dedicated support, ensuring seamless rapid recovery of data during unexpected downtimes. We also announced a multimillion dollar project with the same sports and entertainment organization we touched on. This previous contract was for a custom solution to provide response time to files, file recovery and increased storage capacity to support their critical aspects of the security infrastructure, and we secured a subscription-based contract with one of the largest food distributors in the U.S. We are providing managed disaster recovery solutions to reduce the recovery time of critical data. As you can see, we are witnessing strong contract momentum and continue to maintain a 94% renewal rate with an average term of 24 months, demonstrating our ability to support clients while meeting or exceeding their needs. We currently serve over 450 companies and intend to continue to grow this impressive list. Today, data center companies that provide infrastructure on Windows-based platforms come to Data Storage Corporation for our IBM platforms. These infrastructure partners are a great way to expand our distribution with their expertise, excellent staff, while leveraging our assets deployed. Overall, we are executing on our strategic growth plan, which has resulted in profitability for the third quarter of 2023, as well as new and expanded contracts while increasing our penetration within the market. We are also actively exploring potential strategic acquisitions that would assist and support our growth and, more importantly, complement and improve our current operations. As a result, I believe we're at a pivotal point in the company where we are extremely well positioned to enter large international markets, upsell and cross-sell our products and services and secure additional meaningful subscription-based contracts, all leading to sustainable profitability and revenue growth. At the same time, we have carefully managed expenses and have preserved a strong balance sheet with over $11.5 million in cash and marketable securities enabling us 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 the call over to Chris Panagiotakos, our CFO, to discuss the third quarter financials. Please go ahead, Chris.

Chris Panagiotakos, CFO

Thank you, Chuck. Total revenue for the 3 months ended September 30, 2023, was $6 million, an increase of $1.6 million or 35%, compared to $4.4 million for the three months ended September 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 September 30, 2023, was $3.7 million, an increase of $1.1 million or 42%, compared to $2.6 million for the three months ended September 30, 2022. The increase was mostly related to an increase in sales. Selling, general and administrative expenses for the three months ended September 30, 2023, were $2.3 million, an increase of $240,000 or 12%, as compared to $2.1 million for the three months ended September 30, 2022. The increase was primarily due to an increase in salary expenses as a result of an increase in other employee benefits and an increase in professional fees, offset by a reduction in advertising expenses. Adjusted EBITDA for the three months ended September 30, 2023, was $487,000, compared to adjusted EBITDA of $162,000 for the same period last year. Net income attributable to common shareholders for the three months ended September 30, 2023, was $179,000, compared to a net loss of $246,000 for the three months ended September 30, 2022. We ended the quarter with cash and marketable securities of approximately $11.5 million, compared to $11.3 million at December 31, 2022. Thank you. I will now turn the call back to Chuck.

Charles Piluso, CEO

Thanks, Chris. Probably a good time to open it up for questions.

Operator, Operator

Thank you. We will now be conducting a question-and-answer session. First question comes from Adam Waldo with Lismore Partners. Please go ahead.

Adam Waldo, Analyst

Yes, good day, Chuck and Chris, I hope you can hear me okay. Congratulations on a strong quarter.

Charles Piluso, CEO

Thanks, Adam.

Adam Waldo, Analyst

Chuck, I want to see if we can drill down a little bit on some of the new business pipeline and backlog metrics and also talk a little bit about the sort of what you think the medium-term margin structure and organic growth profile of Flagship might look like now that you've sort of had it in the tent for a while and are making some strong progress with its growth? So on the new business pipeline and backlog side, at the end of the first quarter, you reported year-to-date inbound inquiries of about 6,000 at the end of the second quarter, about 19,000, which was very strong progress. And obviously, that's now translating into the revenue growth profile acceleration. What did that metric look like at the end of the third quarter in terms of year-to-date inbound inquiries in 2023?

Charles Piluso, CEO

I'm going to clarify a bit about Flagship. Since you mentioned Flagship, I want to assure you that we've nearly completed the integration of Flagship with CloudFirst, forming one cohesive company. We have a solid understanding of the organization, including the talent and client base, and we're excited to bring them together into a single, exceptional team. Both CloudFirst and Flagship will continue as distinct brands, and we'll be introducing more branded items. Regarding our pipeline, at the end of August, we had over 60,000 visitors to our site, and based on their engagement with the content, we can categorize leads. I have Hal Schwartz, the President of CloudFirst, here with me now; he can provide more insights on the pipeline.

