Data Storage Corporation — Form 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, cloud computing, infrastructure-as-a-service, disaster recovery, business continuity, email archiving and compliance solutions to commercial and government customers. The company operates data centers and serves industries including healthcare, financial services, education, manufacturing and government.
This report covers the three and six months ended June 30, 2016. The financial statements are unaudited. Data Storage Corporation is a smaller reporting company with 36,588,240 common shares outstanding at June 30, 2016.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2016 | Six Months Ended June 30, 2016 |
|---|---|---|
| Sales | $1,004,613 | $1,989,233 |
| Gross profit | $382,617 | $750,921 |
| Gross margin | 38% | 38% |
| Loss from operations | $(120,846) | $(190,652) |
| Net loss | $(178,777) | $(323,590) |
| Net loss attributable to common stockholders | $(204,955) | $(375,302) |
| Basic and diluted loss per share | $(0.01) | $(0.01) |
| Net cash provided by operating activities | Not provided for the quarter | $113,492 |
Cash and cash equivalents were $76,315 at June 30, 2016, compared with $67,045 at December 31, 2015. Total assets were $3.21 million, while total liabilities were $5.31 million, resulting in stockholders’ deficit of $2.10 million.
Current liabilities were $3.89 million versus current assets of $437,515, producing a working-capital deficiency of $3.45 million. Debt and other obligations included a $99,292 revolving credit facility, a $350,000 bank note, $2.09 million of related-party convertible debt, and $469,344 of capital lease obligations.
Six-month operating cash flow was positive primarily because of noncash charges, including depreciation and amortization, an $85,800 employee-loan write-off and $104,598 of noncash interest expense. Financing activities used $104,222, primarily for capital lease repayments. No investing cash flows were reported.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales decreased 8.6% to $1.00 million, primarily due to lower subscription revenue.
- Six-month sales decreased 3.3% to $1.99 million.
- Gross margin declined to 38% from 39% for both the quarter and six-month period.
- Second-quarter gross profit decreased 10.2% to $382,617, while six-month gross profit decreased 6.8% to $750,921.
- Second-quarter operating expenses were essentially unchanged at $503,463. Six-month operating expenses declined 8.7% to $941,573, primarily from lower salaries and professional fees.
- Second-quarter net loss improved 13% to $178,777, and six-month net loss improved 14% to $323,590, aided by lower operating expenses and interest expense.
- Cash increased by $9,270 from year-end, but the working-capital deficiency increased 8.7% to $3.45 million.
- Net property and equipment declined to $203,242 from $311,466 due to depreciation. The company also wrote off an $85,800 employee loan.
Guidance, Outlook, Risks and Unusual Items
No formal quantitative revenue or earnings guidance is provided. Management stated that it intends to expand its IBM marketplace presence, increase use of its technical and storage capacity, grow managed services and expand email-archiving activities through Message Logic.
Management expressly identified substantial liquidity and going-concern risks. Continuing operations depend on sales growth, expense reductions, profitable operations and obtaining financing. The company has historically relied on funding from its CEO and largest shareholder, directors and equity issuances; management expects the CEO to continue funding the company as needed.
- Several related-party convertible notes are in default, including notes originally due in 2014 or 2015 and a $80,000 note due in February 2016. The company is negotiating remedies.
- The $350,000 bank note is in default; the company is negotiating a possible self-amortizing loan.
- The company has significant near-term obligations, including $249,168 of current capital lease liabilities, $564,785 of dividends payable and $3.89 million of current liabilities.
- Disclosure controls and internal control over financial reporting were deemed ineffective due to insufficient accounting expertise and inadequate segregation of duties. Management intends to add accounting and finance staff.
- Related-party financing creates dependence on management and may result in future interest obligations or equity dilution. The filing reports 7,045,463 outstanding options and 133,334 warrants.
- The company’s deferred tax assets are subject to a full valuation allowance. Goodwill and indefinite-lived intangible assets are subject to impairment testing.
- A former COO’s wage litigation was settled confidentially and discontinued. The company reported no other litigation expected to have a material adverse effect.
- The filing states that there were no defaults upon senior securities during the period, although separate notes disclose defaults on bank and related-party debt; investors should reconcile these disclosures.
Investor Verification Items
- Verify the company’s ability to refinance or otherwise resolve the defaulted bank and related-party obligations.
- Assess whether CEO and other related-party funding will continue and on what terms.
- Reconcile current liabilities, dividend obligations and lease maturities with cash of only $76,315.
- Monitor subscription revenue, gross margin and progress toward profitable operations.
- Review remediation of the material weaknesses in accounting expertise and segregation of duties.
- Evaluate potential dilution from convertible debt, 7.05 million options and 133,334 warrants.
- Review goodwill and intangible-asset impairment assumptions given the company’s recurring losses and stockholders’ deficit.