Data Storage Corporation (DTST) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Data Storage Corporation Third Quarter 2022 Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, [ Alexandra Schultz ]. Ma'am, the floor is yours.

Thank you. Good morning, everyone, and welcome to Data Storage Corporation's 2022 Third Quarter ended September 30, 2022, 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 third quarter 2022 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, 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 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 other cautionary statements included in the company's quarterly report on Form 10-Q for the quarter ended September 30, 2022, and 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. I'd now like to turn the call over to Chuck Piluso. Please go ahead, Chuck.

Thanks, Ali, and good morning, everyone. We continue to witness strong revenue growth, evidenced by achieving revenue of $4.4 million for the third quarter ending September 30, 2022. This represents a 14% increase compared to the same period last year. Notably, our revenue for the 9 months ending September 30, 2022, increased 80% over the same period last year, reaching $17.9 million. Our decades of experience providing an array of multi-cloud technology solutions, properly allocated investments and highly skilled employees are the foundation to our success that has allowed us to firmly position ourselves as a leader within the industry. I'd like to note that we provide solutions to a multibillion-dollar marketplace. In fact, according to Fortune Business Insights, the cloud-managed service industry in North America was $16.3 billion in 2019 and has been growing at a rate of 13.8% compounded annual growth rate, bringing the number to $24 billion by the end of 2022. Disaster recovery is projected to be at $3.6 billion in the U.S. by the end of 2022, which represents 35% of the overall 10.3 global marketplace based on Grandview Research Disaster Recovery Solutions market size report. Our Nexus solutions fit well with our dedicated Internet access, a critical component to access cloud services. Further, the steadily growing VoIP market is expected to reach $90 billion worldwide in 2022 with a compounded annual growth rate of 3.1% with $17 billion in the U.S. according to Global Newswire market analysis and insights. Our goal is to aggressively penetrate these markets while executing on our strategy of securing high-margin, recurring subscription-based and managed service contracts. As we see more companies migrating their IBM power infrastructure to the cloud, we believe this propels our solutions to the forefront of the industry, providing us the potential to capitalize on these growing multibillion-dollar markets. We see this migration underway as the future of our industry, and we are well-positioned to take advantage of these opportunities. Given the migration to the cloud within the IBM market that I've been discussing over the past few conference calls, currently, only 15% of the IBM Power Service are utilizing the cloud today despite over 1 million virtual IBM Power service globally. With limited competition in the market, we have the platform and the talent to capture the migration opportunities in front of us. The company has invested millions of dollars in 6 Tier 3 data centers in the U.S. and Canada. The equipment and technical teams build our solutions. This is not an IBM reseller arrangement. We have the employees overseeing the services and operate our own equipment, cages and racks in the data centers. Today, we service over 350 companies. We compete with just 4 or 5 companies that have this expertise, helping companies looking to migrate to the cloud. And yet I believe we do a better job, less painful, more efficiently and cross competitively. Our company is a leader in this industry. I would also like to reiterate that the businesses that are increasingly under pressure to improve the effectiveness and efficiency of the information and storage systems. -- whereby accelerating the migration from self-managed technical equipment and solutions to fully managed multi-cloud technologies to reduce cost and compete effectively. Additionally, in today's environment, capital preservation is an encouragement to move from a capital-intensive, on-premise technology to a pay-as-you-grow CapEx to OpEx model. These trends create an opportunity for cloud technology service providers and demand for fully managed cloud and cybersecurity services across major operating systems, an addressable market of approximately $48 billion in annual recurring revenue in the U.S. and Canada. Demonstrating our commitment to security, we achieved ISO certification for our Cloud First and Nexus divisions. This third-party certification validates our extensive internal protocols and security measures that ensure our customers' data and information has been addressed, implemented properly controlled in all areas of our organization. We believe this certification will also assist us in accelerating our customer adoption due to the fact many organizations seek this certification prior to implementing certain solutions. We remain committed to adhering to the highest level of security standards for our company and for the trusted support of our clients. Importantly, we are undertaking activities that we anticipate will further improve our margins and profitability as well as accelerate our growth. This includes realigning management and operations. We have recently centralized service delivery and infrastructure. Our sales engineering teams now can better utilize our client proposal tools and software across combined sales teams. Additionally, we are establishing a new major accounts team that will be responsible for supporting our large enterprise-level clients as well as continuing satisfying ongoing equipment, software and IT requirements. We believe the changes stated will significantly improve our infrastructure solutions and recurring revenue to onetime sales ratio and as a result, will enhance gross profit and margins. At the same time, we plan on expanding our international programs and strengthen our established and successful U.S. sales and marketing programs. To streamline our operations, we are reducing redundant operating expenses within the organizations. We have realigned our management team to further increase our profitability. I am also pleased to report that we achieved positive adjusted EBITDA for the third quarter of 2022 and believe our initiatives that I have laid out will advance us towards increased profitability and improve margins. On a final note, we have a strong team, a robust proposal pipeline, and limited competition. With over $11 million in cash in the bank, we are well funded, well positioned to execute on our growth strategy, improve our margins, increase profitability, all while maintaining leadership position in the industry. With that, I'd like to turn it over to Chris, our CFO, to discuss our third quarter financials. Please go ahead, Chris.

