Data Storage Corporation — Form 10-K Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, infrastructure-as-a-service, disaster recovery, business continuity, data backup, high-availability replication, and email archival and compliance solutions. Its principal intellectual property includes Message Logic email archival and analytics software. The company serves healthcare, financial services, government, education, manufacturing, construction, and other industries.
This filing covers the fiscal year ended December 31, 2015, with comparative results for 2014. The audited financial statements received an unqualified opinion from the independent registered public accounting firm. DSC is a smaller reporting company and its common stock trades on the OTCQB under the symbol DTST, with limited trading activity.
Financial Performance and Position
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Net sales | $3.991 million | $4.013 million | Down 0.5% |
| Gross profit | $1.489 million | $1.830 million | Down $341,021 |
| Gross margin | 37.3% | 45.6% | Down 8.3 percentage points |
| Operating expenses | $1.881 million | $2.326 million | Down $445,120 |
| Loss from operations | $(392,270) | $(496,369) | Improved $104,099 |
| Net loss | $(694,340) | $(660,247) | Loss increased $34,093 |
| Net loss available to common shareholders | $(790,353) | $(746,496) | Loss increased $43,857 |
| Basic and diluted loss per share | $(0.02) | $(0.01) | Worsened |
| Cash flow from operations | $88,975 | $(132,799) | Improved $221,774 |
| Cash and cash equivalents | $67,045 | $110,448 | Down $43,403 |
| Working capital deficit | $3.177 million | $2.551 million | Deficit increased $625,688 |
| Stockholders’ deficit | $1.751 million | $1.087 million | Deficit increased $663,832 |
Cost of sales increased to $2.503 million from $2.183 million, primarily because of increased infrastructure services. Management stated that certain customer contracts were assigned to the joint venture and replaced by approximately $350,000 of sales for which DSC earned only a 6.3% margin, although it shared in joint-venture profits.
Operating expense reductions were driven mainly by lower sales and management salaries. Interest expense increased to $287,652 from $166,235, offsetting the operating improvement. The company recorded $4,418 of equity-method income from its 50%-owned joint venture.
At December 31, 2015, total assets were $3.393 million and total liabilities were $5.143 million. Current liabilities of $3.594 million substantially exceeded current assets of $417,107. Significant current obligations included accounts payable and accrued expenses of $1.051 million, convertible related-party debt of $901,924, a $350,000 Enterprise Bank note, a $513,073 preferred dividend payable, and $241,983 of current capital lease obligations.
Material Changes Versus the Prior Comparable Period
- Revenue was essentially flat, but gross margin declined materially because of the shift toward lower-margin infrastructure services and joint-venture-provided sales.
- Operating expenses declined 19.1%, primarily from reduced staffing and compensation.
- Operating loss improved, but higher interest expense and other costs caused net loss to increase.
- Operating cash flow turned positive, but financing cash flow was negative $132,378, largely due to $223,378 of capital lease repayments.
- Cash declined 39.3% to $67,045, while the working capital deficit and stockholders’ deficit remained significant.
- Debt owed to the CEO and other related parties was converted or refinanced into convertible notes. Related-party convertible debt totaled approximately $2.091 million at year-end, including current and long-term amounts.
- The company recognized $126,521 of stock-based compensation and had 6,854,802 options and 133,334 warrants outstanding at year-end, creating potential dilution.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management intended to expand its IBM Power i and email-compliance businesses, leverage its technical capacity, pursue partnerships, and evaluate acquisitions of complementary service providers. Agreements to provide Microsoft 365 and hosted email solutions were expected to support 2016 activity. The filing does not provide quantitative revenue, earnings, or cash-flow guidance.
The financial statements were prepared on a going-concern basis. Management stated that continued operations depend on sales growth, expense reductions, profitable operations, and obtaining sufficient financing to meet obligations. The company has historically relied on funding from its CEO, directors, private placements, and other financing sources, and management expected to continue raising capital as needed.
- Liquidity risk is substantial: cash was $67,045 against a $3.177 million working capital deficit and $5.143 million of total liabilities.
- The $350,000 Enterprise Bank note had principal payable on April 30, 2016.
- Several related-party convertible notes were extended to May 6, 2016; some notes were in default and carried additional interest and warrant obligations.
- Capital lease obligations totaled $588,566, including $241,983 due in 2016.
- The company disclosed material weaknesses in internal control over financial reporting arising from insufficient internal accounting expertise and inadequate segregation of duties. Disclosure controls were therefore considered ineffective.
- The company competes with substantially larger and better-capitalized providers, including IBM, HP Services, SunGard, Symantec, CommVault, Mimecast, and others.
- The prior lawsuit brought by a former chief operating officer was settled confidentially and discontinued. No other material litigation was reported.
- Accrued Series A preferred dividends totaled $513,073. No preferred dividends had been paid.
- The company has federal and state net operating loss carryforwards, but recorded a full valuation allowance and no tax benefit.
- No off-balance-sheet arrangements or subsequent events were reported.
Most Important Facts for Investors to Verify
- Whether DSC can obtain sufficient financing or shareholder support to satisfy near-term debt, lease, and operating obligations.
- The maturity, default status, conversion terms, accrued interest, and potential dilution associated with related-party convertible notes.
- Whether gross margins can recover from the 37.3% level reported for 2015.
- Progress toward remediation of the disclosed material weaknesses in accounting controls.
- The sustainability and profitability of revenue generated through the Secure Infrastructure & Services joint venture.
- The company’s ability to convert its operating cash flow improvement into sustained positive free cash flow.
- The impact of 6.85 million outstanding options, 133,334 warrants, convertible debt, and preferred-stock conversion rights on common-share dilution.
- The limited OTCQB trading market, concentrated ownership, lack of dividends, and resulting difficulty of liquidating an investment.