Item 7. Management’s Discussion and Analysis
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 consolidated financial statements and related notes to the consolidated
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.
30
COMPANY OVERVIEW SUMMARY
DSC is a leading provider of enterprise cloud and
business continuity solutions, specializing in fully managed cloud hosting, disaster recovery, cybersecurity, and IT automation services.
DSC leverages its expertise through its three subsidiaries: CloudFirst Technologies, CloudFirst Europe and Nexxis. Through its CloudFirst
platform – built on IBM Power Systems infrastructure – DSC delivers high-performance cloud solutions tailored for IBM i and
AIX workloads This niche focus on IBM Power environments distinguishes CloudFirst in the market: none of the major public cloud providers
(AWS, Microsoft Azure, or Google Cloud) natively support IBM i/AIX workload, giving DSC a distinct competitive edge in serving clients
with these mission-critical systems. The Company leverages long-term subscription contracts for its cloud and disaster-recovery services,
yielding a highly recurring revenue base and strong customer retention (historically over 90% annual subscription renewal rates) DSC’s
client base exceeds 425 organizations across diverse sectors – including government, healthcare, education, manufacturing, and Fortune
500 enterprises – reflecting broad market demand for its multi-cloud hosting and business continuity solutions. In recent years,
DSC has undertaken strategic expansions (organically and via acquisitions) to reinforce its position as an emerging growth leader in the
multi-billion-dollar cloud hosting and business continuity market. Notably, the integration of Flagship (acquired 2021) into CloudFirst
was completed in January 2024, unlocking operational synergies and enabling cross-selling of the full CloudFirst suite to Flagship’s
established customer base. This integration, combined with enhanced distribution and marketing capabilities post-2021 Nasdaq uplisting,
has bolstered DSC’s growth trajectory and technical expertise.
Recent
Developments
On July 18,
2024, the Company entered into an Equity Distribution Agreement (the “Agreement”), with Maxim Group LLC (“Maxim”),
pursuant to which it may offer and sell, from time to time, through Maxim, as sales agent or principal, shares of the Company’s
common stock. Subject to the terms and conditions of the Agreement, Maxim will use commercially reasonable efforts consistent with its
normal trading and sales practices, applicable state and federal law, rules and regulations and the rules of the Nasdaq Capital Market
to sell shares from time to time based upon the Company’s instructions, including any price, time or size limits specified by us.
Under the Agreement, Maxim may sell shares by any method deemed to be an “at the market” offering as defined in Rule 415 under
the Securities Act of 1933, as amended, or any other method permitted by law, including in privately negotiated transactions. Maxim’s
obligations to sell shares under the Agreement are subject to satisfaction of certain conditions, including customary closing conditions
for transactions of this nature. The Company will pay Maxim a commission of 2.5% of the aggregate gross proceeds from each sale of shares
and have agreed to provide Maxim with customary indemnification and contribution rights. The Company also agreed to reimburse Maxim for
certain specified expenses of up to $50,000. Sales of shares of common stock under the Agreement will be made pursuant to the Company’s
registration statement on Form S-3 (File No. 333-280881) (the “Registration Statement”) and a related prospectus supplement
(the “ATM Prospectus”), both of which were filed with the SEC on July 18, 2024. The ATM Prospectus relates to the offering
of up to $10,600,000 shares of the Company’s common stock. The issuance and sale, if any, of common stock under the Agreement is
subject to the Company maintaining an effective registration statement. The Registration Statement was declared effective on July 26,
2024.
RESULTS OF OPERATIONS
Year ended December 31, 2024, as compared to December
31, 2023
Revenue
Revenue for the year ended December 31, 2024, increased by approximately 2% to
$25,371,303 as compared to sales for the year ended December 31, 2023, of $24,959,576. The Company derives its sales from four types of
services that it provides: infrastructure & disaster recovery/cloud services which is the largest source of its 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. The Company also provides equipment and software and actively participates 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 2% of its sales to international customers. During the year ended December 31, 2024,
the Company derived approximately 31% of revenue from equipment and software sales, 51% of revenue from infrastructure & disaster
recovery/cloud services, 12% of revenue from managed services, 5% of revenue from Nexxis VoIP services. During the year ended December
31, 2023, the Company derived approximately 41% of our revenue from equipment and software sales, 40% of its revenue from infrastructure
& disaster recovery/cloud services, 13% of revenue from managed services, and 4% of revenue from Nexxis VoIP services.
31
The following chart details
the changes in the Company’s sales for the years ended December 31, 2024, and 2023, respectively.
For the Year
Ended December 31,
2024
2023
$ Change
% Change
Cloud Infrastructure & Disaster Recovery
$ 12,898,192
$ 10,154,930
$ 2,743,262
27 %
Equipment and Software
7,962,998
10,344,976
(2,381,978 )
(23 )%
Managed Services
3,155,359
3,293,034
(137,675 )
(4 )%
Nexxis VoIP Services
1,146,174
1,012,193
133,981
13 %
Other
208,580
154,443
54,137
35 %
Total Revenue
$ 25,371,303
$ 24,959,576
$ 411,727
2 %
Expenses
Cost of sales. For the year ended December
31, 2024, cost of sales was $14,267,936, a decrease of $1,115,315, or 7%, compared to $15,383,251 for the year ended December 31, 2023.
