Data Storage Corporation (DTST) Q3 2023 Earnings Report, Transcript and Summary

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. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Alexandra Schilt. Thank you. You may begin.

Thank you. Good morning, everyone, and welcome to Data Storage Corporation's third quarter business update conference call. On the call with us this morning are Chuck Piluso, Chairman and Chief Executive Officer; and Chris Panagiotakos, Chief Financial Officer. The company issued a press release this morning containing its third 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 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 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 find 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 company -- with other cautionary statements included in the company's quarterly report on Form 10-Q for the quarter ended September 30, 2023, and annual report on Form 10-K and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statements 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. I'd now like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

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 move closer to the 50% margin that we generated 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, 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, who are 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 an 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 the 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. That was 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 type platforms come to Data Storage Corporation for their client -- 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.

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 to the 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, and 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.

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

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

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

Thanks, Adam.

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 a 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?

I'm going to back it up just a little bit because you talked about flagship. So right now -- that's okay because you mentioned Flagship and all. So I just want to cover that, and I mentioned it in the earnings call, we're pretty much finished with the full assimilation of Flagship and we're bringing both Flagship and CloudFirst together as one company. So we feel that we know the company well enough. We know the talent that's there, the client base. And so we're bringing that together as one company that will be an unbelievable team that will be underneath the CloudFirst and Flagship will be a brand, as well as CloudFirst dis a brand today and so specs there'll be more branded items on that. As to the pipeline itself and we talk about inquiries coming into our site, I think at the end of August, I don't have an update right now. There were over 60,000 visitors coming into our site on and they're visiting and based on the number of pages they might go into one of those site, it will generate and classify a lead class. I happen to have Hal Schwartz here with me right now, who is the President of CloudFirst, so Hal maybe you can answer that question on the pipeline.

Yes, we have seen steady growth in the number of visitors to our website from -- most recently, we're in the 7,000-plus a month range. So if you want to do a quarterly estimate on that, you're above 20,000. And our pipeline continues to grow. We are well above $10 million in total contract value in our pipeline at the moment, CloudFirst.

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

That's very helpful. Thanks, Chuck, and Hal. And so that's just on the CloudFirst side. Now if we think about the enterprise and the company overall, obviously, now with the integration of Flagship pretty far along. What do you think is a reasonable mid-term gross margin for the services? I know the equipment sales are very lumpy. But for the pure services revenue stream, what do we think is a reasonable target gross margin range -- and then what is the dollar value of our backlog at the end of the third quarter? And that will end my questions. Thank you.

Sure. The first piece is that Tom Kempster that's a heads up Flagship we hope that we're very, very successful on selling equipment and software and cybersecurity software, support and maintenance on the IBM systems. And when we do that, those margins are somewhere between 10% and 16% on the Flagship side. And so when we talk about equipment, there's been some pretty good margins that have improved. Typically, in the past, we saw margins in the area of 15% to 20%. Those margins seems to be moving up. And when we look at the flagship, the annual recurring revenue typically and nothing is guaranteed on anything. But on the annual recurring revenue, it's around $7 million. And that $7 million includes managed services, which is somewhere between a 25% and a 28% margin and then you have software renewals, hardware maintenance and all of that, that could be somewhere between 10% and 14%. But we've been seeing proposals going out and almost, in some cases, at a 40% margin. So it's pretty hard to determine because, as you mentioned, it's lumpy. When we look at our service revenue, and I'm talking about subscription based, it's I'm going to say 52%, an estimated 52% on that. And keep in mind that when we look at the margins on that, I believe, Chris, we put around $1 million we spent on equipment, on CapEx, on CloudFirst. And when you take a look at that, we're not using all of that, but we are getting hit with depreciation on that. So typically, if we were allowed to carry an inventory on it for unused, we'll call it storage and anything else, you'd probably be north of 52. But let's use 50 to 52 as a margin on subscription-based services. I would say, 25% to 28% on managed services. And when we take a look at what we might be entering 2024 with I would estimate that -- I give you the estimate to get the fourth quarter, I'll tell you January 2024, I would say an estimate $18 million as a baseline right now.

