Data Storage Corporation 10-Q Summary
Business Context and Reporting Period
Data Storage Corporation provides cloud storage, cloud computing, disaster recovery, business continuity, data backup, email archiving and compliance solutions to business and government customers. The company operates data centers and sells recurring subscription services and related professional services. The filing covers the quarter and nine months ended September 30, 2013, compared with the corresponding 2012 periods. The company is a smaller reporting company, and the interim financial statements are unaudited.
Key Financial Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Sales | $1.119 million, up 10.5% | $3.466 million, up 15.6% |
| Gross profit | $527,873 | $1.497 million |
| Gross margin | 47.2%, versus 37.8% | 43.2%, versus 33.4% |
| Loss from operations | $157,484 | $570,018 |
| Net loss | $212,655 | $692,027 |
| Net loss attributable to common shareholders | $225,155 | $729,527 |
| Basic and diluted loss per share | $0.01 loss | $0.02 loss |
| Net cash provided by operating activities | Not separately provided | $143,267 |
Cash and cash equivalents were $61,608 at September 30, 2013, compared with $72,756 at December 31, 2012. Total assets were $4.793 million and total liabilities were $5.240 million, resulting in negative stockholders’ equity of $447,916. Current liabilities were $3.806 million versus current assets of $410,000. The filing describes a working-capital deficiency of $3.396 million; the stated percentage comparison to December 31, 2012 is internally unclear.
Debt and financing obligations included $100,292 under a revolving credit facility, $47,312 of loans payable, $677,289 of convertible debt including related-party debt, $899,195 of capital lease obligations, $357,757 of contingent acquisition consideration, and $775,651 due to an officer. The revolving facility is secured by company assets and personally guaranteed by the principal shareholder.
Material Changes Versus the Prior Comparable Period
- Revenue increased $106,419, or 10.5%, in the third quarter and $468,897, or 15.6%, for the nine-month period, primarily from increased recurring revenue.
- Gross profit increased $145,012 in the quarter and $496,683 for the nine-month period. Management attributed the margin improvement to lower installation costs and reduced reliance on outsourced storage as internal capacity increased.
- Operating expenses declined 4.1% in the quarter and 20.5% for the nine-month period, reflecting lower sales salaries, executive compensation, commissions and professional fees.
- Net loss improved by 42.3% in the quarter and 59.5% for the nine-month period. The company nevertheless remained unprofitable.
- Operating cash flow improved from $814,284 used in the first nine months of 2012 to $143,267 provided in the first nine months of 2013.
- Investing activities used $200,348, including $179,048 of capital expenditures and $21,300 invested in a joint venture.
- Cash declined by $11,148 during the first nine months of 2013, compared with a $15,492 increase in the prior-year period.
- The company issued $200,000 of convertible debt during the first nine months, including $100,000 issued to a director and $100,000 issued to the CEO. Each note bears 10% interest, is convertible at $0.15 per share and was issued with warrants.
- The company recognized a $17,452 share of loss from its 50%-owned joint venture, which had not contributed a loss in the prior-year period.
Guidance, Outlook, Risks and Unusual Items
Management did not provide quantitative revenue or earnings guidance. Its stated priorities were to expand in the IBM marketplace, increase technical and storage capacity, expand email archiving through the Message Logic acquisition, grow direct sales and partner channels, and pursue acquisitions of complementary service providers.
Management disclosed substantial going-concern risk. Continued operations depend on sales growth, expense reductions, obtaining financing, continued support from the CEO and directors, and achieving profitable operations. The CEO, who is also the largest shareholder, has funded the company and indicated an intention to continue funding it as needed. Management also expects to seek additional financing and stock issuances.
The company reported material weaknesses in internal control over financial reporting, including insufficient internal accounting expertise and inadequate segregation of duties. Management concluded that disclosure controls and internal control over financial reporting were not effective as of September 30, 2013, and stated that it intends to add financial staff resources.
Other risks include limited liquidity, significant current obligations, related-party balances, capital lease payments of $747,713 due within the following twelve months, reliance on financing and related-party support, and potential dilution from 6,232,992 outstanding options and 161,976 outstanding warrants. The filing states that no material litigation was pending and that there were no defaults upon senior securities.
Investor Verification Checklist
- Verify the company’s ability to fund near-term obligations, particularly the $747,713 current capital lease liability and other current liabilities of $3.806 million.
- Assess whether recurring revenue growth and improved gross margins are sustainable and sufficient to achieve profitability.
- Review the going-concern disclosure and the company’s dependence on CEO and director financing or future equity and debt issuances.
- Confirm the terms, maturity dates, conversion provisions and dilution impact of the related-party convertible notes and warrants.
- Evaluate the negative stockholders’ equity and the reported working-capital deficiency; the filing’s stated percentage change appears inconsistent with the disclosed dollar amounts.
- Monitor remediation of the disclosed material weaknesses in accounting expertise and segregation of duties.
- Review goodwill, customer-list and other intangible assets totaling approximately $2.922 million net, together with the assumptions supporting impairment testing.