Data Storage Corporation

Greetings and welcome to Data Storage Corporation 2022 Fiscal Year Business Update Conference Call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Alexandra Schilt. Please begin.

Thank you. Good morning, everyone, and welcome to Data Storage Corporation's 2022 Fiscal Year Business Update Conference Call. On the call with us this morning are Chuck Peluso, Chairman and Chief Executive Officer, and Chris Patagio-Tacos, 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 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 annual report on Form 10-K for the year ended December 31, 2022, and quarterly reports on Form 10-Q 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 Peluso. Please go ahead, Chuck.

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 goals 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 days 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 Kempster, 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 Cloud First subsidiary, which we achieved 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 positioned the subsidiary as a leader in the market and taking advantage of the cloud migration on IBM Power Servers, 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 and Canada. Turning to flagships. 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 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 migrate 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 will 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 corporations. 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 Cloud First and Flagship under our CTO, Chuck Polillo. 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 advisors 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 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?

Thank you, Chuck. Total revenue for the year-ended December 31st, 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 Cloud First, revenue grew from $10.2 million to $11.5 million, an increase of approximately 13%. At Nexus, 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 nexus avoid services all grew from prior year. Cost of sales for the year ended December 31st, 2022 was 15.8 million compared to 8.5 million for the year ended December 31st, 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 31st, 2022 were 9.8 million, an increase of approximately 2.7 million compared to 7.2 million for the year ended December 31st, 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 31st, 2022 was 4.4 million compared to net income of $204,161 for the year ended December 31st, 2021. For further detail on the 4.4 million loss, we had a goodwill impairment at flagships of 2.3 million. We had approximately a $400,000 expense in one-time equity compensation. We had $127,000 in one-time offering costs 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. Thanks, Chris.

I'd like to open it up for questions, Rob, if you can take over at this point.

Absolutely. Thank you. At this time, we'll be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question comes from Matthew Galinka with Maxim Group. Please proceed with your question.

Hey, good morning, guys, and thanks for taking my questions and, you know, nice job on 2022 results. So, Chuck, I think you touched on the, you know, lining flagship with subscription being consistent with how I think macro shaping how investors or how customers want to consume services. You know, 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?

Hey, Matt. You know, it's a little difficult. First of all, I think that very large clients, which Flagship has many, you know, I think that they – They could be taking an approach to delaying or being more cautious on the large equipment sales. So, you know, you have the very large customers that, you know, might not be moving over to we'll call it infrastructure cloud. But, you know, folks are looking at software as a service. They're looking at cybersecurity as a service. So, you know, 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 on to infrastructure as a service. We know that several large government agencies have moved on to 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. You know, I think we should be expecting some decent results, you know, when we take a look at the first quarter. But folks are consuming on a monthly subscription basis, you know, 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?

Yeah, yeah, that was helpful. Maybe, I know you don't provide guidance, but just given how 22 shaped up through the year, you know, you had the slug of flagship revenue in the first quarter and, you know, fourth quarter was obviously very strong. You know, what's the, can you give us any commentary on what we might expect? You know, just given those high watermarks that you reported during 2022, Does that set a really high bar for us to think about in 23? Does the subscription growth, you know, sort of get to meet that, you know, equipment purchasing that you reported in 22?

When you take a look at the first quarter of 2022, you know, we have, We have some, you know, as I mentioned, flagship has some very large accounts. And so there's some software renewals that you see in there, and that's where 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, you know, 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. It's not all of in one quarter, you know, or in one month. It just happens out 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, you know, our software renewal and hardware maintenance type revenues, you'll see that lumpiness there as well as equipment. You know, 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, a $2 million software renewal that might occur in February, and it may be every February, you can see that lumpiness that's there. So, you know, the software renewal and hardware maintenance changes. 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 the infrastructure to service, we're there to give a proposal, you know, 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. Got it. Okay, that's helpful.

I'm going to ask one more question and then jump back in the queue. You touched on international expansion. You know, 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, you know, I guess what can we expect to see?

Well, I still consider Canada to be international. You know, 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 and two data centers there. So We're looking to do much more in Canada. Additionally, we've been talking to MSPs and the like in Europe, and we'll continue to explore that. We want to make sure in the case of Europe that the MSPs that we can enter into partnership agreements in the same way that Cloud First has done in the United States and Canada. So we're 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, you know, we're focused on English speaking for the most part. It's easier for all of us. And so, yeah, so we're looking at the U.K. and Europe, primarily the U.K., and doing more in Canada with the equipment that we have invested in those two data centers with ABLE1.

Got it. Thank you.

As a reminder, if you'd like to ask a question, please press star one on your telephone keypad. One moment, please, while we poll for questions. Our next question comes from Adam Waldo with Lismore Partners. Please proceed with your question.

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 questioner said, you don't like to give specific financial guidance in terms of revenue and net income, cash flow, and so on. But can you give us a sense, some granularity or quantification of 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 with, let's say, six months or a year ago? And Related to that, can you give us some quantification of where your close rates are trending? And I'll hold my second question.

