Data Storage Corp - Quarter Report: 2014 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

¨  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to ___________

Commission File No. 001-35384

DATA STORAGE CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:   (212) 564-4922

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x    No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes x    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company filer. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨    No x

As of November 14, 2014, 36,588,240 shares of common stock, par value $0.001 per share, were outstanding.

DATA STORAGE CORPORATION

FORM 10-Q

September 30, 2014

INDEX

PART I

ITEM 1.       Financial Statements

DATA STORAGE CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these condensed consolidated financial statements.

DATA STORAGE CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

DATA STORAGE CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated financial statements.

DATA STORAGE CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013

Note 1 - Basis of Presentation, Organization and Other Matters

Headquartered in Garden City, N.Y., Data Storage Corporation (“DSC” or the “Company”) offers its solutions to businesses within the healthcare, banking and finance, distribution services, manufacturing, construction, education, and government industries.

DSC derives revenues from long term subscription services and professional services related to implementation of cloud based services providing businesses in the education, government and healthcare industries protection of critical data, as well as, compliance for the clients email . In 2009 revenues consisted primarily of offsite data backup, de-duplication, continuous data protection and Cloud Disaster Recovery solutions, protecting information for our clients. In 2010 DSC expanded its solutions based on the asset acquisition of SafeData. In 2012 DSC continued to assimilate organizations, expanded its technology as well as technical group and positioned the new organization for growth.  In October 2012 DSC purchased the email archive and data analytics software and assets of Message Logic. DSC has equipment for cloud storage and cloud computing in our data centers in Illinois, Massachusetts, New Jersey, and New York. DSC delivers its solutions over highly reliable, redundant and secure fiber optic networks with separate and diverse routes to the Internet. The network and geographical diversity is important to clients seeking storage hosting and disaster recovery solutions, ensuring protection of data and continuity of business in the case of a network interruption. 

Condensed Consolidated Financial Statements

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q.  The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results of operations for the full year. The condensed consolidated balance sheet at December 31, 2013 was derived from audited consolidated financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. The other information in these condensed consolidated financial statements is unaudited but, in the opinion of management, reflects all adjustments necessary for a fair presentation of the results for the periods covered. All such adjustments are of a normal recurring nature unless disclosed otherwise. These condensed consolidated financial statements, including notes, have been prepared in accordance with the applicable rules of the Securities and Exchange Commission and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and additional information as contained in our Annual Report on Form 10-K for the year ended December 31, 2013.

Liquidity

The financial statements have been prepared using accounting principles generally accepted in the United States of America applicable for a going concern, which assumes that the Company will realize its assets and discharge its liabilities in the ordinary course of business. For the nine months ended September 30, 2014, the Company has generated revenues of $3,066,263 but has incurred a net loss attributed to common shareholders of $571,316. Its ability to continue as a going concern is dependent upon achieving sales growth, reduction of operation expenses and ability of the Company to obtain the necessary financing to meet its obligations and pay its liabilities arising from normal business operations when they come due, and upon profitable operations. The Company has been funded by the Mr. Charles M. Piluso, the Company’s Chief Executive Officer (“CEO”) and largest shareholder since inception as well as several Directors. It is the intention of Mr. Piluso to continue to fund the Company on an as needed basis.

Note 2 - Summary of Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its subsidiary, Data Storage Corporation, a Delaware Corporation.  All significant inter-company transactions and balances have been eliminated in consolidation.

Equity Investments

Equity investments in which the Company exercises significant influence but does not control and is not the primary beneficiary are accounted for using the equity method. The Company's share of its equity method investee’s earnings or losses are included in other income in the accompanying Condensed Consolidated Statements of Operations.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.

