Earnings Call Transcript - DTST Q1 2023

David Waldman, Investor Relations

Thank you and good morning, everyone and welcome to Data Storage Corporation’s first quarter business update conference call. On the call with us this morning are Chuck Piluso, Chairman and CEO; and Chris Panagiotakos, Chief Financial Officer. The company issued a press release this morning containing first 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 would 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 cause actual results, performance or achievements to differ materially from future results, performance or achievements expressed or implied by such forward-looking statements. Statements preceded by a thought that otherwise include the words believes, expects, anticipates, intends, projects, estimates plans and similar expressions or future or conditional verbs such as will, should, would, may and could or generally forward-looking in nature and not historical facts, although not all forward-looking statements include the foregoing. Although the company believes the expectations reflected in such forward-looking statements are reasonable, it 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 to be read together with the other cautionary statements included in the company’s quarterly report on Form 10-Q for the quarter ended March 31, 2023, annual reports on Form 10-K and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statement speaks 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. Now I’d like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

Chuck Piluso, Chairman and CEO

Thank you, David, and good morning, everyone. We continue to make strong progress regarding the implementation of the business initiatives that I highlighted on our last call. These initiatives are highly targeted to accelerate our growth and should assist in achieving our goal of long-term sustainable profitability. Historically, we’ve had an impressive 23% compounded annual growth rate since 2017, but we believe that through these initiatives, we can generate even stronger growth going forward. In fact, our near-term goal is to reach a $50 million high-margin revenue run rate in the coming years through a combination of both strong organic growth and strategic acquisitions. To this end, we have a number of specific activities underway, including expanding our dedicated sales team, hosting revenue-driven sales events, growing our partner program at Flagship Nexus and CloudFirst, increasing our international footprint through strategic partnerships, and finally, we are actively exploring ways to increase our gross profit margins in Flagship and Nexus on recurring services closer to 50%, similar to CloudFirst's gross profit on subscription services. I’d like to note that we are still assimilating Flagship, including the recent realignment of management with Tom Kempster, Flagship’s new President. All of our efforts are focused on efficiently deploying capital based on measurable returns while increasing our penetration into this multibillion-dollar marketplace. We are increasingly being sought out for our products, services, and proven ability to execute. Validating this, our work in process on executed subscription revenue contracts is over $5.5 million in total contract value, further supported by the increasing visitation to our websites with over 19,000 visitors in the first quarter alone. Additionally, we received and announced a seven-figure order from a Global 2000 listed company. This order is from an existing customer with whom we have an established relationship, which we believe will further demonstrate our ability to meet the needs of our customers, specifically large enterprise customers. To provide additional clarity for our shareholders on the performance of each subsidiary, we have decided to break out our revenue by business segment, and the first quarter is the second reporting period for this. While we did report a decrease in revenue in the first quarter of 2023 compared to 2022, I’d like to note that during the first quarter of 2022, we reported a $2.6 million equipment sale to an NFL team. Excluding this sale, our revenues increased 14% over the same period last year. As I mentioned before, we are focusing on recurring revenue. We’re not turning away from equipment and software sales, and we continue to explore these opportunities. However, our long-term goal is steady profitability, which can only be sustained with long-term subscription-based contracts that provide high-margin recurring revenue streams. Concurrently, we’re able to decrease our SG&A expenses by 13% from $2.5 million in the first quarter of 2022 to $2.1 million in the first quarter of 2023, a result of reallocating resources and eliminating redundant expenses. As a result, and very importantly, we’ve achieved profitability for the first quarter with $35,000 in net income and an adjusted EBITDA of $334,000 on revenue of $6.9 million for the first quarter of 2023. With a solid experienced leadership team, we are focused on subsidiaries to secure long-term recurring revenue contracts. While we believe CloudFirst is hitting the mark, given its ability to sustain profitability on a standalone basis, we are extremely dedicated to Flagship and Nexus achieving the same, thereby increasing overall profitability. We continue to drive this strategy by expanding our distribution channels while also increasing our digital and direct marketing programs, which have been performing well given our social and digital lead generation programs. CloudFirst alone had over 16,000 visitors to the website from the beginning of the year to April. Additionally, we continue to explore synergistic acquisitions that complement and enhance our current operations, including companies leading in technology trends, or that add important technical staff and create economies of scale to improve our gross profit margins and net income. We will drive growth by developing and managing collaborative solutions as well as embarking on joint ventures and joint marketing initiatives with our established distribution partners like IBM, our software vendors, IT resellers, managed service providers, application support providers, consultants, and others. Furthermore, we continue to believe there is a significant need for our solutions on a global scale, and we are pursuing growth opportunities internationally as these markets increase their use of multi-cloud solutions, which we are positioned to handle. To give you a better sense of the market, there are an estimated 160,000 systems in the market with multiple partitions. In total, there are about 1 million unique partitions. Once virtualized, we typically price these partitions at $36,000 per year, which equates to a global addressable market of roughly $36 billion in annual recurring revenue. It is also worth noting the average contract term is about 29 months, and we have maintained an impressive 94% renewal rate. So hopefully, you can see, with the effective rollout of these initiatives, we believe our profitability can accelerate and be maintained long term. Overall, we are positioning ourselves as a leader within the industry. There is very limited competition in the market today. And unlike others, we have a 20-year proven track record with an established first-class customer base. With approximately $11 million in cash and short-term investments and no debt, we can deploy capital effectively, execute on our strategic business initiatives, and substantially grow our business. We look forward to announcing additional accomplishments throughout the year. And with that, I’d like to turn the call over to Chris Panagiotakos, our CFO, to discuss our first-quarter financials. Please go ahead, Chris.

