Data Storage Corporation — 2019 Form 10-K Summary
Business Context and Reporting Period
Data Storage Corporation provides subscription-based disaster recovery, Infrastructure as a Service, cloud hosting, managed IT services, cybersecurity, equipment and software, and VoIP services. Its customers primarily operate in healthcare, financial services, manufacturing, construction, education and government. The filing covers the fiscal year ended December 31, 2019, with comparative results for 2018. Although the request identifies 2019 Q4, this is an annual Form 10-K rather than a quarterly filing.
- Headquartered in Melville, New York, with additional offices and data centers in several states.
- Nexxis Inc., an 80%-owned subsidiary, provides VoIP and carrier services.
- Approximately 25% of revenue was described as equipment and software sales in the business discussion; MD&A separately states 23.8%.
Financial Performance and Key Metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenue | $8.484 million | $8.887 million | Down 5% |
| Gross profit | $3.738 million | $3.459 million | Up 8% |
| Gross margin | 44.1% | 38.9% | Up approximately 5.2 percentage points |
| Income from operations | $206,524 | $335,360 | Down 38% |
| Operating margin | 2.4% | 3.8% | Down approximately 1.4 percentage points |
| Net income | $29,323 | $236,671 | Down 88% |
| Net income attributable to Data Storage Corp. | $69,860 | $259,793 | Down 73% |
| Net loss attributable to common stockholders | $(54,452) | $146,781 | Turned to a loss |
| Net cash from operating activities | $799,666 | $541,305 | Up 48% |
| Cash and cash equivalents | $326,561 | $228,790 | Up $97,771 |
Revenue shifted toward higher-margin recurring cloud and disaster recovery services. Infrastructure and disaster recovery/cloud revenue increased 18% to $5.438 million, while equipment and software revenue declined 45% to $1.785 million. Nexxis VoIP revenue increased 273% to $484,024. Managed services revenue declined 39% to $365,767, while professional fees increased 30% to $411,475.
Cost of sales declined 13% to $4.746 million, but operating expenses increased 13% to $3.531 million. The largest expense increases included commissions, salaries, officer compensation, advertising and software-as-a-service costs. Interest expense increased to $177,451 from $98,788, primarily due to new equipment obtained under lease arrangements.
Cash flow from operations benefited materially from $896,697 of depreciation and amortization. Capital expenditures were $40,355, and financing activities used $661,540, primarily for capital lease repayments. No income taxes were paid in 2019.
Liquidity, Debt and Capital Structure
- Working capital deficit was $2.572 million at December 31, 2019, compared with $2.202 million in 2018.
- Current liabilities were $3.670 million versus current assets of $1.099 million.
- Total liabilities were $5.615 million, including $2.546 million of finance lease liabilities, $350,000 of note payable, and a $75,000 revolving credit balance.
- Finance lease liabilities increased substantially, partly reflecting $1.560 million of equipment acquired through finance leases during 2019.
- Accrued preferred stock dividends were $970,997. Preferred dividends of $124,312 were accrued during 2019 and have not been paid.
- Management disclosed that the working capital deficiency and limited cash raised substantial doubt about the Company’s ability to continue as a going concern. Management concluded the doubt was mitigated by operating cash flow, improving subscription revenue and the potential to renegotiate related-party debt and leases.
- The Company had no off-balance-sheet arrangements.
Material Changes Versus 2018
- Revenue declined modestly, but recurring Infrastructure and Disaster Recovery/Cloud revenue increased by $820,977 under new long-term contracts.
- Gross profit and gross margin improved despite lower total revenue, reflecting the mix shift toward cloud and subscription services.
- Operating income and net income declined because operating expenses and interest expense rose faster than gross profit.
- Net income attributable to common stockholders changed from $146,781 of income to a $54,452 loss after preferred dividends.
- Operating cash flow improved by $258,361, but financing cash usage increased because of lease repayments.
- The Company adopted ASC 842 leases effective January 1, 2019 and recorded operating lease right-of-use assets and liabilities.
- The Company issued options for 2,852,537 common shares and had 8,425,824 options outstanding at year-end, in addition to 133,334 warrants.
Guidance, Outlook, Risks and Unusual Items
Management stated that in 2020 it intended to expand its presence in cloud, IBM Power i, disaster recovery and business continuity markets, and would consider acquisitions financed with working capital or additional financing. No quantified revenue, earnings or cash-flow guidance was provided.
- Going concern: Cash resources and working capital were limited, and continued access to related-party financing or lease renegotiations may be important.
- COVID-19: The filing identifies the pandemic as a risk to equipment availability, employees, third-party relationships and operations. The Company classified itself as an essential business and moved employees to a virtual environment.
- Customer concentration: Three customers represented 38% of accounts receivable at December 31, 2019, compared with one customer representing 11% in 2018.
- Competition and technology: The Company competes with larger, better-funded providers in rapidly changing cloud, disaster recovery, infrastructure and VoIP markets, creating pressure on pricing and margins.
- Debt and related parties: Finance leases are payable to Systems Trading Inc., which is owned and operated by the Company’s president. A $350,000 note payable related to the Message Logic acquisition is past its stated maturity, and the Company is negotiating a final settlement.
- Internal controls: Management reported material weaknesses in internal control over financial reporting due to insufficient accounting expertise and inadequate segregation of duties. Disclosure controls were deemed ineffective. The auditor did not provide an internal-control attestation because the Company qualifies as a smaller reporting company.
- Equity dilution: Outstanding options and warrants, including substantial grants to directors and officers, may dilute existing common shareholders.
- Market liquidity: The common stock trades on the OTC Markets under “DTST,” but trading is minimal and a liquid market may not develop.
- Subsequent events: Options for 100,000 shares were exercised in February 2020, and several officer and secretary roles changed.
Most Important Facts for Investors to Verify
- Reconcile the going-concern disclosure with current cash, working capital, lease maturities and the Company’s ability to refinance related-party obligations.
- Review the terms, maturity status and settlement discussions for the $350,000 note payable and the $75,000 revolving credit facility.
- Assess whether recurring cloud and disaster recovery growth can offset declining equipment, software and managed-services revenue.
- Evaluate the effect of preferred dividends, options, warrants and potential future equity financing on common-stockholder value.
- Monitor remediation of the reported material weaknesses in accounting expertise and segregation of duties.
- Review the impact of COVID-19 and subsequent operating developments on customers, equipment procurement, staffing and cash flow.
- Confirm customer concentration, contract duration, renewal rates and the sustainability of the reported gross-margin improvement.