Estimated Fair Value of Financial Instruments

The Company's financial instruments include cash, accounts receivable, accounts payable, line of credit and due to related parties. Management believes the estimated fair value of these accounts at September 30, 2014 approximate their carrying value as reflected in the balance sheets due to the short-term nature of these instruments or the use of market interest rates for debt instruments. The carrying values of certain of the Company’s notes payable and capital lease obligations approximate their fair values based upon a comparison of the interest rate and terms of such debt given the level of risk to the rates and terms of similar debt currently available to the Company in the marketplace.

Goodwill and Other Intangibles

In accordance with GAAP, the Company tests goodwill and other intangible assets for impairment on at least an annual basis.  Goodwill impairment exists if the net book value of a reporting unit exceeds its estimated fair value.  The impairment testing is performed in two steps: (i) the Company determines impairment by comparing the fair value of a reporting unit with its carrying value, and (ii) if there is an impairment, the Company measures the amount of impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill.  To determine the fair value of these intangible assets, the Company uses many assumptions and estimates using a market participant approach that directly impact the results of the testing.  In making these assumptions and estimates, the Company uses industry accepted valuation models and set criteria that are reviewed and approved by various levels of management. 

In September 2011, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2011-08, "Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment", to allow entities to use a qualitative approach to test goodwill for impairment. ASU 2011-08 permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is necessary to perform the currently prescribed two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. The Company adopted ASU 2011-08 in fiscal 2013 and thus performed a qualitative assessment. This adoption did not have a material impact on the Company's condensed consolidated financial statements.

Revenue Recognition

The Company’s revenues consist principally of cloud storage and cloud computing revenues, SaaS and IaaS. Storage revenues consist of monthly charges related to the storage of materials or data (generally on a per unit basis).  Sales are generally recorded in the month the service is provided.  For customers who are billed on an annual basis, deferred revenue is recorded and amortized over the life of the contract. Set up fees charged in connection with storage contracts are deferred and recognized on a straight line basis over the life of the contract.

Net Income (Loss) Per Common Share

In accordance with FASB ASC 260-10-5 Earnings Per Share, basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income (loss) adjusted for income or loss that would result from the assumed conversion of potential common shares from contracts that may be settled in stock or cash by the weighted average number of shares of common stock, common stock equivalents and potentially dilutive securities outstanding during each period. The inclusion of the potential common shares to be issued have an anti-dilutive effect on diluted loss per share and therefore they are not included in the calculation. Potentially dilutive securities at  September 30, 2014 include 5,065,147 options and 133,334 warrants.

Note 3 - Property and Equipment

Property and equipment, at cost, consist of the following:

Depreciation expense for the nine months ended September 30, 2014 and 2013 was $348,287 and $430,091, respectively. Depreciation for the three months ended September 30, 2014 and 2013 was $115,394 and $155,673, respectively.

Note 4 - Goodwill and Intangible Assets

Goodwill and intangible assets consisted of the following:

Scheduled amortization over the next five years as follows:

Amortization expense for the nine months ended September 30, 2014 and 2013 was $164,629 and $183,744 respectively. Amortization expense for the three months ended September 30, 2014 and 2013 was $44,864 and $61,248, respectively.

Note 5 – Investment in At Equity

The Company has a 50% non-controlling ownership interest in Secure Infrastructure & Services, LLC providing infrastructure-as-a-Service (IaaS) for IBM iSeries and AIX v7 systems, Power HA services and network infrastructure hardware and services as needed to support the IaaS and PowerHA implementation and ongoing needs for customers and services sold under the Company. ASC 810 requires the Company to evaluate non-consolidated entities periodically and as circumstances change to determine if an implied controlling interest exists. During fiscal 2013, the Company evaluated this equity investment and concluded that this is a variable interest entity and the Company is not the primary beneficiary. Secure Infrastructure & Services, LLC's fiscal year end is December 31.

The following presents unaudited summary financial information for Secure Infrastructure & Services, LLC. Such summary financial information has been provided herein based upon the individual significance of this unconsolidated equity investment to the consolidated financial information of the Company.