Chris Panagiotakos, CFO

Thank you, Chuck. Total revenue for the three months ended March 31, 2023, was $6.9 million, a decrease of $1.8 million or 21% compared to $8.7 million for the three months ended March 31, 2022. The decrease is attributed to a decline in equipment sales during the current period. Cost of sales for the three months ended March 31, 2023, was $4.8 million, a decrease of $1.2 million or 20% compared to $6 million for the three months ended March 31, 2022. The decrease of 20% was mostly related to a reduction in equipment-related cost of sales. Selling, general and administrative expenses for the three months ended March 31, 2023, were $2.1 million, a decrease of $329,000 or 13% as compared to $2.5 million for the three months ended March 31, 2022. The decrease is primarily attributed to a reduction in force, a decrease in Software-as-a-Service expenses, and a reduction in commissions. Adjusted EBITDA for the three months ended March 31, 2023, was $334,165 compared to adjusted EBITDA of $604,492 for the same period last year. Net income attributable to common shareholders for the three months ended March 31, 2023, was $50,666 compared to net income of $156,010 for the three months ended March 31, 2022. We ended the quarter with cash and short-term investments of approximately $11 million at March 31, 2023, compared to $11.3 million at December 31, 2022. Thank you. I will now turn the call back to Chuck.

Chuck Piluso, Chairman and CEO

Thanks, Chris. I’d like to open the call up for questions.

Matt Galinko, Analyst

Hey, thanks for taking my questions. I guess, can we start with the Fortune 2000 deal that you announced late last week? Was that software equipment? Was that recurring? Anything you could add to how we could expect that to fall into your future results?

Chuck Piluso, Chairman and CEO

Hi, Matt. The deal was software. We don’t like to wait around for approvals from companies to have our press releases go through their organization. So we actually don’t go through the client. But this particular client, we provide managed services, and that was a software sale. We expect that to recur every year, hopefully, but it does go after bids, and we consider it annual recurring revenue because we’ve had it for the previous year. However, you need to compete for it and win it. But it is a customer that we provide a number of different managed services, including software-related patch management and other services.

Matt Galinko, Analyst

Got it. And I guess, this year, was there an expansion of the scope of the contract or size? Or is it relatively the same as the prior year?

Chuck Piluso, Chairman and CEO

I believe it was expanded.

Matt Galinko, Analyst

Got it. Terrific. I guess maybe going to a couple of the growth drivers that you’re looking at, I think, the first one you mentioned was the expansion of the sales team. So anything new this quarter? Did you add a number of heads that you could point to or any notable hires? Or generally, how is the process of adding new qualified reps?

Chuck Piluso, Chairman and CEO

Sure. One example is Verizon’s layoff of their sales organization in the mid-market has benefited us. We’ve hired two individuals, one to cover the Southeast U.S. for Nexus, and Nexus also brought on someone in the New York metro area. So that was good, and we have other candidates that are lined up. And those are two examples of that. So these layoffs have helped us, but the recruiting is ongoing.

Matt Galinko, Analyst

Got it. Terrific. And last one for me. You called out the M&A pipeline again, or at least you mentioned M&A as a growth opportunity. So can you touch on the pipeline? Are you seeing a lot of possible acquisition targets? And are the valuations sort of in the right range these days? How do you think about that today?

Chuck Piluso, Chairman and CEO

Well, on the last call, I stated that we put out somewhere between four or five term sheets last year alone. These were typically companies doing $10 million in revenue. They had net income, but they were very small companies, really didn’t have a sales force, so we decided to look at larger targets, those above $15 million, who are growing the business and have recurring contracts. This year, we are looking internationally for managed service providers, and we’re focused on those that are really trying to grow the business, not companies that have been around for 25, 30 years and are not growing. We have an investment bank engaged to continue looking for M&A opportunities, but we’re focusing on those above the $10 million mark.

Matt Galinko, Analyst

Got it. And if I could just add one more follow-up to that, I guess the international expansion comment that you made earlier would be solved by you making a slightly larger MSP type international acquisition. So is that what you have in mind for international expansion? Or is there also just organic partner expansion in the international market? Can you kind of touch on that?