Hal Schwartz, President of CloudFirst

Yes, we have seen steady growth in the number of visitors to our website, most recently exceeding 7,000 per month. If you want to estimate quarterly, that puts us above 20,000. Our pipeline continues to expand, and we currently have total contract value in our pipeline well over $10 million at CloudFirst.

Charles Piluso, CEO

So I don't know if that helped, Adam on that piece?

Adam Waldo, Analyst

That's very helpful. Thanks, Chuck and Hal. On the CloudFirst side, now that the integration of Flagship is progressing well, what do you consider to be a reasonable mid-term gross margin for services? I understand that equipment sales can be quite variable, but for the services revenue stream, what do we think is a reasonable target gross margin range? Also, what is the dollar value of our backlog at the end of the third quarter? That concludes my questions. Thank you.

Charles Piluso, CEO

Sure. The first point is that Tom Kempster is a heads up for Flagship, and we hope to be very successful in selling equipment, software, and cybersecurity software, along with support and maintenance for the IBM systems. When we achieve that, the margins are typically between 10% and 16% for Flagship. Regarding equipment, margins have improved significantly. In the past, we generally saw margins around 15% to 20%, but those margins are increasing. For Flagship, the annual recurring revenue is typically around $7 million, which includes managed services with margins between 25% and 28%. Additionally, software renewals and hardware maintenance typically fall between 10% and 14%. However, we have noticed proposals being issued at margins as high as 40% in some instances. It’s challenging to determine exact figures due to variability. For our subscription-based service revenue, an estimated margin of 52% is reasonable. It's important to remember that we spent about $1 million on equipment under CapEx for CloudFirst, and while we're not utilizing all of it, the depreciation impacts us. If we were able to account for inventory related to unused storage and other factors, margins could potentially exceed 52%. But for now, we can estimate a margin of 50% to 52% for subscription-based services and 25% to 28% for managed services. As for what we might enter 2024 with, I estimate a baseline of $18 million for January 2024.

Adam Waldo, Analyst

ARR on the service side, Chuck.

Charles Piluso, CEO

Yes. ARR on the service side, on managed services and software and hardware renewal programs.

Adam Waldo, Analyst

Okay, great. And then the dollar value or new business backlog at the end of the third quarter was what I think were $5.8 million at the end of the second quarter.

Charles Piluso, CEO

Yes, okay. On those numbers, I was told that around $3.7 million of that is estimated. It's been installed with another $2 million more to go plus any new contracts that are in. But just to back into that number, it said, well, $2.8 million more to go. I was just stated.

Adam Waldo, Analyst

Okay. Thanks so much. Continued wishes for an ongoing strong progress. Thanks.

Charles Piluso, CEO

Thank you. Thanks, Adam.

Operator, Operator

Next question comes from Nick Pinkus with Forest Capital. Please proceed.

Nick Pinkus, Analyst

Hey, congratulations on another strong quarter. First question I've got is, you touched on this in the last question, but could you elaborate some more on the potential synergies of bringing Flagship and CloudFirst together?

Charles Piluso, CEO

Sure. Flagship has 25 large accounts. About 3 to 4 months ago, Chuck Paolillo, our CTO, started overseeing service delivery, operations, and engineering for both CloudFirst and Flagship. One advantage of this is utilizing the technical expertise within our company. Additionally, we have a Director of Sales and a major account team focused on data center distribution, particularly for companies lacking an IBM platform, which is most of them. We face competition from three or four major players. By combining our strong account business development and experienced sales team under one leader, we believe we can gain a significant edge. Initially, Flagship struggled with cross-selling subscription-based services, which has taken about 18 months to two years to address. Once Tom Chemistry became involved, we started educating the sales team on how they could increase their earnings through these services. Clients are also transitioning from equipment to cloud solutions, creating compelling synergies that will help us enhance our service offerings across those large accounts and others. Now that our operations are aligned, we are focusing on integrating the sales aspect. On the accounting side, our controller reports solidly to the CFO and has a dotted line to the Presidents and Management. This is the next step for us to boost cross-selling and integration. I hope that clarifies things, Nick.

Nick Pinkus, Analyst

It does. Thank you. And you also mentioned plans to build partnerships and create new distribution channels in the U.K. Can you talk a little bit more about the U.K. strategy?

