Data Storage Corporation: Q1 2019 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. The company serves customers across healthcare, financial services, distribution, manufacturing, construction, education, and government. The filing covers the three months ended March 31, 2019, with comparisons to the three months ended March 31, 2018. The financial statements are unaudited.
Key Financial Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Sales | $2.001 million | $1.950 million | +2.7% |
| Gross profit | $924,738 | $773,770 | +19.5% |
| Gross margin | 46.2% | 39.7% | +6.5 percentage points |
| Income from operations | $101,870 | $29,308 | +247.6% |
| Operating margin | 5.1% | 1.5% | Improved |
| Net income | $52,538 | $16,148 | +225.4% |
| Net income attributable to Data Storage Corp. | $62,861 | $18,265 | +244.2% |
| Net income attributable to common stockholders | $31,783 | $(12,154) | Improved |
| Interest expense | $50,621 | $13,876 | +264.8% |
| Net cash provided by operating activities | $227,765 | $97,751 | +132.9% |
Cash and cash equivalents were $255,395 at March 31, 2019, compared with $228,790 at December 31, 2018. Capital expenditures were $17,570. Financing cash outflows were $183,590, primarily for repayments of finance lease obligations. Cash increased $26,605 during the quarter.
Total assets were $7.670 million and total liabilities were $5.870 million at March 31, 2019. Finance lease liabilities, primarily related party obligations, totaled $3.047 million, including $760,633 current and $2.287 million long term. Operating lease liabilities totaled $346,442. The company also reported a $350,000 note payable related to the 2012 Message Logic acquisition; interest payments stopped in October 2018, and management is negotiating a final settlement. A dividend payable totaled $877,763.
Material Changes Versus the Prior Comparable Period
- Revenue increased modestly, driven by Infrastructure and Disaster Recovery/Cloud Services, which rose to $1.259 million from $1.105 million, and Managed Services, which rose to $463,949 from $299,368.
- Equipment and software revenue declined slightly to $278,730 from $285,891. Professional services and other revenue were zero in Q1 2019 compared with $57,537 and $201,523, respectively, in Q1 2018.
- Cost of sales declined 8.4%, producing a significant improvement in gross profit and gross margin.
- Selling, general and administrative expense increased 10.5% to $822,868. Officer compensation and commissions increased, partly offset by lower staff salaries and professional fees.
- Interest expense increased substantially because of newly leased equipment and related finance lease obligations.
- The company adopted ASC 842 on January 1, 2019, recognizing operating lease right-of-use assets and liabilities. The filing also states that adoption produced $18,890 of income, an unusual non-operating item.
- Net property and equipment increased to $2.633 million from $1.288 million, primarily reflecting equipment acquired through finance leases. The financing statement reports $1.503 million of non-cash assets acquired through finance leases.
Liquidity, Outlook, Risks, and Unusual Items
Management disclosed that cash of $255,395 and a working capital deficiency raised substantial doubt about the company’s ability to continue as a going concern. Management believes revenue growth, improved gross margins, expense controls, and potential related-party financing will provide sufficient resources through May 20, 2020. The filing states that management concluded the initial going-concern uncertainty had been alleviated, but also cautions that there can be no assurance the strategy will succeed.
The filing presents two different working-capital deficiency figures: $2.415 million in the financial statement liquidity note and $2.508 million in the MD&A section. The filing text does not clearly reconcile this difference.
Management intends to expand its cloud, IBM Power i, disaster recovery, and business continuity offerings. No formal revenue or earnings guidance was provided. Forward-looking results depend on increasing revenue, controlling operating expenses, managing growth, obtaining financing if needed, and potentially renegotiating related-party equipment leases or obtaining financing from major shareholders or senior management.
- Two customers represented 21% of revenue in Q1 2019; no customer concentration was reported in Q1 2018.
- Disclosure controls and internal control over financial reporting were deemed ineffective due to insufficient accounting expertise and inadequate segregation of duties. Management intends to add financial staff resources.
- The company has a substantial accumulated deficit of $15.704 million, although total stockholders’ equity was $1.800 million at quarter-end.
- The $350,000 note payable is past its scheduled maturity, and the company stopped making interest-only payments in October 2018. No default notice had been received as of the filing.
- No material litigation, unregistered securities sales, or defaults upon senior securities were reported.
Most Important Facts for Investors to Verify
- Reconcile the conflicting working-capital deficiency amounts of $2.415 million and $2.508 million.
- Assess whether operating cash flow can consistently cover finance lease repayments, lease obligations, dividends payable, and other current liabilities.
- Review the terms, related-party nature, and refinancing requirements of the $3.047 million finance lease balance.
- Monitor the status and settlement terms of the $350,000 past-due note payable.
- Evaluate customer concentration risk and the sustainability of recent Infrastructure and Managed Services growth.
- Confirm remediation of the disclosed material weaknesses in accounting expertise, segregation of duties, and disclosure controls.
- Assess the effect of preferred stock dividends and potential dilution from outstanding options and warrants on common-stock returns.