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. 26 COMPANY OVERVIEW Data Storage Corporation, headquartered in Melville, New York, together with its three subsidiaries, DSC now CloudFirst Technologies, 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 2022 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 90,000 visitors arrived at the Company’s websites in 2022. 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 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. 2022 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, 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), and Cyber Security as a Service (CSaaS). 27 Flagship focuses on the IBM user community with solutions and services such as, equipment, software, cyber security, and 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, and Cyber Security as a Service. 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, 2022, as compared to December 31, 2021 Revenue Sales for the year ended December 31, 2022, increased by approximately 60% to $23,870,837 as compared to sales for the year ended December 31, 2021, or $14,876,227. 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 2% of its sales to international customers. The following chart details the changes in the Company’s sales for the years ended December 31, 2022, and 2021, respectively. For the Year Ended December 31, 2022 2021 $ Change % Change Cloud Infrastructure & Disaster Recovery $ 8,300,378 $ 7,203,246 $ 1,097,132 15 % Equipment and Software 6,194,634 2,080,463 4,114,171 198 % Managed Services 8,445,455 4,661,777 3,783,678 81 % Nexxis VoIP Services 799,675 772,344 27,331 4 % Other 130,695 158,397 (27,702 ) (17 )% Total Sales $ 23,870,837 $ 14,876,227 $ 8,994,610 60 % Expenses Cost of Sales. For the year ended December 31, 2022, cost of sales was $15,787,544, an increase of $7,328,427 or 87% compared to $8,459,117 for the year ended December 31, 2021. The increase of $7,328,427 was mostly related to the increase in overall sales and the increase in sales which resulted from the Flagship merger. Impairment of goodwill . During the year ended December 31, 2022, the Company recorded an Impairment of goodwill of $2,322,000 regarding its Flagship segment . Selling, general and administrative expenses . For the year ended December 31, 2022, selling, general and administrative expenses were $9,837,308, an increase of $2,653,126, or 37%, as compared to $7,184,182 for the year ended December 31, 2021. The net [increase/decrease] is reflected in the chart below. 28 Selling, general and administrative expenses For the Year Ended December 31, 2022 2021 $ Change % Change Increase in Salaries $ 5,199,513 $ 3,768,804 $ 1,430,709 38 % Increase in Professional Fees 927,441 804,755 122,686 15 % Increase in Software as a Service Expense 230,725 228,119 2,606 1 % Increase in Advertising Expenses 966,248 541,788 424,460 78 % Increase in Commissions Expense 1,301,949 968,415 333,534 34 % Decrease in Amortization and Depreciation Expense 294,477 342,516 (48,039 ) (14 )% Increase in Travel and Entertainment Expense 280,763 127,676 153,087 120 % Increase in Rent and Occupancy Expense 219,545 130,835 88,710 68 % Increase in Insurance Expense 111,294 75,270 36,024 48 % Increase in all other Expenses 305,353 196,004 109,349 56 % Total Expenses $ 9,837,308 $ 7,184,182 $ 2,653,126 37 % Salaries. Salaries increased as a result of the increased staff due to the Flagship merger, the hiring of our Chief Financial Officer and the increase in stock-based compensation. Professional fees. Professional fees increased primarily due to a new investor relations firm, an increase in legal fees, and an increase in fees associated with being on NASDAQ. Advertising Expenses. Advertising Expenses increased primarily due to the Flagship merger and the company sponsoring American mixed martial arts events. Commissions Expense. Commissions expenses increased due to the Flagship merger and the sales associated with Flagship. Travel And Entertainment. Travel And Entertainment increased primarily due to the Flagship merger and the lifting of Covid-19 restrictions. Rent and Occupancy. Rent and Occupancy increased primarily due to the Flagship merger and the WeWork in Austin, TX that started in January 2022. All Other Expenses . Increased primarily due to the Flagship merger. Other Income (Expense). Other income for the year ended December 31, 2022, decreased $960,210 to $(332,848) from $627,362 for the year ended December 31, 2021. The decrease in other income is primarily attributable to the increase in interest expense, the increase in impairment of deferred offering costs, and the decrease from the gain on forgiveness of debt from the PPP loan. (Net Loss) before provision for income taxes . Net loss before provision for income taxes for the year ended December 31, 2022, was $4,408,863, as compared to a net loss of $139,710 for the year ended December 31, 2021. 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. 29 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 2023, 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, 2022, Data Storage’s cash decreased $9,849,081 to $2,286,722 from $12,135,803 December 31, 2021. Net cash of $663,801 was provided by Data Storage’s operating activities resulting primarily from changes in assets and liabilities. Net cash of $9,138,225 was used in investing activities from the purchase of short-term investments and capital expenditures. Net cash of $1,374,657 was used in financing activities resulting primarily in payments on finance lease obligations and payments for deferred offering costs. This was offset by the cash received for the exercised options. The Company’s working capital was $10,855,407 on December 31, 2022, decreasing by $1,229,408 from $12,084,815 at December 31, 2021. The decrease is primarily attributable to a decrease in cash, deferred revenue, and leases payable related party. This was offset by an increase in short-term investments, accounts receivables, prepaids and other current assets, accounts payable, and leases payable. 