Data Storage Corporation 10-Q Summary
Reporting period: Three months ended March 31, 2017, compared with the three months ended March 31, 2016. The filing was signed May 22, 2017. Data Storage Corporation is a smaller reporting company providing cloud storage, cloud computing, cybersecurity, disaster recovery, compliance, managed services and related solutions.
Financial Performance and Position
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $2.324 million | $0.985 million | Up 136.0% |
| Gross profit | $1.000 million | $0.368 million | Up 171.5% |
| Gross margin | 43.0% | 37.4% | Up approximately 5.6 percentage points |
| Income (loss) from operations | $0.395 million | $(0.070) million | Improved by $0.465 million |
| Operating margin | 17.0% | (7.1%) | Improved |
| Net income (loss) | $0.369 million | $(0.145) million | Improved by $0.514 million |
| Net income (loss) attributable to common shareholders | $0.341 million | $(0.170) million | Improved by $0.511 million |
| Operating cash flow | $0.072 million | $0.072 million | Essentially unchanged |
Basic and diluted earnings per share were reported as $(0.00) in both periods despite positive 2017 earnings, reflecting the company’s very large share count. Weighted-average shares increased to 128.0 million from 36.6 million. Preferred stock dividends were $28,208 in Q1 2017.
At March 31, 2017, cash and cash equivalents were $150,322, down from $255,817 at December 31, 2016. Total current assets were $1.330 million and total current liabilities were $3.619 million, resulting in a reported working capital deficit of $2.289 million. Total assets were $7.526 million, total liabilities were $5.452 million and stockholders’ equity was $2.074 million.
Debt and financing obligations included a $350,000 bank note, $2.028 million of capital lease obligations, and a related-party note payable. The filing reports the related-party note balance as “416.435”; the source text does not provide a clear dollar-format value. Capital lease obligations included $614,292 due within one year and $1.414 million due long term. A $1.747 million equipment acquisition was financed through capital leasing during the quarter.
Material Changes Versus the Prior Period
- Revenue growth was attributed primarily to the October 2016 acquisition of assets from ABC Services, Inc. and ABC Services II, Inc.
- Cost of sales increased 114.8%, while operating expenses increased 37.9%, allowing gross profit and operating income to improve substantially.
- Interest expense declined to $27,430 from $67,428, which management attributed to conversion agreements for outstanding convertible debt.
- Property and equipment increased to $5.148 million from $3.401 million, primarily reflecting newly acquired data center equipment and capital lease activity.
- Cash declined by $105,495 during the quarter. Operating cash flow of $72,185 was more than offset by $177,680 of financing cash outflows, including loan and capital lease repayments.
- Accounts receivable increased to $954,827 from $807,515, while deferred revenue declined to $761,730 from $919,103.
Liquidity, Outlook, Risks and Unusual Items
Management states that the company’s ability to continue as a going concern depends on sales growth, reducing operating expenses, obtaining financing, meeting obligations as they become due and achieving profitable operations. The company has historically been funded by its chief executive officer and largest shareholder, Charles M. Piluso, and other directors, but the filing states there is no guarantee that this funding will continue.
Management expects to continue raising capital through stock issuances and, if necessary, debt or equity financings. Future equity or convertible debt financing could materially dilute existing shareholders, while debt financing could impose restrictive covenants. The company may be unable to obtain financing on acceptable terms or at all.
Management’s stated 2017 priorities include expanding its presence in the IBM marketplace, using increased technical capacity and managed-services capabilities, and expanding email-archiving activities through its Message Logic acquisition. No quantitative revenue, earnings or cash-flow guidance is provided.
Enterprise Bank requested that the company move from interest-only payments on its bank note to a self-amortizing arrangement. The company was developing a recommended payment schedule during the first half of 2017. The filing states there had been no default notice, but the note’s maturity date and payment-status disclosures should be reviewed carefully.
Disclosure controls and internal control over financial reporting were determined to be ineffective because of insufficient internal accounting expertise and inadequate segregation of duties. Management intended to add financial staff resources. No material litigation was reported, and no defaults upon senior securities occurred during the quarter.
The balance sheet includes substantial goodwill of $3.986 million and net intangible assets of $320,750, creating potential exposure to future impairment charges. The company also has significant related-party lease obligations and depends on related-party financial support.
Important Facts for Investors to Verify
- Verify the sustainability and quality of the acquisition-driven revenue increase, including customer retention, recurring revenue and deferred-revenue trends.
- Reconcile the reported related-party note payable amount shown as “416.435” and confirm its repayment terms.
- Review the bank note’s current maturity, payment schedule, covenant status and whether any refinancing or default risk exists.
- Assess the company’s ability to fund approximately $2.225 million of scheduled capital lease payments and other near-term obligations.
- Evaluate the going-concern disclosure and the company’s reliance on future equity, debt and related-party financing.
- Monitor dilution risk from the 128.0 million outstanding common shares, 7.1 million options and 133,334 warrants.
- Review remediation of the disclosed material weaknesses in accounting expertise, segregation of duties and financial reporting controls.
- Test the carrying values of goodwill, intangible assets and leased data-center equipment for impairment risk.