Data Storage Corporation Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides hybrid-cloud, cloud-storage, SaaS, backup, disaster-recovery, business-continuity, data-protection, and professional services through three data centers serving customers in the United States and Canada. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2012.
The filing was submitted November 20, 2012, after the November 14 deadline. The company attributed the delay to power, internet, office-access, and auditor disruptions caused by Hurricane Sandy.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Sales | $1.013 million, down 7.0% | $2.997 million, up 4.8% |
| Gross profit | $383 thousand | $1.000 million |
| Gross margin | Approximately 37.8% | 33.4%, versus 34.3% in 2011 |
| Loss from operations | $(332) thousand | $(1.600) million |
| Net loss | $(368) thousand | $(1.709) million |
| Net loss available to common shareholders | $(381) thousand | $(1.746) million |
| Basic and diluted loss per share | $(0.01) | $(0.06) |
For the nine months, operating expenses were $2.600 million, up 14.9% year over year. Cash used in operating activities was $814 thousand, and capital expenditures used $100 thousand. Financing activities provided $930 thousand, primarily from $500 thousand of common-stock issuance, $500 thousand of convertible-debt proceeds, and $128 thousand of officer advances.
Cash and cash equivalents were $184 thousand at September 30, 2012, compared with $168 thousand at December 31, 2011. Working-capital deficiency was $2.270 million, compared with $2.199 million at year-end 2011. Total liabilities were $4.863 million versus total assets of $5.261 million, leaving stockholders’ equity of $398 thousand.
Debt and obligations included a $500 thousand, three-year convertible note bearing 10% interest and convertible at $0.85 per share; a $100 thousand revolving credit-line balance; $1.166 million of capital-lease obligations; $94 thousand of loans payable; and $753 thousand due to the CEO. The CEO’s advances were non-interest-bearing and had no stated repayment terms.
Material Changes Versus Prior Comparable Period
- Third-quarter sales declined $76 thousand, or 7.0%, primarily because of lower equipment sales and professional-services revenue.
- Nine-month sales increased $137 thousand, or 4.8%, but cost of sales rose 6.4%, reducing gross margin to 33.4% from 34.3%.
- Third-quarter operating expenses fell 29.7%, primarily from lower officer compensation, sales commissions, and advertising expense.
- Nine-month operating expenses increased $337 thousand, driven principally by higher sales salaries, executive salaries, and stock-based compensation.
- Nine-month net loss increased $174 thousand, or 11.4%, despite lower interest expense and debt-discount amortization. The prior-year period included a $176 thousand gain on settlement of contingent consideration that did not recur.
- Common shares outstanding increased to 32,439,681 at September 30, 2012 from 28,912,712 at December 31, 2011, principally reflecting a $500 thousand issuance of 3,333,333 shares to directors and affiliates.
Outlook, Risks, Contingencies, and Unusual Items
Management stated that continued operations depend on sales growth, expense reductions, additional financing, and eventual profitable operations. Management expected to continue pursuing growth in the IBM marketplace, using additional technical capacity and managed services, and intended to raise capital through stock issuances and receive funding from the CEO as needed. No specific revenue or earnings guidance was provided.
At September 30, 2012, the company had a substantial working-capital deficit, recurring operating losses, negative operating cash flow, significant lease and debt obligations, and reliance on related-party funding and additional financing. These conditions create substantial liquidity and going-concern risks, although the filing does not state that substantial doubt has been formally raised beyond the disclosed dependence on financing and profitable operations.
Disclosure controls and procedures were reported as ineffective because the company lacked sufficient size and complexity to segregate duties adequately. Management reported no material changes to internal control over financial reporting during the quarter.
Potential dilution included 4.219 million outstanding options, 28,642 warrants, and 588,235 shares issuable upon conversion of debt. No material litigation was disclosed.
After quarter-end, on October 31, 2012, the company agreed to acquire substantially all assets of Message Logic, Inc. The transaction involved issuing 1,495,190 common shares, assuming $373 thousand of liabilities, and potential payments of $800 thousand over two years if specified benchmarks are achieved. The company also entered into a two-year employment agreement with Message Logic’s CEO providing for a $150 thousand base salary and additional revenue-based compensation.
Important Facts for Investors to Verify
- Whether the company can generate sufficient sales growth and reduce expenses to address recurring losses and negative operating cash flow.
- The availability and terms of future financing, continued CEO funding, and the company’s ability to meet near-term lease, debt, and other obligations.
- The terms, accounting treatment, performance benchmarks, and integration risks associated with the Message Logic acquisition.
- The potential dilution from the convertible note, options, warrants, equity issuances, and acquisition-related shares.
- The effectiveness of internal controls and whether the disclosed control deficiency has been remediated.
- The recoverability of goodwill and intangible assets, which totaled approximately $3.0 million net at September 30, 2012, relative to the company’s limited equity base.