ARR on the service side, Chuck.

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

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.

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.

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

Thank you. Thanks, Adam.

[Operator Instructions] Next question, Nick Pinkus with Forest Capital. Please go ahead.

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?

Sure. The first piece is that Flagship has 25 very large accounts. And approximately 3 or 4 months ago, Chuck Paolillo, our CTO, has been managing all of the service delivery and operations and engineering of both CloudFirst and Flagship. So that was the first stages of that. So one of the benefits is leveraging all of the technical folks that we have in the company, which is a huge benefit. On top of that, we have a Director of Sales, and we have a major account team and folks concentrating on distribution on the data center side. For those companies that do not have an IBM platform, which is pretty much all of them. So we're with three or four other major competitors. So what ends up happening is by bringing it together where we have some very good major account type business development, very experienced sales folks combined with our overall team, we think that placing that together under one leader will be a good advantage to us. So we'll have -- we had a problem in the beginning with flagship, frankly, on the cross-selling of the subscription-based services. And that has taken too long probably 18-months to two years and when Tom Chemistry got involved over there, education started happening more and more, how salespeople can make more money by selling subscription-based services. The clients are also moving over from equipment to cloud-based. So there's some great synergies there to take those 25 very large accounts in addition to the other accounts and moving those higher-margin services that are our product that we create out of our six data centers. So we think that the operations is there now, now we're bringing together the sales in bringing together the sales piece of it. On the accounting side, we always have it set up with the controller as a reported solid line to the CFO to Chris and dotted line to the Presidents and to Management. So it's really the next step for us on the sales side to improve cross-selling and bringing it together. I don't know if that helps, Nick, does it.

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?

Sure. So we are going out every day, there's a number of e-mails that go out to -- we have a list of 1,000 MSPs, managed service providers. We really -- it's hard to tell whether they're IBM, whether they're x86 and where they are. But we're trying to focus more on the IBM side only for the fact that -- this is -- we know the migration has taken place, and there are not many competitors that are doing it. I'm not saying there are zero competitors, but we could be one of them in this very, very large marketplace of Europe. So starting with the U.K., so we have e-mails going out saying we're willing to make the investment. We have the cash in the bank. And like we do in the United States and Canada, co-op marketing dollars, support, training, all the marketing material and help them roll out a program. So that's kind of what's in the e-mail that's going out to these MSPs. And we hope to line up with, frankly, 10 to 15 would be a fantastic start. And with that, then Hal and I will go over to the U.K. and spend a little time and finding out who -- what folks want to be in business with. If one turned into an acquisition, that would be great. But right now, we're looking on the partner side.

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?

You want to comment. Maybe can Hal can cover it.

Yes, yes. No problem. So it's part of our overall authority-based marketing and sales strategy. So we have a publication -- educational publications that we produce, and we are reaching out to this list and signing these people up to get them early to get on our distribution list and get them early in the buying cycle. So this has proved out to be a good strategy and very successful to this point. And we've also companies that are further along the buying cycle, we will arrange an appointment with a sales specialist and that's also proved to be successful. So it helped us increase our opportunities substantially and is helping grow our pipeline.

Thank you. And then one last question. This is more of a macro question. But there have been an exploding number of cases of ransomware, major companies like Johnson Controls, ICBC, which I'm sure you guys know is one of the biggest banks in the world. It actually had a -- it disrupted the treasury markets and it seems like the problem of these attacks is not getting any better. It's actually getting a lot worse. So I was hoping you could talk about how this is affecting the market and the demand for disaster recovery. You take the big companies like this would -- big companies like these would have something in place. But apparently, they don't.

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 dock. 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.

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.

Go on, sorry.

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.

Yes, I would agree.

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

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

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

Okay.

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

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.

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