The investment balance carried on the Company's balance sheet amounts to $20,595 as of September 30, 2014.

The Company's share of the net income from Secure Infrastructure & Services, LLC for the nine months ended September 30, 2014 was $20,595.

Note 6 – Capital Lease Obligations

The Company entered into a new lease agreement with Systems Trading, Inc. on May 1, 2014 to refinance all outstanding leases into one capital lease. This lease obligation is payable to Systems Trading, Inc. with monthly installments of $21,826 from June 1, 2014 through May 1, 2018 .This lease is secured with the computer equipment and has been capitalized. Pursuant to Accounting Standards Codification (“ASC”) 470-50-40, Debt Modifications and Extinguishments-Derecognition, the Company determined that modification accounting applied to the refinancing. The new capital lease obligation has an effective interest rate of 7.22%.

Future minimum lease payments under the capital leases are as follows:

Long-term obligations under capital leases at September 30, 2014 mature as follows:

The assets held under the capital leases are included in property and equipment as follows:

Note 7 - Commitments and Contingencies

Revolving Credit Facility

On January 31, 2008 the Company entered into a revolving credit line with a bank. The credit facility provides for $100,000 at prime plus .5%, 3.75% at September 30, 2014, and is secured by all assets of the Company and personally guaranteed by the Company’s principal shareholder. As of September 30, 2014, the Company owed $100,292 under this agreement.

Contingent Collateral Obligation

In connection with the 2012 acquisition of Message Logic, LLC, the Company acquired software subject to a UCC filing in the amount of $350,000 plus accrued interest. The Company believes that it will pay this lien regardless of whether they are required to pay any of the contingent purchase price and accordingly the liability has been recorded on the Company’s balance sheet. On September 5, 2014, the Company entered into an agreement whereby the Company will make payments of all arrears of interest over 7 months at $3,910 per month. In addition, the Company has agreed to make monthly interest payments of $1,553 per month with the principal balance of $350,000 payable on April 30, 2016. Upon signing of this agreement the contingent collateral obligation became classified as a note payable as opposed to its original contingent collateral obligation on the condensed balance sheet.

Operating Leases

The Company currently leases office space in Garden City, NY, and Warwick, RI and data centers in Westbury, NY and Waltham, MA.

The Company leases a data center in Westbury, NY on a month to month basis. Monthly rent is $1,500, plus utilities and the lease is with the Chairman of the Company.

The Company leases space in a data center in Waltham, MA. The lease calls for monthly payments under an annually renewable contract for space and services. The payments are approximately $29,000 per month depending upon services used and the original contract terms were renewed to September 30, 2015.  

The lease for office space in Garden City, NY calls for escalating monthly payments ranging from $6,056 to $6,617 plus a portion of the operating expenses through June 2014. This lease was renewed for an additional year through June 30, 2015 at the rate of $6,617 per month.

The Company leases space in a data center in Warwick, RI. This lease commenced on February 1, 2014 and continues through January 31, 2019.

Minimum obligations under these lease agreements are as follows:

Rent expense for the nine months ended September 30, 2014 and September 30, 2013 was $91,641 and $113,732, respectively. Rent expense for the three months ended September 30, 2014 and September 30, 2013 was $34,177 and $40,661, respectively.

Note 8 - Related Party Transactions

Due to related party represents rent accrued to a partnership controlled by Mr. Piluso for the New York Data Center. The rent expense for the data center is $1,500 per month plus electric service.

As of September 30, 2014 the Company owed Mr. Piluso $934,459. These advances bear no interest and have no stated terms of repayment.  

Note 9 – Convertible debt

Related Party

On January 31, 2012 the Company entered into a $500,000 convertible promissory note with a director of the Company. The note is convertible into the Company’s common stock at $0.85 per share and carries interest at 10%. Interest is payable quarterly through the maturity date of January 31, 2015. DSC has accrued interest on this note totaling $133,287 and is in arrears on its interest payments.

