Data Storage Corporation (NASDAQ:DTST) Q4 2022 Earnings Call Transcript

Data Storage Corporation (NASDAQ:DTST) Q4 2022 Earnings Call Transcript March 31, 2023

Operator: Greetings and welcome to the Data Storage Corporation 2022 Fiscal Year Business Update Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow a formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host . Please begin.

Unidentified Company Representative: Thank you. Good morning, everyone, and welcome to Data Storage Corporations 2022 fiscal year 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 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, intends, projects, estimates, plans and similar expressions are 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 the expectations reflected in such forward-looking statements are reasonable, and 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 annual report on Form 10-K for the year ended December 31, 2022, and quarterly report on Form 10-Q and current reports on Form 8-K filed with the Securities and Exchange Commission. Any forward-looking statements speak 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.

Chuck Piluso: Thank you, Allie, and good morning, everyone. 2022 was a year of assimilation for Data Storage Corporation, especially as it relates to our Flagship subsidiary. And while we are proud to report achieving a 60% increase in revenue to 23.9 million for 2022, we have also implemented meaningful business initiatives during the year that we believe will enable us to further accelerate growth and streamline the organization with the goal of long-term profitability. Additionally, this is the first reporting period that we have broken out our revenues by business segment, which we believe allows us to paint a better picture for each of our business units. While each of our subsidiaries address important aspects of information technology and provide solutions and services to a broad range of clients across various industries, our primary focus is targeting long-term contracts with subscription services that provide meaningful recurring revenue streams, allowing us to maintain long-term growth and profitability.

The day of waiting for that one large equipment or software sale in order for a subsidiary to be profitable for a quarter is over. The objective is recurring revenue. However, we are not turning away from equipment and software sales. We are instead basing profitability each month on recurring revenue. Our revenue objective is to have 80% of our annual revenue recurring, while we are not 100% there at Flagship, Tom Kemps to the new President of Flagship since November 2022, is highly focused on the strategy and vision. An example of how the strategy is working is our CloudFirst subsidiary, which we achieve profitability on a standalone basis with net income of $1.9 million and an EBITDA margin of 27% or $3 million with revenue of 11.5 million for 2022.

Hal Schwartz, President of CloudFirst has positioning the subsidiary as a leader in the market and taking advantage of the cloud migration on IBM Power Service, which is currently underway. We have only begun to scratch the surface to this market, a $36 billion annual addressable market in the United States in Canada. Turning to Flagship. When we acquired Flagship, we understood and still believe today that Flagship’s brand and reputation is in very high regard. However, given the current economy, companies are being more cautious in terms of large equipment purchases and the timing of the purchases. While we’ll continue to pursue these opportunities, we are focusing Flagship on subscription based services, which typically provide a higher margin.

The strategy is aligned with the overall market and economy as customers are working to outsource and migrates the cloud type services and solutions, where CapEx moves to OpEx and customers can pay as they grow. Flagship will continue to provide equipment to their client base. However, we will not base the business health on a one-time equipment sale. As a result, after reviewing proposals outstanding for 2023 for equipment sales, we felt it prudent to reduce goodwill by $2.3 million. Today, Flagship is positioned with IBM and is working closely with IBM on cybersecurity solutions and software. Moving forward, we’ll be making an investment with IBM to accelerate cybersecurity revenue. Additionally, to further assist in the success of Flagship, we are refreshing the Flagship website, hiring new business development personnel, expanding distribution channels through key marketing programs.

We believe these steps will assist in reaching profitability for Flagship on a standalone basis as well as aid in the overall profitability of Data Storage Corporation. Furthermore, we intend to deploy capital effectively and have outlined several objectives that we expect to execute throughout 2023. First, we intend on hosting high margin revenue driven events during the year in various cities around the United States. Second, while we provide solutions to government agencies, we are building out a government focused business unit. Third, we intend to expand internationally as our products and services are applicable worldwide. There are many large markets we can penetrate. Fourth, we are already underway with the consolidation of the technical teams of CloudFirst and Flagship under our CTO, Chuck Paolillo.