Thank you, Chuck. Total revenue for the 3 months ended September 30, 2022, was $4.4 million, an increase of approximately $600,000 or 14% compared to $3.9 million for the 3 months ended September 30, 2021. The increase is primarily attributed to the increase of equipment and software sales. This was offset by a slight decrease in managed services for the 3 months ended September 30, 2022. Cost of sales for the 3 months ended September 30, 2022, was $2.6 million, an increase of approximately $250,000 or 11% compared to $2.3 million for the 3 months ended September 30, 2021. The increase was mostly related to the increase in revenue. Selling, general and administrative expenses for the 3 months ended September 30, 2022, were $2.1 million, an increase of approximately $200,000 or 11% as compared to $1.9 million for the 3 months ended September 30, 2021. The increase is primarily attributed to the increase in salaries as a result of new sales and marketing staff and increased marketing expenses. Adjusted EBITDA for the quarter was $162,390 compared to adjusted EBITDA of $104,985 for the same period last year. Net loss attributable to common shareholders for the 3 months ended September 30, 2022, was $245,619 compared to net income of $135,630 for the same period in 2021. We ended the quarter with cash and cash equivalents of $11.3 million as of September 30, 2022, compared to $12.1 million at December 31, 2021. Thank you. I will now turn the call back to Chuck.

Tanks, Chris. I'd like to open it up right now for some Q&A. Any questions that we may have?

[Operator Instructions] Your first question for today is coming from Matthew Galinko at Maxim Group.

Can you start off with what the pipeline today looks like for SaaS recovery in cloud infrastructure looking forward?

Matt, yes, I can go in more detail on that. We have around approximately $20 million in the sales funnel. And so when we look at the sales funnel, we look at it as total contract value. So there's approximately $6 million or so in one type one-time charges that could be IT services, equipment, and software and approximately $14 million total contract value. And if you remember that previous calls, I revealed that we usually get a 36-month term contract. It can be sometimes 12 and as high as 60 months. But I would say, on average, 36 months. So if the number that occurs the most, the mode is $3,000 a month. That's how we'll come up with that $14 million in sales proposals. So a quick number is to kind of divide that by 36 and you'll see what we're working with. But usually, we try to keep it around that level. Most of the times, we won't lose there's very few competitors. In most cases, people are asking for proposals and quotes, and then what ends up happening is they're not ready to do it yet but are gathering budgetaries. So actually, in our sales force, we rated where we're from a quote to negotiation of an agreement to a win. So overall, the proposals outstanding today are $14 million in total subscription recurring.

Got it. And I guess the follow-up to that is, are you seeing any changes to customer behavior in terms of how they structure deals, how they approach cloud versus premise as we've seen the capital market environment change and the macro environment change?

We've seen larger deals come in actually. It's -- you'll see some deals that come in that might be 1,000, but we're seeing deals that could range from $12,000 to $18,000 in monthly recurring revenue that are being proposed. I don't want to go through too much detail on that, but we are seeing an uptick. We had approximately 6,000 or so organic searches off of our Cloud First division, and it resulted in 100 leads that are being worked by the sales organization. So that's looking -- at this point, what we need to do is increase that by -- we're in the process of hiring salespeople. But just from the lead flow, it's pretty effective to be able to get leads and work those leads and convert into proposals and sales. So the actual numbers as it relates to the economy, I think people are questioning whether they should refresh their equipment on-premise versus go with a company like ours. Remember, keep in mind, these systems, we don't compete with AWS, Google or Microsoft. These systems on the operating system, some of them have the actual tools where the applications have been custom developed. So there wasn't a solution so fast for them before. They may have migrated all their intel over already. So now we're seeing, I think, this uptick and this lead flow coming on because they realize the cloud is secure possibly where ISO and is seeing that and feeling comfortable. And I believe that they're evaluating whether they should go put the money to a piece of equipment and for -- and everything that goes along with that with the staff launching that equipment and managing it and doing the backups versus coming to us where I believe we do a better job at this has to recovery than someone that's doing in off-premise, unless you're talking about Citibank, Deutsche Bank and firms like that, they do fantastic jobs. But for that midrange customer, we do an unbelievable job for them for disaster recovery, cybersecurity, and they don't have to spend the money. We charge an implementation fee that's kind of very reasonable, and we keep them. We have a 94% renewal rate. So we're doing something right with that.

