Data Storage Corporation 2022 Form 10-K Summary
Business context and reporting period
Data Storage Corporation (Nasdaq: DTST) provides subscription-based cloud infrastructure, disaster recovery, cybersecurity, managed services, equipment and software, and Nexxis voice, internet and data services. Operations are conducted through CloudFirst Technologies, Flagship Solutions Group and Nexxis. The filing covers the fiscal year ended December 31, 2022, with comparative fiscal-year information for 2021; it is not a quarterly filing, although a material goodwill impairment was recorded in the fourth quarter of 2022.
The company operates primarily in the United States and maintains infrastructure in seven geographically diverse data centers in the United States and Canada. More than 90% of revenue was generated in the United States, and management reported an approximate 94% subscription renewal rate after customers’ initial contract terms.
Financial performance and liquidity
| Metric | 2022 | 2021 | Change |
|---|---|---|---|
| Revenue | $23.871 million | $14.876 million | +60% |
| Gross profit | $8.083 million | $6.417 million | +26% |
| Gross margin | 33.9% | 43.1% | Down 9.2 percentage points |
| Loss from operations | $(4.076) million | $(0.767) million | Loss increased |
| Operating margin | (17.1%) | (5.2%) | Down 11.9 percentage points |
| Net loss attributable to common stockholders | $(4.357) million | $0.204 million income | Material deterioration |
| Basic loss per share | $(0.64) | $0.04 | Declined |
| Adjusted EBITDA | $4 thousand | $825 thousand | Substantially lower |
| Cash flow from operations | $0.664 million | $(0.361) million | Improved |
Revenue growth was driven primarily by equipment and software sales, which increased 198% to $6.195 million, and managed services, which increased 81% to $8.445 million. Cloud infrastructure and disaster recovery revenue increased 15% to $8.300 million, while Nexxis VoIP revenue increased 4% to $0.800 million.
Cost of sales increased 87% to $15.788 million, outpacing revenue growth. Selling, general and administrative expense increased 37% to $9.837 million, reflecting higher salaries, advertising, commissions, professional fees, travel and occupancy costs. The company recorded a $2.322 million goodwill impairment charge related to Flagship and $0.127 million of deferred offering-cost impairment associated with canceled financing efforts.
Cash and cash equivalents were $2.287 million at December 31, 2022, compared with $12.136 million at December 31, 2021. Marketable securities were $9.011 million, resulting in cash and marketable securities of approximately $11.298 million. Working capital was $10.855 million, down from $12.085 million.
Investing activities used $9.138 million, primarily for purchases of marketable securities. Financing activities used $1.375 million, principally for finance-lease repayments and deferred offering costs. Total liabilities were $5.139 million, including $1.418 million of finance-lease liabilities, of which $0.777 million was related to related-party leases, and $0.232 million of operating-lease liabilities. The company reported no conventional outstanding bank debt at year-end; the PPP loans had been forgiven in 2021.
Material changes versus the prior comparable period
- Revenue increased by $8.995 million, or 60%, but gross margin declined substantially because cost of sales grew faster than revenue.
- Flagship-related activity contributed to higher revenue and operating expenses; Flagship revenue increased from $3.853 million in 2021 to $11.396 million in 2022.
- The company recorded a $2.322 million Flagship goodwill impairment, reducing goodwill from $6.561 million to $4.239 million.
- The company moved from $0.204 million of net income attributable to common stockholders in 2021 to a $4.357 million net loss in 2022.
- Operating cash flow improved to $0.664 million, but cash declined by $9.849 million because of investment purchases, capital expenditures and financing-related payments.
- Common shares outstanding increased to 6,822,127 from 6,693,793. Options and warrants for an aggregate of 2,720,584 shares remained outstanding at year-end, creating potential dilution.
- The company’s CEO and CFO concluded that disclosure controls were not effective at December 31, 2022. Material weaknesses contributed to a restatement of previously filed June 30, 2022 quarterly financial information.
- Mark Wyllie resigned as Flagship CEO, company Executive Vice President and director on October 28, 2022. Thomas Kempster became President of Flagship Solutions Group.
Guidance, outlook, commentary and risks
Management did not provide quantitative revenue, earnings or cash-flow guidance. Its stated 2023 priorities include expanding distribution channels, increasing sales and marketing, growing the IBM Power cloud and business-continuity business, expanding cybersecurity and managed services, and pursuing synergistic acquisitions. Management stated that the total contract value of existing subscription contracts exceeds $10 million, although this is not presented as recognized revenue or a forecast.
- Profitability risk: The company has limited history of sustained profitability and reported a significant 2022 loss. Continued investments in personnel, marketing, infrastructure and acquisitions may increase costs.
- Liquidity and capital risk: Cash declined materially during 2022. Management indicated that inaccurate assumptions or adverse changes could require reductions in marketing and salaries, renegotiation of related-party equipment leases, or additional financing.
- Internal-control risk: Material weaknesses remain under remediation, and additional weaknesses or future financial-statement restatements cannot be ruled out.
- Goodwill and acquisition risk: Flagship goodwill was impaired, and future acquisitions could require cash, debt or equity financing, create dilution, or result in additional impairment and integration costs.
- Cybersecurity and service-continuity risk: Breaches, ransomware, outages, hardware failures, data-center disruptions and failures of third-party providers could result in customer losses, liability, credits and reputational damage.
- Competitive and concentration risk: The company competes with substantially larger providers, including IBM, Microsoft, Google and AWS. Two customers represented 18% and 11% of 2022 revenue, and two customers represented 23% and 14% of year-end accounts receivable.
- Related-party risk: The company leases equipment from Systems Trading, which is owned and operated by President Harold Schwartz, and received funds from Nexxis Capital, which is owned by Charles Piluso and Harold Schwartz.
- Contractual commitments: The company has approximately $1.3 million of payments over five years under a marketing-related licensing agreement acquired with Flagship, in addition to lease obligations.
- Tax and legal matters: Federal and state net operating loss carryforwards totaled approximately $7.841 million and $7.511 million, respectively, but a full valuation allowance was maintained. Management reported no material pending litigation.
Most important facts for an investor to verify
- Reconcile the $23.871 million revenue increase with the sharp decline in gross margin and the limited $4 thousand of Adjusted EBITDA.
- Assess the sustainability and cash-conversion quality of the company’s subscription and managed-services revenue, including renewal rates and remaining contract obligations.
- Review the $2.322 million Flagship goodwill impairment and the assumptions used in the valuation, including projected cash flows and discount rates.
- Monitor remediation of the material weaknesses and confirm that future filings are not affected by additional restatements.
- Evaluate liquidity after considering only $2.287 million of cash, $9.011 million of marketable securities, lease payments and operating needs.
- Quantify potential dilution from 301,391 outstanding options and 2,419,193 outstanding warrants, as well as subsequent 2023 equity awards.
- Review related-party lease terms, outstanding balances and governance controls.
- Verify customer concentration, data-center dependencies, cybersecurity controls and the company’s ability to maintain service levels.