Data Storage Corp: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited financial statements and notes thereto for the year ended December 31, 2022, included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 filed on March 31, 2023 (the “Annual Report”) with the U.S. Securities and Exchange Commission (the “SEC”). This Quarterly Report on Form 10-Q contains forward-looking statements, including without limitation, statements related to our plans, strategies, objectives, expectations, intentions, and adequacy of resources. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) our plans, strategies, objectives, expectations, and intentions are subject to change at any time at our discretion; (ii) our plans and results of operations will be affected by our ability to manage growth; and (iii) other risks and uncertainties indicated from time to time in our filings with the SEC.

In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We are under no duty to update any of the forward-looking statements after the date of this report.

The Industry and Opportunity

Data Storage Corporation provides managed technologies across multiple platforms. Our technical assets are in geographically diverse, Tier 3 compliant data centers throughout the USA and Canada.

Hybrid and Multi-Cloud have become mainstream technological offerings of the Cloud infrastructure managed services industry as companies have moved away from legacy, on-premises technology solutions. This approach has grown more complex, as companies utilize disparate technical environments, including on-premises equipment and software, multi-clouds interfacing with Software as a Service providers.

Cloud Managed Service Providers assist businesses in achieving their desired cyber security levels, technical cloud infrastructure and financial objectives while optimizing the value of these technologies ensuring business continuity, governance, and operational efficiencies.

One subset and a highly focused segment of ours is the Power server, manufactured by IBM. This niche cloud infrastructure subset has a multi-billion-dollar addressable market. The marketplace is global. This addressable marketplace today is not a focus for AWS, Google, or Microsoft. It is estimated that mid and enterprise businesses in USA and Canada are operating over one million virtual IBM Power servers, with few qualified cloud service providers to assist in migration of their infrastructure to the cloud. According to the most recent information received from IBM, the typical industries utilizing IBM Power servers are finance, retail, healthcare, government, and distribution organizations with only 15% utilizing some type of cloud service.

We, through our subsidiary, CloudFirst Technologies Corporation, a Delaware corporation (“CloudFirst”), are a leader in providing cloud infrastructure to this niche marketplace along with disaster recovery and have provided these unique offerings for over 15 years.

We believe businesses are increasingly under pressure to improve the efficiency of their information and storage systems accelerating the migration from self-managed technical equipment and solutions to fully managed multi-cloud technologies to reduce cost, protect capital, ensure disaster recovery, protect the custom applications developed for these systems, and compete effectively. These trends create an opportunity for cloud technology service providers.

The Company’s market opportunity is derived from the demand for fully managed cloud and cybersecurity services across all major operating systems.

The Company operates through three subsidiaries:

CloudFirst’s addressable market in the niche addressable marketplace is approximately $3.6 billion in annual recurring revenue, if only one virtual infrastructure partition was provided, where most mid and enterprise level organizations run multiple partitions on one server. This unit has technical assets deployed in six Tier 3 data centers, with technical support and a distribution channel.

Our subsidiary, Flagship Solutions, LLC, a Florida limited liability company (“Flagship”), provides business continuity and infrastructure solutions combining on-premises equipment and software with its value-added managed services to mid and enterprise level business customers. Flagship maintains strong partner relationships with some of the largest IT manufactures, such as the IBM Corporation in supplying the technology behind the highly technical designs built for business customers. Flagship’s vision is to expand its multi-cloud infrastructure solutions with more managed services, highlighted by its expanding Cyber Security offerings to capture more of the marketplace outside of the CloudFirst sales and marketing programs.

Our subsidiary, Nexxis Inc., a Nevada corporation (“Nexxis”), is a voice and data solution provider that utilizes major nationwide carriers and providers. The subsidiary provides a suite of communications services including Hosted VoIP, Internet Access, Data Transport, and SD-WAN. The complete voice and data solution combines elements of services into a fully managed solution that delivers high reliability and is engineered to further enhance the clients’ business continuity. Nexxis Inc.’s goal is to provide a higher level of technology with simplified management and deliver cost savings wherever possible.