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”. 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. 30 The following table shows our reconciliation of net income to adjusted EBITDA for the year ended December 31, 2022, and 2021, respectively: For the Year Ended December 31, December 31, 2022 2021 Net (Loss) Income $ (4,408,863 ) $ 259,921 Non-GAAP adjustments: Depreciation and amortization 1,225,911 1,284,345 Benefit from income taxes — (399,631 ) Flagship acquisition costs 770 135,512 Interest income and expense 130,087 126,746 Impairment of goodwill 2,322,000 — Loss on disposal of assets — 44,732 Gain on forgiveness of debt — (798,840 ) Stock-based compensation 734,479 171,798 Adjusted EBITDA $ 4,384 $ 824,58 3 CRITICAL ACCOUNTING POLICIES We believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating this “Management’s Discussion and Analysis of Financial Condition and Results of Operation.” Use of Estimates The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Estimated Fair Value of Financial Instruments The Company’s financial instruments include cash, accounts receivable, accounts payable and, lease commitments. Management believes the estimated fair value of these accounts on December 31 ,2022, approximate their carrying value as reflected in the balance sheet due to the short-term nature. The carrying values of certain of the Company’s notes payable and capital lease obligations approximate their fair values based upon a comparison of the interest rate and terms of such debt given the level of risk to the rates and terms of similar debt currently available to the Company in the marketplace. Property and Equipment Property and equipment are recorded at cost and depreciated over their estimated useful lives or the term of the lease using the straight-line method for financial statement purposes. Estimated useful lives in years for depreciation are five to seven years for property and equipment. Additions, betterments and replacements are capitalized, while expenditures for repairs and maintenance are charged to operations when incurred. As units of property are sold or retired, the related cost and accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in income. Deferred Offering Costs The Company capitalizes certain legal, professional accounting and other third-party fees that are directly associated with in-process equity financings as deferred offering costs until such financings are consummated. After consummation of the equity financing, these costs are recorded in stockholders’ deficit as a reduction of additional paid-in capital generated as a result of the offering. Should the planned equity financing be abandoned, the deferred offering costs will be expensed immediately as a charge to other income and expenses in the consolidated statement of operations. In accordance with this policy, for the years ended December 31, 2022, and 2021, the Company expensed financing costs of $127,343 and $0, respectively. Goodwill and Other Intangibles The Company tests goodwill and other intangible assets for impairment on at least an annual basis. Impairment exists if the carrying value of a reporting unit exceeds its estimated fair value. To determine the fair value of goodwill and intangible assets, the Company uses many assumptions and estimates using a market participant approach that directly impact the results of the testing. In making these assumptions and estimates, the Company uses industry accepted valuation models and set criteria that are reviewed and approved by various levels of management. The Company tests goodwill for impairment on an annual basis on December 31, or more frequently if events occur or circumstances change indicating that the fair value of the goodwill may be below its carrying amount. The Company has four reporting units. The Company uses an income-based approach to determine the fair value of the reporting units. This approach uses a discounted cash flow methodology and the ability of our reporting units to generate cash flows as measures of fair value of our reporting units. During the year ended December 31, 2022, and 2021, the Company completed its annual impairment tests of goodwill. The Company performed the qualitative assessment as permitted by ASC 350-20 and determined for three of its reporting units that the fair value of those reporting units was more likely than not greater than their carrying value, including Goodwill. However, based on this qualitative assessment, the Company determined that the carrying value of the Flagship reporting units was more likely than not greater than its carrying value, including Goodwill. Based on the completion of the annual impairment test, the Company recorded an impairment charge of $2,322,000 and $0 for goodwill for the years ended December 31, 2022, and 2021, respectively. Revenue Recognition Nature of goods and services The following is a description of the products and services from which the Company generates revenue, as well as the nature, timing of satisfaction of performance obligations, and significant payment terms for each: 1) Cloud Infrastructure and Disaster Recovery Revenue Cloud Infrastructure provides clients the ability to migrate their on-premise computing and digital storage to DSC’s enterprise-level technical compute and digital storage assets located in Tier 3 data centers. Data Storage Corporation owns the assets and provides a turnkey solution whereby achieving reliable and cost-effective, multi-tenant IBM Power compute, x86/intel, flash digital storage, while providing disaster recovery and cyber security while eliminating client capital expenditures. The client pays a monthly fee and can increase capacity as required. Clients can subscribe to an array of disaster recovery solutions without subscribing to cloud infrastructure. Product offerings provided directly from DSC are High Availability, Data Vaulting and retention solutions, including standby servers which allows clients to centralize and streamline their mission-critical digital information and technical environment while ensuring business continuity if they experience a cyber-attack or natural disaster Client’s data is vaulted, at two data centers with the maintenance of retention schedules for corporate governances and regulations all to meet their back to work objective in a disaster. 