One positive outcome expected should be an improvement in gross profit. Fifth, we will expand our channel partner program in the United States and Canada. Channel partners are a great way to grow quickly, since these MSPs are the trusted advisers to their client base. And finally, as I have touched on before, we plan to expand the sales force with dedicated sales representatives and teams, aligned with the business segments and departments and we can then focus both on growth and profitability. With the realignment of management refocused efforts on business initiatives and a growing sales team, we believe the value of the activities, we undertook in 2022 will become apparent in 2023. Importantly, we expect these steps will be reflected in our first quarter 2023 results, which is shaping up extremely well.

Overall, we remain committed to growth. And with limited competition in several of our core services and solutions, we believe our sales teams and our proposal pipeline will aid in advancing our service delivery teams and assist in long-term profitability. With approximately $11.3 million of cash and short-term investments and no debt, we expect to deploy capital effectively and efficiently, including expanding our distribution channels, increasing marketing activities and exploring accretive acquisitions. We believe we are well on our way towards becoming a multi-billion dollar leader in this growing market. With that, I’d like to turn it over to Chris, our CFO, to discuss the 2022 financials. Chris?

Chris Panagiotakos: Thank you, Chuck. Total revenue for the year ended December 31, 2022 increased by approximately 60% to $23.9 million compared to $14.9 million for 2021. All of our subsidiaries saw increases in revenue. The primary increase in revenue relates to the acquisition of Flagship. At CloudFirst, revenue grew from $10.2 million to $11.5 million an increase of approximately 13%. At Nexxis, revenue grew from $817,000 to $931,000 an increase of approximately 14%. The Company saw increases from mostly all of its revenue sources, cloud infrastructure and disaster recovery, equipment and software, managed services and Nexxis’ VoIP services all grew from prior year. Cost of sales for the year ended December 31, 2022 was $15.8 million compared to $8.5 million for the year ended December 31, 2021.

The increase of $7.3 million was mostly related to the increase in sales, which resulted from the Flagship acquisition. Selling, general and administrative expenses for the year ended December 31, 2022 were $9.8 million, an increase of approximately $2.7 million compared to $7.2 million for the year ended December 31, 2021. The increase is primarily attributed to the Flagship acquisition. We also saw increases in salaries as a result of new sales and marketing staff, increased marketing expenses, and increases in professional fees associated with being on NASDAQ. Adjusted EBITDA for the year was $4,384 compared to adjusted EBITDA of $824,583 for the same period last year. Net loss attributable to common shareholders for the year ended December 31, 2022 was $4.4 million compared to net income of $204,161 for the year ended December 31, 2021.

For further detail on the $4.4 million loss we had a goodwill impairment at Flagship of 2.3 million. We had approximately a $400,000 expense in 1x equity compensation. We had127,000 in 1x offering cost and approximately a $1.5 million loss, mostly attributed to Flagship and our public company and corporate expenses. We ended the year with cash and short-term investments of $11.3 million at December 31, 2022, compared to $12.1 million at December 31, 2021. Thank you. I will now turn the call back to Chuck.

Chuck Piluso: Thanks, Chris. I’d like to open it up for questions. Rob, if you can take over at this point.

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Q&A Session

Operator: Absolutely, thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from Matthew Galinko with Maxim Group. Please proceed with your question.

Matthew Galinko: Nice job on 2022 results. So Chuck, I think you touched on the aligning Flagship with subscription being consistent with how I think macro is shaping how investors or how customers want to consume services. They want to go more towards the rental model than the capital purchase model. Did I understand you correctly? And can you go a little bit more into how this environment is resulting in some changes to customer conversations? Is that having a material impact on that shift?

