Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, cloud computing, infrastructure-as-a-service, data backup, disaster recovery, business continuity, email archiving and compliance solutions to commercial and government customers. The unaudited filing covers the three and six months ended June 30, 2015, with comparisons to the same 2014 periods. The company reported 36,588,240 common shares outstanding as of August 13, 2015.
Financial Performance and Position
| Metric | Three Months Ended June 30, 2015 | Three Months Ended June 30, 2014 | Six Months Ended June 30, 2015 | Six Months Ended June 30, 2014 |
|---|---|---|---|---|
| Sales | $1.100 million | $1.004 million | $2.058 million | $2.052 million |
| Gross profit | $426,115 | $465,814 | $805,353 | $905,869 |
| Gross margin | 39% | 46% | 39% | 44% |
| Loss from operations | $(76,891) | $(166,152) | $(225,519) | $(294,128) |
| Net loss | $(206,004) | $(183,367) | $(377,105) | $(350,821) |
| Net loss attributable to common shareholders | $(229,701) | $(204,591) | $(423,917) | $(392,531) |
| Basic and diluted loss per share | $(0.01) | $(0.01) | $(0.01) | $(0.01) |
- Cash and cash equivalents were $56,650 at June 30, 2015, down from $110,448 at December 31, 2014.
- Operating activities used $25,175 of cash during the first six months of 2015, compared with $5,627 provided in the prior-year period. Financing activities used $28,623, including $108,623 of lease repayments and $80,000 of convertible debt issuance.
- Working capital deficit was $2.867 million at June 30, 2015, compared with $2.941 million at December 31, 2014.
- Total assets were $3.611 million and total liabilities were $5.073 million, resulting in stockholders’ deficit of $1.461 million.
- Current liabilities included $100,292 under a revolving credit facility, $350,000 payable to Enterprise Bank, $780,000 of related-party convertible debt net of discount, $463,872 of dividends payable and $227,243 of current lease obligations. Long-term liabilities included $1.311 million of related-party convertible debt and $453,637 of lease obligations.
- Interest expense was $146,934 for the first six months of 2015, compared with $76,256 in 2014. No income tax provision was recorded, and deferred tax assets were fully offset by a valuation allowance.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 10% to $1.100 million, primarily from higher professional-services revenue. Six-month sales increased 3% to $2.058 million.
- Cost of sales increased 25% in the quarter and 9% year to date, attributed to increased infrastructure services. Gross margin declined to 39% from 46% for the quarter and to 39% from 44% year to date.
- Selling, general and administrative expense declined 20% in the quarter and 14% year to date, primarily due to lower salaries, professional fees and bad-debt expense.
- Operating losses improved, but higher interest expense and weaker results from the equity-method joint venture caused the quarterly and year-to-date net losses to widen.
- The company converted $245,601 owed to a related party and $1.066 million owed to the CEO into convertible debt. It also issued an additional $80,000 convertible promissory note to the CEO.
- Several related-party notes that had matured or were in default were extended to May 6, 2016. Certain notes carry 10% interest, and defaulted notes are subject to additional interest and warrant obligations.
Outlook, Risks, Contingencies and Unusual Items
- Management states that continued operations depend on sales growth, lower operating expenses, additional financing and achieving profitable operations. The CEO and largest shareholder has historically funded the company and intends to continue doing so as needed; management also expects to seek financing, including stock issuances.
- The filing does not provide formal quantitative revenue, earnings or cash-flow guidance. Management intends to expand its IBM marketplace presence, infrastructure-as-a-service offerings and managed services.
- The financial statements identify substantial liquidity risk: cash was only $56,650 against a $2.867 million working capital deficit, continued losses and significant near-term debt, lease and dividend obligations.
- Disclosure controls and internal control over financial reporting were assessed as ineffective because of insufficient accounting expertise and inadequate segregation of duties. Management intends to add finance and accounting staff.
- The company is defending a former chief operating officer’s lawsuit claiming $67,392 of unpaid wages, plus statutory damages and legal fees. The company believes it has counterclaims.
- The company’s 50% equity-method joint venture reported a $9,306 net loss for the six months ended June 30, 2015; DSC recognized a $4,653 share of the loss for the period.
- Capital lease obligations totaled $680,880, with scheduled payments through 2018. The Enterprise Bank note has a $350,000 principal balance due April 30, 2016.
- Potential dilution included 6,221,222 outstanding options and 133,334 warrants at June 30, 2015, in addition to convertible debt that may be converted into common stock.
- Subsequent events included the appointment of Stephen Catanzano as corporate secretary and Hal Schwartz as a director in July 2015.
Important Facts for Investors to Verify
- Whether the company can obtain sufficient financing or continued related-party support to meet obligations as they mature.
- The maturity, default terms, accrued interest, conversion prices and potential dilution associated with related-party convertible notes.
- Whether declining gross margins and recurring operating losses can be reversed through growth in professional, infrastructure and IBM-related services.
- The status and potential financial exposure of the former executive’s litigation.
- Remediation of the material weaknesses in accounting expertise, segregation of duties and disclosure controls.
- The collectability of the increase in accounts receivable to $253,416 from $114,556 at year-end 2014 and the company’s ability to generate positive operating cash flow.