2) Managed Services These services are performed at the inception of a contract. The Company provides professional assistance to its clients during the implementation processes. On-boarding and set-up services ensure that the solution or software is installed properly and function as designed to provide clients with the best solutions. In addition, clients that are managed service clients have a requirement for DSC to offer time and material billing supplementing the client’s staff. The Company also derives both one-time and subscription-based revenue, from providing support, management and renewal of software, hardware, third party maintenance contracts and third-party cloud services to clients. The managed services include help desk, remote access, operating system and software patch management, annual recovery tests and manufacturer support for equipment and on-gong monitoring of client system performance. 3) Equipment and Software The Company provides equipment and software and actively participates in collaboration with IBM to provide innovative business solutions to clients. The Company is a partner of IBM and the various software, infrastructure and hybrid cloud solutions provided to clients. 4) Nexxis Voice over Internet and Direct Internet Access The Company provides VoIP, Internet access and data transport services to ensure businesses are fully connected to the internet from any location, remote and on premise. The company provides Hosted VoIP solutions with equipment options for IP phones and internet speeds of up to 10Gb delivered over fiber optics. Transaction price allocated to the remaining performance obligations The Company has the following performance obligations: 1) Data Vaulting : Subscription-based cloud service that encrypts and transfers data to a secure Tier 3 data center and further replicates the data to a second Tier 3 DSC technical center where it remains encrypted. Ensuring client retention schedules for corporate compliance and disaster recovery. Provides for twenty-four (24) hour or less recovery time and utilizes advanced data reduction, reduplication technology to shorten back-up and restore time. 2) High Availability : A managed cloud subscription-based service that provides cost-effective mirroring software replication technology and provides one (1) hour or less recovery time for a client to be back in business. 3) Cloud Infrastructure : subscription-based cloud service provides for “capacity on-demand” for IBM Power and X86 Intel server systems. 4) Internet : Subscription-based service, offering continuous internet connection combined with FailSAFE which provides disaster recovery for both a clients’ voice and data environments. 5) Support and Maintenance : Subscription based service offers support for clients on their servers, firewalls, desktops or software. Services are provided 24x7x365 to our clients. 6) Implementation / Set-Up Fees : Onboarding and set-up for cloud infrastructure and disaster recovery as well as Cyber Security. 7) Equipment sales : Sale of servers and data storage equipment to the client. 9) License : Granting SSL certificates and licenses. Impairment of Long-Lived Assets The Company reviews its long-lived assets for impairment whenever events and circumstances indicate that the carrying value of an asset might not be recoverable. An impairment loss, measured as the amount by which the carrying value exceeds the fair value is recognized if the carrying amount exceeds estimated un-discounted future cash flows. Stock-Based Compensation The Company follows the requirements of FASB ASC 718-10-10, Share-Based Payments with regards to stock-based compensation issued to employees and non-employees. The Company has agreements and arrangements that call for stock to be awarded to the employees and consultants at various times as compensation and periodic bonuses. The expense for this stock-based compensation is equal to the fair value of the stock price on the day the stock was awarded multiplied by the number of shares awarded. The Company has a relatively low forfeiture rate of stock-based compensation and forfeitures are recognized as they occur. The valuation methodology used to determine the fair value of the options issued during the period is the Black-Scholes option-pricing model. The Black-Scholes model requires the use of a number of assumptions including the volatility of the stock price, the average risk-free interest rate, and the weighted average expected life of the options. Risk-free interest rates are calculated based on continuously compounded risk-free rates for the appropriate term. The dividend yield is assumed to be zero as the Company has never paid or declared any cash dividends on its Common Stock and does not intend to pay dividends on its Common Stock in the foreseeable future. The expected forfeiture rate is estimated based on management’s best assessment. Estimated volatility is a measure of the amount by which DSC’s stock price is expected to fluctuate each year during the expected life of the award. The Company’s calculation of estimated volatility is based on historical stock prices over a period equal to the expected life of the awards. 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 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 adoption of ASU 2021-08 did not have a material impact on the consolidated financial statements. 31 OFF-BALANCE SHEET TRANSACTIONS The Company has no off-balance sheet arrangements.