Data Storage Corporation — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2013; filed April 15, 2014. The filing reports annual results, not a standalone fourth-quarter period. DSC is a smaller reporting company whose common stock traded on the OTC Bulletin Board under “DTST.”
Business Context
DSC provides cloud storage, cloud computing, disaster recovery, business continuity, high-availability replication, Infrastructure-as-a-Service, and email archival and analytics solutions. Its offerings include Recovery Cloud services, IBM Power i solutions through Secure Infrastructure & Services, LLC, and Message Logic email compliance software. Revenue is primarily generated from recurring subscription and professional-services contracts.
The company continues to pursue organic growth, partnerships, and acquisitions of complementary service providers. Key relationships include IBM, Dell, Amazon Web Services, and Nasdaq OMX. DSC owns a 50% non-controlling interest in Secure Infrastructure & Services, LLC.
Financial Performance and Position
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net sales | $4,576,298 | $4,018,351 | +13.9% |
| Recurring revenue | $4,422,277 | $3,793,609 | +$628,668 |
| Non-recurring revenue | $154,021 | $224,742 | Declined $70,721 |
| Cost of sales | $2,584,161 | $2,715,060 | -$130,899 |
| Gross profit | $1,992,137 | $1,303,291 | +$688,846 |
| Gross margin | 43.53% | 32.4% | Improved 11.1 percentage points |
| Operating expenses | $2,802,961 | $3,468,423 | -$665,462 |
| Loss from operations | $810,824 | $2,165,132 | Improved |
| Net loss | $984,759 | $2,308,045 | Loss reduced $1,323,286 |
| Net loss available to common shareholders | $1,103,070 | $2,358,045 | Loss reduced |
| Basic and diluted loss per share | $0.03 | $0.08 | Improved |
Cost reductions reflected elimination of nonessential employees, greater use of internal storage, lower subcontractor and payroll costs, and closure of the Providence, Rhode Island data center in December 2013. These savings were partly offset by higher utility costs. Interest expense declined to $119,583 from $143,005, while 2013 included $21,917 of debt-discount amortization and a $32,450 loss on the equity-method investment.
Cash Flow, Liquidity, Debt, and Capitalization
- Cash and cash equivalents increased to $87,675 at December 31, 2013 from $72,756.
- Operating activities provided $68,808 of cash, compared with $806,737 used in 2012.
- Investing activities used $40,875, principally for the joint-venture investment and capital expenditures.
- Financing activities used $13,014. Financing sources included $200,000 of convertible debt, $27,596 of common-stock proceeds, and $43,555 of shareholder advances; these were offset by $274,850 of capital-lease repayments.
- Working capital remained substantially negative at $(3,127,247), compared with $(3,064,207) in 2012.
- Total liabilities were $5,047,367 versus total assets of $4,567,794, resulting in stockholders’ deficit of $(479,573), compared with positive equity of $123,142 in 2012.
- Current liabilities included $736,636 of capital-lease obligations, $703,941 of deferred revenue, $356,204 of contingent collateral obligation, $330,811 of accrued preferred dividends, $207,848 due to a related party, and $186,215 of current convertible debt.
- Long-term liabilities included $500,000 of related-party convertible debt, $801,875 due to the CEO, and $86,180 of long-term lease obligations.
- The company had no off-balance-sheet arrangements and no derivative or hedging activities.
Material Changes Versus 2012
- Revenue grew 13.9%, driven by recurring subscriptions and services; equipment-related non-recurring revenue declined.
- Gross margin expanded from 32.4% to 43.53% due primarily to cost restructuring and increased use of internal infrastructure.
- Operating expenses fell 19.2%, led by lower sales salaries, executive compensation, and commissions.
- Net loss improved materially but remained significant at $984,759.
- Common shares outstanding increased to 36,125,845 from 33,165,915, including 2,959,930 shares issued to CEO Charles Piluso in lieu of accrued compensation.
- Stock-based compensation expense was $490,386, and 6,921,084 options and 133,334 warrants were outstanding at year-end.
- The company’s equity position deteriorated from positive equity to a stockholders’ deficit, despite improved operating cash flow.
Guidance, Outlook, Risks, and Unusual Items
Management expects to expand its presence in the IBM marketplace and use its technical capacity, storage infrastructure, and managed-services capabilities to support growth. Management also intends to continue raising capital through stock issuances and relying on funding from CEO and principal shareholder Charles Piluso as needed. No specific revenue, earnings, or cash-flow guidance was provided.
- Going concern: The financial statements assume continuation as a going concern, but management states that continued operations depend on sales growth, expense reductions, profitable operations, and obtaining financing to meet obligations.
- Debt and default risk: A $100,000 related-party convertible note due February 28, 2014 was reported as in default in 2014 and carries additional interest and warrant obligations. Another $100,000 CEO convertible note matured April 30, 2014.
- Related-party dependence: The company owed $801,875 to the CEO, with no interest and no stated repayment terms, and owed approximately $207,848 for rent to an entity controlled by the CEO.
- Contingent acquisition consideration: Message Logic purchase consideration could include up to $800,000 in cash and 769,230 additional shares. The first two 2013 sales benchmarks were not achieved; additional benchmarks remained possible in 2014.
- Legal contingency: Former COO Richard Rebetti sued DSC for $67,392 in alleged unpaid wages, plus statutory damages and legal fees. DSC intends to defend and asserts potential counterclaims.
- Internal controls: Management concluded that disclosure controls and internal control over financial reporting were not effective because of insufficient accounting expertise and inadequate segregation of duties. No auditor attestation was required due to the company’s smaller reporting-company status.
- Market liquidity: The common stock had minimal trading activity and no assurance was provided that a liquid market would develop. The company does not expect to pay common-stock dividends in the foreseeable future.
- Joint venture: Secure Infrastructure & Services reported 2013 net sales of $87,828 and a net loss of $73,212. DSC recognized a $32,450 equity-method loss, limited to its investment balance.
Investor Verification Checklist
- Verify the company’s ability to fund operations given $87,675 of cash, a $3.13 million working-capital deficit, negative stockholders’ equity, and continued net losses.
- Review maturity, default, conversion, interest, and warrant terms for related-party convertible debt and capital leases.
- Assess the sustainability of the 43.53% gross margin and whether 2013 cost reductions can continue without impairing service capacity.
- Evaluate recurring-revenue retention, customer concentration, Message Logic sales performance, and the remaining contingent acquisition obligations.
- Review related-party balances, CEO financing support, rent arrangements, and equity compensation for dilution and governance implications.
- Monitor the Rebetti litigation, internal-control remediation, and any subsequent filings concerning the 2014 debt default.