Data Storage Corporation — Q1 2015 Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, infrastructure-as-a-service, disaster recovery, business continuity, data backup, email archiving and compliance solutions to commercial and government customers. The unaudited report covers the three months ended March 31, 2015, compared with the three months ended March 31, 2014, and presents balances as of March 31, 2015 versus December 31, 2014.
Financial Performance and Position
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Sales | $958,133 | $1,042,963 | Down 8% |
| Gross profit | $379,236 | $422,055 | Down 10% |
| Gross margin | 39.6% | 40.5% | Broadly stable |
| Operating loss | $(148,630) | $(127,975) | Loss widened |
| Net loss | $(171,101) | $(167,454) | Loss widened 2% |
| Net loss attributable to common shareholders | $(194,215) | $(187,940) | Loss widened 3% |
| Loss per share | $(0.01) | $(0.01) | No change stated |
| Cash flow from operations | $(94,727) | $(44,643) | Higher cash use |
| Cash flow from investing | $0 | $(3,318) | Improved |
| Cash flow from financing | $26,905 | $106,744 | Lower financing inflow |
Operating expenses were $527,866, or approximately 55.1% of sales, versus $550,030, or approximately 52.7% of sales, in the prior-year quarter. Interest expense increased to $73,972 from $32,048, partly offset by a $51,500 equity-method gain from the company’s 50% joint venture. No income tax provision was recorded, and deferred tax assets were subject to a full valuation allowance.
At March 31, 2015, cash and cash equivalents were $41,816, down from $110,448 at December 31, 2014. Accounts receivable were $137,532, while total current assets were $266,923. Total liabilities were $4,883,151, including $700,000 of current convertible debt, $1,391,363 of long-term related-party convertible debt, $350,000 owed to Enterprise Bank, $735,598 of capital lease obligations and $100,292 outstanding under a revolving credit facility. Stockholders’ deficit was $(1,256,402), and the working-capital deficit was reported at $2,362,374.
Material Changes Versus the Prior Comparable Period
- Sales declined $84,830, primarily because certain customers were assigned to the joint venture during 2014.
- Cost of sales declined 7%, broadly consistent with the revenue decline; management reported an approximately 40% gross margin.
- Operating expenses declined 4%, mainly due to a $32,597 reduction in executive salary expense.
- Interest expense increased by approximately $41,924; the filing’s MD&A discussion contains an inconsistent comparison figure, but the financial statements report $73,972 in Q1 2015 versus $32,048 in Q1 2014.
- The company recognized $51,500 of income from its equity-method investment, reflecting its share of the joint venture’s $103,000 quarterly net income.
- Related-party obligations were restructured into convertible debt: $245,601 owed to a related party and approximately $1.07 million owed to the CEO were converted into notes. The company also issued an additional $80,000 convertible promissory note to the CEO.
- Cash used in operations more than doubled year over year, while cash declined by $68,632 during the quarter.
Guidance, Outlook, Risks and Unusual Items
The filing provides no quantitative revenue, earnings or cash-flow guidance. Management stated that it intends to increase its presence in the IBM marketplace, expand managed services and continue seeking financing, stock issuances and CEO funding as needed. Management also stated that growth, expense reduction, financing availability and profitable operations are necessary to meet obligations.
The financial statements identify substantial liquidity and going-concern risks. The company reported recurring losses, negative working capital, a stockholders’ deficit and only $41,816 of cash. Its ability to continue as a going concern depends on sales growth, reduced operating expenses, additional financing and continued support from CEO and principal shareholder Charles Piluso.
Several related-party notes carry 10% interest and conversion features. Certain notes were in default and subject to additional interest and warrants; maturity dates for three notes were subsequently extended to May 6, 2016. The $350,000 Enterprise Bank principal balance is payable April 30, 2016. Capital lease payments total $807,570 before $71,972 of interest, with $223,869 classified as current.
Disclosure controls and internal control over financial reporting were deemed ineffective because of insufficient accounting expertise and inadequate segregation of duties. The company intends to add financial staff. A former chief operating officer sued the company and its CEO for $67,392 plus statutory damages and legal fees; the company intends to defend the action and assert counterclaims.
The filing reports no equity securities sales or repurchases during the quarter and no defaults upon senior securities during the period, although certain convertible notes were previously in default and subsequently amended.
Important Facts for Investors to Verify
- Whether the company can obtain sufficient financing or continued related-party funding to satisfy near-term obligations and avoid a going-concern failure.
- The terms, maturity dates, accrued interest, default provisions, conversion prices and potential dilution associated with related-party convertible debt, options and warrants.
- The company’s ability to reverse operating cash burn and improve profitability after the customer assignments to the joint venture.
- The status and potential exposure from the former COO litigation.
- Remediation progress for the material weaknesses in accounting expertise, segregation of duties and disclosure controls.
- The filing contains a cash-flow presentation discrepancy: financing cash flow is $26,905 in the statement of cash flows, while MD&A refers to $26,095; the correct amount should be verified against the filed financial statements.
- The potential impairment risk associated with $2.20 million of goodwill and $404,413 of net intangible assets relative to the company’s limited liquidity and continuing losses.