Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides subscription-based disaster recovery, cloud infrastructure, cybersecurity, managed services, equipment and software, and voice and data solutions. The company operates through CloudFirst, Flagship Solutions and Nexxis, serving customers primarily in the United States and Canada.
This filing covers the three and nine months ended September 30, 2022. The financial statements are unaudited and prepared under U.S. GAAP. Flagship Solutions was acquired on May 31, 2021, affecting year-over-year comparability, particularly for the nine-month period.
Key Financial Metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Revenue | $4.42 million | $3.86 million | $17.90 million | $9.96 million |
| Gross profit | $1.85 million | $1.54 million | $6.06 million | $4.16 million |
| Gross margin | 41.9% | 40.0% | 33.8% | 41.7% |
| Loss from operations | $(0.22) million | $(0.33) million | $(1.07) million | $(0.39) million |
| Net income attributable to common stockholders | $(0.25) million | $0.14 million | $(1.23) million | $0.21 million |
| Adjusted EBITDA | $0.16 million | $0.10 million | $0.50 million | $0.80 million |
| Diluted EPS | $(0.04) | $0.02 | $(0.18) | $0.05 |
- Q3 revenue increased 14%, driven primarily by equipment and software sales, while managed services revenue declined 32%.
- Nine-month revenue increased 80%, primarily from the Flagship acquisition, higher subscription revenue and increased equipment and software sales.
- Nine-month cost of sales increased 104%, faster than revenue, resulting in a substantial gross-margin decline.
- SG&A increased 57% for the nine-month period, reflecting higher staffing, stock-based compensation, commissions, advertising, professional fees and post-acquisition costs.
- Cash provided by operating activities was $145,692 for the nine months ended September 30, 2022, compared with $153,045 in the prior-year period.
- Capital expenditures were $62,564. Financing activities used $937,228, primarily for finance lease repayments.
- Cash and cash equivalents were $11.28 million at September 30, 2022. Working capital was reported at $11.58 million.
- Total liabilities were $3.57 million, including $1.73 million of finance lease liabilities, of which $1.00 million was related-party finance lease debt, and $0.28 million of operating lease liabilities.
- Total stockholders’ equity was $22.01 million, including an accumulated deficit of $16.76 million.
Material Changes Versus Prior Comparable Period
- Infrastructure and disaster recovery/cloud services revenue increased 19% in Q3 and 17% for the nine-month period.
- Equipment and software revenue increased 223% in Q3 and 374% for the nine-month period.
- Managed services revenue decreased 32% in Q3 but increased 52% for the nine-month period.
- Q3 results moved from net income to a net loss, notwithstanding higher revenue, as higher operating costs and the absence of the prior-year debt-forgiveness gain outweighed the revenue increase.
- Nine-month results also moved from net income to a net loss. The 2021 comparison included a $789,277 gain on forgiveness of debt; Q3 2021 included a $481,977 gain.
- Common shares outstanding increased to 6,822,127 at September 30, 2022, from 6,693,793 at December 31, 2021. The company also issued 125,000 restricted shares to employees for services valued at $400,000.
Guidance, Outlook, Risks and Unusual Items
- The filing does not provide formal quantitative revenue, earnings or cash-flow guidance. Management emphasizes growth in annual recurring revenue, cloud infrastructure, disaster recovery, cybersecurity and managed services. Management stated that baseline annual recurring revenue entering 2022 exceeded $12 million.
- Management believes subscription contract value exceeds $10 million and reports an approximately 94% renewal rate after customers’ initial subscription terms.
- Liquidity depends on continued operating performance and access to working capital. If conditions deteriorate, management identified potential actions including renegotiating related-party equipment leases, reducing advertising and marketing, renegotiating the Nexxis arrangement and reducing certain officer salaries.
- The company has approximately $1.3 million of payments over the next five years under a marketing-related licensing agreement acquired with Flagship.
- Management reported no material litigation and no material changes to previously disclosed risk factors.
- As of September 30, 2022, disclosure controls were not effective because of material weaknesses in accounting for and disclosing complex transactions. The weakness resulted in a restatement of previously filed June 30, 2022 quarterly information, including accrued expenses, cost of goods sold, gross profit, operating loss, net loss and EPS. Remediation was ongoing as of November 2022.
- Flagship’s former CEO, Mark Wyllie, resigned on October 28, 2022 and also ceased serving as the company’s executive vice president and director.
- The company states that no subsequent events were identified, although the Wyllie resignation occurred after quarter-end and was disclosed elsewhere in the filing.
Investor Verification Priorities
- Verify the remediation status and impact of the material weakness and June 30, 2022 restatement.
- Reconcile the reported September 30 cash balance and cash-flow roll-forward. The balance sheet uses December 31, 2021 cash of $12.14 million, while MD&A references $11.31 million.
- Assess whether gross-margin pressure from equipment sales and rising cost of sales is temporary or structural.
- Evaluate recurring versus nonrecurring revenue, particularly the contribution from Flagship and equipment and software sales.
- Review related-party finance leases, repayment requirements and the company’s ability to fund approximately $1.73 million of finance lease liabilities.
- Monitor operating cash generation, customer concentration and credit exposure; two customers represented 18% and 14% of accounts receivable at September 30, 2022, and two customers represented 20% and 14% of nine-month revenue.
- Consider dilution from outstanding options and warrants. The filing excludes approximately 2.71 million potentially dilutive shares from diluted EPS for the nine-month 2022 period.