The decrease of $1,115,315 was mostly related to the decrease in one-time equipment and managed services related cost of sales.
Selling, general and administrative
expenses . For the year ended December 31, 2024, selling, general and administrative expenses were $11,023,476, an increase of $1,278,740,
or 13%, as compared to $9,744,736 for the year ended December 31, 2023. The increase is reflected in the chart below.
Selling,
general and administrative expenses
For
the Year
Ended
December 31,
2024
2023
$
Change
%
Change
Salaries and Director Fees
$
4,790,489
$
4,529,833
$
260,656
6
%
Stock
Based Compensation
794,687
506,205
288,482
57
%
Professional
Fees
1,591,181
1,143,700
447,481
39
%
Software
as a Service Expense
235,379
182,765
52,614
29
%
Advertising
Expenses
749,257
815,674
(66,417
)
(8
)%
Commissions
Expense
1,323,818
1,420,492
(96,674
)
(7
)%
Amortization
and Depreciation Expense
285,381
293,166
(7,785
)
(3
)%
Travel
and Entertainment Expense
404,811
202,051
202,760
100
%
Rent
and Occupancy Expense
242,747
225,466
17,281
8
%
Insurance
Expense
128,746
119,472
9,274
8
%
All
Other Expenses
476,980
305,912
171,068
56
%
Total
Expenses
$
11,023,476
$
9,744,736
$
1,278,740
13
%
Salaries and Director Fees. Salaries and
director fees increased as a result of an increase in headcount, an increase in the number of Board Members and an increase due to
annual employee performance reviews.
Stock Based Compensation. Stock Based Compensation
increased primarily due to an increase in the number of RSU’s granted and higher fair value per share for both RSU’s and stock
options.
Professional Fees. Professional fees increased
primarily due to business development consulting fees, an increase in legal and accounting fees related to the filing of certain registration
statements, and an increase in recruiting fees.
Software as a Service Expense (SaaS). SaaS
increased due to new projects for improvement initiatives for one of the Company’s customer relationship management systems.
Advertising Expenses. Advertising expense
decreased due to the Company’s strategy to offset stadium expense by re-selling the suite for certain events.
32
Commissions Expense. Commissions expense
decreased due to lower one-time equipment sales.
Travel and Entertainment. Travel and entertainment
expenses increased due to international expansion efforts in addition to travel related to domestic customer expansion efforts.
All Other
Expenses. All other expenses increased primarily due to the Company receiving communications from the New York State Department
of Taxation and Finance regarding sales and use tax matters. On July 31, 2024, the Company received additional correspondence and
entered into discussions with the agency concerning an audit of its sales and use tax filings. On February 4, 2025, the Company
received a Statement of Proposed Audit Change from the Department, proposing a total liability of $219,352. The proposed liability
related to the audit period from December 1, 2018 through May 31, 2023, and included $142,021 in tax and $77,331 in interest, with
no penalties assessed. As of September 30, 2024, the Company recorded an initial accrual of $89,000 based on the information
available at the time. Upon receipt of the proposed assessment and completion of its evaluation, the Company recorded the remaining
liability of $53,021 in other expenses and $77,331 in interest expense as of December 31, 2024, bringing the total accrual to
$219,352. The Company subsequently paid the full amount to the New York State Department of Taxation and Finance in February
2025.
Income before provision for income taxes. Income
before provision for income taxes for the years ended December 31, 2024, and 2023 was $552,103, and $299,316 respectively, primarily attributable
to the items discussed above.
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 in distribution channel expansion and in sales proposals. In 2025, 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.
On July 18, 2024, the Company
entered into the Agreement with Maxim, discussed under “Recent Developments” above, pursuant to which the Company may offer
and sell, from time to time, through Maxim, as sales agent or principal, shares of its common stock. There can be no guarantee that the
Company will be able to raise capital from sales under the Agreement. To date, the Company has not made any sales under the Agreement.
The Company’s working
capital was $11,869,914 on December 31, 2024, increasing by $858,507 from $11,011,407 at December 31, 2023. The increase is primarily
attributable to an increase in accounts receivable and prepaid expenses and other current assets which was offset, in part, by an increase
in accounts payable.
Cash Flows for the year ended December 31, 2024,
as compared to December 31, 2023
The following table summarizes
the Company’s cash flows:
Year Ended December 31,
2024
2023
Cash provided by operating activities
$ 1,740,089
$ 3,873,047
Cash used in investing activities
(1,743,174 )
(3,852,245 )
Cash used in financing activities
(352,957 )
(878,794 )
Effect of exchange rate changes on cash
(2,591 )
Decrease in cash
(358,633 )
(857,992 )
Cash, beginning of period
1,428,730
2,286,722
Cash, end of period
$ 1,070,097
$ 1,428,730
33
Operating activities
For the year ended December
31, 2024, cash provided by operating activities was $1,740,089, compared to $3,873,047 for the year ended December 31, 2023. The decrease
is primarily due to an increase in accounts receivable of $1,010,880 for the year ended December 31, 2024, as compared to a decrease in
accounts receivable for the year ended December 31, 2023 of $2,242,864.
