Data Storage Corporation — 2011 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2011; the filing presents annual results rather than a separate fourth-quarter period. The company provides subscription-based hybrid cloud storage, cloud computing, disaster recovery, business continuity, backup, high-availability replication, and related professional services in the United States and Canada. The business includes assets and customer relationships acquired from SafeData in 2010.
Financial Performance and Position
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Revenue | $3,940,323 | $2,514,340 | Up 56.7% |
| Gross profit | $1,430,402 | $930,881 | Up $499,521 |
| Gross margin | 36.3% | 37.0% | Down 0.7 percentage points |
| Operating loss | $(1,826,689) | $(1,364,872) | Loss increased |
| Net loss | $(2,803,647) | $(1,798,981) | Loss increased $1,004,666 |
| Net loss available to common shareholders | $(2,853,647) | $(1,848,981) | Loss increased |
| Basic and diluted loss per share | $(0.13) | $(0.12) | Worsened |
| Operating cash flow | $(519,493) | $(22,548) | Greater cash use |
| Cash at year-end | $168,490 | $50,395 | Up $118,095 |
| Working capital | $(2,281,776) | $(2,543,851) | Improved $262,075 |
| Total liabilities | $4,167,962 | $4,216,502 | Down $48,540 |
| Stockholders’ equity | $1,139,781 | $590,750 | Up $549,031 |
Cost of sales increased to $2,509,921 from $1,583,459. Selling, general and administrative expense rose to $3,257,091 from $2,295,753, driven principally by higher executive salaries, sales salaries, commissions, and investment in a sales team and chief operating officer. Executive salary expense increased to $461,006, sales salaries to $487,238, and sales commissions to $308,899.
Other expense included $753,935 of debt-discount amortization, $245,496 of interest expense, a $142,925 loss on extinguishment of debt, and a $176,497 gain from final settlement of SafeData contingent consideration. No income tax provision was recorded because deferred tax assets were fully offset by a valuation allowance.
Cash Flow, Debt, and Liquidity
- Operating activities used $519,493 of cash; investing activities used $96,575, primarily for capital expenditures; financing activities provided $734,163.
- Financing included $1,755,000 from common-stock issuance, offset by $328,470 of capital-lease repayments, $133,673 of loan repayments, and $546,516 paid toward SafeData contingent consideration.
- Current liabilities were $3,000,288 versus current assets of $718,512, producing substantially negative working capital.
- Capital lease obligations totaled $1,008,953, including $499,325 current and $509,628 long term. Scheduled capital-lease payments for 2012 were approximately $500,020.
- The company owed $100,292 under a revolving credit facility and reported $140,069 of loan payable related to Systems Trading, LLC.
- The company owed its chief executive officer $624,818 in non-interest-bearing advances with no stated repayment terms. Management stated that the CEO and other financing sources had funded the company and that additional stock issuances and financing would be pursued as needed.
Material Changes and Unusual Items
- Revenue growth reflected increased sales personnel and a full year of revenue from the SafeData acquisition.
- SafeData’s remaining contingent consideration was settled in 2011 through $546,516 of cash and $150,000 of common stock, producing a $176,497 gain.
- Convertible debt was converted into common stock, with related warrants exercised in cashless transactions. The transactions resulted in a $142,925 loss on extinguishment of debt and materially increased common shares outstanding.
- The company issued 11,052,379 common shares and 522,215 options during 2011, while common shares outstanding increased to 28,912,712 from 17,127,541.
- Property and equipment increased to $3,024,302 gross, including equipment acquired under capital leases. Net property and equipment increased to $1,343,818 from $831,323.
- Goodwill remained $2,201,828, and net intangible assets declined to $955,048 from $1,169,404 due to amortization.
Outlook, Risks, and Governance Matters
Management planned to expand its presence in the IBM marketplace, use its data-center capacity and technical expertise to grow organically, increase direct sales and partnerships, and pursue acquisitions of complementary cloud storage, disaster recovery, e-discovery, and infrastructure-as-a-service providers. The filing does not provide quantitative revenue or earnings guidance.
The financial statements explicitly depend on the company achieving sales growth, reducing operating expenses, obtaining financing, and eventually reaching profitable operations. Management disclosed substantial doubt-related liquidity conditions through its going-concern discussion, although the independent auditor issued an unqualified opinion on the financial statements.
- Management concluded that internal control over financial reporting was not effective as of December 31, 2011 because of insufficient internal accounting expertise and inadequate segregation of duties.
- The company had a limited OTC Bulletin Board market, minimal trading activity, and no assurance that a liquid market would develop.
- The company reported no material litigation, no off-balance-sheet arrangements, and no derivative or hedging activities.
- Customer concentration was disclosed for 2010, when one customer represented 11% of sales; the filing text does not provide a comparable 2011 concentration percentage.
- A $500,000 convertible debt offering with a director was completed on January 31, 2012, convertible into common stock at $0.85 per share.
- The company had 2,563,115 outstanding options and 173,427 outstanding warrants at December 31, 2011, creating potential dilution.
Most Important Facts to Verify
- Whether the company can fund operations and near-term obligations despite $168,490 of cash, negative working capital of $2.28 million, recurring operating losses, and negative operating cash flow.
- The terms, maturity schedule, and refinancing prospects for capital leases, loans, the revolving credit facility, related-party advances, and subsequent convertible debt.
- The extent to which 2011 revenue growth is recurring subscription revenue versus acquisition-related contribution, and whether gross-margin pressure persists.
- The potential dilution from common-stock financing, convertible-debt conversions, options, warrants, and the Southridge equity purchase arrangement of up to $20 million.
- Management’s remediation of the disclosed material weaknesses in internal control over financial reporting.
- The recoverability of $2.20 million of goodwill and $955,048 of net intangible assets given the company’s continuing losses and going-concern dependence.