According to Fortune Business Insights, the Cloud Managed Services industry in North America was $16.3 billion in 2019 and has been growing at a rate of 13.8% CAGR bringing us to $24 billion by the end of 2022. Disaster Recovery is projected to be a $3.6 billion in the US by the end of 2022 which is 35% of the $10.3 billion globally based on Grandview Research Disaster Recovery Solutions Market Size report. Cyber Security, specifically the MDR segment, is an established market recognized by buyers. Gartner observed a 35% growth in end users’ inquiries on the topic in the last year. Gartner estimates that by 2025, the MDR market will reach $2.15 billion in revenue, up from $1.03 billion in 2021, for a compound annual growth rate (CAGR) of 20.2%. The Company’s VOIP solutions fit well into this steadily growing segment which is expected to reach $90 billion worldwide in 2022 with a CAGR of 3.1% with $17 billion in the US according to Globe Newswire Market Analysis and Insights: Global VoIP Market.

Company Overview

Data Storage Corporation (“DSC”, the “Company,” “we,” “us,” or “our”) is headquartered in Melville, New York. Our common stock and warrants are traded on the Nasdaq under the ticker symbols “DTST” and “DTSTW”. We operate through three subsidiaries; CloudFirst; Flagship; and Nexxis. These subsidiaries provide 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 channels.

We typically provide long-term subscription-based disaster recovery, and cloud infrastructure, cyber security, third party cloud management, managed services, dedicated internet access and UCaaS / VoIP services.

During 2022, based on the May 2021 capital raise and the up list to Nasdaq, we accelerated our organic growth strategies by adding distribution, marketing, and technical personnel. Management continues to be focused on building our sales and marketing strategy and expanding our technology assets throughout its data center network.

We believe businesses are increasingly under pressure to improve the reliability and efficiency of their information and storage systems accelerating the migration from self-managed technical equipment and solutions to fully managed multi-cloud technologies to reduce cost and compete effectively. Further, in today’s environment, capital preservation is an encouragement to move from a capital-intensive, on-premises technology to a pay as you grow, CapEx to OpEx model. These trends create an opportunity for Cloud Technology Service providers.

Our market opportunity is derived from the demand for fully managed cloud and cybersecurity services across all major operating systems.

We have designed and built our solutions and services to support demand for cloud-based IBM Power System that support client critical workloads and custom in-house developed applications, manage hybrid cloud deployments and continue to provide solutions that keep data and workloads protected from disasters and security attacks.

Our business offices are in New York, Florida, and Texas. The New York and Florida offices include a technology center and labs adapted to meet the technical requirements of our clients. We maintain our own infrastructure, storage, and networking equipment required to provide subscription solutions in seven geographically diverse data centers located in New York, Massachusetts, Texas, North Carolina, and in Canada, Toronto, and Barrie, serving clients in the United States and Canada.

Our disaster recovery and business continuity solutions allow clients to quickly recover from system outages, human and natural disasters, and cyber security attacks, such as Ransomware. Our managed cloud services begin with migration to the cloud and provide ongoing system support and management that enables its clients to run their software applications and technical workloads in a multi-cloud environment. Our cyber security offerings include comprehensive consultation and a suite of data security, disaster recovery, and remote monitoring services and technologies that are incorporated into our cloud solutions or are delivered as a standalone managed security offering covering the client site endpoint devices, users, servers, and equipment.

Our solution architects and business development teams work with organizations identifying and solving critical business problems. We carefully plan and manage the migration and configuration process, continuing the relationship and advising its clients long after the services have been implemented. Reflecting on client satisfaction, our renewal rate on client subscription solutions is approximately 94% after their initial contract term expired.

