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. 29 COMPANY OVERVIEW SUMMARY Data Storage Corporation, based in Melville, New York, is a leading provider of data management and cloud solutions across multiple industries including healthcare, finance, manufacturing, and government. Through its subsidiaries, CloudFirst Technologies, Flagship Solutions LLC, and Nexxis, Inc., the Company offers a comprehensive suite of services designed to enhance operational resilience and data integrity for its clients. Strategic Growth and Infrastructure: In response to a capital raise and Nasdaq uplisting in 2021, the Company expanded its distribution networks and bolstered its team, focusing on enhancing its sales, marketing, and technological capabilities. Data Storage Corporation operates six geographically diverse data centers across the U.S. and Canada, supporting its commitment to providing secure and reliable subscription-based services. Core Services: ● Business Continuity Solutions: Offers rapid recovery from system outages and disasters, ensuring minimal operational disruption. ● Managed Cloud Infrastructure Services: Facilitates cloud migration and provides ongoing support for software applications and technical workloads in a multi-cloud environment. ● Cyber Security: Delivers comprehensive security consultation, data protection, disaster recovery, and remote monitoring services, either integrated into cloud solutions or as standalone offerings. Client Engagement and Revenue Generation: The Company engages with clients through direct business development efforts and a broad distribution network, offering solutions that lower barriers to entry for disaster recovery and cloud infrastructure services. While subscription-based services constitute a significant portion of its revenue, Data Storage Corporation also generates income from the sale of equipment and software, emphasizing cybersecurity, data storage, and IBM Power systems solutions. This overview highlights Data Storage Corporation’s strategic approach to leveraging technology and expertise to meet the complex needs of its diverse client base, ensuring business continuity and security in an increasingly digital world. Key Merger Highlights: ● Synergistic Integration: The merger with Flagship is expected to create a unified platform that leverages both entities’ strengths in IBM solutions, managed services, and cloud-based security, promising enhanced operational efficiency. ● Expanded Offerings: The combined expertise of Data Storage Corporation and Flagship Solutions is set to offer a comprehensive range of multi-cloud IT solutions, including Infrastructure as a Service (IaaS), Disaster Recovery as a Service (DRaaS), and Cyber Security as a Service (CSaaS), targeting both enterprise and mid-market customers. ● Strategic Growth: Post-merger, the focus remains on harnessing this strategic integration to extend the range of high-security, reliable cloud services for IBM Power systems, Microsoft Windows, and Linux platforms. The Company is committed to continuing its growth through further synergistic acquisitions. As of January 1, 2024 CloudFirst Technologies and Flagship Solutions LLC have merged. 30 Operational Footprint: Data Storage Corporation operates from offices in New York, Florida and Texas, equipped with technology centers designed to meet client requirements effectively. The Company also employs remote staff to complement its office teams and manages a robust infrastructure across six geographically diverse data centers in the United States and Canada, supporting its comprehensive subscription-based solutions. This merger represents a pivotal step in Data Storage Corporation’s strategy to expand its service offerings and enhance its competitive edge in the rapidly evolving cloud services and IT solutions market. RESULTS OF OPERATIONS Year ended December 31, 2023, as compared to December 31, 2022 Revenue Sales for the year ended December 31, 2023, increased by approximately 5% to $24,959,576 as compared to sales for the year ended December 31, 2022, of $23,870,837. The Company derives its sales from four types of services that we provide: infrastructure & disaster recovery/cloud services which is the largest source of our sales, followed by managed services, equipment and software sales, 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. During the year ended December 31, 2023, the Company derived approximately 24% of our revenue from equipment and software sales, 39% of our revenue from infrastructure & disaster recovery/cloud services, 32% of our revenue from managed services, 4% of our revenue from Nexxis VoIP services. During the year ended December 31, 2022, we derived approximately 