Data Storage Corporation 2017 Form 10-K Summary
Business Context and Reporting Period
Data Storage Corporation provides business continuity, hybrid cloud, Infrastructure as a Service, Disaster Recovery as a Service, email archival, compliance, cybersecurity, managed services, software, maintenance and equipment solutions. More than 35% of revenue is derived from equipment sales. The company serves healthcare, financial services, manufacturing, education, government and other sectors through direct sales and distributors.
This Form 10-K covers the fiscal year ended December 31, 2017, with comparative results for 2016. The 2017 results include a full year of operations from the ABC Services and Secure Infrastructure and Services asset acquisitions completed in October 2016, and Nexxis Inc. from its formation on October 19, 2017. DSC owns 80% of Nexxis, a new VOIP services division.
Financial Performance and Position
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $8,256,918 | $4,384,930 | +$3,871,988; 88.3% |
| Gross profit | $3,346,587 | $1,280,916 | +$2,065,671 |
| Gross margin | 40% | 29% | +11 percentage points |
| Operating loss | $(84,757) | $(632,895) | Improved by $548,138 |
| Net loss | $(188,493) | $(925,723) | Improved by $737,230 |
| Net loss attributable to DSC | $(184,084) | $(925,723) | Improved by $741,639 |
| Net loss available to common shareholders | $(298,620) | $(1,031,788) | Improved by $733,168 |
| Interest expense | $106,906 | $228,277 | Down $121,371 |
| Cash flow from operating activities | $478,679 | $57,144 | +$421,535 |
| Cash and cash equivalents | $105,139 | $255,817 | Down $150,678 |
| Working capital deficit | $2,951,388 | $2,491,976 | Deficit increased $495,412 |
Operating expenses increased to $3,431,344 from $1,913,811, primarily due to higher staffing, officer compensation and consulting expenses. Technical and management salaries increased to $438,826 from $73,750, officer salaries increased to $535,150 from $256,901, and consulting fees increased to $211,122 from $32,752.
Total assets were $6,393,639 at December 31, 2017, including $1,623,788 of net property and equipment, $3,015,700 of goodwill and $1,044,046 of net intangible assets. Total liabilities were $4,814,877 and total stockholders’ equity was $1,578,762. Accounts receivable declined to $406,393 from $807,515, while deferred revenue declined to $566,731 from $919,103.
The statement of cash flows reports $629,357 of cash used in financing activities, primarily capital lease and related-party loan repayments. The MD&A section separately cites $696,357 of financing cash use; the filing does not explain this discrepancy. Capital lease obligations totaled $1,789,240, including $658,476 due within one year. Related-party notes payable totaled $286,821, and the Enterprise Bank note payable was $350,000.
Material Changes Versus the Prior Comparable Period
- Revenue increased 88.3%, largely due to the first full year contribution from the ABC and Secure Infrastructure and Services acquisitions and increased equipment and software sales.
- Gross margin improved from 29% to 40%, although the company remained unprofitable.
- Operating and net losses narrowed materially, supported by higher revenue, improved margins and lower interest expense.
- Operating cash flow turned substantially positive, but cash declined because financing repayments exceeded operating cash generation.
- Property and equipment increased by approximately $1.45 million, principally reflecting additional computer, data center and leased equipment.
- Common shares outstanding increased from 128,039,418 to 128,139,418. The company recorded $183,703 of stock-based compensation and had 5,052,148 options and 133,334 warrants outstanding at year-end.
- Preferred stock dividends accrued increased to $733,673 from $619,138. No preferred or common dividends had been paid.
Guidance, Outlook, Risks and Unusual Items
Management intends to expand its cloud and business continuity offerings, particularly IBM Power i solutions, and pursue organic growth, distribution partnerships and synergistic acquisitions. Management stated that it expects improved revenue, gross margins and expense control to support liquidity, but the filing does not provide quantitative revenue or earnings guidance.
The financial statements disclose that the company had substantial doubt regarding its ability to continue as a going concern because of its $298,620 net loss available to common shareholders, $105,139 of cash and $2,951,388 working capital deficit. Management concluded that the doubt was alleviated based on expected revenue growth, improved cash flow and the potential availability of related-party financing. Management estimated that available cash resources would meet requirements through the first quarter of fiscal 2019, but stated that no assurance can be given.
The Enterprise Bank note was current with interest-only payments made through December 2017, and the company was negotiating a revised amortization or extension arrangement. Related-party capital leases are payable to Systems Trading, a company owned by DSC’s president. In 2018, DSC entered into a new lease with Systems Trading to refinance existing leases.
Disclosure controls and internal control over financial reporting were deemed ineffective due to material weaknesses involving insufficient internal accounting expertise and inadequate segregation of duties. The company planned to add finance and accounting personnel. The external auditor audited the financial statements but was not engaged to provide an opinion on internal control over financial reporting.
The company reports no material litigation and no off-balance-sheet arrangements. It faces substantial competition from larger companies with greater financial resources and brand recognition. The stock trades on the OTCQB with minimal trading volume and may not provide investors with a liquid exit. The company does not expect to pay common dividends in the foreseeable future.
DSC adopted ASC 606 revenue recognition on January 1, 2018 using the modified retrospective method and expected no material impact on financial position or results of operations other than enhanced disclosures. The filing states that the effects of other recently issued accounting standards were still being evaluated.
Most Important Facts for Investors to Verify
- Reconcile the financing cash flow discrepancy between the MD&A discussion and the consolidated statement of cash flows.
- Assess the company’s ability to fund operations given $105,139 of cash, a $2.95 million working capital deficit and significant near-term lease and debt obligations.
- Review the going-concern conclusion, assumptions supporting liquidity through the first quarter of fiscal 2019 and the availability of related-party financing.
- Evaluate the sustainability of the 40% gross margin and the extent to which 2017 revenue growth depended on acquired operations and equipment sales.
- Monitor the Enterprise Bank renegotiation and the refinancing of related-party capital leases.
- Consider dilution from 5,052,148 outstanding options, 133,334 warrants, preferred stock convertible into common stock and additional shares available for future grants.
- Review remediation of the material weaknesses in accounting expertise, segregation of duties and disclosure controls.
- Confirm the terms and performance of the Nexxis VOIP venture, including its 80% ownership structure and related-party executive compensation arrangements.