Growth Strategies

We will continue to drive revenues by expanding distribution channels while expanding digital and direct marketing programs. We will accelerate building upon its social and digital lead generation programs. Further, we will continue to seek synergetic acquisitions that expand distribution, leading a technology trend, add to our existing technical staff and create economies of scale improving gross profit margins.

We increase revenue and drive growth by developing and managing collaborative solutions as well as joint marketing initiatives. We have a diverse community of distribution partners, ranging from IBM Business Partners, Software Vendors, IT resellers, Managed Service Providers, application support providers, consultants, and other cloud infrastructure providers.

We believe there is a significant need for our solutions on a global basis and, accordingly, the opportunity for us to grow our business through international expansion as these markets increase their use of multi-cloud solutions.

Our Core Services: We provide an array of multi-cloud information technology solutions in highly secure, enterprise-level cloud services for companies using IBM Power Systems, Microsoft Windows, and Linux. Specifically, our support services cover:

Cyber Security Solutions:

• ezSecurity™ offers a suite of comprehensive cyber security solutions that can be utilized on systems at the client’s location or on systems hosted by us. These solutions include fully managed endpoint (PCs and other user devices) security with active threat mitigation, system security assessments, risk analysis, and applications to ensure continuous security. ezSecurity™ contains a specialized offering for protecting and auditing IBM systems including a package designed to protect IBM systems against Ransomware attacks.

Data Protection and Recovery Solutions:

• ezVault™ solution is at the core of our data protection services and allows our clients to have their data protected and stored offsite with unlimited data retention in a secure location that uses encrypted, enterprise-grade storage which allows for remote recovery from system outages, human and natural disasters, and cyber security attacks like Ransomware and viruses allowing restoration of data from a known good point in time prior to an attack.
• ezRecovery™ provides standby systems, networking, and storage in our cloud infrastructure that allows for faster recovery from client backups stored using ezVault™ at the same cloud based hosted location.
• ezAvailability™ solution offers reliable real-time data replication for mission-critical applications with Recovery Time Objective under fifteen minutes and near-zero Recovery Point Objective, with optional, fully managed replication services. Our ezAvailability™ service consists of a full-time enterprise system, storage, and network resources, allowing quick and easily switched production workloads to our cloud when needed. Our ezAvailability™ services are backed by a Service-Level Agreement (“SLA”) to help assure performance, availability, and access.
• ezMirror™ solution provides replication services that mirror the clients’ data at the storage level and allows for similar near-zero Recovery Point Objective as ezAvailability with less application management and Recovery Time Objective under 1 hour.

Cloud Hosted Production Systems: ezHost™ solution provides managed cloud services that removes the burden of system management from its clients and ensures that their software applications and IT workloads are running smoothly. ezHost™ provides full-time, scalable compute, storage, and network infrastructure resources to run clients’ workloads on our enterprise-class infrastructure. ezHost™ replaces the cost of support, maintenance, system administration, space, electrical power, and cooling of the typical hardware on-premises systems with a predictable monthly expense. Our ezHost services are backed by an SLA governing performance, availability, and access.

Voice & Data Solutions: Nexxis, our voice and data division, specializes in stand-alone and fully-managed VoIP, Internet Access, and Data Transport solutions that satisfy the requirements of the traditional corporate and modern remote workforce. Nexxis dedicated internet access services with speeds of up to 10 Gbps and data transport circuits are typically delivered over fiber-optic networks while shared internet access is typically delivered via fiber, coaxial, and wireless networks to help businesses stay fully connected from any location. SD-WAN options provide the ability for multi-site companies to prioritize their data traffic from site to site while FailSAFE, a Cloud-first SD-WAN solution, can be used by a single location to gain industry-leading connectivity to cloud services and the internet. Nexxis Hosted VoIP with Unified Communications is a full-featured cloud-based PBX solution with built-in redundancy that provides business continuity and includes the option to integrate with Microsoft Teams.

