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 to business and government customers. The unaudited Form 10-Q covers the three months ended March 31, 2021, compared with the three months ended March 31, 2020.
Key Financial Metrics
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Revenue | $2.575 million | $2.099 million | +$475,981, or 23% |
| Gross profit | $1.154 million | $883 thousand | +$271,199 |
| Gross margin | 44.8% | 42.0% | +2.8 percentage points |
| Income from operations | $35 thousand | $6 thousand | +$29,418 |
| Operating margin | 1.4% | 0.3% | Improved |
| Net income attributable to Data Storage Corp | $2 thousand | $(34) thousand | Improved |
| Net loss attributable to common stockholders | $(37) thousand | $(69) thousand | Loss narrowed |
| Basic and diluted loss per share | $(0.01) | $(0.02) | Improved |
| Net cash provided by operating activities | $349 thousand | $298 thousand | +$51 thousand |
| Capital expenditures | $257 thousand | $57 thousand | +$200 thousand |
| Cash and cash equivalents at period end | $634 thousand | $328 thousand at March 31, 2020 | Current-period cash declined $259 thousand from December 31, 2020 |
Financial Position, Debt and Liquidity
- Total assets were $7.972 million at March 31, 2021, compared with $7.752 million at December 31, 2020.
- Working capital was negative $3.041 million, worsening from negative $2.666 million at year-end 2020.
- Total liabilities were $6.047 million, including $2.239 million of finance lease liabilities, $481,977 of notes payable if not forgiven, $1.155 million of accrued preferred dividends and $230,710 of operating lease liabilities.
- Operating activities generated $349 thousand, while investing and financing activities used $257 thousand and $351 thousand, respectively. Financing cash use primarily reflected payments on finance lease obligations, including $314 thousand paid to a related party.
- Management stated that the conditions that initially raised substantial doubt about going concern had been alleviated based on improving operating cash flow, revenue growth and the potential ability to renegotiate related-party debt and capitalized leases. Liquidity remains constrained by the working-capital deficit and substantial near-term obligations.
Material Changes Versus the Prior Comparable Period
- Revenue increased 23%, led by Infrastructure and Disaster Recovery/Cloud Services, up 19%; Equipment and Software, up 41%; and Nexxis VoIP Services, up 27%.
- Cost of sales increased 17%, below the revenue growth rate, resulting in improved gross margin.
- Selling, general and administrative expense increased 28% to $1.118 million. Increases included salaries, professional fees, software-as-a-service costs, advertising and commissions.
- Interest expense declined to $35 thousand from $46 thousand. The filing’s MD&A contains an apparent inconsistency regarding pretax income: the financial statements report $340 of pretax income for 2021, while the MD&A text states $42,511 for 2020 and otherwise appears misstated. The financial statements should be used as the primary source.
- Prepaid expenses increased substantially, partly because the Company recorded $273,423 of deferred offering costs.
Guidance, Outlook, Risks and Unusual Items
- Management expects continued growth in subscription solutions, expanded distribution channels and greater presence in IBM Power infrastructure cloud and business continuity markets. It states that the total contract value of existing subscription contracts exceeds $10 million; this is a management estimate, not recognized revenue.
- The Company entered into a proposed Flagship Solutions merger with consideration of up to $10.5 million, comprising $5.55 million in cash and up to $4.95 million in common stock, subject to adjustments. The transaction was expected to close by May 31, 2021 and required additional funding; the Company had no committed outside financing at the filing date.
- Subsequent to quarter-end, the Company completed a 1-for-40 reverse stock split and announced an underwritten offering of 1.6 million units at $6.75 per unit, with estimated gross proceeds of $10.8 million before expenses. The underwriters also partially exercised an over-allotment option for additional warrants.
- The Company disclosed material weaknesses in internal controls: insufficient internal accounting expertise and inadequate segregation of duties. Disclosure controls were therefore considered ineffective. Management planned to add finance personnel and appoint a chief financial officer subject to the planned offering and Nasdaq uplisting.
- COVID-19 could affect operations, equipment availability, employees, customers, financing access, cybersecurity and asset valuations. The Company operated remotely and identified increased cybersecurity and confidential-information risks.
- Customer concentration increased: two customers represented 36% of revenue and 58% of accounts receivable in Q1 2021. The filing reports no material litigation.
Most Important Facts to Verify
- Whether the Flagship merger closed, the final consideration, funding sources and any resulting dilution or liabilities.
- Actual net proceeds and final dilution from the May 2021 public offering, warrants and reverse stock split.
- Status of forgiveness of the $481,977 PPP loan and the Company’s ability to meet near-term lease, note and preferred-dividend obligations.
- Whether management remediated the disclosed material weaknesses and improved segregation of duties and GAAP reporting expertise.
- Whether subscription growth and operating cash flow continued, given the Company’s negative working capital and limited cash balance.
- The correct pretax-income comparison in MD&A, because that narrative is inconsistent with the reported financial statements.