Chuck Piluso: Hey, Matt, it’s a little difficult. First of all, I think that very large clients, which we — which Flagship has many I think that they could be taking an approach to delaying or being more cautious on the large equipment sales. So, you have the very large customers that might not be moving over to we called infrastructure cloud, but folks are looking at software-as-a-service. They’re looking at cybersecurity-as-a-service. So, instead of just purchasing and running it on their own systems, so you have a couple of things going on. One is possibly delaying on equipment sales, and putting that off a little bit, and others that are investigating or evaluating should they move onto infrastructure-as-a-service. We know that several large government agencies have moved onto infrastructure-as-a-service.

So, I would say for the most part it’s according to the size of the accounts, and all, but there is I believe a delay just based on the economy of people putting off that and very easily on equipment sales it can move from where you would think you’re going to close it one month and it rolls over to the next quarter and then we get the sale. I think we should be expecting some decent results when we take a look at the first quarter, but folks are consuming on a monthly subscription basis. Overall when we talk about the overall business environment, instead of making big capital purchases or software that they would usually license for an entire year or for three years. I don’t know, if that answers your question, Matt. Does it?

Matthew Galinko: Yes. That was helpful. Maybe, I know you don’t provide guidance, but just given how ’22 shaped up through the year you had the plug of Flagship revenue in the first quarter and fourth quarter was obviously very strong. What’s the — can you give us any commentary on what we might expect just given those high water marks that you reported during 2022? Does that set a really high bar for us to think about in ’23? Does the subscription growth sort of get to meet that equipment purchasing that you reported in ’22?

Chris Panagiotakos: When you take a look at the first quarter of 2022, we have some, as I mentioned, Flagship has some very large accounts and so there’s some software renewals that you see in there and that’s why we get the lumpiness when it goes — when we start looking at quarters. So when you take a look, I think our press release as well from last year, you’ll see that there was a large equipment sale and there’s also a large software renewal. These software renewals and hardware maintenance revenue, what happens is that, they occur in various months of the year. There’s not all of in one quarter or in one month. It just happens out through, through the entire year. And then at that point they go out. In some cases the clients put them out for competitive bids.

So, if you take a look at last year and you can see, our software renewal and hardware maintenance type revenues, you’ll see that lumpiness there as well as equipment. What we’re trying to do is just move more and more towards where it is straight lined and steady and you can see a consistent growth. But what ends up happening is when you get, for example, the $2 million software renewal that might occur in February, and it may be every February, you can see that lumpiness that’s there. So, the software renew on hardware maintenance, but with equipment that can just easily, as I mentioned before, just move to another month or another quarter. But if they’re looking to move to infrastructure to service were there to give a proposal on our infrastructure to see if they’re planning on moving to it.

So, it’s very hard to predict the equipment closes and that’s why we took the goodwill impairment, frankly, on Flagship, because it’s very hard to predict. And we wanted to be really conservative and prudent with that. But if you look at that lumpiness, Matt, you’ll be able to see that a lot of that is software renewal and hardware maintenance that occurs annually.

Matthew Galinko: I’m going to ask one more question and then jump back in the queue. You touched on international expansion. It’s definitely a topic that’s come up over the last few quarters. Can you talk a little bit more about how those plans will shape up for 2023? What’s new in that strategy and I guess what can we expect to see?

Chris Panagiotakos: Well, I still consider Canada to be international. We have with the partner ABLe Communications was purchased by a much larger MSP, which we have relationship now with. And we have in the Toronto metro area — we have the two — our equipment in two data centers there. So, we are looking to do much more in Canada. Additionally, we have been talking to MSPs and alike in Europe and we will continue to explore that. We really — we want to make sure, in the case of Europe that’s the MSPs that we can enter into partnership agreements in the same way that, the CloudFirst has done in the United States and Canada. So, we are exploring those MSPs that are there. We have programs going on to expand the MSP channel partner program in Canada and of course the United States.

So, we are focused on English speaking for the most part. It’s easier for all of us. And so, yes — so we are looking at the UK and Europe, primarily the UK, and doing more in Canada with the equipment that we have invested in those two data centers with Able-One.

Operator: Our next question comes from Adam Waldo with Lismore Partners. Please proceed with your question.