RESULTS OF OPERATIONS

Three months ended September 30, 2023, as compared to September 30, 2022

Total Revenue. For the three months ended September 30, 2023, total revenue was $5,986,625, an increase of $1,567,340 or 35% compared to $4,419,285 for the three months ended September 30, 2022. The increase is attributed to an increase in all our revenue streams during the current period. The increased revenue in Infrastructure & Disaster Recovery/Cloud was primarily to increased sales at out CloudFirst division. The increased revenue in Equipment and Software was attributed to an increase in sales at CloudFirst by approximately $263,459 and Flagship by approximately $726,550, offset by a slight decrease at Nexxis of approximately $7.050. The increase in Managed Services was attributed to an increase in sales at CloudFirst of approximately $169,159 and an increase at Flagship of approximately $32,303. The increase in Nexxis VoIP services is attributable to an increase in sales at our Nexxis division.

Cost of Sales. For the three months ended September 30, 2023, cost of sales was $3,656,271, an increase of $1,089,287 or 42% compared to $2,566,984 for the three months ended September 30, 2022. The increase of 42% was mostly related to the increase in sales. Cost of Sales at CloudFirst, Flagship and Nexxis increased by approximately $465,245, $591,231, and $32,903 respectively all related to increase in sales.

Selling, General and Administrative Expenses. For the three months ended September 30, 2023, selling, general and administrative expenses were $2,316,213, an increase of $240,688, or 12%, as compared to $2,075,525 for the three months ended September 30, 2022. The net increase is reflected in the chart below.

Salaries. Salaries increased as a result of an increase in personnel cost and in increase in other employee benefits across all divisions.

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 increased due to the consulting engagements related to one of our CRM platforms across all divisions.

Advertising Expenses. Advertising Expenses decreased due to non-renewal of a marketing program at Flagship.

Commissions Expense. Commissions expenses increased due to an increase in sales across all divisions.

Travel And Entertainment. Travel And Entertainment expenses decreased due to less travel by executives and reduced corporate events.

Other Income (Expense). Other income for the three months ended September 30, 2023, increased $173,336 to $143,597 from $(29,739) for the three months ended September 30, 2022. The increase in other income is primarily attributable to the increase in interest income from the marketable securities.

Net Income (Loss) before provision for income taxes. Net income before provision for income taxes for the three months ended September 30, 2023, was $157,738, as compared to a net loss of $(252,963) for the three months ended September 30, 2022.

Nine months ended September 30, 2023, as compared to September 30, 2022

Total Revenue. For the nine months ended September 30, 2023, total revenue was $18,770,739, an increase of $866,506 or 5% compared to $17,904,233 for the nine months ended September 30, 2022. The increase is primarily attributed to an increase in Infrastructure & Disaster Recovery/Cloud Service and Managed Services and Nexxis VoIP Services offset by a decrease in one-time equipment sales during the current period. The increased revenue in Infrastructure & Disaster Recovery/Cloud was primarily to increased sales at out CloudFirst division. The decreased revenue in Equipment and Software was attributed to a decrease of one-time equipment sales at Flagship by approximately $1,009,177 offset by an increase of $779,618 in one time equipment sales at CloudFirst. The increase in Managed Services was attributed to an increase in sales at CloudFirst of approximately $96,159 offset by a decrease at Flagship of approximately $115,040. The increase in Nexxis VoIP services is attributable to an increase in sales at our Nexxis division.

Cost of Sales. For the nine months ended September 30, 2023, cost of sales was $11,771,886, a decrease of $75,574 or 1% compared to $11,847,460 for the nine months ended September 30, 2022. The decrease of 1% 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.

Selling, General and Administrative Expenses. For the nine months ended September 30, 2023, selling, general and administrative expenses were $6,918,982, a decrease of $210,613, or 3%, as compared to $7,129,595 for the nine months ended September 30, 2022. The net decrease is reflected in the chart below.

