Data Storage Corporation — Q1 2020 Form 10-Q Summary
Business context and reporting period
Data Storage Corporation provides subscription-based disaster recovery, Infrastructure as a Service, cloud, managed services, software, equipment, onboarding, and VoIP solutions. The report covers the three months ended March 31, 2020, with comparative results for the three months ended March 31, 2019. The company is a smaller reporting company and its financial statements are unaudited.
Financial performance and position
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $2.099 million | $2.001 million | +5% |
| Gross profit | $883 thousand | $925 thousand | -5% |
| Gross margin | 42.0% | 46.2% | -4.2 percentage points |
| Income from operations | $6 thousand | $102 thousand | Down $96 thousand |
| Net income (loss) | $(40) thousand | $53 thousand | Declined $93 thousand |
| Net loss attributable to common stockholders | $(69) thousand | $32 thousand | Declined $100 thousand |
| Cash flow from operating activities | $298 thousand | $228 thousand | +31% |
Revenue growth was driven by Infrastructure and Disaster Recovery/Cloud Services, which increased 10% to $1.394 million, and Nexxis VoIP Services, which increased 69% to $153 thousand. Equipment and Software revenue declined 23% to $329 thousand. Cost of sales increased 13% to $1.216 million, primarily from data-center expenses. Selling, general and administrative expenses increased 7% to $877 thousand, including higher salaries, software-as-a-service costs, advertising, and stock-based compensation.
Cash and cash equivalents were $328 thousand at March 31, 2020, compared with $327 thousand at December 31, 2019. Capital expenditures were $57 thousand, and financing cash outflows were $239 thousand, principally for finance lease repayments. Cash paid for interest was $177 thousand, compared with $51 thousand in the prior-year quarter.
Total assets were $7.651 million and total liabilities were $5.959 million at March 31, 2020. Working capital was negative $2.764 million, worsening from negative $2.572 million at December 31, 2019. Debt and lease obligations included $2.713 million of related-party finance lease liabilities, a $350 thousand note payable, and a $24 balance on the revolving credit facility. Accrued Series A preferred dividends totaled $1.005 million.
Material changes versus the prior comparable period
- Revenue increased $97 thousand, or 5%, but gross margin declined because cost of sales grew faster than revenue.
- Operating income fell to $6 thousand from $102 thousand as higher gross profit pressure and operating expenses offset revenue growth.
- The company moved from $53 thousand of net income to a $40 thousand net loss; preferred dividends resulted in a $69 thousand loss attributable to common stockholders.
- Operating cash flow improved to $298 thousand from $228 thousand, despite the reported net loss.
- Accounts receivable increased to $837 thousand from $691 thousand at year-end 2019, while deferred revenue increased to $547 thousand from $433 thousand.
- The company issued 250,000 options, exercised 100,000 options, and recognized $33 thousand of stock-based compensation. Options outstanding at March 31, 2020 totaled 8.326 million.
Outlook, risks, contingencies, and unusual items
Management intends to expand its presence in cloud, business continuity, IBM Power, and disaster recovery markets and may use working capital or financing for potential acquisitions. The filing does not provide quantitative revenue or earnings guidance.
Management disclosed substantial doubt regarding the company’s ability to continue as a going concern because of its cash balance, working capital deficit, losses available to shareholders, and obligations. Management concluded that improving operating cash flow and the anticipated ability to renegotiate related-party debt financing and capital leases mitigated the initial concern; however, liquidity remains a significant risk.
COVID-19 could disrupt equipment supply, employees, third-party relationships, and operations. The company was classified as an essential business and employees were working remotely. The filing states that the ultimate impact of the pandemic was uncertain.
The company disclosed a $350 thousand note payable associated with the Message Logic acquisition. Interest-only payments stopped in October 2018, no default notice had been received, and the company was negotiating a final settlement. The revolving credit facility is secured by company assets and personally guaranteed by the CEO.
Subsequent to quarter-end, the company entered into a new equipment lease and received a $482 thousand Paycheck Protection Program loan bearing 1% interest and maturing April 30, 2022. Potential forgiveness depends on the use of proceeds for qualifying expenses.
Management determined that disclosure controls and internal control over financial reporting were not effective as of March 31, 2020 because of insufficient internal accounting expertise and inadequate segregation of duties. No material litigation was reported.
Most important facts for investors to verify
- Whether recurring subscription growth can offset declining equipment revenue and restore gross margins.
- The company’s ability to fund near-term obligations given $328 thousand of cash, negative $2.764 million of working capital, and substantial lease and preferred dividend obligations.
- Terms, collectability, and potential settlement of the $350 thousand note payable and the company’s ability to refinance related-party lease obligations.
- Eligibility for, and amount of, forgiveness of the $482 thousand PPP loan.
- The financial impact of COVID-19 on customers, data-center operations, equipment availability, and cash collections.
- Remediation of the disclosed material weaknesses in accounting expertise, segregation of duties, and financial reporting controls.
- Customer concentration and receivables exposure: two customers represented 30% of accounts receivable and one customer represented 14% of Q1 2020 revenue.