26% of our revenue from equipment and software sales, 34% of our revenue from infrastructure & disaster recovery/cloud services, 35% of our revenue from managed services, and 3% of our revenue from Nexxis VoIP services. The following chart details the changes in the Company’s sales for the years ended December 31, 2023 and 2022, respectively. For the Year Ended December 31, 2023 2022 $ Change % Change Cloud Infrastructure & Disaster Recovery $ 9,695,833 $ 8,300,378 $ 1,395,455 17 % Equipment and Software 6,056,723 6,194,634 (137,911 ) (2 )% Managed Services 8,040,384 8,445,455 (405,071 ) (5 )% Nexxis VoIP Services 1,012,193 799,675 212,518 27 % Other 154,443 130,695 23,748 18 % Total Sales $ 24,959,576 $ 23,870,837 $ 1,088,739 5 % Expenses Cost of sales. For the year ended December 31, 2023, cost of sales was $15,383,251, a decrease of $404,293, or 3%, compared to $15,787,544 for the year ended December 31, 2022. The decrease of $404,293 was mostly related to new, negotiated pricing at Flagship, offset by an increase in cost of sales at CloudFirst and Nexxis due to the increase in revenue. 31 Impairment of goodwill. During the year ended December 31, 2022, the Company recorded a goodwill impairment charge of $2,322,000 regarding its Flagship segment . There were no goodwill impairment charges during the year ended December 31, 2023. Selling, general and administrative expenses . For the year ended December 31, 2023, selling, general and administrative expenses were $9,744,736, a decrease of $92,572, or 1%, as compared to $9,837,308 for the year ended December 31, 2022. The decrease is reflected in the chart below. Selling, general and administrative expenses For the Year Ended December 31, 2023 2022 $ Change % Change Salaries $ 5,036,038 $ 5,199,513 $ (163,475 ) (3 )% Professional Fees 1,143,700 927,441 216,259 23 % Software as a Service Expense 182,765 230,725 (47,960 ) (21 )% Advertising Expenses 815,674 966,248 (150,574 ) (16 )% Commissions Expense 1,420,492 1,301,949 118,543 9 % Amortization and Depreciation Expense 293,166 294,477 (1,311 ) 0 % Travel and Entertainment Expense 202,051 280,763 (78,712 ) (28 )% Rent and Occupancy Expense 225,466 219,545 5,921 3 % Insurance Expense 119,472 111,294 8,178 7 % All Other Expenses 305,912 305,353 559 0 % Total Expenses $ 9,744,736 $ 9,837,308 $ (92,572 ) (1 )% Salaries. Salaries decreased as a result of a reduction in stock-based compensation at Flagship , offset by an increase in employee benefits due to the addition of a new employee benefit program in 2023. Professional Fees. Professional fees increased primarily due to an increase in legal fees relating to employment matters and other corporate projects. Software as a Service Expense (SaaS). SaaS decreased due to the completion of certain consulting engagements related to one of our customer relationship management platforms. Advertising Expenses. Advertising Expenses decreased due to non-renewal of a marketing program at Flagship. Commissions Expense. Commissions expense increased due to an increase in sales at CloudFirst and Nexxis. Travel and Entertainment. Travel and Entertainment expense decreased due to less travel by executives and reduced corporate events. Rent and Occupancy. Rent and Occupancy increased primarily due to contractual increases in rent for office space. All Other Expenses. Increased primarily due to an increase in bad debt expense offset by a reduction in all other expenses. Other Income (Expense). Other income (expense) for the year ended December 31, 2023, increased $800,576 to $467,727 from $(332,848) for the year ended December 31, 2022. The increase in other income (expense) is primarily attributable to net interest income for the year ended December 31, 2023 from marketable securities and a decrease in impairment of deferred offering costs. Income (Loss) before provision for income taxes. Net income before provision for income taxes for the year ended December 31, 2023, was $299,316, as compared to a loss before provision for income taxes of $4,408,863 for the year ended December 31, 2022, primarily attributable to the items discussed above. 