Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud, business continuity, disaster recovery, infrastructure-as-a-service, email archival, compliance, managed support, equipment and software services to commercial and government-sector customers. The filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. The company operated as a smaller reporting company and had 128,139,418 common shares outstanding at March 31, 2018.
Financial Performance and Position
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $1.950 million | $2.324 million | Down 16.1% |
| Gross profit | $0.774 million | $1.000 million | Down 22.6% |
| Gross margin | 39.7% | 43.0% | Down approximately 3.3 percentage points |
| Income from operations | $29,308 | $394,791 | Down 92.6% |
| Net income | $16,148 | $368,922 | Down 95.6% |
| Net income attributable to common stockholders | $(12,154) | $340,714 | Declined to a loss |
| Net cash provided by operating activities | $97,751 | $72,185 | Improved by $25,566 |
- Revenue declined primarily because equipment sales were described as non-recurring and decreased to approximately $388,000 from approximately $668,000. Cloud service revenue was broadly stable, while managed services increased.
- Operating expenses increased 35.7% to $744,462, including higher advertising and sales salaries. Advertising expense increased to $59,459 from $7,710.
- Cash and cash equivalents were $146,776 at March 31, 2018, compared with $105,139 at December 31, 2017. The company reported a working-capital deficiency of $2.412 million.
- Total assets were $6.465 million and total liabilities were $4.857 million at March 31, 2018. Stockholders’ equity, including non-controlling interest, was $1.607 million.
- Debt and lease obligations included a $350,000 Enterprise Bank note, $2.036 million of capital lease obligations, and a $155 revolving credit balance. Related-party capital lease obligations totaled $2.036 million, including $448,184 classified as current.
- Cash flow from investing activities was $(16,587), primarily for capital expenditures. Cash flow from financing activities was $(39,527), primarily for capital lease repayments.
- Depreciation and amortization were $160,106 for the quarter. Goodwill was $3.016 million and net intangible assets were $994,712 at quarter-end.
Material Changes Versus the Prior Comparable Period
- Sales and profitability declined substantially, reflecting lower equipment-related revenue and increased operating expenses.
- Gross margin decreased despite lower cost of sales, as the reduction in revenue exceeded the reduction in costs.
- Operating cash flow improved because of changes in accounts payable and accrued expenses, partially offset by higher accounts receivable and the build-up of $114,091 of inventory.
- Interest expense decreased to $13,876 from $27,430 following the refinancing and consolidation of prior leases and related-party notes.
- On March 7, 2018, the company entered into a related-party capital lease with Systems Trading, an entity owned by the company’s president, to refinance and consolidate prior obligations. The lease carries a 5% interest rate, requires bi-monthly payments of $23,475 and expires in April 2022.
- The company adopted ASC 606 using the modified retrospective method on January 1, 2018. Set-up fees became a separate performance obligation recognized when the set-up service is performed; comparative periods were not restated. The company stated that the adoption did not materially affect financial position or results of operations.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management stated that revenue growth, improved gross margins and expense control are expected to support cash requirements through the first quarter of fiscal 2019. Management also expects continued profitability during 2018 and the foreseeable future, but no quantitative revenue or earnings guidance was provided.
- The filing notes that prior conditions raised substantial doubt about the company’s ability to continue as a going concern. Management concluded that its plans, improving cash flow and potential related-party financing alleviated the initial substantial doubt; however, the filing states there can be no assurance that the strategy will succeed.
- Continued operations depend on implementing the business plan, generating sufficient revenue, controlling operating expenses and obtaining additional financing if necessary. Future equity or convertible-debt financing could dilute existing shareholders, while debt financing could impose restrictive covenants.
- The Enterprise Bank note was due April 30, 2016. The company reported no default notice, stated that interest-only payments were last made in February 2018, and disclosed that it was negotiating a modified or extended payment plan.
- Management determined that disclosure controls and internal control over financial reporting were not effective because of insufficient internal accounting expertise and inadequate segregation of duties. The company intends to add financial staff resources.
- The company reported no material litigation, no unregistered equity sales, no defaults upon senior securities and no subsequent events.
- The filing contains an apparent cash-flow discrepancy: the consolidated cash-flow statement reports $97,751 of operating cash flow, while the MD&A refers to $97,951. The statement value should be verified against the filed financial statements.
Important Facts for Investors to Verify
- Verify the company’s ability to fund operations given $146,776 of cash, a $2.412 million working-capital deficiency and substantial current obligations.
- Review the status and terms of the overdue Enterprise Bank note and any required restructuring or repayment arrangement.
- Assess dependence on related-party financing and the March 2018 related-party lease, including potential conflicts of interest and payment requirements.
- Determine whether recurring cloud and managed-service growth can offset lower equipment sales and restore margins.
- Monitor remediation of the disclosed material weaknesses in accounting expertise and segregation of duties.
- Reconcile the reported operating cash flow discrepancy and confirm the accounting effects of ASC 606 adoption and set-up-fee recognition.