On February 28, 2013 the Company entered into a $100,000 convertible promissory note with a director of the Company carries interest at 10%. Interest is payable quarterly through the maturity date of February 28, 2014. The Company issued 66,667 warrants valued at of $17,851 which was recorded as a discount to the convertible promissory note. The note is convertible into common stock at $0.15 per share. In 2014, the Company defaulted on this note and is subject to additional interest of 5% per annum as well as additional 10% warrants for each year in default. DSC has accrued interest on this note totaling $15,863. Subsequent to the original maturity date the note was extended through February 28, 2015.

On August 9, 2013, the Company entered into a $100,000 convertible promissory note with the CEO of the Company. The convertible promissory note is convertible at $0.15 and carries interest at 10%. Interest is payable quarterly through the maturity date of April 30, 2014. The Company issued 66,667 warrants valued at $17,851 in connection with this agreement, which was recorded as a discount to the convertible promissory notes based on its relative fair value with an offset to additional paid in capital. In 2014, the Company defaulted on this note and is subject to additional interest of 5% per annum as well as the additional 10% warrants for each year in default. DSC has accrued interest on this note totaling $11,192. Subsequent to the original maturity date the note was extended through February 28, 2015.

Note 10 - Stockholders’ Equity

On September 22, 2014 the Company issued 462,395 shares of its common stock under a cashless stock option exercise.

Capital Stock

The Company has 260,000,000 shares of capital stock authorized, consisting of 250,000,000 shares of common stock, par value $0.001, 10,000,000 shares of Series A Preferred Stock, par value $0.001 per share.

Common Stock Options

2008 Equity Incentive Plan

In October 2008, the Company’s board of directors (the “Board”) adopted, the 2008 Equity Incentive Plan (the “2008 Plan”).  Under the 2008 Plan, we may grant options (including incentive stock options) to purchase our common stock or restricted stock awards to our employees, consultants or non-employee directors. The 2008 Plan is administered by the Board. Awards may be granted pursuant to the 2008 Plan for 10 years from the date the Board approved the 2008 Plan. Any grant under the 2008 Plan may be repriced, replaced or regranted at the discretion of the Board. From time to time, we may issue awards pursuant to the 2008 Plan.  

The material terms of options granted under the 2008 Plan (all of which have been nonqualified stock options) are consistent with the terms described in the footnotes to the "Outstanding Equity Awards at Fiscal Year-End December 31, 2011”, including 5 year graded vesting schedules and exercise prices equal to the fair market value of our common stock on the date of grant.  Stock grants made under the 2008 Plan have not been subject to vesting requirements. The 2008 Plan was terminated with respect to the issuance of new awards as of February 3, 2012.  There are 2,435,414 options outstanding under this plan as of September 30, 2014.

2010 Incentive Award Plan

The Company has reserved 2,000,000 shares of common stock for issuance under the terms of the Data Storage Corporation 2010 Incentive Award Plan (the “2010 Plan”). The 2010 Plan is intended to promote the interests of the Company by attracting and retaining exceptional employees, consultants, directors, officers and independent contractors (collectively referred to as the “Participants”), and enabling such Participants to participate in the long-term growth and financial success of the Company. Under the 2010 Plan, the Company may grant stock options, which are intended to qualify as “incentive stock options” under Section 422 of the Internal Revenue Code of 1986, as amended, non-qualified stock options, stock appreciation rights and restricted stock awards, which are restricted shares of common stock (collectively referred to as “Incentive Awards”). Incentive Awards may be granted pursuant to the 2010 Plan for 10 years from the Effective Date.  From time to time, we may issue Incentive Awards pursuant to the 2010 Plan.  Each of the awards will be evidenced by and issued under a written agreement.  