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Salaries. Salaries decreased as a result of a reduction in stock-based compensation at Flagship.

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 CRM platforms.

Advertising Expenses. Advertising Expenses decreased due to non-renewal of a marketing program at Flagship.

Commissions Expense. Commissions expenses increased due to an increase in sales at Cloudfirst.

Travel and Entertainment. Travel And Entertainment expense decreased due to less travel by executives and reduced corporate events.

All Other Expenses. Other expenses decreased primarily due to reduction of bad debt expense, tax expense and reductions across all other expenses such as computer, training and dues and subscriptions.

Other Income (Expense). Other income for the nine months ended September 30, 2023, increased $505,031 to $318,698 from $(186,063) for the nine months ended September 30, 2022. The increase in other income is primarily attributable to the increase in interest income from the marketable securities.

Net Income (Loss) before provision for income taxes. Net income before provision for income taxes for the nine months ended September 30, 2023, was $398,839, as compared to a net loss of $(1,258,885) for the nine months ended September 30, 2022.

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 we will realize our assets and discharge our liabilities in the ordinary course of business.

To the extent we are successful in growing our business, identifying potential acquisition targets, and negotiating the terms of such acquisition, and the purchase price may include a cash component, we plan to use our working capital and the proceeds of any financing to finance such acquisition costs.

Our opinion concerning our liquidity is based on current information. If this information proves to be inaccurate, or if circumstances change, we may not be able to meet our 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.

We have long-term contracts to supply our subscription-based solutions that are invoiced to clients monthly. We believe the total contract value of our subscription contracts with clients based on the actual contracts that we have to date, exceeds $10 million. Further, we continue to see an uptick in client interest distribution channel expansion and in sales proposals. In 2023, we intend to continue to work to increase our 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. We believe that the cash generated from operations will be sufficient to meet our cash requirements for the next twelve months and beyond the next twelve months.

During the nine months ended September 30, 2023, our cash decreased by $1,293,334 to $993,388 from $2,286,722 on December 31, 2022. Net cash of $2,161,424 was provided by our operating activities resulting primarily from the changes in assets and liabilities. Net cash of $2,767,949 was used in investing activities from the purchase of equipment and short-term investments. Net cash of $686,809 was used by financing activities resulting primarily from repayments on capital lease obligations.

Our working capital was $10,941,697 on September 30, 2023, increasing by $86,290 from $10,855,407 at December 31, 2022. The increase is primarily attributable to an increase in cash and accounts receivable. This was offset by a decrease in accounts payable and finance and operating leases.

Off-Balance Sheet Arrangements

We do 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, debtholders, 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 three months ended September 30, 2023 and 2022, respectively:

For the three months ended September 30, 2023

For the three months ended September 30, 2022

The following table shows our reconciliation of net income to adjusted EBITDA for the nine months ended September 30, 2023 and 2022, respectively:

For the nine months ended September 30, 2023

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For the nine months ended September 30, 2022

Evaluation of Disclosure Controls and Procedures.

As of the end of the period covered by this Report, under the supervision and with the participation of DSC’s management, including its principal executive officer and principal financial officer, DSC conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Rule 13a-15(e) under the Exchange Act defines “disclosure controls and procedures” as controls and other procedures of a company that are designed to ensure that the information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to a company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective at the reasonable assurance level at September 30, 2023.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met. As set forth above, our Chief Executive Officer and Chief Financial Officer have concluded, based on the evaluation as of the end of the period covered by this Report, that our disclosure controls and procedures were effective to provide reasonable assurance that the objectives of our disclosure control system were met.

Changes in Internal Control Over Financial Reporting.

There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2023, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our business, financial condition, results of operations, and cash flows may be impacted by a number of factors, many of which are beyond our control, including those set forth in our most recent Annual Report on Form 10-K for the year ended December 31, 2022, the occurrence of any one of which could have a material adverse effect on our actual results.

There have been no material changes to the Risk Factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.