Adam Waldo: Yes. Good day. Thank you very much for taking my questions. I’d like to explore two areas, the new business pipeline and then the outlook for cash generation and capital deployment. So, on the new business pipeline, I know, as the prior question said, you don’t like to give specific financial guidance in terms of revenue, net income, cash flow and so on. But can you give us a sense some granularity or quantification, what your new business pipeline looks like at this time on a value basis in the recurring revenue side of the business? And how that would have compared, let’s say, six months or a year ago? And related to that, can you give us some quantification of where your closed rates are trending? Then I’ll hold my second question.

Chuck Piluso: Sure. I’ll go in reverse direction. Our close rates are around 25%. What happens is, when we take a look at each company, which is very separate, you take a look at Flagship. These are large customers that are being covered by folks that have dealt with them for a while and the close rate on it is typically very high. I’m going to say, probably higher than 50% on it. Their sales funnel is not in the sense of the same way that CloudFirst is. So you will see in the case of Flagship, you will see equipment and you will see some recurring. On the other side with CloudFirst, you will see probably an excess of a $13 million total contract value. And what happens sometimes is it’s not that necessarily, you are losing an account.

It’s just that they are putting off their decisions on it. So most of the time, you will get a delay in decision making and put off for another period. But the close rate is around 25% or so on CloudFirst, it’s actually a little bit higher and we move those out to our channel partners, some of those leads. And what happens is that, through our sales force, the system is automated when a lead comes through because they have downloaded a white paper. And based on how many pages they came through, the lead is actually rated. And if it’s a highly rated lead, the close rate is higher than 25%. We know what pages they’ve been at. They’re very interested. We see they might have downloaded the page, migrating your IBM systems, power systems to the cloud.

And it’s a much higher rate. The exact number on it, I’d have to ask Hal Schwartz to get that. So, if you want to know the exact rates, I know that Hal tracks all of that. But I also know that, we had usually around 6,000 visitors to our site to the CloudFirst site typically each month. I understand that that’s more than doubled over the last month because we’ve added in our marketing programs AIX on that, so to run on our systems. So, we get an inflow of leads when they comes in the higher closing rate versus, no one’s cold calling anymore frankly. We’re working through channel partners and the other trusted advisors. If their client wants to move to the cloud and they happen to be a partner of us that close rate is, let’s call it 90%.

Adam Waldo: No, that’s tremendously helpful. And Chuck, you talked about the 13 million value, annualized value of the current sort of pipeline at CloudFirst. How does that dollar value compare with let’s say six months to 12 months ago? If you go back six months, what would that have looked like? If you go back a year ago, what would that have looked like?

Chuck Piluso: Sure, just to clarify, it’s the total contract value typically.

Adam Waldo: Okay. Sorry. Sorry.

Chuck Piluso: No, it’s okay. I just want to make sure. So that typically we signed a 36-month agreement, but I believe that you average everything out and pull out the ones that have 60-month agreements. We have one very large client that’s a 60-month, that we service is 60-month agreement. It’s on average. Hal tells me of around 30 months on average. Usually, it ranges from $13 million to $15million typically, and has been consistent with that over the last couple of years.

Adam Waldo: Okay, that’s very helpful. And then turning to you’ve given guidance sort of qualitatively that your ambition is to be profitable and cash generative in 2023 and beyond. You’ve right-sized the organization late last year to be able to do that and resources as well within the organization. So how comfortable are you at this juncture that you should be able to be profitable cash generative for all of 2023 although there may be because of lumpiness in the business a quarter here or there where, it might be a little bit tight?

Chuck Piluso: It’s a tough to answer that question and to not put myself in a corner on it. We — all of our business plans that were approved by the board this year for 2023, our aim is to be an objective is to have net income profitability. Now, we’re not one to wildly spell spend the cash, but we are searching for experienced sales representatives that requires recruiters to do that. And we are planning on hiring. And so, take Nexxis for example. Nexxis, as you’ll see in the filings, is a small telecom voice data company in the board. And the offices have approved John Camello, the President of that unit, to hire and recruit sales reps. A lot of times you might lose money in that Nexxis subsidiary, while you’re growing that sales force and while they’re selling and the benefit for that is in 2024.

