Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cybersecurity, cloud, compliance, managed services, Infrastructure as a Service, Disaster Recovery as a Service, email archival, software, maintenance, and equipment solutions. The company serves healthcare, banking and finance, distribution, manufacturing, construction, education, and government customers.
This report covers the three and six months ended June 30, 2017. The financial statements are unaudited. The October 2016 acquisition of ABC Services, Inc. and ABC Services II, Inc. materially affected the reported results.
Financial Performance and Position
| Metric | Three Months Ended June 30, 2017 | Three Months Ended June 30, 2016 | Six Months Ended June 30, 2017 | Six Months Ended June 30, 2016 |
|---|---|---|---|---|
| Sales | $2.027 million | $1.005 million | $4.351 million | $1.989 million |
| Gross profit | $811,324 | $382,617 | $1.811 million | $750,921 |
| Gross margin | 40.0% | 38.1% | 41.6% | 37.8% |
| Operating income (loss) | $67,188 | $(120,846) | $461,979 | $(190,652) |
| Operating margin | 3.3% | (12.0%) | 10.6% | (9.6%) |
| Net income (loss) | $29,365 | $(178,777) | $398,288 | $(323,590) |
| Net income (loss) attributable to common stockholders | $446 | $(204,955) | $341,161 | $(375,302) |
Six-month operating cash flow was $384,335, compared with $113,492 in the prior-year period. Financing activities used $456,154, primarily for loan repayments and capital lease obligations. Cash declined from $255,817 at December 31, 2016 to $183,998 at June 30, 2017.
At June 30, 2017, total assets were $7.193 million, including $1.811 million of net property and equipment and $3.986 million of goodwill. Current assets were $1.033 million versus current liabilities of $3.435 million, producing a working capital deficit of $2.408 million.
Total liabilities were $5.115 million. Material obligations included a $350,000 bank note, a $374,991 related-party note, and $1.952 million of related-party capital lease obligations, of which $648,655 was current and $1.303 million was long term. The company reported $676,265 of dividends payable and $720,937 of deferred revenue.
Basic and diluted income per common share was approximately $0.00 for both the quarter and six-month period. Weighted-average common shares increased to 128.0 million from 36.6 million in the comparable periods, reflecting prior financing and conversion activity. Potentially dilutive securities included 6.742 million options and 133,334 warrants.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 101.8% and six-month sales increased 118.7%, primarily due to the ABC acquisition.
- Six-month gross profit increased 141.2%, while gross margin improved to 41.6% from 37.8%.
- The company returned to operating profitability and net profitability in both the quarter and six-month period.
- Interest expense declined to $65,902 for the six months from $134,236, which management attributed to conversion agreements for outstanding convertible debt.
- Property and equipment increased substantially, including $1.825 million of assets acquired through capital leases, principally reflecting additional data center equipment.
- Cash decreased despite positive operating cash flow because financing cash outflows exceeded operating cash generation.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management stated that it expects the profitability trend to continue through August 2018 and the foreseeable future, but the filing does not provide formal revenue, earnings, or cash-flow guidance. Management also expects cost-cutting, synergies, and economies of scale to improve profitability and margins.
The company may require additional equity or debt financing to support growth, acquisitions, and liquidity needs. Management noted that future equity or convertible debt issuance could dilute existing shareholders, while debt financing could impose restrictive covenants. The company states that it has been successful in raising funds as needed but may not obtain financing on favorable terms, or at all.
The company is negotiating with Enterprise Bank to modify or extend the $350,000 bank note and to move from interest-only payments to a self-amortizing arrangement. Interest-only payments were last made in February 2017. The filing states that no default notice had been received.
Substantial related-party lease obligations are payable to Systems Trading, Inc., an entity owned by a major shareholder. Future minimum payments under capital leases totaled $2.124 million as of June 30, 2017.
Management concluded that disclosure controls and internal control over financial reporting were not effective as of June 30, 2017. Reported material weaknesses were insufficient internal accounting expertise and inadequate segregation of duties. Management intends to add financial staff resources.
The filing reports no material litigation, no defaults upon senior securities, and no unregistered equity sales during the period. The company carries a full valuation allowance against deferred tax assets. No customer concentration was reported for the six-month periods ended June 30, 2017 and 2016.
Important Facts for Investors to Verify
- Whether the ABC acquisition’s revenue and profitability contribution is sustainable and comparable with the pre-acquisition business.
- The company’s ability to fund operations while maintaining only $183,998 of cash and a $2.408 million working capital deficit.
- The outcome and timing of negotiations to modify or extend the $350,000 bank note.
- Required payments and refinancing risk associated with the $1.952 million of related-party capital lease obligations.
- Whether management’s expected profitability through August 2018 is achieved without additional dilutive financing.
- Remediation of the material weaknesses in accounting expertise, segregation of duties, and financial reporting controls.
- The recoverability of $3.986 million of goodwill and the carrying value of other intangible assets.
- The effect of the materially higher common share count and outstanding options and warrants on future per-share results.