And one more for me before I jump back in the queue, and I probably have more after that, but I don't want to hog the line. I guess with respect to the funnel for cloud deals, and you mentioned the -- I guess, the funnel and the leads that you're generating. How confident are you that you're canvassing and finding customers when they're getting to that decision point of, hey, do we migrate to cloud or do we do another premise purchase? Do you feel like you're touching all of the cloud opportunities and migration opportunities there are in IDM Power? Or do you feel like there's more you can be doing to further expand that net?

I'm -- frankly, I'm never happy, and it's never enough. It's just my personality, Matt, and I know you follow us and write about us. I will say that we're not doing enough. I think there's tremendous opportunity out there. Cable companies today, the only service they're eventually going to end up with is the Internet. And with that Internet, they're looking for increased revenue per customer for businesses like hospitals, financial firms, and all businesses they serve. So there's tremendous opportunity, I think, still to increase, and we're only touching on it. We're in the process of hiring some folks. The people that we are hiring though and where we're getting most of our business today other than the lead flow is we work with managed service providers that have sold that equipment and that they know us, the managed service provider is the trusted adviser for that client. They typically have multiple clients because they have a business. And then with that, when the client is ready to look at it, the MSPs are prepared, folks that we call channel partners that have been trained by us, have the marketing materials from us and with us. We do joint calls with us or our sales engineering group and our sales teams. But is it enough? It's never enough. We -- but we are deploying that capital, the $11 billion. We are deploying that so that we can increase our sales organization and also reach into Canada as well on that. Recently, our partner, Able One in Canada was acquired by Quadbridge, which is a much larger organization. We met with them during -- in October fest. We were invited up, and they're having all of their folks trained on our services. So that will increase our reach plus other plans we have in Canada, but we're not doing enough, frankly. There's just a lot more to touch on. And we have to get it to the point where it's not just the folks that sold the equipment, but companies like a cable company that has these customers and they can go out and layer our services onto their Internet. I don't know if that answers it, but the answer is we're never going to do enough. It's just a personality thing for me.

Your next question for today is coming from [ Elon Friedman at SKC Capital ].

How do you anticipate improving your margins, especially as it relates to FlagShip?

Sure. FlagShip primarily the relationships with IBM and a few other large providers. The margins were small. Leads would come in or do come in from IBM, HCL, Red Hat and organizations like that. And these clients would get entertained that they bring in to those services, which are typically at 20% to 35% margin on that. So we're redirecting all of the events. And FlagShip has had -- they have a great Director of Marketing and has done a fantastic job with many events throughout the United States over the 15 months since we purchased FlagShip. So we're working with director of marketing and moving that -- some of those events more towards not introducing IBM's cloud, but now our cloud, our infrastructure, our disaster recovery. So that movement of 20% to 25%, and it could be higher at 35%. We're hoping to see more of the 50% margin products introduced to the folks that are attending these events. So it is part of our marketing plans that we're putting in place for 2023. So I would say that's one way of improving margins. Also, FlagShip has a data center in Miami, Chuck Paulillo, our CTO, along with great staff at FlagShip and also cloud-first are going to be migrating that data center to 1 of the 6 Tier 3 data centers we have throughout the United States, with the 4 in the United States. And we've also centralized operations between FlagShip and between CloudFirst and under Chuck Paulillo, the CTO. And with that, we believe that let's not go add someone so fast to it. Let's see what the talents are in the organization to be able to see who can cover that, and we're uncovering some of those things today. Although we need to add, if we're going to continue to grow, we need to operate -- we call service delivery and infrastructure, we'll need to add to that. But right now, the situation is FlagShip could be using some contractors and looking at those numbers, Chuck Paulillo will see whether we should hire an employee that's more cost-effective. So I would say on centralizing operations, Miami data center, and moving these marketing events to not say that we're selling IBM's cloud, but selling our own cloud where we have millions of dollars invested in the 6 data centers. We're also introducing as well continuing. The marketing programs will continue for cybersecurity and other IT services but we're not going to bring in IBM and sell their cloud when we know we have greater than a 50% margin, and that's something that we are just not doing anymore, frankly. I hope that answered the question on margins.

Your next question is coming from [ Ryan Kay at RKS Capital Partners ].

I appreciate your time on today's earnings call. Could you comment a little bit more. You touched on quite a bit about initiatives related to the sales strategy and the sales pipeline as well as improving margins. Could you comment a little bit more -- give a little more color to time lines as to when some of these initiatives may materialize?

