Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, cloud computing, data backup, disaster recovery, business continuity, email archiving and compliance services. Its offerings include SaaS, IaaS and IBM iSeries-related services, supported by data centers and distribution relationships with IBM, Amazon and Dell. The filing covers the quarter and six months ended June 30, 2013; financial statements are unaudited.
The company continued integrating the October 2012 Message Logic asset acquisition and reported a 50% non-controlling interest in Secure Infrastructure & Services, LLC.
Financial Results and Position
| Metric | Three Months Ended June 30, 2013 | Three Months Ended June 30, 2012 | Six Months Ended June 30, 2013 | Six Months Ended June 30, 2012 |
|---|---|---|---|---|
| Sales | $1.170 million | $1.014 million | $2.347 million | $1.984 million |
| Gross profit | $520 thousand | $232 thousand | $969 thousand | $617 thousand |
| Gross margin | 44% | 23% | 41% | 31% |
| Loss from operations | $(140) thousand | $(754) thousand | $(413) thousand | $(1.268) million |
| Net loss | $(175) thousand | $(790) thousand | $(479) thousand | $(1.340) million |
| Loss available to common shareholders | $(188) thousand | $(802) thousand | $(504) thousand | $(1.365) million |
| Basic and diluted loss per share | $(0.01) | $(0.03) | $(0.01) | $(0.05) |
For the six months ended June 30, 2013, operating cash flow was $134 thousand, compared with $(557) thousand in the prior-year period. Investing cash flow was $(183) thousand, primarily reflecting $168 thousand of capital expenditures and $16 thousand invested in the joint venture. Financing cash flow was $51 thousand, including $100 thousand of convertible debt and $44 thousand of shareholder advances, partly offset by $89 thousand of capital lease repayments. Cash increased by $2 thousand to $75 thousand.
At June 30, 2013, total assets were $5.033 million, including $75 thousand of cash, $252 thousand of accounts receivable, $1.555 million of net property and equipment, and $2.202 million of goodwill. Total liabilities were $5.314 million, resulting in negative stockholders’ equity of $282 thousand. Current liabilities were $3.782 million versus current assets of $429 thousand, producing a working-capital deficit of approximately $3.353 million.
Significant obligations included $1.008 million of capital lease obligations, $600 thousand of related-party convertible debt, $802 thousand owed to the CEO, $186 thousand owed to related parties, $100 thousand under a revolving credit line, $610 thousand of deferred revenue, and $362 thousand of contingent consideration related to the Message Logic acquisition.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 15% and first-half sales increased 19%, driven primarily by higher recurring revenue, Message Logic-related activity, increased customer storage requirements and new sales.
- Second-quarter gross margin improved to 44% from 23%; first-half gross margin improved to 41% from 31%. Management attributed the improvement to lower installation costs and reduced outsourcing of storage as internal capacity increased.
- Operating expenses declined 33% in the second quarter and 27% for the first six months, mainly due to lower sales salaries, executive salaries, professional fees, commissions and stock-based compensation.
- First-half net loss decreased 64% to $479 thousand from $1.340 million, although the company remained unprofitable.
- Operating cash flow changed from a $557 thousand use of cash to $134 thousand of cash provided, but the company’s working-capital deficit increased by approximately $288 thousand from December 31, 2012.
- Accounts receivable increased to $252 thousand from $201 thousand, while prepaid and other current assets decreased to $85 thousand from $185 thousand.
Guidance, Outlook, Risks and Unusual Items
Management did not provide quantified revenue or earnings guidance. Its stated objectives are to grow through direct sales, partnerships and potential acquisitions, particularly in cloud storage, disaster recovery, e-discovery and IaaS, while reducing costs through scale.
The company disclosed substantial going-concern uncertainty. Continued operations depend on sales growth, expense reductions, profitable operations and obtaining financing to meet obligations. Management stated that CEO and largest shareholder Charles M. Piluso and other directors have funded the company and that Mr. Piluso intends to continue providing funding as needed. The company also expects to seek financing and may issue stock.
On February 28, 2013, the company issued a $100 thousand related-party convertible note to a director, convertible at $0.15 per share and bearing 10% interest. Subsequent to quarter-end, on August 13, 2013, the company issued Mr. Piluso a $100 thousand, 10% convertible note due August 13, 2014, together with a warrant to purchase 66,667 shares at $0.15 per share.
Management concluded that disclosure controls and internal control over financial reporting were not effective as of June 30, 2013 because of insufficient accounting expertise and inadequate segregation of duties. The company planned to add finance personnel.
The filing reports no material litigation, no defaults upon senior securities and no material market-risk exposure from interest-rate changes. The company does not use derivative or hedging instruments. Potential dilution included 6.233 million outstanding options and 28,642 warrants, in addition to the subsequent-event warrant.
Important Facts for Investors to Verify
- Whether the company can resolve its approximately $3.353 million working-capital deficit and fund near-term lease, debt, acquisition and operating obligations.
- The availability, timing and terms of additional financing or related-party funding, including potential equity dilution.
- Whether recurring revenue growth and improved gross margins are sustainable after the Message Logic integration.
- The potential cash and stock obligations under the Message Logic contingent consideration arrangement, which permits up to $800 thousand in cash and 769,290 additional shares based on specified performance metrics.
- Progress in remediating the disclosed material weaknesses in accounting expertise and segregation of duties.
- The collectability of accounts receivable and the company’s ability to convert deferred revenue and customer contracts into profitable cash flow.
- The terms and repayment status of related-party balances, the revolving credit line, overdue loan payable and capital lease obligations.
- The company’s ability to achieve profitability, given continuing net losses, negative equity and reliance on external or related-party financing.