Data Storage Corporation 2012 Form 10-K Summary
Business Context and Reporting Period
Data Storage Corporation provides subscription-based cloud storage, disaster recovery, business continuity, data protection, email archiving and compliance solutions for businesses in the United States and Canada. Its services include Infrastructure-as-a-Service, Platform-as-a-Service, high availability replication, backup and recovery, data vaulting and email analytics. The company operates data centers in New York, Massachusetts and Rhode Island and distributes or markets solutions through relationships with IBM, Amazon AWS and Dell.
The filing reports the fiscal year ended December 31, 2012, with comparative results for fiscal 2011. Although the request identifies 2012 Q4, this is an annual Form 10-K rather than a standalone quarterly filing.
Financial Performance and Position
| Metric | 2012 | 2011 | Change |
|---|---|---|---|
| Net sales | $4.018 million | $3.940 million | Up 2% |
| Recurring revenue | $3.794 million | $3.510 million | Up $0.284 million |
| Non-recurring revenue | $0.225 million | $0.431 million | Down $0.206 million |
| Gross profit | $1.303 million | $1.430 million | Down $0.127 million |
| Gross margin | 32.4% | 36.3% | Down 3.9 percentage points |
| Operating expenses | $3.468 million | $3.257 million | Up $0.211 million |
| Loss from operations | $(2.165) million | $(1.827) million | Higher operating loss |
| Net loss | $(2.308) million | $(2.804) million | Improved $0.496 million |
| Net loss available to common shareholders | $(2.358) million | $(2.854) million | Improved $0.496 million |
| Basic and diluted loss per share | $(0.08) | $(0.13) | Improved |
Revenue growth was driven by recurring subscription revenue, but recurring services carried higher costs, reducing gross margin. Operating expenses increased primarily because of higher sales and executive salaries, partly offset by lower sales commissions. The 2012 net loss benefited from the absence of 2011 debt discount amortization, debt extinguishment losses and other settlement charges.
- Cash and cash equivalents declined to $72,756 from $168,490.
- Operating activities used $806,737 of cash, compared with $519,493 used in 2011.
- Investing activities used $106,053, primarily for capital expenditures.
- Financing activities provided $817,056, including $500,000 of common-stock proceeds, $500,000 of convertible debt, and $133,502 of shareholder advances.
- Working capital deficit was $3.064 million, compared with $2.282 million at December 31, 2011.
- Total assets were $5.319 million and total liabilities were $5.196 million at year-end, leaving stockholders’ equity of $123,142.
- Current liabilities included $1.215 million of accounts payable and accrued expenses, $722,658 of deferred revenue, $715,095 of current lease obligations, $365,519 of contingent Message Logic consideration and $212,500 of preferred dividends payable.
- Long-term obligations included $500,000 of related-party convertible debt, $758,320 due to the CEO and $382,572 of long-term lease obligations.
Material Changes Compared with 2011
- Recurring revenue increased 8%, but total revenue increased only 2% because non-recurring revenue declined substantially.
- Gross margin contracted from 36.3% to 32.4% as the revenue mix shifted toward higher-cost recurring services.
- Operating expenses increased 6.5%, including higher sales salaries and executive compensation.
- Net loss improved primarily because 2011 included $753,935 of debt discount amortization, a $142,925 loss on debt extinguishment, a $176,497 gain on settlement of contingent consideration and other unusual items.
- Common shares outstanding increased from 28.913 million to 33.166 million, principally through equity financing, acquisition-related issuance and other stock issuances.
- In October 2012, DSC acquired Message Logic’s email archiving and analytics assets. The transaction involved 725,960 shares, assumed liabilities of $102,109 and contingent consideration of up to $800,000 and 769,230 additional shares.
- DSC entered or expanded strategic relationships with an IBM partner, Amazon AWS, Dell and IBM during 2012 to support IaaS, cloud and email archiving offerings.
Guidance, Outlook, Risks and Unusual Items
Management expects to increase its presence in the IBM marketplace, expand its technical and managed-services capabilities, pursue organic growth and continue evaluating acquisitions of complementary service providers. The filing does not provide quantitative revenue, profit or cash-flow guidance.
The financial statements are prepared on a going-concern basis, but management states that continued operations depend on sales growth, expense reductions, additional financing and achieving profitable operations. DSC has historically relied on funding from its CEO, directors and private stock placements and intends to continue raising capital as needed.
- Cash generation is inadequate to fund operations: operating cash use increased to $806,737 while year-end cash was only $72,756.
- The company has a substantial working-capital deficit and significant near-term lease, debt, payable and preferred-dividend obligations.
- A $500,000 related-party convertible note bears 10% interest, is convertible at $0.85 per share, matures January 31, 2015 and had $45,890 of accrued interest in arrears at year-end.
- Message Logic contingent consideration is recorded at $365,519 as a current liability and could require additional cash and equity issuance if performance metrics are met.
- On February 28, 2013, DSC completed an additional $100,000 related-party convertible debt offering convertible at $0.15 per share.
- Management disclosed material weaknesses in internal control over financial reporting, including insufficient internal accounting expertise and inadequate segregation of duties. Disclosure controls were deemed ineffective as of December 31, 2012.
- Goodwill and intangible assets totaled approximately $3.106 million net, including $2.202 million of goodwill, creating impairment risk if operating performance deteriorates.
- Deferred tax assets are fully reserved; federal and state net operating loss carryforwards were approximately $3.365 million and $3.383 million, respectively.
- The common stock traded on the OTC Bulletin Board with minimal trading volume, and the company cautioned that a liquid market may never develop.
- The company reported no material litigation, no off-balance-sheet arrangements and no material impact from recently adopted accounting standards.
Most Important Facts to Verify
- Verify the company’s ability to obtain additional financing and fund near-term obligations given the $3.064 million working-capital deficit and low cash balance.
- Verify whether recurring-revenue growth can offset lower margins and higher operating expenses.
- Review the terms, maturity, conversion features and accrued interest of related-party debt and shareholder advances.
- Assess the potential cash and equity dilution from Message Logic contingent consideration and outstanding options and warrants.
- Track remediation of the disclosed material weaknesses in accounting expertise, segregation of duties and disclosure controls.
- Evaluate the carrying values of goodwill, customer relationships, software and other intangible assets for impairment risk.
- Confirm the effect of the Message Logic acquisition and the IBM, AWS and Dell relationships on subsequent revenue and cash flow.
- Consider the substantial concentration of voting control and related-party transactions, including rent and amounts owed to the CEO.