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RACK > SEC Filings for RACK > Form 10-Q on 20-May-2013All Recent SEC Filings

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Form 10-Q for RACKWISE, INC.


20-May-2013

Quarterly Report


Note 2 - Liquidity, Going Concern and Management's Plans

The Company has incurred substantial recurring losses since its inception. The Company's current strategy is to raise capital and invest that capital in such a way that the Company rapidly grows its market share and revenues, eventually resulting in profits and cash from operations. However, this strategy has required a rapid build-up of infrastructure that initially exacerbated the Company's operating deficit and use of cash in operations, because the expected revenue expansion will lag the investment in infrastructure. The capital that the Company has raised, and likely will continue to raise, will be used to invest in an expanded salesforce, to fund development of the software product, to fund incremental legal and accounting costs associated with being a public company and to fund the Company's operating deficit and general working capital requirements.

During the three months ended March 31, 2013 and the twelve months ended December 31, 2012, the Company generated approximately $460,000 and $4,561,000 in cash from financing activities, respectively, from factoring its receivables and from private offerings of common stock, warrants and debt funding. This capital has permitted the Company to continue its investment in product development and has provided working capital for the Company to win a modest amount of new business throughout 2012. However, the amount of new business generated did not support the Company's increased infrastructure and due to cash constraints the Company was forced to reduce costs until such time that either the anticipated level of revenue materializes or the Company raises sufficient additional capital.

During the three months ended March 31, 2013 and 2012, the Company recorded net losses of approximately $1,959,000 and $2,229,000, respectively. Through cost reduction measures, the Company decreased its net loss despite revenues decreasing to approximately $543,000 from approximately $684,000. During the three months ended March 31, 2013 and 2012, the Company used cash in operating activities of approximately $432,000 and $1,734,000, respectively. As of March 31, 2013, the Company had limited cash of approximately $36,000, a working capital deficiency of approximately $7,461,000, an accumulated deficit of approximately $45,439,000 and owes approximately $1,331,000 for payroll tax liabilities, penalties and interest which has yet to be remitted to the taxing authorities. The Company also continues to incur unpaid payroll tax liabilities for the second quarter of 2013 of approximately $72,000. The IRS has placed federal tax liens that aggregate to approximately $771,000 against the Company in connection with the unpaid payroll taxes through the third quarter of 2012.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 2 - Liquidity, Going Concern and Management's Plans - Continued

Subsequent to March 31, 2013, the Company borrowed an aggregate of $312,535 via short-term interest free loans from a related party (the loans are intended to convert into the securities to be sold by the Company in a subsequent offering; see Note 9 - