Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides subscription-based disaster recovery, Infrastructure as a Service, cloud, managed services, VoIP, equipment, software and maintenance solutions. Approximately 70% of revenue is subscription-based and 30% is from equipment sales and other services. The company serves healthcare, financial, manufacturing, education, government and other industries from technical centers in several states.
This unaudited Form 10-Q covers the three and six months ended June 30, 2019, with comparisons to the corresponding 2018 periods. The company is a smaller reporting company and had 128,139,418 common shares outstanding as of August 13, 2019.
Financial Performance and Position
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Revenue | $2.034 million | $2.751 million | $4.035 million | $4.700 million |
| Gross profit | $932,019 | $997,594 | $1.857 million | $1.770 million |
| Gross margin | 45.8% | 36.3% | 46.0% | 37.7% |
| Income from operations | $72,196 | $23,258 | $174,066 | $52,565 |
| Net income | $37,045 | $(3,008) | $89,583 | $13,139 |
| Net income attributable to common stockholders | $17,233 | $(28,522) | $49,016 | $(41,037) |
| Net cash provided by operating activities | Not provided for quarter | Not provided for quarter | $317,008 | $113,546 |
At June 30, 2019, cash and cash equivalents were $192,012, accounts receivable were $542,093 and total assets were $7.556 million. Current liabilities were $3.382 million versus current assets of $966,614, resulting in a working capital deficiency of $2.415 million. Total liabilities were $5.748 million and total stockholders’ equity was $1.808 million.
Finance lease liabilities to a related party totaled $2.968 million, including $842,779 current and $2.125 million long term. The company also reported a $350,000 note payable whose principal was due in 2016; interest payments stopped in October 2018, and the company is negotiating a final settlement. Operating lease liabilities totaled $330,415.
Material Changes Versus Prior Comparable Period
- Second-quarter revenue decreased 26%, primarily because equipment and software revenue declined $1.006 million, partly offset by a $298,509 increase in Infrastructure and Disaster Recovery/Cloud Services revenue.
- Six-month revenue decreased 14%; equipment and software revenue declined $892,745, while Infrastructure and Disaster Recovery/Cloud Services revenue increased $319,180.
- Gross profit increased 5% for the six-month period despite lower revenue, and gross margin expanded to 46.0% from 37.7%, primarily because of the lower proportion of equipment sales and related costs.
- Operating expenses declined 12% in the second quarter and 2% for the six-month period. The company cited lower officer compensation and professional fees, partly offset by higher salaries, commissions and staffing costs.
- Interest expense increased to $45,921 in the quarter and $96,542 for six months, driven by new equipment financed through leases.
- Operating cash flow increased to $317,008 from $113,546, but cash declined $36,778 during the six months because operating cash was more than offset by lease repayments and capital expenditures.
- Property and equipment increased to $2.528 million from $1.288 million at December 31, 2018, primarily reflecting data center equipment acquired through finance leases. The company recorded $1.560 million of assets acquired through finance leases as a non-cash transaction.
Outlook, Liquidity, Risks and Unusual Items
- Management expects cash resources to be sufficient to meet requirements through August 2020, based on expected revenue growth, improved gross margins and expense controls. Management also identified potential related-party debt financing or lease refinancing if needed.
- The filing states that the working capital deficiency and limited cash raised substantial doubt about the company’s ability to continue as a going concern. Management concluded that its plans and improving cash flow alleviated the initial substantial doubt, but acknowledged that execution, revenue generation, cost control and access to financing are not assured.
- The company adopted ASC 842 on January 1, 2019, recognizing operating lease right-of-use assets and liabilities. It reported $323,531 of operating lease right-of-use assets and $330,415 of operating lease liabilities at June 30, 2019.
- Customer concentration remains material. One value-added reseller represented 11% of six-month sales, and three customers represented 40% of accounts receivable at June 30, 2019.
- Disclosure controls and internal control over financial reporting were deemed ineffective because of insufficient accounting expertise and inadequate segregation of duties. Management intends to add financial staff resources.
- The company reported no material litigation, no unregistered sales of equity securities and no defaults upon senior securities during the period. No subsequent events were reported.
- The company has a full valuation allowance against deferred tax assets and recorded no income tax provision for the reported periods.
Most Important Facts for Investors to Verify
- Whether subscription and cloud-service growth can offset continued weakness in equipment and software sales.
- Whether operating cash flow can remain positive while the company services approximately $2.968 million of related-party finance lease liabilities and other obligations.
- The status and settlement terms of the $350,000 overdue note payable, including any accrued interest or potential default exposure.
- Whether management’s forecast of sufficient cash through August 2020 is achievable without additional related-party financing, refinancing or equity funding.
- Whether the identified material weaknesses in accounting expertise and segregation of duties are remediated promptly.
- The collectability of concentrated accounts receivable and the company’s exposure to its largest reseller and customers.