Charles Piluso, CEO

We are actively reaching out every day, sending out numerous emails to a list of 1,000 managed service providers. It's challenging to identify whether they are IBM or x86 providers and their specific locations. However, we are concentrating more on the IBM aspect because we recognize that migration has occurred, and there aren't many competitors in this space. While I won't claim there are no competitors, we could be one of the few in this significant European market. Starting with the U.K., we are sending emails indicating our willingness to invest, as we have the necessary funds available. Similar to our approach in the United States and Canada, we will provide co-op marketing dollars, support, training, marketing materials, and assist them in launching a program. This is essentially the content of the emails directed to these managed service providers. We aim to establish partnerships with about 10 to 15 providers as a strong beginning. Following that, Hal and I intend to visit the U.K. to identify potential business partners. If one of these partnerships leads to an acquisition, that would be a positive outcome, but our current focus is on establishing partnerships.

Nick Pinkus, Analyst

Okay, thank you. You also talked about the nurture list on this call and in the past, it seems like it's an important part of the strategy. Can you talk about how you plan to take advantage of this nurture list?

Charles Piluso, CEO

You want to comment. Maybe Hal can cover it.

Hal Schwartz, President of CloudFirst

Yes, absolutely. This is part of our overall authority-based marketing and sales strategy. We produce educational publications and are reaching out to our list to sign people up for our distribution list early in their buying cycle. This approach has proven to be a successful strategy so far. For companies that are further along in the buying process, we arrange appointments with a sales specialist, which has also been effective. This has significantly increased our opportunities and is helping to grow our pipeline.

Nick Pinkus, Analyst

Thank you. I have one last question, which is more of a macro question. There has been a significant increase in ransomware cases affecting major companies like Johnson Controls and ICBC, which is one of the largest banks in the world. These incidents have disrupted the treasury markets, and it appears that the situation is worsening rather than improving. I would like you to discuss how this trend is impacting the market and the demand for disaster recovery solutions. Although large companies typically have safeguards in place, it seems that many do not.

Charles Piluso, CEO

I'm going to answer that in two parts. I'll do the first and Hal can do the second. The first part of it, I've made so many sales calls early years in the business and even recently, and when you sit down with offices of the company and you talk about disaster recovery, for the most part, they're in the dark. There's more awareness now, but if you ask them how long it would take you to recover various critical systems, their expectations are not in line with what the technology folks within their own company know. So there is a little bit of darkness and expectations not matching up, just as I mentioned in the earnings call with one company with an unexpected downtime. So this alignment really is not there. Along with the fact that a lot of these problems are also caused by employees that are not educated and the companies are not educating them enough, they help create the problems themselves. But as to the growing need for cybersecurity and our services, Hal, you want to touch on that piece? How you see it growing.

Hal Schwartz, President of CloudFirst

Yes. There's definitely a huge demand for it. And part of the reason is that a lot of companies don't have a holistic approach to security. Many even large enterprises are not required to meet or gain certification and security standards. And these standards, look at the overall big picture for training, best practices and the like. So there's a huge demand out there from companies that want to gain this knowledge and implement that strategy. And that is part of our overall growth strategy for 2024 is to attack that market and gain traction there.

Charles Piluso, CEO

Go on, sorry.

Nick Pinkus, Analyst

No. It seems to me that it's only a matter of time when you have a company like ICBC that's not putting the right controls in place, and it's disrupting treasury markets. This isn't really a question, but it seems like it's only a matter of time before there's going to be more regulation requiring these services.

Hal Schwartz, President of CloudFirst

Yes, I would agree.

Charles Piluso, CEO

Yes. Flagship has recently sold, I think, a large cybersecurity and I believe one of the IBM products, I believe, right?

Hal Schwartz, President of CloudFirst

Yes. IBM QRadar. And we also have several large security opportunities in our pipeline at the moment.

Nick Pinkus, Analyst

That's great. Thank you guys for answering all the questions.

Charles Piluso, CEO

Okay.

Operator, Operator

There are no further questions. I would like to turn the floor back over to management for closing comments.

Charles Piluso, CEO

Thank you for the questions, Nick and Adam. We have successfully implemented our business strategy, and we believe it will support our growth and long-term sustainable profitability. We'll maximize our value to our shareholders. We expect to realize the full benefits of our initiatives over time, and we're excited about the outlook for the business. We look forward to providing meaningful updates to shareholders. And with that, I'd like to thank everyone who joined today on the call. Thank you, and have a great day.

Operator, Operator

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