On April 23, 2012, the Board of Directors of the Company amended and restated the Data Storage Corporation 2010 Plan. The 2010 Plan, as amended and restated, has been renamed the “Amended and Restated Data Storage Corporation Incentive Award Plan”.  The new plan provides for flexibility in vesting periods and includes a limit of $100,000 per employee per year for incentive stock options.

There are 3,845,146 options outstanding under this plan as of September 30, 2014. 

There are 1,154,854 shares available for future grants under the plans.

A summary of the Company's option activity and related information follows:

Share-based compensation expense for options totaling $111,423 and $174,375 was recognized in our results for the nine months ended September 30, 2014 and 2013, respectively is based on awards vested. Share-based compensation expense for options totaling $36,833 and $58,125 was recognized in our results for the three months ended September 30, 2014 and 2013, respectively is based on awards vested.

The valuation methodology used to determine the fair value of the options issued during the year was the Black-Scholes option-pricing model. The Black-Scholes model requires the use of a number of assumptions including volatility of the stock price, the average risk-free interest rate, and the weighted average expected life of the options.

The risk-free interest rate assumption is based upon observed interest rates on zero coupon U.S. Treasury bonds whose maturity period is appropriate for the term of the warrants and is calculated by using the average daily historical stock prices through the day preceding the grant date.

Estimated volatility is a measure of the amount by which the Company’s stock price is expected to fluctuate each year during the expected life of the award. The Company’s estimated volatility is an average of the historical volatility of peer entities whose stock prices were publicly available. The Company’s calculation of estimated volatility is based on historical stock prices of these peer entities over a period equal to the expected life of the awards. The Company uses the historical volatility of peer entities due to the lack of sufficient historical data of its stock price.

As of September 30, 2014, there was $171,886 of total unrecognized compensation expense related to unvested employee options granted under the Company’s share-based compensation plans that is expected to be recognized over a weighted average period of approximately 1.7 years.

Common Stock Warrants

A summary of the Company's warrant activity and related information follows:

Note 11 - Litigation

The Company has been named as a defendant in a lawsuit filed in New York State Supreme Court, Nassau County, by Richard Rebetti, the Company's former Chief Operating Officer.  In the lawsuit, Rebetti v. Data Storage Corp. and Charles M. Piluso, Rebetti asserts claims for unpaid wages in the amount of $67,392 plus statutory damages and counsel fees.  The Company intends to vigorously defend against this action and believes that it has counterclaims against Rebetti, and intends to interpose same in the action.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward looking statements, including without limitation, statements related to our plans, strategies, objectives, expectations, intentions and adequacy of resources. Investors are cautioned that such forward-looking statements involve risks and uncertainties including without limitation the following: (i) our plans, strategies, objectives, expectations and intentions are subject to change at any time at our discretion; (ii) our plans and results of operations will be affected by our ability to manage growth; and (iii) other risks and uncertainties indicated from time to time in our filings with the Securities and Exchange Commission.

In some cases, you can identify forward-looking statements by terminology such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘could,’’ ‘‘expects,’’ ‘‘plans,’’ ‘‘intends,’’ ‘‘anticipates,’’ ‘‘believes,’’ ‘‘estimates,’’ ‘‘predicts,’’ ‘‘potential,’’ or ‘‘continue’’ or the negative of such terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We are under no duty to update any of the forward-looking statements after the date of this report.

Company Overview

DSC has re-positioned from our 2001 launch date. From the beginning we focused on assisting businesses in their disaster recovery to business continuity plans. We continue to pivot, but with our same mission. Protecting our client’s data, ensuring business continuity, assisting in their compliance requirements and assisting our clients in better control over their information. We continue to stay on top of this dynamic industry with new solutions and services. Today, the Company owns intellectual property with our email archival and data analysis software, Message Logic. We provide Recovery Clouds for Managed Service Providers, so that these companies can enter the industry of providing Disaster Recovery and Business Continuity solutions at a lower entry point. Our IBM solutions continue to grow with our legacy solutions and our newly formed joint venture, Secure Infrastructure and Services LLC, leading the way for Infrastructure as a Service on IBM’s Power i systems and our cloud services.