But overall, that’s small. So when we take a look at Flagship, when we take a look at CloudFirst, we’re expecting a positive net income. And also, when you add Nexxis in, the overall company can absorb in our plans, can absorb that loss, that short term loss, that they’ll have. So we’re highly focused on net income after our headquarters and corporate overhead absorption that we assigned to each subsidiary. So, we’re highly focused on it. We’re trying to size the actual business. Well, in the case of Flagship, we’re trying to size it up for the recurring revenue, but giving Tom enough run way to be able to get those recurring revenues going on it. But we are sizing everything up for recurring revenue. And then what we’re planning is that as in the case of Flagship with cybersecurity and some other services, the plan is to add to that so that we know on the baseline recurring revenue, it’s profitable and now we’re investing in the growth in new services.

So, we could see some — we could see on a segment based reporting, we could see a loss there. But overall, when we consolidate everything, we believe it’ll be a positive net income.

Adam Waldo: And then the final topic is capital returns and deployment, right? Your stock trades at basically net cash. You look to be pretty comfortable that you can be at least somewhat profitable cash generative this year and beyond. Hopefully, it’s scaling beyond. So what opportunities are there to try to close the gap in value between the stock price valuation and the sort of private market value in the business, which is much higher? What thoughts do you have currently around stock buybacks, dividends and so forth?

Chuck Piluso: Well, if we do a stock buyback, which we probably should, because it’s ridiculous where the price is. We have $8 million to $10 million in assets deployed into six data centers, and we have more cash in the bank that — and looking at everything that we do with limited competition in a huge marketplace, it’s really very upsetting frankly to everybody that’s internally, and I’m sure some of the investors as well. But if we buy back stock, it’s like really saying to ourselves that we don’t have use of that money. And I believe we do have use of that money, but if it continues to dropdown, we’ll keep looking at stop buyback options. But I do believe we have use of that money. I think we have to produce quarter over quarter growth.

And as we show quarter over quarter revenue growth and profitability, hopefully people will pay attention and we’ll have a different market cap. I think if we continue to look at the right kind of acquisitions, we put out several term sheets last year, and we have to due diligence on it, we decided not to move forward with them. So, we’re pretty busy with looking at acquisitions. I think that will make a difference possibly and people will pay attention, but then there’s always the assimilation that comes along with that acquisition that takes time and is some sometimes painful. So, we’re looking at all options, but where the stock price is today it’s — if someone’s looking to move it from a $1.70 to $2 and all of a sudden they sell, I would say that’s not what we’re up to.

We’re in a significant business CloudFirst alone. It’s a $36 billion annual recurring addressable marketplace in the U.S. and Canada. We’re not saying that we’re going to get a 100% of the market, but let’s just think about 2%, 3%, 4%, 5%, 10% of that. And today there’s around six to seven competitors and Amazon, Google and Microsoft do not have the services that we have so whether they are getting that in the future, I’m not sure. But for the most part, when we see that stock price, it’s upsetting. And if it goes down more, we will look at stock buybacks because it doesn’t make any sense. But right now, we are not entertaining that. We haven’t put anything before the Board. We want to spend the money on acquisitions, and we want to spend the money on deploying the capital to grow our distribution channels and technical teams.

I don’t know does that help?

Adam Waldo: Yes, it helps a lot. If you can permit me, one clarifying follow-up on this topic. So, it sounds like dividends rolled out for a lot of good reasons, internal growth returns look higher, and share buyback returns look higher. Is it fair to say that acquisitions though are pretty high bar in terms of the financial returns, adjusted for integration risk given the high financial returns that basically risk free nature of buying back your own stock?

