Data Storage Corporation — Q1 2014 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, compliance, and infrastructure-as-a-service solutions to commercial and government customers. The filing covers the three months ended March 31, 2014, compared with the three months ended March 31, 2013. The interim financial statements are unaudited.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Sales | $1.043 million | $1.176 million | Down 11.3% |
| Gross profit | $422,055 | $449,064 | Down 6.0% |
| Gross margin | 40.5% | 38.2% | Up 2.3 percentage points |
| Operating expenses | $550,030 | $721,395 | Down 23.8% |
| Loss from operations | $(127,975) | $(272,331) | Improved |
| Net loss | $(167,454) | $(304,093) | Improved 44.9% |
| Net loss attributable to common shareholders | $(187,940) | $(316,593) | Improved |
| Basic and diluted loss per share | $(0.01) | $(0.01) | No stated change |
- Cash and cash equivalents increased to $146,458 from $87,675 at December 31, 2013.
- Operating activities used $33,689 of cash; investing activities used $3,318, primarily for capital expenditures; financing activities provided $95,790, primarily from officer and related-party advances.
- Working capital deficiency was $3.575 million at March 31, 2014, versus $3.127 million at December 31, 2013.
- Total assets were $4.490 million and total liabilities were $5.123 million, resulting in stockholders’ deficit of $632,699.
- Current liabilities were $4.195 million, including $693,653 of current convertible related-party debt, $817,690 of current lease obligations, $688,688 of deferred revenue, and $350,000 of contingent collateral obligations.
- The company owed $903,869 to its CEO under advances with no interest and no stated repayment terms.
- Interest and debt-discount expense totaled approximately $39,479 for the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue declined $133,215 because certain customers were assigned to the joint venture during 2013.
- Cost of sales declined $106,206, reflecting lower installation costs and reduced outsourcing of storage as internal capacity increased.
- Gross margin expanded from 38.2% to 40.5%.
- Operating expenses declined $171,364, primarily because of lower sales salaries, executive salaries, and sales commissions.
- Net loss improved by $136,639, although the company remained unprofitable.
- Cash generation remained dependent on financing: financing inflows exceeded operating and investing cash uses by $58,783.
- Convertible related-party debt classified as current increased to $693,653 from $186,215 at year-end, while long-term convertible related-party debt declined from $500,000 to zero.
Outlook, Risks, Contingencies, and Unusual Items
- Management plans to expand its IBM marketplace presence, use increased technical and storage capacity, grow managed services, and expand email archiving through Message Logic.
- No quantitative revenue or earnings guidance was provided.
- Management states that continued operation depends on sales growth, expense reductions, additional financing, and achieving profitable operations. The CEO intends to continue funding the company as needed.
- The company has a material working capital deficiency and recurring losses, creating substantial liquidity and going-concern risk.
- A $100,000 convertible note issued in February 2013 was in default in 2014, triggering additional interest of 5% annually and additional warrants of 10% for each year in default. The filing text does not clearly state the outstanding balance after default-related adjustments.
- The company has significant near-term obligations, including capital lease payments of $817,690 due in the twelve months ending March 31, 2015, and convertible debt maturities or accrued interest obligations.
- The company is defending a former COO’s lawsuit seeking $67,392 plus statutory damages and legal fees for alleged unpaid wages. Management states it intends to defend the matter and believes it has counterclaims.
- Disclosure controls and internal control over financial reporting were deemed ineffective because of insufficient accounting expertise and inadequate segregation of duties. Management plans to add financial staff.
- The company has 6,921,084 options outstanding and 133,334 warrants outstanding at March 31, 2014, creating potential dilution.
Important Facts for Investors to Verify
- Whether the company can fund operations and meet substantial current liabilities without continued CEO advances, equity issuance, or other financing.
- The status, maturity, default terms, accrued interest, and potential dilution associated with all convertible related-party debt.
- Whether revenue losses from customers assigned to the joint venture are recurring and whether the joint venture can generate offsetting economic benefits.
- Whether the improved gross margin and lower operating expenses are sustainable.
- The amount and timing of required capital lease, loan, contingent collateral, and lease payments.
- The potential financial impact of the former COO litigation and any other contingencies.
- Remediation of the disclosed material weaknesses in internal control and whether future filings may require corrections or restatements.