DTST

Business Context and Reporting Period

Data Storage Corporation (DSC) filed its Form 10-Q for the quarterly period ended September 30, 2010. The company provides professional technology services focused on disaster recovery, business continuity, and regulatory compliance for electronic information. DSC operates four data centers across Rhode Island, New York, Florida, and Massachusetts. A material event during the period was the acquisition of SafeData, LLC on June 17, 2010, which significantly expanded the company's asset base and revenue streams.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Sales increased 491.4% for the three months and 281.9% for the nine months compared to the prior year periods. This surge is primarily attributed to the SafeData acquisition and the addition of equipment sales.
• Profitability: While revenue grew significantly, the company reported a net loss for both periods. The nine-month net loss of $739,397 was a slight improvement (decrease) of $48,686 compared to the $788,083 loss in the prior year.
• Expense Increases: Operating expenses rose 113.6% for the three months and 47.6% for the nine months. Key drivers included increased professional fees, salaries, and depreciation/amortization related to the acquisition.
• Interest Expense: Interest expense spiked to $97,634 for the quarter (from $958 prior year) due to convertible debt issued to finance the SafeData acquisition and associated warrant costs.
• Balance Sheet Expansion: Total assets grew from $688,443 at year-end 2009 to $4,995,726, driven by the acquisition of SafeData assets, including $2.2 million in goodwill and significant intangible assets.

Guidance, Outlook, and Risks

• Liquidity and Going Concern: The filing states that the company's ability to continue as a going concern is dependent on achieving sales growth, reducing operating expenses, and obtaining necessary financing. The company has historically been funded by the CEO and majority shareholder, Charles M. Piluso, who intends to continue funding operations as needed.
• Outlook: Management intends to increase market presence through organic growth and further acquisitions. Future liquidity needs may be met through working capital and proceeds from financing.
• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of September 30, 2010, citing a lack of size and complexity to sufficiently segregate duties.
• Debt Obligations: The company has significant lease obligations ($534,843 total) and a note payable of $271,023 related to the acquisition. Convertible debt of $1,000,000 was issued with a beneficial conversion feature.
• Customer Concentration: For the nine months ended September 30, 2010, one customer represented approximately 16% of sales.

Investor Verification Checklist

• Acquisition Integration: Verify the actual revenue contribution and margin performance of the SafeData acquisition post-closing to ensure it meets pro forma expectations.
• Debt Service Capability: Assess the company's ability to service the new capital lease obligations ($55,200/month) and convertible debt interest given the current negative working capital position.
• Financing Dependence: Confirm the availability of continued funding from the CEO/majority shareholder, as the company relies on this for liquidity.
• Internal Control Remediation: Review plans to address the ineffective disclosure controls and lack of segregation of duties.
• Customer Retention: Monitor the retention of the single customer representing 16% of sales to mitigate concentration risk.