Chris Panagiotakos: Let’s say that, as an example, we find a competitor that has $3.5 million in 30-month average term contracts and remaining contract value of $10 million, and we buy that customer base, and they have a sales organization. It’s not just the president that has baptized every one of his customers’ children. I would say for the most part, that’s a good acquisition when we look at that. So, we want to continue before we entertain buying back the shares, I think, we should see how better we can use that to grow this business north of $35 million.

Adam Waldo: Tremendously helpful.

Chuck Piluso: I think it’s a quarter-over-quarter growth story. We have to produce that. And I think folks will pay attention, but I think we need to really get north of a certain revenue numbers in order for us to pull out of the stock price. But hopefully, people pay attention. It’s a long-term growth on it, and the addressable market is significant. UK, Europe has lot — these systems in it as well. It’s significant. And on top of that cybersecurity, where Flagship is highly focused on, now, I just think it’s a good story. Look at the whole thing is up to execution. So let’s see how we do.

Adam Waldo: No, that’s very helpful. Appreciate the detailed insight into your thinking and good luck.

Operator: Our next question is from Matthew Galinko with Maxim Group. Please proceed with your question.

Matthew Galinko: Hey, guys. Again, thanks for my follow-up here. Chuck, I think you mentioned making an investment through Flagship in cybersecurity and your work with IBM. Can you go a little bit further into that? What’s the investments look like and what specifically in cybersecurity? And when would we start — when would you plan to start seeing return on and the investments you are making in 2023 on that?

Chuck Piluso: I would say, over the next three to six months. I think we should see Tom ramping that up with the sales organization. We’re going to be adding sales folks to business development teams to Flagship and focusing first on their existing accounts that they have as well as Nexxis and CloudFirst accounts. IBM is working very closely with Tom and with the group there. They have a great, great group at Flagship. So, I can’t give you the exact programs that are going on. You can always speak with Tom if you want, Matt.But there are programs underway right now with IBM and Flagship. And remember, it’s not new that cybersecurity is not new to us. CloudFirst offers certain types of cybersecurity on their infrastructure. We’ve always had certain security with encryption on all of our disaster — on most of our disaster recovery software and services.

So — and also, I believe that Flagship has sold IBM software to the Atlanta Falcons. So, it’s not new to them, but this is really additional programs and additional software that would be rolling out.

Matthew Galinko: Got it. Thanks. Last question for me is just on the hiring environment. You mentioned, adding to the team particularly in sales I think. Is it easier today to add is the current environment we’re in supportive of expanding headcount in the areas where you want to?

Chuck Piluso: Nothing’s easy today. No one wants to talk on the phone. It’s everybody wants to have a video call, which you can’t get a good feel for. But I will tell you, just as an example Verizon laid off, a number of people in a certain market segment. I had two — I like to see everybody by the way, that’s being hired. And I actually had follow-up interviews off of Nexxis for two individuals that were laid off from Verizon. I don’t know how many that John Camello actually interviewed total, but the two individuals that I interviewed were both excellent. So, I think this layoff environment that’s going on by these very large companies that treat everybody as a number, which we don’t. We try to bring everybody into our culture and our environment.

These two individuals were excellent. And I believe that John will be bringing them on Board, but that’s HR and John Camello. But I did do the last interviews and they were both excellent, if we can get more candidates like that. So, as these layoffs continue, I think it’s only an opportunity for us at the Company.

Operator: We have reached the end of the question-and-answer session. I’d now like to turn the call back over to management for closing remarks.

Chuck Piluso: Thank you, Rob. To wrap up, while, we continue to generate strong year-over-year revenue growth have preserved a solid balance sheet, we intend to deploy capital efficiently and effectively to accelerate our growth and remain at the forefront of this industry. We have taken the steps to streamline the organization and reduce redundant cost, which should be apparent as early as the first quarter of 2023. And we are excited about the outlook for the business and we look forward to providing further updates as developments unfold. I’d like to thank everyone for joining us today and have a great day.

Operator: This concludes today’s conference. You may disconnect your lines at this time, and we thank you for your participation.

Chuck Piluso: Thank you, Rob.