Data Storage Corporation — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2019; filed November 19, 2019. The interim financial statements are unaudited. Data Storage Corporation provides cloud infrastructure, disaster recovery, managed services, software, maintenance, equipment, and onboarding services to commercial, government, education, and healthcare customers.
Financial Results and Position
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Revenue | $2.014 million | $2.561 million | $6.047 million | $7.261 million |
| Gross profit | $781,029 | $1.034 million | $2.636 million | $2.804 million |
| Gross margin | 38.8% | 40.4% | 43.6% | 38.6% |
| Operating income (loss) | $(103,621) | $257,269 | $70,444 | $309,835 |
| Net income (loss) | $(133,288) | $228,497 | $(43,707) | $241,637 |
| Loss attributable to common stockholders | $(152,673) | $200,843 | $(103,659) | $159,807 |
| Cash flow from operations | Not provided for quarter | Not provided for quarter | $634,428 | $373,968 |
Balance sheet at September 30, 2019: Cash and cash equivalents were $283,682, accounts receivable were $528,997, and total assets were $7.380 million. Total liabilities were $5.734 million, including $2.742 million of related-party finance lease liabilities, $350,000 of note payable, and $352,348 of operating lease liabilities. Total stockholders’ equity was $1.646 million. Working capital was negative $2.554 million.
Cash flow and capital spending: Nine-month operating cash flow was $634,428. Investing activities used $33,354, primarily for capital expenditures, while financing activities used $546,182 for capital lease repayments. Cash increased $54,892 from December 31, 2018. The company acquired $1.560 million of assets through finance leases during the period.
Material Changes Versus Prior Comparable Period
- Q3 revenue declined 21% year over year, driven primarily by a 58% decrease in equipment and software revenue to $410,238.
- Nine-month revenue declined 17% to $6.047 million. Equipment and software revenue decreased 53% to $1.285 million.
- Infrastructure and disaster recovery/cloud-service revenue increased 9% in Q3 and 13% for the nine-month period, reaching $3.960 million for nine months, supported by new long-term contracts.
- Nine-month gross margin improved to approximately 44% from 39%, reflecting a greater mix of subscription services and fewer lower-margin equipment sales.
- Q3 operating expenses increased 14% to $884,650, causing an operating loss. Nine-month operating expenses increased 3% to $2.565 million.
- Interest expense approximately doubled for the nine-month period to $137,425, primarily because of new equipment financed through leases.
- Related-party finance lease liabilities increased from $1.728 million at December 31, 2018 to $2.742 million at September 30, 2019.
- Cash flow from operations improved year over year, but substantially offsetting lease repayments and capital expenditures limited the increase in cash.
Outlook, Liquidity, Risks, and Unusual Items
- Management stated that the company’s net loss, limited cash, and $2.554 million working-capital deficiency raised substantial doubt about its ability to continue as a going concern.
- Management believes cash resources, the ability to reduce sales and marketing spending, improving cash flow, and potential related-party financing make it probable that cash requirements can be met through November 2020. The filing provides no assurance that these plans will succeed.
- Continuation as a going concern depends on executing the business plan, generating sufficient revenue, controlling expenses, and potentially obtaining additional financing or refinancing lease obligations.
- The company is transitioning customers from on-premise equipment to higher-margin IBM Power Infrastructure as a Service and other cloud offerings. Management expects this strategy to reduce near-term equipment revenue but improve margins and long-term contract value.
- The $350,000 note payable related to the 2012 Message Logic acquisition is past due. The company stopped making interest-only payments in October 2018 and is negotiating a final settlement; no default notice had been received as of the filing.
- The company reported material weaknesses in internal control over financial reporting, including insufficient accounting expertise and inadequate segregation of duties. Management intends to add finance and accounting resources.
- Customer concentration is material: one value-added reseller represented 12% of nine-month sales, and two customers represented 31% of accounts receivable at September 30, 2019.
- The company adopted ASC 842 lease accounting on January 1, 2019, recognizing operating lease right-of-use assets and liabilities. No material litigation was reported, and no subsequent events were disclosed.
Investor Verification Items
- Verify the company’s ability to fund operations through November 2020 without additional equity, debt, or related-party financing.
- Review the terms, maturity schedules, and related-party nature of the $2.742 million finance lease liability and other lease commitments.
- Monitor resolution of the $350,000 past-due note payable and any related settlement or default risk.
- Assess whether growth in recurring cloud and disaster-recovery revenue can offset continued declines in equipment and software sales.
- Evaluate remediation of the disclosed material weaknesses in internal control over financial reporting.
- Track customer concentration, accounts-receivable collections, and the company’s ability to convert operating cash flow into liquidity after lease payments.