Data Storage Corp 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion of our plan of operation and results of operations should be read in conjunction with the financial statements and related notes to the financial statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These risks and other factors include, among others, those listed under “Forward-Looking Statements” and “Risk Factors” and those included elsewhere in this report. COMPANY OVERVIEW Data Storage Corporation, headquartered in Melville, New York, together with its three subsidiaries, DSC, Flagship Solutions LLC and Nexxis, Inc. provides solutions and services to a broad range of clients in several industries, including healthcare, banking and finance, distribution services, manufacturing, construction, education, and government. The subsidiaries maintain business development teams, as well as independent distribution companies. As an example, the Company’s distribution channel of companies provides long-term subscription-based disaster recovery and cloud infrastructure without investing in the infrastructure, data centers, telecommunications or specialized technical staff, which substantially lowers their barrier of entry in providing these solutions to their client base. The distribution company has typically provided equipment and software. However, a client’s awareness in 2021 of the ability to migrate to an IBM Power cloud infrastructure and disaster recovery affords the distributor the ability to maintain the client and create an annuity year after year. To further support that awareness, over 55,000 visitors arrived at the Company’s website in 2021. During 2021, based on the May capital raise and the up list to Nasdaq, the Company added distribution, business development representatives, marketing, and technical personnel. Management continues to be focused on building the Company’s sales and marketing strategy and expanding its technology assets throughout its data center network. The Company’s business offices are in New York and Florida. The offices include a technology center and lab, adapted to meet the technical requirements of the Company’s clients. The Company maintains its own infrastructure, storage, and networking equipment required to provide subscription solutions in seven geographically diverse data centers located in New York, Massachusetts, Texas, Florida and North Carolina, and in Canada, Toronto, and Barrie, serving clients in the United States and Canada. The Company’s Business Continuity Solutions allow clients to quickly recover from system outages, human and natural disasters, and cyber security attacks, such as Ransomware. The Company’s Managed Cloud Services starts with migration to the cloud and provides ongoing system support and management that enables its clients to run their software applications and technical workloads in a multi-cloud environment. The Company’s Cyber Security offerings include comprehensive consultation and a suite of data security, disaster recovery, and remote monitoring services and technologies that can be incorporated into the Company’s cloud solutions or be delivered as a standalone managed security offering covering the client site endpoint devices, users, servers, and equipment. Solution architects and the Company’s business development teams work with organizations identifying and solving critical business problems. The Company carefully plans and manages the migration and configuration process, continuing the relationship and advising its clients long after the services have been implemented. As of this filing the Company has proposals outstanding of approximately $14 million in total contract value; and, total proposals outstanding including equipment and software of approximately $20 million. Reflecting on client satisfaction, the Company’s renewal rate on client subscription solutions is approximately 94% after their initial contract term expired. The Company provides our clients subscription-based, long-term agreements for cloud disaster recovery, cloud infrastructure, telecommunications solutions, and high processing on-site computing power and software solutions. While a significant portion of our revenue has been subscription-based, we also generate revenue from the sale of equipment and software for cybersecurity, data storage, IBM Power systems equipment and managed service solutions. As of this filing the company has a backlog of over $500,000 in Annual Recurring Revenue (ARR) and equipment and software of approximately $2 million. 2021 Business Update On May 31, 2021, the Company completed a merger (the “Merger”) under an Agreement and Plan of Merger (the “Merger Agreement”) with Flagship Solutions, LLC (“Flagship”) (a Florida limited liability company) and the Company’s wholly-owned subsidiary, Data Storage FL, LLC, a Florida limited liability company. Flagship is a provider of IBM solutions, managed services, data analytics, cyber security and cloud solutions. The Company expects that Flagship’s business will be synergistic with the Company’s existing IBM business and anticipates meaningful operation efficiency of the two organizations. The Company also believes the Merger will provide the combined entities a comprehensive one-stop provider to cross-sell solutions across each organization’s respective enterprise, as well as middle-market customers. Key offerings for the combined companies are expected to include a wide