Data Storage Corporation 2014 Form 10-K Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, infrastructure-as-a-service, disaster recovery, business continuity, high-availability replication, email archiving and analytics services. Its principal offerings include Recovery Cloud services, IBM Power i infrastructure services through Secure Infrastructure & Services LLC, and Message Logic email archival software.
The filing covers the fiscal year ended December 31, 2014, with comparative results for the year ended December 31, 2013. The consolidated financial statements were audited by Rosenberg Rich Baker Berman & Company, which issued an unqualified opinion dated March 31, 2015.
Financial Metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net sales | $4.013 million | $4.576 million | Down 12.4% |
| Gross profit | $1.830 million | $2.051 million | Down 10.8% |
| Gross margin | 45.6% | 45.5% | Up slightly |
| Operating loss | $496,369 | $810,824 | Improved $314,455 |
| Net loss | $660,247 | $984,759 | Improved $324,512 |
| Net loss available to common shareholders | $746,496 | $1.103 million | Improved $356,574 |
| Basic and diluted loss per share | $0.01 | $0.03 | Improved |
| Cash flow from operating activities | $(132,799) | $23,764 | Declined $156,563 |
| Cash and cash equivalents | $110,448 | $87,675 | Up $22,773 |
Operating expenses declined to $2.326 million from $2.862 million, primarily due to lower sales salaries, executive salaries and employee commissions. Interest expense increased to $166,235 from $119,583. The company recorded $15,699 of equity-method income from its 50% interest in Secure Infrastructure & Services LLC, compared with a $32,450 loss in 2013.
Total assets were $3.794 million and total liabilities were $4.880 million at December 31, 2014. Stockholders’ deficit increased to $1.087 million from $480,000. Working capital deficit was $2.551 million, compared with $3.127 million in 2013.
Debt, Liquidity and Capital Resources
- Current liabilities totaled $2.895 million, including $700,000 of related-party convertible debt, $470,267 of deferred revenue, $417,060 of accrued preferred dividends, $245,601 due to a related party and $220,544 of current lease obligations.
- Long-term liabilities totaled $1.985 million, including $1.066 million due to the CEO, $568,959 of long-term capital lease obligations and a $350,000 Enterprise Bank note payable.
- The company’s capital lease refinancing created total lease obligations of $789,502, payable through 2018.
- Financing activities provided $155,572 of cash, including $263,887 in advances from a shareholder and $37,753 in related-party funding, partially offset by lease repayments and contingent consideration payments.
- Management stated that it expects to continue raising capital through stock issuances and relying on funding from CEO and principal shareholder Charles M. Piluso as needed.
- The financial statements are prepared on a going-concern basis. Management stated that continuation depends on sales growth, expense reductions, additional financing and achieving profitable operations.
Material Changes Versus the Prior Period
- Revenue decreased 12.4%, which management attributed primarily to the assignment of certain customers to the joint venture during 2013–2014.
- Gross margin was broadly stable despite lower revenue, helped by lower installation costs and reduced outsourced storage costs as internal storage capacity increased.
- Operating expenses declined by approximately $536,000 based on the consolidated statements, mainly due to lower compensation costs.
- Net loss improved by approximately $325,000, but the company remained unprofitable and operating cash flow became negative.
- Cash increased modestly despite negative operating cash flow because of shareholder advances and other financing activities.
- Accounts receivable declined to $114,556 from $258,567, while deferred revenue declined to $470,267 from $703,941.
- Convertible debt and related-party obligations increased materially, while the company’s stockholders’ deficit worsened.
The filing contains a comparative cost-of-sales discrepancy: the MD&A section reports 2013 cost of sales of $2,584,161, while the consolidated statements report $2,524,911. The consolidated statements imply 2013 gross profit of $2,051,387 and a 44.8% gross margin, whereas management describes the 2013 gross margin as 45.53%. Investors should reconcile these figures to the filed financial statements.
Guidance, Outlook, Risks and Unusual Items
Management described a strategy focused on expanding the IBM marketplace, increasing technical capacity and managed services, developing channel partnerships and pursuing synergistic acquisitions. No quantified revenue, earnings or cash-flow guidance was provided.
- Going-concern risk: The company has recurring losses, negative working capital, negative stockholders’ equity and dependence on external and related-party financing.
- Debt default risk: The company defaulted on two related-party convertible notes in 2014. The notes carried additional interest and additional warrant provisions upon default; maturity dates were extended through February 28, 2015.
- Related-party dependence: The company owed the CEO $1.066 million in non-interest-bearing advances and owed a CEO-controlled entity approximately $246,000 for data-center rent.
- Internal controls: Management concluded that disclosure controls and internal control over financial reporting were not effective because of insufficient GAAP accounting expertise and inadequate segregation of duties. The company planned to add financial staff.
- Litigation: A former chief operating officer sued for $67,392 of alleged unpaid wages plus statutory damages and legal fees. The company intends to defend the action and assert counterclaims.
- Competition: The company competes with substantially larger and better-funded providers, including IBM, HP Services, SunGard, Symantec, Mimecast, Barracuda and others.
- Equity dilution: At December 31, 2014, 6.281 million options and 133,334 warrants were outstanding. The company also had 1.155 million shares available for future grants under its equity plans.
- Preferred dividends: Accrued and unpaid preferred dividends reached $417,060 at year-end and have not been paid.
- Subsequent events: The board authorized $121,924 of new convertible debt and $1.189 million of convertible debt to the CEO to retire accounts payable and document existing obligations, respectively.
Investor Verification Checklist
- Reconcile the cost-of-sales and gross-margin discrepancies between MD&A and the consolidated statements.
- Assess the company’s ability to fund operations, lease payments and maturing debt without continued CEO advances or new equity or convertible-debt financing.
- Review the terms, maturity status, default provisions and potential dilution from related-party convertible notes and warrants.
- Evaluate the material weaknesses in internal controls and whether remediation has been implemented.
- Review the going-concern disclosures and the company’s forecast liquidity under lower revenue or delayed customer payments.
- Consider the effect of accrued preferred dividends, stock options, warrants and subsequent convertible debt on common-stock dilution and priority.
- Monitor the former COO litigation and the company’s related-party leases and advances.