DSC, is a 13 year veteran in cloud storage and cloud computing, providing data protection, disaster recovery, business continuity and compliance solutions that assist organizations in protecting their data, minimizing downtime and ensuring regulatory compliance. Serving the rapidly emerging business continuity market, DSC’s clients save time and money, gain more control and better access to data and enable high level of security for that data. Solutions include: Infrastructure-as-a-Service, data backup, recovery and restore, high availability data replication services; email archive and compliance solutions for e-discovery; continuous data protection; data de-duplication; and virtualized system recovery. DSC has forged relationships with leading organizations for distribution such as Amazon AWS, VMware, and IBM to name a few.

Headquartered in Garden City, NY, DSC offers its solutions and services to businesses within the healthcare, banking and finance, distribution services, manufacturing, construction, education, and government.

DSC derives its revenues from the sale and subscription of services and solutions DSC has equipment in several technical centers: New York Metro, Boston, Chicago and New Jersey. Clients are supported from staffed technical offices in New York and Rhode Island, which consist of modern offices and a technology suite adapted to meet the needs of a technology based business.

DSC varies its use of resource, technology and work processes to meet the changing opportunities and challenges presented by the market and the internal customer requirements.

RESULTS OF OPERATIONS

For the three months ended September 30, 2014 as compared to the three months ended September 30, 2013

Net Sales. Net sales for the three months ended September 30, 2014 were $1,014,129, a decrease of $104,903, or 9.4%, compared to $1,119,032 for the three months ended September 30, 2013. The decrease is attributable to the assignment of certain customers to the joint venture during 2014.

Cost of Sales. For the three months ended September 30, 2014, cost of sales were $535,392, a decrease of $55,767, or 9.4%, compared to $591,159 for the three months ended September 30, 2013. The decrease in cost of sales is the result of lower installation costs for non-recurring sales and lower outsourcing of storage due to the Company’s increased internal storage capacity. DSC's gross margin is 47.2% for the three months ended September 30, 2014 as compared to 47.2% for the three months ended September 30, 2013. For the three months ended September 30, 2014, software development costs were $18,000, a decrease of $18,000 or 50%, as compared to $36,000 for the three months ended September 30, 2013 due to an allocation to research and development expenses of $12,000 of the monthly payment to Zojax.

Operating Expenses. For the three months ended September 30, 2014, operating expenses were $574,047, a decrease of $111,310, or 16.2%, as compared to $685,357 for the three months ended September 30, 2013. The majority of the decrease in operating expenses for the three months ended September 30, 2014 is a result of decrease in salaries. Sales salaries decreased $41,195 to $37,618 for the three months ended September 30, 2014, as compared to $78,813 for the three months ended September 30, 2013. Officer’s salaries decreased $45,465 to $57,986 for the three months ended September 30, 2014, as compared to $103,451 for the three months ended September 30, 2013.

Other Income (Expense). Interest income for the three months ended September 30, 2014 increased $18 to $18 from $0 for the three months ended September 30, 2013. Interest expense for the three months ended September 30, 2014 increased $22,371 to $62,333 from $39,962 for the three months ended September 30, 2013. Gain on equity method investment increased $16,266 to $1,057 for the three months ended September 30, 2014 from ($15,209) for the three months ended September 30, 2013.

Net Loss. Net loss for the three months ended September 30, 2014 was ($156,568) a decrease of $56,087, or 26.4%, as compared to net loss of ($212,655) for the three months ended September 30, 2013.

For the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013

Net Sales. Net sales for the nine months ended September 30, 2014 were $3,066,263, a decrease of $399,311, or 11.5%, compared to $3,465,574 for the nine months ended September 30, 2013. The decrease is attributable to the assignment of certain customers to the joint venture during 2013-2014.