array of multi-cloud information technology solutions in highly secure, reliable enterprise level cloud services for companies using IBM Power systems, Microsoft Windows and Linux, including: Infrastructure as a Service (IaaS), Disaster Recovery of digital information (DRaaS), Cyber Security as a Service (CSaaS), and Data Analytics as a Service. Flagship focuses on the IBM user community with solutions and services such as, equipment, software, cyber security, data analytics, managed cloud solutions globally. The Company expects that Flagship’s business will be synergistic with the Company’s existing IBM user community focus and anticipates meaningful operation efficiency through the integration the organizations. The Company also believes the Merger will also provide the combined entities a comprehensive one-stop provider to cross-sell solutions across each organization’s respective enterprise, as well as middle-market customers. Key offerings for the combined companies are expected to include a wide array of multi-cloud information technology solutions in highly secure, reliable enterprise level cloud services for companies using IBM Power systems, Microsoft Windows and Linux, including: cloud Infrastructure as a Service, Disaster Recovery of digital information, Cyber Security as a Service, and Data Analytics. The Company intends to continue its strategy of growth through synergistic acquisitions. The Company’s offices are in New York and Florida including technology centers, which are adapted to meet the requirements of its clients. In addition to office staffing, the Company employs additional remote staff. The Company maintains its infrastructure, storage and networking equipment required to provide our subscription solutions in seven geographically diverse data centers located in New York, Massachusetts, Texas, Florida, North Carolina and Canada. RESULTS OF OPERATIONS Year ended December 31, 2021 as compared to December 31, 2020 27 Revenue Sales for the year ended December 31, 2021, increased by approximately 60% to $14,876,227 as compared to sales for the year ended December 31, 2020, or $9,320,933. The increase is primarily attributed to the additional sales from the Flagship merger and an increase in monthly subscription revenue. The Company derives its sales from five types of services that we provide: infrastructure & disaster recovery / cloud services which is the largest source of our sales, followed by equipment and software sales, managed services, professional fees, and Nexxis, VOIP and internet access services. The cloud infrastructure & disaster recovery/cloud services are subscription-based. We also provide equipment and software and actively participate in collaboration with IBM to provide innovative business solutions to clients. The professional services are providing the client cloud infrastructure and or Disaster Recovery implementation services as well as time and materials billing. Substantially all of the Company’s sales were to customers in the United States, with less than 1% of its sales to international customers. The following chart details the changes in the Company’s sales for the years ended December 31, 2021 and 2020, respectively. For the Year Ended December 31, 2021 2020 $ Change % Change Cloud Infrastructure & Disaster Recovery $ 7,203,246 $ 5,806,370 $ 1,396,876 24 % Equipment and Software 2,080,463 2,074,911 5,552 — % Managed Services 4,661,777 380,701 4,281,076 1,125 % Nexxis Services 772,344 696,576 75,768 11 % Other 158,397 362,375 (203,978 ) (56 )% Total Sales $ 14,876,227 $ 9,320,933 $ 5,555,294 60 % Expenses Cost of Sales. For the year ended December 31, 2021, cost of sales was $8,459,117, an increase of $3,033,912 or 56% compared to $5,425,205 for the year ended December 31, 2020. The increase of $3,033,912 was mostly related to variable cost incurred to produce and sell the Company’s products or services. Selling, general and administrative expenses . For the year ended December 31, 2021, selling, general and administrative expenses were $7,184,182, an increase of $3,287,391, or 84%, as compared to $3,896,791 for the year ended December 31, 2020. The net increase is reflected in the chart below. Selling, general and administrative expenses For the Year Ended December 31, 2021 2020 $ Change % Change Increase in Salaries $ 3,765,519 $ 1,924,287 $ 1,841,232 96 % Increase in Professional Fees 808,039 208,775 599,264 287 % Increase in Software as a Service Expense 228,119 141,642 86,477 61 % Increase in Advertising Expenses 541,788 309,003 232,785 75 % Increase in Commissions Expense 920,050 870,431 49,619 6 % Increase in all other Expenses 920,667 442,653 478,014 108 % Total Expenses $ 7,184,182 $ 3,896,791 $ 3,287,391 84 % Salaries. Salaries increased as a result of the increased staff due to the Flagship merger, and the hiring of additional employees, and raises granted to employees. Professional fees. Professional fees increased primarily due to fees incurred for the Flagship merger, two new investor relations firms, and an increase in fees associated with being on NASDAQ. S oftware as a Service Expense (SaaS). SaaS increased due to additional costs paid to existing vendors to make improvements to the Company’s customer relationship management software and purchases of new user licenses. Advertising Expense. Advertising expense increased primarily due to additional marketing campaigns for the Flagship merger and an increase in existing advertising campaigns. Commissions Expense. Commissions expense increased due to the increase in new revenues. Commission expense varies due to different contractual agreements with both contracted distributors and employees. 