Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three and six months ended June 30, 2021, filed August 16, 2021. Data Storage Corporation provides subscription-based disaster recovery, Infrastructure as a Service, cybersecurity, managed services, cloud, equipment, software, and Voice and Data solutions to customers primarily in the United States.
On May 31, 2021, the Company acquired Flagship Solutions, LLC, an IBM solutions, managed services, and cloud provider. The Company expects integration efficiencies, cross-selling opportunities, and expanded multicloud offerings, although Flagship contributed only approximately one month of post-acquisition results to the reported period.
Financial Performance and Key Metrics
| Metric | Three Months Ended June 30, 2021 | Three Months Ended June 30, 2020 | Six Months Ended June 30, 2021 | Six Months Ended June 30, 2020 |
|---|---|---|---|---|
| Revenue | $3.528 million | $2.006 million | $6.103 million | $4.104 million |
| Gross profit | $1.507 million | $0.865 million | $2.661 million | $1.748 million |
| Gross margin | 42.7% | 43.1% | 43.6% | 42.6% |
| Operating income (loss) | $(0.095) million | $(0.123) million | $(0.060) million | $(0.117) million |
| Operating margin | (2.7)% | (6.1)% | (1.0)% | (2.9)% |
| Net income attributable to common stockholders | $0.114 million | $0.156 million | $0.078 million | $0.087 million |
| Diluted EPS | $0.03 | $0.05 | $0.02 | $0.03 |
| Adjusted EBITDA | $0.249 million | $0.171 million | $0.593 million | $0.452 million |
- Second-quarter revenue increased 76%, primarily from Flagship-related sales and higher monthly subscription revenue. Six-month revenue increased 49%.
- Second-quarter gross profit increased 74%, while gross margin declined modestly. Six-month gross margin improved by approximately 100 basis points.
- Operating expenses increased 62% in the second quarter and 46% for the six-month period, reflecting added personnel, merger and professional fees, marketing, software costs, commissions, travel, and bad-debt expense.
- Reported net income included $307,300 of gain from forgiveness of Flagship’s PPP loan. The prior-year periods included a $350,000 gain on a contingent liability.
Cash Flow, Liquidity, Debt, and Capitalization
- Cash and cash equivalents were $3.076 million at June 30, 2021, compared with $0.894 million at December 31, 2020.
- Operating activities generated $0.825 million during the first six months, compared with $0.381 million in the prior-year period.
- Investing activities used $6.241 million, including $5.937 million of cash consideration for the Flagship acquisition and $0.303 million of capital expenditures.
- Financing activities provided $7.598 million, primarily from $9.455 million of common-stock and warrant issuance proceeds, partly offset by $1.179 million of dividend repayments and finance-lease repayments.
- Working capital remained negative at $(3.637) million, compared with $(2.666) million at December 31, 2020. The increase in the deficit was primarily attributed to $4.950 million of contingent consideration related to the Flagship acquisition, payable in shares.
- The revolving credit facility had no balance at June 30, 2021. Current obligations included $4.950 million of contingent consideration, $1.148 million of finance leases, $0.482 million of notes payable, and $1.547 million of accounts payable and accrued expenses. Total finance lease liabilities were $1.912 million, including related-party obligations.
- The Company raised $10.8 million of gross proceeds in a May 2021 public offering of common stock and warrants, with $9.455 million of net proceeds reflected in financing cash flow.
Material Changes Versus the Prior Comparable Period
- Revenue growth was broad-based, with six-month Infrastructure and Disaster Recovery/Cloud revenue up 22%, Equipment and Software revenue up 113%, Managed Services revenue up 136%, and Nexxis VoIP revenue up 23%.
- The Flagship acquisition increased goodwill from $3.016 million at year-end 2020 to $13.216 million at June 30, 2021. The preliminary purchase price was $11.099 million, consisting of $6.149 million in cash and $4.950 million in contingent stock consideration.
- Common shares outstanding increased to 4.862 million at June 30, 2021 from 3.213 million at December 31, 2020. The Company also converted all 1.402 million Series A preferred shares into 43,806 common shares and paid $1.179 million of accrued preferred dividends.
- The Company completed a one-for-40 reverse stock split on May 14, 2021; reported share and per-share amounts were adjusted accordingly.
- Adjusted EBITDA increased 46% for the six months, but operating income remained negative and reported profitability depended in part on nonrecurring items.
Guidance, Outlook, Risks, and Unusual Items
- Management did not provide specific numerical revenue, earnings, or cash-flow guidance. It plans to expand sales and distribution, increase its presence in IBM Power infrastructure and business continuity markets, develop cybersecurity offerings such as ezSecurity, and pursue synergistic acquisitions.
- Management stated that the total contract value of existing subscription contracts exceeded $10 million, but this is not presented as recognized revenue or a forecast.
- Key risks include inability to sustain profitability or positive cash flow, the working-capital deficit, integration and execution risks from the Flagship merger, potential need for additional capital, customer concentration, cybersecurity threats, COVID-19-related disruption, and possible impairment of goodwill or other assets.
- Two customers represented 33% of accounts receivable at June 30, 2021, and one customer represented 15% of six-month revenue.
- Disclosure controls and procedures were reported as ineffective because of insufficient accounting expertise and inadequate segregation of duties. The Company hired a new CFO on May 18, 2021, but stated that the material weaknesses remained.
- Subsequent to quarter-end, investors exercised warrants for $3.381 million, and on July 21, 2021 the Company completed an offering generating $7.6 million of net proceeds from 1.375 million shares and 1.031 million warrants.
- The filing states that no material litigation was pending and that the financial statements were prepared on a going-concern basis, but continued liquidity depends on operating performance, financing, and management of obligations.
Important Facts for Investors to Verify
- Whether Flagship integration produces the expected revenue synergies, operating efficiencies, and cash flow, and whether the provisional purchase-price allocation changes during the measurement period.
- The terms, settlement timing, and dilution associated with the $4.950 million contingent stock consideration and outstanding warrants and options.
- The Company’s ability to fund its working-capital deficit and lease obligations without additional equity issuance or related-party concessions.
- Progress in remediating the disclosed material weaknesses in internal control over financial reporting.
- The sustainability of reported earnings after excluding PPP forgiveness, prior-period contingent-liability gains, and other unusual items.
- Customer concentration, accounts-receivable collectability, goodwill impairment exposure, and the continuing effects of COVID-19 and cybersecurity risks.