Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation is a managed service provider focused on IBM and Intel cloud infrastructure, infrastructure-as-a-service, disaster recovery, data vaulting, managed services, email archival, equipment and software, and telecommunications through its 80%-owned Nexxis subsidiary. This quarterly report covers the three and nine months ended September 30, 2018; the financial statements are unaudited.
Financial Results and Key Metrics
| Metric | Three Months Ended September 30, 2018 | Three Months Ended September 30, 2017 | Nine Months Ended September 30, 2018 | Nine Months Ended September 30, 2017 |
|---|---|---|---|---|
| Sales | $2.561 million | $2.036 million | $7.261 million | $6.387 million |
| Gross profit | $1.034 million | $0.810 million | $2.804 million | $2.621 million |
| Gross margin | 40.4% | 39.8% | 38.6% | 41.0% |
| Income from operations | $0.257 million | $0.068 million | $0.310 million | $0.530 million |
| Operating margin | 10.0% | 3.4% | 4.3% | 8.3% |
| Net income attributable to common stockholders | $0.201 million | $0.004 million | $0.160 million | $0.345 million |
Interest expense was $28,785 for the quarter and $68,927 for the nine-month period. No income tax provision was recorded, and basic and diluted earnings per share were reported as approximately $0.00.
- Cash and cash equivalents were $204,642 at September 30, 2018, compared with $105,139 at December 31, 2017.
- Operating cash flow was $373,968 for the nine months, versus $561,957 in the prior-year period.
- Investing cash flow was negative $44,977, consisting of capital expenditures. Financing cash flow was negative $229,488, primarily from capital lease repayments.
- Working capital was negative $2.160 million at September 30, 2018, an improvement from a negative $2.951 million at December 31, 2017.
- Total liabilities were $4.432 million, including $1.847 million of related-party capital lease obligations, $350,000 owed to Enterprise Bank, $1.246 million of current liabilities for dividends and deferred revenue, and other current obligations.
- Accounts receivable were $562,140, net of a $90,000 allowance for doubtful accounts.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 25.7%, while nine-month sales increased 13.7%. Management attributed the growth primarily to non-recurring equipment and software sales.
- Equipment and software revenue increased to $2.744 million for the nine months from $1.611 million. Infrastructure and disaster recovery revenue declined modestly to $3.490 million from $3.541 million.
- Despite higher nine-month revenue, gross margin declined because equipment and software generally carry lower margins than subscription services.
- Third-quarter operating income increased substantially, but nine-month operating income declined 41.6% because operating expenses increased 20.5%, including higher commissions.
- Nine-month net income attributable to common stockholders declined to $159,807 from $345,133, while preferred stock dividends increased to $94,591 from $86,774.
- Interest expense declined due to refinancing and consolidation of prior related-party leases and notes into a new related-party capital lease arrangement.
- On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method. A $41,970 adjustment was recorded to retained earnings, and comparative periods were not adjusted.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management stated that it expects profitability to continue through 2018 and the foreseeable future, but provided no quantified revenue, earnings, or cash-flow guidance.
- The Company stated that conditions previously raising substantial doubt about its ability to continue as a going concern had been alleviated; however, the filing continues to identify substantial liquidity risks. Management expects to rely on sales growth, expense control, potential refinancing of related-party leases, additional financing, and senior management funding of operations for the next 12 months. No assurance is provided that these measures will succeed.
- The Enterprise Bank note has a stated balance of $350,000 and was due in April 2016. The Company has continued interest-only payments, most recently in September 2018, and is negotiating with the bank regarding repayment terms. The filing states that no default notice has been received.
- Related-party capital lease payments are $23,475 every two weeks and extend through April 2022. Total future minimum payments are $2.019 million, of which $461,941 is classified as current.
- One customer represented 12.6% of nine-month revenue, creating customer-concentration risk. Cash deposits may exceed federally insured limits.
- Management concluded that disclosure controls and internal control over financial reporting were not effective because of insufficient accounting expertise and inadequate segregation of duties. Management intends to add financial staff.
- Potentially dilutive securities included 133,334 warrants and 3,667,227 options, although they were excluded from diluted earnings per share as anti-dilutive.
- On November 5, 2018, after the reporting date, Nexxis acquired Broadsmart Florida, Inc. for incidental cash consideration plus 15% of net billing from existing customer agreements, subject to the terms described in the filing.
- The filing reports no current litigation, no unregistered sales of equity securities, and no defaults upon senior securities during the period.
Important Facts for Investors to Verify
- Reconcile the MD&A net-income figures with the financial statements: MD&A reports nine-month net income of $230,122 and third-quarter net profit of $209,223, while the statements report consolidated net income of $241,637 and net income attributable to common stockholders of $159,807 for the nine months, and $233,499 for the quarter.
- Assess whether $204,642 of cash and approximately $2.160 million of negative working capital are adequate to meet current obligations and capital lease payments.
- Review the status and potential repayment or restructuring of the overdue Enterprise Bank obligation.
- Evaluate the sustainability of revenue growth given the significant increase in lower-margin, potentially non-recurring equipment and software sales.
- Monitor the customer concentration, related-party financing, preferred dividends, and potential equity dilution.
- Track remediation of the material weaknesses in accounting expertise and segregation of duties.
- Review the financial impact, purchase accounting, and ongoing profit-sharing obligations associated with the Broadsmart acquisition.