28 All Other Expenses . Other expenses increased primarily due to a combination of an increase in online training and continuing education, increase in travel after the Flagship merger, and an increase in bad debt expense. This was partially offset by a reduction in costs associated with employees working from home due to the pandemic as well as a reduction in expenses related to the Company’s office space in Melville, New York. Other Income (Expense). Other income for the year ended December 31, 2021, increased $452,940 to $627,362 from $174,422 for the year ended December 31, 2020. The increase in other income is primarily attributable to the gain on forgiveness of debt from the PPP loans and a decrease in interest expense. This was offset by the gain on contingent liability recorded in the prior year and the loss on disposal of assets recorded during the year. Net Income (Loss) before provision for income taxes . Net (loss) before provision for income taxes for the year ended December 31, 2021, was $(105,543), as compared to a net income of $173,359 for the year ended December 31, 2020. LIQUIDITY AND CAPITAL RESOURCES The consolidated financial statements have been prepared using generally accepted accounting principles in the United States of America (“GAAP”) applicable for a going concern, which assumes that the Company will realize its assets and discharge its liabilities in the ordinary course of business. To the extent the Company is successful in growing its business, identifying potential acquisition targets, and negotiating the terms of such acquisition, and the purchase price may include a cash component, the Company plans to use its working capital and the proceeds of any financing to finance such acquisition costs. The Company’s opinion concerning its liquidity is based on current information. If this information proves to be inaccurate, or if circumstances change, The Company may not be able to meet its liquidity needs, which will require a renegotiation of related party capital equipment leases, a reduction in advertising and marketing programs, and/or a reduction in salaries for officers that are major shareholders. The Company has long-term contracts to supply its subscription-based solutions that are invoiced to clients monthly. The Company believes its total contract value of its subscription contracts with clients based on the actual contracts that it has to date, exceeds $10 million. Further, the Company continues to see an uptick in client interest distribution channel expansion and in sales proposals. In 2021, the Company intends to continue to work to increase its presence in the IBM “Power I” infrastructure cloud and business continuity marketplace in the niche of IBM “Power” and in the disaster recovery global marketplace utilizing its technical expertise, data centers utilization, assets deployed in the data centers, 24 x 365 monitoring and software. During the year ended December 31, 2021, Data Storage’s cash increased $11,242,205 to $12,135,803 from $893,598 December 31, 2020. Net cash of $360,690 was used by Data Storage’s operating activities resulting primarily from the changes in assets and liabilities. Net cash of $6,418,110 was used in investing activities primarily from the purchase of Flagship. Net cash of $18,021,005 was provided by financing activities resulting primarily from the sale of common stock and warrants. This was offset by the repayment of principle and accrued dividends as well as finance lease obligations. The Company’s working capital was $12,084,815 on December 31, 2021, increasing by $14,751,263 from $(2,666,448) at December 31, 2020. The increase is primarily attributable to an increase in cash, accounts receivable, and a decrease in dividend payable. This was offset by an increase in accounts payable and lease payables. Off-Balance Sheet Arrangements The Company does not have any off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities”. 29 Non-GAAP Financial Measures Adjusted EBITDA To supplement our consolidated financial statements presented in accordance with GAAP and to provide investors with additional information regarding our financial results, we consider and are including herein Adjusted EBITDA, a Non-GAAP financial measure. We view Adjusted EBITDA as an operating performance measure and, as such, we believe that the GAAP financial measure most directly comparable to it is net income (loss). We define Adjusted EBITDA as net income adjusted for interest and financing fees, depreciation, amortization, stock-based compensation, and other non-cash income and expenses. We believe that Adjusted EBITDA provides us an important measure of operating performance because it allows management, investors, debt holders and others to evaluate and compare ongoing operating results from period to period by removing the impact of our asset base, any asset disposals or impairments, stock-based compensation and other non-cash income and expense items associated with our reliance on issuing equity-linked debt securities to fund our working capital. Our use of Adjusted EBITDA has limitations as an analytical tool, and this measure should not be considered in isolation or as a