Chuck Piluso, Chairman and CEO

Sure. For us to set up a data center with some racks in two cities in the UK is not such a big deal. We really know how to do it. What we’re looking to do is to find MSPs providing similar services to us as ABC did in 2017 with equipment and software focused in that same marketplace. If we can acquire one of those companies, we can deploy them, and they can be part of our organization, running their own unit, their own subsidiary. We can still set up operations and invest whatever it might be, $0.5 million to start in two cities based on our multi-tenant design. We can do that, but we are looking for acquiring MSPs focusing on cybersecurity that also has an element of AI. Our first target is the UK, which is a bit easier for us. I don’t think we are large enough now to say, oh, let’s go into other parts of Europe or multilingual Asia.

Matt Galinko, Analyst

Got it. Thank you.

Chuck Piluso, Chairman and CEO

Thanks, Matt.

Adam Waldo, Analyst

Good day, everyone. Chuck, thanks very much for taking my questions. I wonder if we can start just to flush out the recent enterprise win just a little bit more beyond Matt’s questions a few minutes ago. You press released it obviously as a seven-figure deal. You have disclosed now on the call as a software deal, so we have a sense for what the margins look like. Can you give any more color as to how far into that seven-figure deal it is? And to what extent there is opportunity for increased scope of sales based on that sale?

Chuck Piluso, Chairman and CEO

Sure. Hi, Adam. I believe it was $2.2 million. Last year, it was $1.9 million. So, it continues to expand on that side. This is an organization that’s growing very rapidly, and it’s a Forbes Global 2000 company. We provide project managers and technicians on this account. This is through Flagship, and we provide what’s called patch management with BigFix and a number of other services to them. It is one of the larger accounts at Flagship. Tom Kempster and the sales team continue to penetrate more of this account. The relationship is strong.

Adam Waldo, Analyst

That’s very helpful. Stepping back a level, last quarter, you gave some helpful quantification in terms of the dollar value of your new business pipeline in your biggest segment CloudFirst, and also some quantification of the step-up in unsolicited inquiries coming from the website. If I am remembering properly in the 6,000 range in the first quarter, and that was quite a bit higher than in the fourth quarter. Can you quantify a little bit more for us the dollar value of the new business pipeline as it stands right now in each of the three principal business segments, and the size of the backlog, and then any changes recently in your close rates? Thank you.

Chuck Piluso, Chairman and CEO

That's a lot of information. Let me try to break it out a little bit. So overall, on all three websites, we have Nexus, Flagship, and CloudFirst. CloudFirst, which was the original Data Storage Corporation operating company that we rebranded last year, had 16,000 visitors to the website through the first quarter. It increased significantly, given that we started moving away from just IBM and also AIX. Our lead generation programs are significantly effective. The other two companies had a combined increase of 3,000 additional visitors. That’s a good beginning. Since we realigned management, our Director of Marketing is refreshing the Flagship website to get it closer to a lead-generating machine like CloudFirst, but that takes time. About the pipeline, CloudFirst uses Salesforce, which rates the opportunities from 10% to 90% probability. We have something over $12 million in total contract value in the pipeline.

Adam Waldo, Analyst

No, absolutely. Maybe I wasn’t clear. I was sort of hinting at that in the backlog, but – and that’s the big – that’s the vast majority of the backlog at this point, right? Is the $5.5 million on the CloudFirst side?

Chuck Piluso, Chairman and CEO

Yes. And that’s if you break that out... The average term is 29 months. We have accounts that might be anywhere from 6 months to 60 months. The billing typically features an average of $3,000 a month. But it is $5.5 million in contracts that are executed and in the process of being installed.

Adam Waldo, Analyst

Right. And then finally, in terms of close rates, can you give some color or quantification around close rate changes here in the first quarter and into the second? Are they pretty stable? Are they improving? Can you quantify that, please?

Chuck Piluso, Chairman and CEO

On Flagship, they have a smaller number of accounts than CloudFirst. The relationship with large accounts like the Miami Heat is very strong, so the close rate is extremely high. I estimate it’s probably around 80%. For CloudFirst, which deals with a much higher volume, it’s around 23%. Then for Nexus, I estimate it's about 25%. On the Flagship side, they don’t lose deals frequently; a budget might get pushed up. However, some deals can be delayed because a client might not want to transition their on-premise infrastructure to off-premise too quickly. Things sometimes shift because of big incidents like disaster recovery.

Adam Waldo, Analyst

Right. Tremendously helpful. Thanks very much.

Operator, Operator

Excuse me. We are closing our question-and-answer session. Now, I would like to turn the floor back over to Chuck Piluso for closing comments. Please go ahead.

Chuck Piluso, Chairman and CEO

Thank you, everyone, for joining. To wrap up, we are actively pursuing aggressive growth strategies and have effectively implemented our business initiatives that we believe will drive revenue and assist in sustainable profitability. We remain committed to reducing redundant expenses, streamlining operations, and maintaining a solid balance sheet to position ourselves as a leader within this industry. We are proud of our progress, and we look forward to reporting additional developments as they unfold. Thank you all for joining today.

Operator, Operator

This concludes today’s conference call. You may now disconnect your lines at this time. Thank you for your participation and have a great day.