Cost of Sales. For the nine months ended September 30, 2014, cost of sales were $1,681,658, a decrease of $287,281, or 14.6%, compared to $1,968,939 for the nine months ended September 30, 2013. The decrease in cost of sales is the result of lower installation costs for non-recurring sales and lower outsourcing of storage due to the Company’s increased internal storage capacity. The Company's gross margin is 45.2 % for the nine months ended September 30, 2014 as compared to 43.2 % for the nine months ended September 30, 2013.

Operating Expenses. For the nine months ended September 30, 2014, operating expenses were $1,774,044 a decrease of $292,609, or 14.2%, as compared to $2,066,653 for the nine months ended September 30, 2013. The majority of the decrease in operating expenses for the nine months ended September 30, 2014 is a result of decrease in salaries. Sales salaries decreased $148,596 to $186,143, as compared to $334,739 for the nine months ended September 30, 2013. Officer’s salaries expense decreased $92,413 to $199,104, as compared to $291,517 for the nine months ended September 30, 2013. Sales commission expense decreased $5,765 to $35,175, as compared to $40,940 for the nine months ended September 30, 2013. Stock based compensation decreased $62,953 to $111,423 for the nine months ended September 30, 2014 as compared to $174,376 for the nine months ended September 30, 2013.

Other Income (Expense). Interest income for the nine months ended September 30, 2014 increased $27 to $42 from $15 for the nine months ended September 30, 2013. Interest expense and related debt discounts for the nine months ended September 30, 2014 increased $34,017 to $138,589 from $104,572 for the nine months ended September 30, 2013. Gain on equity method investment increased $38,047 to $20,595 for the nine months ended September 30, 2014 from ($17,452) for the nine months ended September 30, 2013.

Net Loss. Net loss for the nine months ended September 30, 2014 was ($507,391) a decrease of $184,636, or 26.7%, as compared to net loss of ($692,027) for the nine months ended September 30, 2013.

LIQUIDITY AND CAPITAL RESOURCES

The financial statements have been prepared using accounting principles generally accepted in the United States of America applicable for a going concern, which assumes that the Company will realize its assets and discharge its liabilities in the ordinary course of business. The Company has been funded by the CEO and largest shareholder combined with private placements of the Company’s stock. The Company has been successful in raising money as needed. Further it is the intention of management to continue to raise money through stock issuances and to fund the Company on an as needed basis. During 2014, we intend to continue to work to increase our presence in the IBM marketplace utilizing our increased technical expertise, capacity for data storage and managed services and expand our presence in the email archiving marketplace through our acquisition of Message Logic.

To the extent we are successful in growing our business, identifying potential acquisition targets and negotiating the terms of such acquisition, and the purchase price includes a cash component, we plan to use our working capital and the proceeds of any financing to finance such acquisition costs. Our opinion concerning our liquidity is based on current information. If this information proves to be inaccurate, or if circumstances change, we may not be able to meet our liquidity needs.

During the nine months ended September 30, 2014 the Company’s cash increased $37,329 to $125,004, from $87,675 at December 31, 2013. Net cash of ($63,367) was used by the Company’s operating activities. No cash was used in investing activities. Net cash of $100,696 was provided by the Company’s financing activities, primarily due to the officer and related party advances of $132,584.

The Company's working capital deficiency was $2,634,254 at September 30, 2014, decreasing $492,993 or 15.8% from $3,127,247 at December 31, 2013. This is principally due to the restructuring of the Company’s long term capital lease obligations and contingent collateral obligation.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

Interest due on DSC’s loans is based upon the applicable stated fixed contractual rate with the lender. Interest earned on DSC’s bank accounts is linked to the applicable base interest rate. For the nine months ended September 30, 2014 and nine months ended September 30, 2013, DSC had interest including amortization of debt discounts and expense, net of interest income, of approximately $117,952 and $122,009, respectively. DSC believes that its results of operations are not materially affected by changes in interest rates.

