Data Storage Corporation (DTST) Q2 2023 Earnings Report, Transcript and Summary

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

Thank you. Good morning to everyone, and welcome to Data Storage Corporation's second quarter business update conference call. On the call with us this morning are Chuck Piluso, Chairman and Chief Executive Officer; and Chris Panagiotakos, Chief Financial Officer. So, here we go. The company issued a press release this morning containing its second quarter 2023 financial results, which is also posted on the company's website. If you have any questions after the call or would like any additional information about the company, please contact Crescendo Communications at 212-671-1020. Before we begin, I'd like to remind listeners that this conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 as amended, that are intended to be covered by the safe harbor created, thereby. Forward-looking statements are subject to risks and uncertainties and that could cause actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Statements preceded by, followed by or that otherwise include the words, believes, expects, anticipates, intends, projects, estimates, plans and similar expressions or future conditional verbs, such as will, should, would, may, and could are generally forward-looking in nature and not historical facts, although not all forward-looking statements include the foregoing. Although the company believes that the expectations reflected in such forward-looking statements are reasonable, they can provide no assurance that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from the company's expectations include, but are not limited to, the company's ability to leverage the scalability and performance of Flagship Solutions, the company's ability to benefit from the IBM Cloud migration underway, the company's ability to position itself for future profitability and the company's ability to maintain its NASDAQ listing. These risks should not be construed as exhaustive and should be read together with the other cautionary statements included in the company's quarterly report on Form 10-Q for the quarter ended June 30, 2023, annual reports on Form 10-K and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statements speak only as the date on which it was initially made. Except as required by law, the company assumes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, changed circumstances or otherwise. I'd now like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

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

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

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

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

Hey. Good morning, and thank you for taking my questions. Can we start with -- it just seems like given the last couple of months that the velocity of large deals has been picking up a little bit, am I right to see that pattern? And is there anything specific you could attribute that to in terms of your go-to-market and execution? Is it just there's an uncertain cadence to win large contracts sort of land? Or just help me understand how that came to be.

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

Got you. That's helpful. I think you touched on a pipeline number. I think it was -- I think you said $9 million in prepared. But correct me if I'm wrong. I guess is that -- do your pipeline numbers generally include the large kind of multimillion dollar opportunities that are moving through? Or that $9 million, like how is that -- what does the composition look like in terms of size?

So what happens is Hal Schwartz, President of CloudFirst, has -- he's like a scientist on evaluating at what level a particular proposal is. So, everyone puts in, if it's 5%, 10%, 20%, 50% on the probability side. So, when you see the $9 million, it means that these are individuals, these are companies that have requested or have worked with the technical staff and our sales staff on receiving proposals. So this is total contract value on the $9 million. Now, when there's very, very large deals, we really typically don't include that. Now, when it moves to a 90%, I believe they're negotiating terms and conditions. So, it's fairly scientific. So, when we look at $9 million, you could say if the average is 29 months, which is our average contract rate, although most of them are 36 months, you could divide that out and come up with what the monthly recurring revenue is on that. But for the most part, we have folks at 12 months, and we have some at 60 months. But -- so it varies. But these are folks that have requested and have worked with our technical team to get a proposal on our services. But if it's a real monster deal, which that happens sometimes, because Flagship works on some very large equipment-type deals, we typically do pull that, and we don't put that in there or we reduce it down to a 5% or 10%. So, we're fairly between Tom Kempster, who runs the -- CEO and President of Flagship, they're pretty -- I'll use the word, not just conservative, but very scientific at what stage the discussions take place with the client and the client's technical team and our technical team. So, in answer to the question, $9 million in proposal is outstanding. When it moves to 90%, Hal has those numbers, and we basically know for the rest of '23 and the beginning of '24, what that recurring revenue will be. In addition to they move out of these proposals and it goes into work in process, which we're not reporting at all right now -- I don't think we have Chris right?

No.