substitute for an analysis of our results as reported under GAAP, as the excluded items may have significant effects on our operating results and financial condition. Additionally, our measure of Adjusted EBITDA may differ from other companies’ measure of Adjusted EBITDA. When evaluating our performance, Adjusted EBITDA should be considered with other financial performance measures, including various cash flow metrics, net income and other GAAP results. In the future, we may disclose different non-GAAP financial measures in order to help our investors and others more meaningfully evaluate and compare our future results of operations to our previously reported results of operations. The following table shows our reconciliation of net income to adjusted EBITDA for the year ended December 31, 2021 and 2020, respectively: For the Year Ended December 31, December 31, 2021 2020 Net Income $ 259,921 $ 173,359 Non-GAAP adjustments: Depreciation and amortization 1,284,345 1,032,566 Benefit from income taxes (399,631) — Flagship acquisition costs 135,512 — Interest income and expense 126,746 175,578 Gain on contingent liability — (350,000 ) Loss on disposal of assets 44,732 — Gain on forgiveness of debt (798,840 ) — Stock-based compensation 171,798 158,728 Adjusted EBITDA $ 824,583 $ 1,190,231 CRITICAL ACCOUNTING POLICIES The Company’s financial statements and related public financial information are based on the application of GAAP. GAAP requires the use of estimates; assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue, and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. The Company believes its use of estimates and underlying accounting assumptions adhere to GAAP and are consistently applied. The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. The Company continues to monitor significant estimates made during the preparation of our financial statements. 30 The Company’s significant accounting policies are summarized in Note 2 of its financial statements. While all these significant accounting policies impact the Company’s financial condition and results of operations, it views certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on the Company’s financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. The Company’s management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause effect on its consolidated results of operations, financial position or liquidity for the periods presented in this report. RECENTLY ISSUED AND NEWLY ADOPTED ACCOUNTING PRONOUNCEMENTS In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments (“ASU-2016-13”). ASU 2016-13 affects loans, debt securities, trade receivables, and any other financial assets that have the contractual right to receive cash. The ASU requires an entity to recognize expected credit losses rather than incurred losses for financial assets. ASU 2016-13 is effective for the fiscal year beginning after December 15, 2022, including interim periods within that fiscal year. The Company expects that there would be no material impact on the Company’s consolidated financial statements upon the adoption of this ASU. In October 2016, the FASB issued ASU 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other than Inventory”, which eliminates the exception that prohibits the recognition of current and deferred income tax effects for intra-entity transfers of assets other than inventory until the asset has been sold to an outside party. The updated guidance is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption of the update is permitted. The adoption of ASU 2016-16 did not have a material impact on the consolidated financial statements. In January 2017, the FASB issued ASU 2017-04 Intangibles-Goodwill and Other (“ASC 350”): Simplifying the Accounting for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under ASU 2017-04, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. ASU 2017-04 is effective for annual or any interim goodwill impairment tests for fiscal years beginning after December 15, 2019. The adoption of ASU 2017-04 did not have a material impact on the consolidated financial statements. In July 2021, the FASB issued ASU No. 2021-05, Lessors—Certain Leases with Variable Lease Payments (Topic 842), Which requires a lessor to classify a lease with variable lease payments that do not depend on an index or rate (hereafter referred to as “variable payments”) as an operating lease on the commencement date of the lease if specified criteria are met. ASU 2021-05 is effective for the fiscal year beginning after December 15, 2022, including interim periods within that fiscal year. The Company expects that there would be no material impact on the Company’s condensed consolidated financial statements upon the adoption of this ASU. In November 2021, the FASB issued ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, issued by the Financial Accounting Standards Board. This ASU requires entities to recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The update will generally result in the recognition of contract assets and contract liabilities at amounts consistent with those recorded by the acquiree immediately before the acquisition date rather than at fair value. The Company expects that there would be no material impact on the Company’s condensed consolidated financial statements upon the adoption of this ASU. 31 OFF-BALANCE SHEET TRANSACTIONS The Company has no off-balance sheet arrangements.