32 LIQUIDITY AND CAPITAL RESOURCES The consolidated financial statements have been prepared in accordance with 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 acquisitions, and where the purchase price may include a cash component, the Company expects to use its working capital and the proceeds of any financing to finance such acquisition costs. The Company’s conclusion 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 2024, 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, 2023, Data Storage’s cash decreased $857,992 to $1,428,730 from $2,286,722 on December 31, 2022.For the year ended December 31, 2023, net cash of $3,873,047 was provided by Data Storage’s operating activities resulting primarily from changes in net working capital requirements. Net cash of $3,852,245 was used in investing activities for the year ended December 31, 2023, primarily related to the purchase of short-term investments and capital expenditures. Net cash of $878,794 was used in financing activities for the year ended December 31, 2023, primarily related to payments in connection with finance lease obligations and payments for deferred offering costs. This was primarily offset by cash received in connection with the exercise of stock options. The Company’s working capital was $11,011,407 on December 31, 2023, increasing by $156,000 from $10,855,407 at December 31, 2022. The increase is primarily attributable to a decrease in cash, accounts receivable, prepaids and other current assets, accounts payable and leases payable related party. This was offset by an increase in short-term investments and deferred revenue. 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. 33 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 (loss) to adjusted EBITDA for the years ended December 31, 2023, and 2022, respectively: For the year ended December 31, 2023 CloudFirst Technologies Flagship Solutions LLC Nexxis Inc. Corporate Total Net income (loss) $ 2,598,026 $ 27,853 $ (229,377 ) $ (2,097,186 ) $ 299,316 Non-GAAP adjustments: Depreciation and amortization 1,016,900 283,337 705 652 1,301,594 Interest and letter of credit fees 74,502 — — (542,229 ) (467,227 ) Stock-based compensation 64,184 97,820 17,603 326,598 506,205 Adjusted EBITDA $ 3,753,612 $ 409,010 $ (211,069 ) $ (2,312,165 ) $ 1,639,388 For the year ended December 31, 2022 CloudFirst Technologies Flagship Solutions LLC Nexxis Inc. Corporate Total Net income $ 933,789 $ (4,916,934 ) $ (292,731 ) $ (132,987 ) $ (4,408,863 ) Non-GAAP adjustments: Flagship acquisition costs — — — 770 770 Depreciation and amortization 943,224 282,687 — 1,225,911 Interest and letter of credit fees 138,365 319 — (8,598 ) 130,086 Impairment of goodwill — 2,322,000 — — 2,322,000 Stock-based compensation 101,522 513,320 7,204 112,433 734,479 Adjusted EBITDA $ 2,116,900 $ (1,798,608 ) $ (285,527 ) $ (28,382 ) $ 4,383 CRITICAL ACCOUNTING ESTIMATES 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. We believe that the accounting estimates employed are appropriate and resulting balances are reasonable; however, due to inherent uncertainties in making estimates, actual results may differ from the original estimates, requiring adjustments to these balances in future periods. There are accounting policies, each of which requires significant judgments and estimates on the part of management, that we believe are significant to the presentation of our consolidated financial statements. The most significant accounting estimates are set forth below. 34 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, 2023, 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. 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 impacts 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. For the year ended December 31, 2023, and 2022, 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 its reporting units was more likely than not greater than their carrying value, including Goodwill at December 31, 2023. However, based on this qualitative assessment on December 31, 2022 the Company determined that the carrying value of the Flagship reporting unit was more likely than not greater than its fair, including Goodwill. Based on the completion of the annual impairment test on December 31, 2022, the Company recorded an impairment charge of $2,322,000 for goodwill for the year ended December 31, 2022 . 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 CloudFirst’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. 35 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 client’s 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. 36 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 Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The FASB subsequently issued amendments to ASU 2016-13, which have the same effective date and transition date of January 1, 2023. These standards replace the existing incurred loss impairment model with an expected credit loss model and requires a financial asset measure at amortized cost to be presented at the net amount expected to be collected. The Company determined that this change does not have a material impact to the financial statements or financial statement disclosures. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As a smaller reporting company, this item is not required.