We haven't reported that. I think that I believe we have around $160,000 in -- not pending, but being installed right now on the recurring revenue side alone on that -- I believe that's the number. So that will be added in over the next few months, but it's a continual process. I don't know if that helps at all, but we're pretty we're pretty conservative in the way we do it.

No, that's very helpful. I guess maybe the last one for me at the moment. So I think your SG&A line tends to bump around a fair bit. But how -- I guess, how would you categorize or frame your spending on go-to-market through the balance of the year, just given the momentum you seem to have year-to-date?

I think when you're looking at the SG&A, sometimes when there is equipment sales -- just before we go into the marketing piece of it, with the equipment sales, you'll get large commissions on it. The percentage of the gross profit is paid to the sales rep on equipment. And so, you'll see that type of bump on there. But you also have stock compensation that is sitting in the SG&A as well, which we get hit with on the stock options and stock grants. So that's the other reason why you might see a bump like that. I believe it was over $400,000 for Flagship in 2022, and in 2023, $52,000. So we gave the executives there at the time at Flagship stock compensation, because they didn't achieve what was intended to at Flagship based on performance, and we wanted them to be able to be part of the company. So that's why you'll see that bump in stock compensation. I believe it was approximately $460,000 for Flagship in 2022.

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

[Operator Instructions] Next question comes from Adam Waldo with Lismore Partners. Please go ahead.

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

Good morning, Adam. Let me try to separate the questions. On the new business, the pipeline and this migration, I just want to say that on the migration, it's not that people are moving to IBM, although the platform is increasing by, I believe, 9% over the previous period. So, people are moving there, but it's not with -- it's the folks that have these systems installed already that are seeing that it might be better to preserve capital and to have the pay-as-you-grow kind of concept and build it up for the latest and greatest systems and get the best disaster recovery. So it's not that they are moving to IBM Power, although there is some growth, these are folks that have these systems in there. IBM is typically, I'll use the term cut or culture and they stick with it. On the acceleration with the inquiries, when I mentioned 45,000, it's for all three sites. So, if we're comparing, because they are accelerating the other two subsidiaries. But let's just talk about CloudFirst. Yes, that was, I believe, around 38,000 year-to-date today. When I gave that number the last time, I think it was as of the April-May timeframe on those numbers. So yes, the inquiries are coming in. We have a pretty good close rate on it when they're calling in to us. An inbound lead is usually better, something is going on in their environment. Whether it's the CFO saying, "Let's take a look at this. It might be more beneficial to us," or IBM technicians that are managing the hardware are getting a little older possibly, getting ready to retire, and these custom applications that are sitting there that have been built on this platform, the developers are still developing that, and it could be folks that just graduated from college, but the folks that are actually maintaining this hardware that is an exposure for these companies. And so with that, they are investigating. And that's why that nurture list is very large. And we continue -- and they don't opt out either. So it's pretty interesting that we continue to send information, inquiries come in. So, this migration is, number one, underway. Our pipeline, we're starting to close them. It's not just proposals sitting in a pipeline and just sitting there for years. So I would say that we have a good close rate, migration is underway. Our pipeline is $9 million. That pipeline was higher, but we closed some of those deals, and that's why it's reduced from what it was before, but it's underway. And I think we're going to take advantage of that. And if we can look to utilize some of the cash we have in the bank for some additional growth in potentially the U.K. that we're looking at and also expanding Canada with the two data centers we have there with our partners in Canada. So, we expect to grow the pipeline and the migration is happening and there's limited competition. So, Adam, we're kind of excited about it, frankly. In the case of -- just to go back to Flagship for a moment, the cross-selling is finally working. Deals are coming in from Flagship. And they have -- I'm going to say 25 very large recognizable accounts that are looking at these cloud-based solutions that's provided through CloudFirst. At the same time, they're doing a great job with selling equipment and provisioning. So I'm excited. I think it's good. More excited than previously, although I'm kind of never satisfied as a personality disorder, but I would say that it's moving. If you take a look at that inhibitor on CloudFirst, it's good. And I believe that Tom Kempster is moving up those gross profit margins because they are visiting the accounts and improving the margins on those accounts. I don't know if that answered your question fully.

