Data Storage Corporation — Q1 2016 Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, cloud computing, infrastructure-as-a-service, disaster recovery, data backup, email archiving and compliance solutions to customers in sectors including healthcare, finance, education, government, manufacturing and construction. The company operates data centers in Massachusetts, Rhode Island and New York and maintains a 50% non-controlling interest in Secure Infrastructure & Services, LLC.
This unaudited Form 10-Q covers the three months ended March 31, 2016, with comparative results for the three months ended March 31, 2015. The company is a smaller reporting company and had 36,588,240 common shares outstanding at March 31, 2016.
Financial Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Sales | $984,620 | $958,133 | +3% |
| Gross profit | $368,304 | $379,236 | -$10,932 |
| Gross margin | 37% | 40% | -3 percentage points |
| Operating loss | $(69,806) | $(148,630) | Improved $78,824 |
| Net loss | $(144,813) | $(171,101) | Improved $26,288 |
| Net loss attributable to common shareholders | $(170,347) | $(194,215) | Improved $23,868 |
| Basic and diluted loss per share | $(0.00) | $(0.01) | Not meaningful |
| Cash flow from operations | $72,071 | $(94,727) | Improved $166,798 |
| Cash flow from financing | $(59,176) | $26,095 | Declined $85,271 |
| Cash and cash equivalents, period-end | $79,940 | $41,816 | +$38,124 |
Revenue increased primarily from higher subscription revenue, while cost of sales increased faster than revenue because of higher infrastructure service costs. Selling, general and administrative expense declined 17% to $438,110, primarily due to lower executive salaries and professional fees. Interest expense declined to $67,428 from $73,972.
At March 31, 2016, total assets were $3.28 million, total liabilities were $5.19 million and stockholders’ deficit was $1.91 million. Current assets were $385,747 versus current liabilities of $3.71 million, resulting in a working capital deficiency of $3.32 million, up 4% from December 31, 2015.
Significant obligations included $99,292 outstanding under a revolving credit facility, a $350,000 bank note due April 30, 2016, $2.09 million of related-party convertible debt, and $529,390 of capital lease obligations, including $245,549 classified as current.
Material Changes Versus the Prior Comparable Period
- Sales grew 3%, but gross profit declined 3% and gross margin contracted from 40% to 37%.
- Operating expenses decreased $89,756, or 17%, including a $47,131 reduction in executive salaries and an $18,829 reduction in professional fees.
- Operating loss and net loss improved despite lower gross profit.
- Operating cash flow changed from a $94,727 use of cash to a $72,071 source of cash, primarily reflecting changes in accounts receivable and accounts payable and accrued expenses.
- Financing cash flow was negative because of $59,176 in capital lease repayments; the prior-year period included $80,000 of convertible debt issuance.
- The equity-method investment generated a $9,087 loss in Q1 2016 versus $51,500 of income in Q1 2015.
Guidance, Outlook, Risks and Unusual Items
Management did not provide quantified financial guidance. Management stated that it intends to increase its presence in the IBM marketplace, expand managed services and grow its email-archiving business through Message Logic. Management also indicated that future acquisitions, if pursued, could be funded with working capital and financing proceeds.
The financial statements include a going-concern uncertainty. Continued operations depend on sales growth, reduced operating expenses, profitable operations and obtaining sufficient financing. The company has historically relied on funding from its CEO and largest shareholder and stated that he intends to continue funding the company as needed. Management also expects to raise funds through stock issuances and other financing.
Liquidity risk is significant given the $3.32 million working capital deficiency, negative stockholders’ equity, limited cash balance and debt maturities. Several related-party convertible notes were in default or had accrued unpaid interest; certain maturity dates were extended to May 6, 2016. The bank note principal of $350,000 was payable April 30, 2016. The filing reports no defaults upon senior securities during the quarter and no subsequent events.
Management concluded that disclosure controls and internal control over financial reporting were not effective as of March 31, 2016 because of insufficient accounting expertise and inadequate segregation of duties. Management stated that it intends to add financial staff resources.
The former chief operating officer’s lawsuit seeking $67,392 plus statutory damages and legal fees was settled confidentially, with a stipulation of discontinuance filed. The company disclosed no other material pending litigation. Potential dilution included 7,104,802 outstanding options and 133,334 warrants.
Important Facts for Investors to Verify
- Whether the company repaid, refinanced or otherwise resolved the $350,000 bank note due April 30, 2016.
- Whether the related-party convertible notes due or extended to May 6, 2016 were repaid, converted or further extended.
- The company’s ability to obtain additional financing and continued support from its CEO and related parties.
- Progress in remediating the identified material weaknesses in accounting expertise and segregation of duties.
- Whether subscription revenue growth can offset infrastructure cost increases and restore gross margins.
- The carrying value and future impairment risk of $2.20 million of goodwill and $342,774 of net intangible assets.
- Potential dilution from outstanding options, warrants and convertible debt.