Sure. I'll go in reverse direction. Our close rates were at 25%. And what happens is when we take a look at each company, which is very separate, you take a look at Flagship, you know, 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, you know, probably higher than 50% on it. Their sales funnel is not in the sense of the same way that Cloud First is. So you'll see in the case of Flagship, you'll see equipment and you'll see some recurring. On the other side with Cloud First, you'll see probably in excess of a $13 million total contract value. And what happens sometimes is it's not that necessarily you're losing an account, it's just that they're putting off their decisions on it. So most of the time you'll get a delay in decision-making and put off for another period. But the close rate is around 25% or so on Cloud First. It's actually a little bit higher, you know, and we move those out to our channel partners, some of those leads. And what happens is that through our Salesforce, the system is automated when a lead comes through because they've 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, you know, Hal Schwartz to get that. So if you, you know, want to know the exact rates, I know that Hal tracks all of that. But I also know that, you know, we had usually around 6,000 visitors to our site, to the cloud first 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, you know, we get an inflow of leads when it comes in the higher closing rate versus, you know, no one's cold calling anymore, frankly. You know, 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, you know, let's call it 90%.

No, that's tremendously helpful. And, Chuck, you know, you talked about the $13 million annualized value of the current sort of pipeline at Cloud First. 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 look like? If you go back a year ago, what would that look like?

Sure. Just to clarify, it's the total contract value. Okay, sorry, sorry. No, it's okay. I just want to make sure. So that typically we sign a 36-month agreement, but I believe that you average everything out and pull out the ones that have 60-month, you know, agreements. We have one very large client that's a 60-month that we service, a 60-month agreement. It's on average, Hal tells me, of around 30 months on average. Usually it ranges from $13 to $15 million typically and has been consistent with that over the last couple of years.

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

You know, it's a tough – It's tough to answer that question and to not put myself in a corner on it. All of our business plans that were approved by the board this year for 2023, you know, our aim is to be and our objective is to have net income profitability. Now, we're not one to wildly spend the cash, but we are searching for experienced sales representatives. That requires recruiters to do that. And we are planning on hiring. So take Nexus, for example. Nexus, as you'll see in the filings, is a small telecom voice data company. The board and the offices have approved John Camillo, the president of that unit, to hire and recruit sales reps, a lot of times, you know, you might lose money in that Nexus 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 cloud first, you know, we're expecting a positive net income. And also when you add Nexus 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 assign 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 runway to be able to get those recurring revenues going. 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, you know, 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.

Right. That's tremendously helpful. And then the final topic is capital returns and deployment, right? The 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 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 business, which is much higher? What thoughts do you have currently around stock buybacks, dividends, and so forth?

Well, you know, if we do a stock buyback, which we probably should, because it's ridiculous where the price is. We have $8 to $10 million in assets deployed into six data centers, and we have more cash in the bank than looking at, you know, 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 drop down, we'll keep looking at stock 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 do diligence on it. We decided not to move forward with them. 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 sometimes painful. So we're looking at all options, but where the stock price is today, if someone's looking to move it from $1.70 to $2 and all of a sudden they sell, I would say that's not what what we're up to. You know, we're in a significant business. Cloud First 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 100% of the market, but let's just think about, you know, two, three, four, five, 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're getting that in the future, I'm not sure. But, you know, for the most part, when we see that stock price, it's upsetting. And if it goes down more, we'll look at stock buybacks because it doesn't make any sense. But right now, we're 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, Adam, does that help?

Okay. It helps a lot. If you'll permit me one clarifying follow-up on this topic, though. 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?

Well, 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. You know, 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. Tremendously helpful. 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 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. U.K., Europe has these systems in it as well. It's – It's significant. And on top of that, cybersecurity, which Flagship is highly focused on now, I just think it's a good story, you know. Look, the whole thing is up to execution. So let's see how we do.

No, that's very helpful. Appreciate the detailed insight into your thinking, and good luck.

Thank you. Our next question is from Matthew Galenko with Maxim Group. Please proceed with your question.

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? You know, what do the investments look like and, you know, what specifically in cybersecurity and, you know, when would we start to – and the investments you're making in 2023 on that?

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 Nexus and Cloud First accounts. You know, 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. Cybersecurity is not new to us. Cloud First offers certain types of cybersecurity on their infrastructure. We've always had certain security with encryption on most of our disaster recovery software and services. And also, I believe that flagship – sold IBM software to the Atlanta Falcons. So it's not new to them, but this is really additional programs and additional software that will be rolling out.

Got it.

Thanks.

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

Nothing's easy today. You know, no one wants to talk on the phone. You know, 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 Nexus for two individuals that were laid off from Verizon. You know, I don't know how many that John Camillo actually interviewed total, but the two individuals that – 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, you know, our culture and our environment. These two individuals were excellent. And I believe that, you know, John will be bringing them on board, but that's HR and John Camillo. 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. Great, thank you.

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. Thank you, Rob.

To wrap up, While we continue to generate strong year-over-year revenue growth and 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 costs, 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.

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