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

I tell you what, I think we're doing a good job with a great job and what we need to do more of frankly, because on the inbound lead side, it is moving. Actually, Flagships is moving up now. There's been some changes to the website. But on the inbound, lead side is going great. We have to do more with our indirect with the alternate channels, with channel partners and looking for -- typically, in the past, we always look for the companies that sold these IBM systems. And as you look at that, eventually, it gets a little tired. And there's a lot of other revenue we believe that's out there that the fiber is already in the ground. Think about cable companies and telecom companies that are looking to increase the revenue per customer where they have the relationships. So, we have to look at more non-traditional type of channel partners. I'm not saying we're doing a poor job there. I don't misunderstand me. We do a good job there. But I think we can -- I think we could do more and we need to expand the support that the team that focuses on channel partners, we need to be able to expand that. But there's way -- when you bring -- when you have a channel partner that has sold the customer already, it's an easier sale. First is you're not knocking on doors anymore or making phone calls. So, inbound leads, networking and going after the folks that have these customers that are trusted advisers or they have the customer base. Look at the cable companies, they're just getting crushed, but they do have the network. So, it's things like that, that we're also looking at.

Right. And as you prioritize, Chuck -- you made a point obviously that trusted partners, as channel partners, obviously, accelerate the sales cycle and close rates relative to sort of as you compare that to international expansion, right, where you'd be sort of going more de novo or maybe you plan to go internationally with channel partners. Maybe you could just flesh that out for us a little bit more as you think about the U.K. and Canada, would that be with channel partners, or would that be de novo? And how are you kind of prioritizing the relative capital efficiency of channel partners and the returns on that versus potential international expansion if it will be de novo?

Yes. Just a little background on me for just 30 seconds. I did this with International Telecommunications Corporation, and we had switches globally and partners globally, and we did it through partners. That company went public after we were rolled all together for $800 million. So, I've been around internationally before. And the best way of doing it is doing it with partners, you can accelerate faster. We have the cash to be able to support those partners, which is key, because a lot of these companies really do not have the cash. So, being able to pick up channel partners in the U.K. -- we already have that in Canada, but be able to pick them up in the U.K. and work with them and then put the equipment under our -- under the way we build it, Chuck Paolillo, our CTO, and the way they -- what he builds it in his team, basically, we can roll it out to U.K. very fast, but we want to do that with channel partners. It doesn't mean we won't have sales reps or country management, technicians, but they'd be geared to support the partners that we try to bring into agreements in the same way that happens here in the United States under Steve Romweber, Director of our Channel, and Chris [indiscernible] and the team and all. So, we're going to do it with partners.

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

Well, I don't really want to give guidance on it, and I really can't give timing on it, but we're not talking, let me -- but I want to answer the question. What happens a lot of times when you have -- when you're putting up infrastructure as a service, you have to work closely with the client's technical team. So even though our folks might be ready to go, their folks might be ready to go, but it's not such a fast process on the infrastructure side. So I really couldn't give the timing on that. I could tell you right now that approximately, I believe, $160,000 in monthly recurring revenue is in the process of being installed. But I can't give you a timing on what month that might hit or what quarter, because it could be client delays, their priorities and all, but these are executed contracts.

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

Yes. I mean, some could be 12 months, some could be 60 in that range. I really don't know top of my head it does range in that area. But the way -- yes, the average is 29 months on that. But yes, the timing is tough to be able to give that. And if we knew exactly I would give guidance on it, it will be the first time we gave guidance, but sometimes we expect something to happen in a month and it goes up, and then all of a sudden something goes on the networking side or it's delayed because of their projects that are going on in the client side. So it's tough to actually predict that, but these are executed agreements.

Okay. Thanks very much.

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

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

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