Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, cloud computing, infrastructure-as-a-service, data backup, disaster recovery, business continuity, email archiving, and compliance solutions to commercial and government customers. The filing covers the three and nine months ended September 30, 2014; financial statements are unaudited and prepared under U.S. GAAP. The company is a smaller reporting company.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | Nine Months 2014 | Nine Months 2013 |
|---|---|---|---|---|
| Sales | $1.014 million | $1.119 million | $3.066 million | $3.466 million |
| Gross profit | $479 thousand | $528 thousand | $1.385 million | $1.497 million |
| Gross margin | 47.2% | 47.2% | 45.2% | 43.2% |
| Operating loss | $(95) thousand | $(157) thousand | $(389) thousand | $(570) thousand |
| Net loss | $(157) thousand | $(213) thousand | $(507) thousand | $(692) thousand |
| Net loss available to common shareholders | $(179) thousand | $(225) thousand | $(571) thousand | $(730) thousand |
| Basic and diluted loss per share | $(0.01) | $(0.01) | $(0.01) | $(0.01) |
For the nine months, operating cash flow was $(63) thousand, compared with $178 thousand provided in the prior-year period. Investing activities used no cash in 2014, versus $200 thousand used in 2013. Financing activities provided $101 thousand, primarily from officer and related-party advances. Cash increased to $125 thousand at September 30, 2014 from $88 thousand at December 31, 2013.
Current assets were $545 thousand and current liabilities were $3.179 million, producing a working-capital deficiency of approximately $2.634 million. Total liabilities were $5.089 million versus total assets of $4.143 million, resulting in stockholders’ deficit of $946 thousand.
Debt and obligations included a $100 thousand revolving credit balance, $350 thousand owed to Enterprise Bank, $843 thousand of capital lease obligations, $700 thousand of current convertible debt owed to related parties, $934 thousand due to an officer, and $240 thousand due to a related party. The revolving facility bears interest at prime plus 0.5% and is secured by company assets and personally guaranteed by the principal shareholder.
Material Changes Versus the Prior Comparable Period
- Q3 sales declined 9.4%, and nine-month sales declined 11.5%, primarily because certain customers were assigned to the joint venture.
- Q3 gross margin was unchanged at 47.2%; nine-month gross margin improved to 45.2% from 43.2%, reflecting lower installation costs and reduced outsourced storage costs as internal capacity increased.
- Operating expenses declined 16.2% in Q3 and 14.2% for the nine months, primarily from lower sales and officer salaries and reduced stock-based compensation.
- The Q3 net loss improved 26.4%, while the nine-month net loss improved 26.7%, but the company remained unprofitable.
- Interest expense increased to $139 thousand for the nine months from $105 thousand, despite lower operating losses.
- The company refinanced outstanding leases into a capital lease beginning May 1, 2014. The former contingent collateral obligation was reclassified as a $350 thousand note payable, with principal due April 30, 2016.
- On September 22, 2014, the company issued 462,395 common shares through a cashless stock-option exercise. Common shares outstanding increased to 36,588,240.
Guidance, Outlook, Risks, and Unusual Items
No quantitative revenue, earnings, or cash-flow guidance is provided. Management stated that it intends to expand its IBM marketplace presence, use increased technical capacity and managed services, and grow its email-archiving business. Management also expects to continue raising capital and receiving funding from CEO and principal shareholder Charles M. Piluso as needed.
The filing states that the company’s ability to continue as a going concern depends on sales growth, expense reductions, obtaining financing, continued related-party support, and achieving profitable operations. The company reported a nine-month net loss attributable to common shareholders of $571 thousand and negative operating cash flow.
- Several related-party convertible notes were in default after maturity and carry additional interest and warrant obligations. Accrued interest was reported on these notes.
- Disclosure controls and internal control over financial reporting were deemed ineffective due to insufficient accounting expertise and inadequate segregation of duties. Management intended to add financial staff.
- The company faces a lawsuit by its former chief operating officer seeking $67,392 plus statutory damages and legal fees for alleged unpaid wages. The company intends to defend the action and pursue counterclaims.
- Goodwill of $2.202 million and net intangible assets of $494 thousand remain significant relative to total assets and are subject to impairment assumptions.
- The filing identifies forward-looking risks involving growth management, financing, operational execution, and changing business conditions.
Facts Investors Should Verify
- Whether sales stabilise after the transfer of certain customers to the joint venture and whether the joint venture generates sufficient economic benefit for DSC.
- The company’s ability to fund its $2.634 million working-capital deficiency and satisfy lease, debt, interest, dividend, and related-party obligations.
- Availability and terms of additional financing, stock issuances, and ongoing advances from the CEO and other related parties.
- Status, maturity extensions, default interest, and potential dilution associated with related-party convertible notes, options, and warrants.
- Remediation of the disclosed material weaknesses in accounting personnel and segregation of duties.
- Potential exposure from the former executive’s lawsuit and any other contingent liabilities.
- Whether goodwill and intangible assets remain recoverable and whether future impairment charges could materially affect results.