I think there's -- if we were to look at things on a per month basis, I believe we'll start seeing changes if it was December. But for the most part, I think that will be the first, second, and third quarter. I think it will take us 2 to 3 quarters to get to where we really want to be on it and having everything matched out. Chuck Paulillo just took over all the service delivery just a month or so ago and working through that with the staff. So I would say it will take some time on that. When you're talking about sales funnel, sales organization, we're going to be adding to the organization. That's an increased expense, but we want to ensure that we're not burning cash. We want to be able to grow from a profitable baseline on it. But in adding individuals that are going to focus on expanding our channel partner program, that will get expensive for a little while. But what ends up happening is for these managed service providers that become channel partners, which today is a primary way that CloudFirst cells. They have the customer base. So if their client is looking for cloud, we're in there given those proposals. And on top of that, we're handling the leads in most cases directly. Sometimes we pass them out to the channel partners, but we need to increase from the 50 active channel partners we have today, we need to double that, and we're going to be hiring to be able to do that. So on the sales funnel, it continues to grow, some fall off. When we say fall off, it just means they're just not ready at that point. We have what we consider a definition for a qualified prospect, and there's all sorts of ratings within Salesforce that Hal Schwartz is the President of CloudFirst has put in place, and that's actually being rolled out across both -- it's at Nexus already, but it needs to now roll out to FlagShip and FlagShip folks are anxious to have that all combined as well. So we can really take close looks for forecasting purposes. In the future, we hope to give some guidance. And as we start nailing this down a little bit more with Salesforce and pulling that together, I think we may be able to do that. So the sales force will grow. They'll be focused on managed service providers, channel partners. Our time frame basically, I would say, 2 to 3 quarters to really see that change. So -- and I've talked about improved in EBITDA margins is one thing, but I believe we'll start seeing this gross profit margin start to improve possibly in 2 quarters.

That gives me a lot of good context. I appreciate the insight and all the transformative growth opportunity and strategy to make sense. That's my question.

Your next question is a follow-up question coming from Matt Galinko.

With respect to the changes you talked about today, are we going to see any one-time cash or noncash in the fourth quarter or sometime in the early part of 2023?

Are you referring to cash because to raise capital? Or are you talking about, let's say, a large equipment sale? What are you referring to?

I'm talking about the realignment of FlagShip strategy, management, and the organizational structure. Are there any costs related to that?

Not that we've identified at this point. We have not identified any situations that would cost us cash today.

Okay. Great. And then anything you could share about the end markets that you're seeing changes or increased, decreased traction with? Where are you seeing activity?

Well, companies are recycling. They're on the 3- to 5-year recycle mode. So some of the very large accounts that we have that are related to equipment sales and software renewals. That continues with the existing accounts with proposals that we have outstanding, hopefully, to close in this quarter. So the folks that buy equipment, they'll continue to buy equipment based on their cycle. And as to leads coming in on subscription-based -- we -- that just continues as a steady flow. I don't think that the end of the year accelerates that at all for the most part because it takes several months to migrate someone's cloud infrastructure onto our cloud infrastructure from on-premise disaster recovery a lot faster. So it's really when the company is ready to kind of do that. There's no race that someone's going to say, "I need to do this immediately unless something went on unusual in their environment. But we hope to close out some equipment sales that folks may have budgets this quarter to be able to do that.

Got it. Maybe just last one on the cost side. I saw that your SG&A line was lower sequentially and sort of lower than it was over the last 3 quarters in the third quarter. What changes were there any specific changes that resulted in the lower G&A expense this quarter? And is that a number that you'll reinvest into? Or how should we think about that number?

Are you saying because SG&A went up? Is that what you're referring to?

So it went down sequentially, at least my model is correct. So I think you were at about $2.6 million in the June quarter and $2.1 million in the September quarter. So I was just curious why the dip sequentially.

Well, a lot has to do with commissions. The commission -- when you start seeing that, when you have more new sales come in, you'll see that our software renewals, the account executives are paid commission when a software renews on that. And if you see equipment sales, you're going to see commissions being up, and that's because also the sales engineers and the account executive or the channel partner has commissioned that relates to that. So if there's an account executive sales engineer, it could vary with that, Matt. So commissions. But as to the salaried in quarter, we had any reductions there. I would say that, that would be more in the third quarter that we had some reductions in management, things like that. But I would say commissions and minor when it comes to when it comes to I'd have to look at it a little closer to give you an exact answer, but typically, it relates to either some reductions or likely a larger part of that.

There appear to be no further questions in queue. I would...

Thank you. To wrap up, we've established ourselves as a leader within the industry. We had continued to generate strong revenue year-over-year. We are focusing our efforts on the contracts as we believe it's the future of our industry. Given our initiatives, our continued execution penetrate this market. I look forward to providing meaningful updates to the shareholders as developments unfold. And thank you all…

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your…