Investing activities
During the year ended December
31, 2024, net cash used in investing activities totaled $1,743,174, compared to $3,852,245 during the year ended December 31, 2023. The
decrease of $2,109,071 was primarily due to a net decrease in the purchases of marketable securities.
Financing activities
During the year ended December
31, 2024, net cash used in financing activities totaled $352,957, compared to $878,794 during the year ended December 31, 2023. The decrease
of $525,837 was primarily due to lower repayments of finance lease obligations.
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 the Company’s consolidated financial statements presented
in accordance with GAAP and to provide investors with additional information regarding the Company’s financial results, the Company
considers and is including herein Adjusted EBITDA, a Non-GAAP financial measure. The Company views Adjusted EBITDA as an operating performance
measure and, as such, the Company believes that the GAAP financial measure most directly comparable to it is net income (loss). The Company
defines Adjusted EBITDA as net income adjusted for interest and financing fees, depreciation, amortization, stock-based compensation,
sales tax settlement, and other non-cash income and expenses. The Company believes that Adjusted EBITDA provides 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 the Company’s asset base, any asset disposals or impairments, stock-based compensation
and other non-cash income and expense items associated with its reliance on issuing equity-linked debt securities to fund its working capital.
The Company’s 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 its results as reported under GAAP, as the excluded items may have significant effects on its operating results and financial
condition. Additionally, the Company’s measure of Adjusted EBITDA may differ from other companies’ measure of Adjusted EBITDA.
When evaluating the Company’s 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, the Company may disclose different non-GAAP financial measures
in order to help its investors and others more meaningfully evaluate and compare the Company’s future results of operations to its
previously reported results of operations.
34
The following table shows
the Company’s reconciliation of net income (loss) to adjusted EBITDA for the years ended December 31, 2024, and 2023:
For the year ended December 31, 2024
CloudFirst Technologies
CloudFirst Europe Ltd.
Nexxis Inc.
Corporate
Total
Net income (loss)
$ 3,562,622
$ (290,219 )
$ (93,514 )
$ (2,665,817 )
$ 513,072
Non-GAAP adjustments:
Depreciation and amortization
1,348,534
79
850
775
1,350,238
Sales tax settlement
142,021
142,021
Interest income
(592,819 )
(592,819 )
Interest expense
119,008
119,008
Provision for income tax
39,031
39,031
Stock-based compensation
295,688
25,991
473,008
794,687
Adjusted EBITDA
$ 5,467,873
$ (290,140 )
$ (66,673 )
$ (2,745,822 )
$ 2,365,238
For the year ended December 31, 2023
CloudFirst Technologies
CloudFirst Europe Ltd.
Nexxis Inc.
Corporate
Total
Net income (loss)
$
2,625,879
$
—
$
(229,377
)
$
(2,097,186
)
$
299,316
Non-GAAP adjustments:
Depreciation and amortization
1,300,237
—
705
652
1,301,594
Interest income
—
—
—
(542,229
)
(542,229
)
Interest expense
74,502
—
—
—
74,502
Stock-based compensation
162,004
—
17,603
326,598
506,205
Adjusted EBITDA
$
4,162,622
$
—
$
(211,069
)
$
(2,312,165
)
$
1,639,38 8
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. The Company believes 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 the Company believes are significant to the presentation of its consolidated financial
statements. The most significant accounting estimates are set forth below.
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, 2024, 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.
35
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 assesses 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 the Company’s reporting units
to generate cash flows as measures of fair value of its reporting units. The Company performs a qualitative analysis of goodwill and other
intangible assets for impairment indicators on at least an annual basis. If this assessment shows impairment indicators the Company will
perform an impairment test to determine if the carrying value of a reporting unit exceeds its estimated fair value.
For the year ended December
31, 2024, the Company was not required to perform an impairment test of goodwill since the qualitative analysis did not show any impairment
indicators and no triggering events were identified. 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 testing results. 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.
For the year ended December 31, 2023, the Company
was required to complete its annual impairment tests of goodwill since the Company combined two reporting units. The Company performed
the quantitative assessment and determined that the fair value of the reporting units was more likely than not greater than their carrying
value, including goodwill at December 31, 2023. Based on the completion of the annual impairment test on December 31, 2023, the Company
did not record an impairment charge.
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 with 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. DSC 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.
36
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 are 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 the Company’s 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.
37
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.
Impact of Recently Issued Accounting Standards
In the normal course of business, we evaluate all
new accounting pronouncements issued by the FASB, SEC, or other authoritative accounting bodies to determine the potential impact they
may have on the Company’s Consolidated Financial Statements. See Note 2 “Summary of Significant Accounting Policies”
of the notes to the Company’s consolidated financial statements in this Annual Report for additional information about these recently
issued accounting standards and their potential impact on the Company’s financial condition or results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
As a smaller reporting company, this item is not required.