Data Storage Corporation — FY2020 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2020; filed March 31, 2021. The filing reports annual results, not a standalone fourth-quarter period. Data Storage provides subscription-based disaster recovery, infrastructure and cybersecurity services, data analytics, managed services, equipment and software, and VoIP services.
Financial performance and liquidity
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Revenue | $9.321 million | $8.484 million | +10% |
| Gross profit | $3.896 million | $3.738 million | +4% |
| Gross margin | 41.8% | 44.1% | Down approximately 2.3 percentage points |
| Operating income (loss) | $(1,063) | $206,524 | Declined materially |
| Net income | $173,359 | $29,323 | Improved |
| Net income attributable to common stockholders | $55,339 | $(54,452) | Turned positive |
| Net cash from operating activities | $1.111 million | $799,666 | +39% |
| Cash and cash equivalents | $893,598 | $326,561 | +174% |
| Working capital | $(2.666) million deficiency | $(2.572) million deficiency | Deficiency increased $84,790 |
- Infrastructure and disaster recovery/cloud revenue increased 6.8% to $5.806 million and remained the largest revenue category.
- Equipment and software revenue increased 16% to $2.075 million; Nexxis VoIP revenue increased 44% to $696,576.
- Cost of sales increased 14% to $5.425 million, exceeding revenue growth, primarily due to data-center expansion, new IBM systems and equipment purchases.
- Selling, general and administrative expenses increased 13% to $3.897 million. Salary, officer compensation, software-as-a-service and advertising costs increased, while professional fees and certain travel and office costs declined.
- Operating results included a $350,000 gain from extinguishment of a contingent liability related to the discontinued use of Message Logic assets. Without this unusual item, reported profitability would have been substantially weaker.
- Capital expenditures were $181,072. Financing cash outflows were $362,570, including $718,690 of payments on related-party equipment leases, partly offset by $481,977 of PPP loan proceeds.
- Total liabilities were $5.831 million, including $2.540 million of finance lease liabilities, $481,977 of notes payable if the PPP loan is not forgiven, and $1.116 million of accrued Series A preferred dividends.
Material changes versus 2019
- Revenue grew 10%, led by cloud subscriptions, equipment and software, and VoIP services; international revenue was less than 2% of total revenue.
- Gross margin compressed because costs grew faster than revenue, and operating income declined from $206,524 to an operating loss of $1,063.
- Net income improved primarily because of the $350,000 contingent-liability gain and lower interest expense, while preferred dividend accruals increased to $144,677.
- Operating cash generation strengthened to $1.111 million, but the company continued to report a significant working-capital deficiency and relied on lease financing and the PPP loan.
- Cash increased by $567,037 during the year, ending at $893,598.
Outlook, commentary, risks and unusual items
- Management plans to expand IBM Power infrastructure and business-continuity services, add distribution partners, increase cybersecurity offerings, pursue international expansion and evaluate strategic acquisitions. No quantitative revenue or earnings guidance was provided.
- Management stated that COVID-19 had not materially affected 2020 operations or financial performance and that more than 90% of employees worked remotely. The pandemic accelerated customer interest in cloud and disaster-recovery solutions, but future effects remain uncertain.
- The company initially identified conditions raising substantial doubt about its ability to continue as a going concern, including the working-capital deficiency and limited cash. Management concluded the doubt was alleviated based on improving operating cash flow and the potential renegotiation of related-party financing and capitalized leases. The filing nevertheless states that the company has no committed outside financing.
- On February 4, 2021, the company agreed to acquire Flagship Solutions, LLC for up to $10.5 million, consisting of $5.55 million in cash and up to $4.95 million in common stock, subject to adjustments. Closing depended on financing, a public offering and Nasdaq listing, among other conditions, with an expected outside date of May 31, 2021.
- The proposed Flagship transaction would require substantial financing and could cause significant dilution. Flagship debt of approximately $525,000 under a bank line and $499,900 under an SBA EIDL would remain outstanding, with the company expected to provide a parent guarantee after closing.
- The board and holders of more than 50% of voting power approved a reverse stock split ranging from 1-for-2 to 1-for-60 and approved a new 2021 equity incentive plan covering up to 15 million shares.
- Management reported material weaknesses in internal control over financial reporting arising from insufficient GAAP accounting expertise and inadequate segregation of duties. Disclosure controls were deemed ineffective; the auditor was not engaged to attest to internal control effectiveness.
- Key risks include intense cloud-services competition, cybersecurity and data-center outages, privacy and HIPAA compliance, customer and distributor concentration, dependence on related-party leases, limited liquidity, dilution from options, warrants, preferred stock and proposed acquisitions, and volatile OTC trading.
- One value-added reseller accounted for 15% of 2020 revenue, and three customers represented 45% of accounts receivable at year-end.
Most important facts for investors to verify
- Whether the company can sustain positive operating cash flow and address its $2.666 million working-capital deficiency without additional financing.
- Whether the PPP loan was ultimately forgiven; the filing contains inconsistent timing language regarding the forgiveness application.
- Whether the Flagship acquisition, related financing, cash payment and share issuance were completed, and the resulting dilution and debt obligations.
- Whether the identified internal-control material weaknesses were remediated and whether future filings require corrections or restatements.
- Whether cloud-service growth can offset declining operating margins and higher data-center, compensation and lease costs.
- The recoverability of $3.016 million of goodwill and $455,935 of net intangible assets, which depend on forecasts of revenue, margins and discount rates.
- The extent of accrued Series A preferred dividends, conversion rights and the potential issuance of additional common shares from options, warrants and preferred stock.
- Whether the proposed reverse stock split and Nasdaq application improve liquidity and listing eligibility; the common stock traded on the OTCQB at the filing date.