DSC’s exposure to market risk is confined to its cash and cash equivalents, all of which have maturities of less than three months and bear and pay interest in U.S. dollars. Since DSC invests in highly liquid, relatively low yield investments, we do not believe interest rate changes would have a material impact on us.

DSC does not hold any derivative instruments and does not engage in any hedging activities.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

As of the end of the period covered by this Report, under the supervision and with the participation of DSC’s management, including its principal executive officer and principal financial officer, DSC conducted an evaluation of its disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, DSC’s principal executive officer and principal financial officers have concluded that DSC’s disclosure controls and procedures are not effective to ensure that information required to be disclosed by DSC in the reports it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s (the “SEC”) rules based on the material weakness described below.

The material weaknesses identified during management’s assessment were (i) a lack of sufficient internal accounting expertise to provide reasonable assurance that our financial statements and notes thereto are prepared in accordance with GAAP and (ii) a lack of segregation of duties to ensure adequate review of financial statement preparation. In light of these material weaknesses, management has concluded that, as of September 30, 2014, DSC did not maintain effective internal control over financial reporting. As defined by the Public Company Accounting Oversight Board Auditing Standard No. 5, a material weakness is a deficiency or a combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected. In order to ensure the effectiveness of DSC’s disclosure controls in the future DSC intends on adding financial staff resources to our accounting and finance department.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Changes in Internal Control Over Financial Reporting.

There have been no changes in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

Except as set forth below we are currently not involved in any litigation that we believe could have a materially adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our company or any of our subsidiaries, threatened against or affecting DSC, its common stock, any of its subsidiaries or of DSC’s or DSC’s subsidiaries’ officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.

The Company has been named as a defendant in a lawsuit filed in New York State Supreme Court, Nassau County, by Richard Rebetti, the Company's former Chief Operating Officer. In the lawsuit, Rebetti v. Data Storage Corp. and Charles M. Piluso , Index No. 14-2504, Rebetti asserts claims for unpaid wages in the amount of $67,392 plus statutory damages and counsel fees. The Company intends to vigorously defend against this action and believes that it has counterclaims against Rebetti, and intends to interpose same in the action.

Item 1A. Risk Factors.

As a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act, we are not required to provide the information required by this Item.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

During the year ended December 31, 2013 the Company issued 2,959,930 shares of the Company’s common stock, $0.001 par value per share (the “Common Stock) at a price of $0.09 for an aggregate of $266,393. The shares were issued to Charles M. Piluso, Chief Executive Officer in lieu of accrued salary compensation for 2012 and 2013.

Item 3. Defaults Upon Senior Securities.

There were no defaults upon senior securities during the period ended September 30, 2014.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information.

On February 21, 2014, Richard Rebetti Jr. resigned as Director of the Company.  Mr. Rebetti’s resignation was not the result of any disagreements with management.

On June 24, 2014, Jan Burman resigned as Director of the Company as a result of lack of time to commit to the Company and other Board affiliations.  Mr. Burman’s resignation was not the result of any disagreements with management.

On August 14, 2014, Biagio Civale resigned as Director of the Company. Mr. Civale’s resignation was not the result of any disagreements with the Company on any matter relating to the Company’s operations, policies or practices.

On October 12, 2014, Todd Correll was appointed by the Company to serve as a director of the Company.

There is no understanding or arrangement between Mr. Correll and any other person pursuant to which he was appointed as a director.  Mr. Correll does not have any family relationship with any director, executive officer or person nominated or chosen by us to become a director.  Mr. Correll has not had direct or indirect material interest in any transaction or proposed transaction, in which the Company was or is a proposed participant, exceeding $120,000.

Mr. Correll has served as the CEO of North American Telecommunications Corporation, a Florida Corporation, d/b/a Broadsmart, from 2001 through the present.

Item 6. Exhibits

(a) Exhibits

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.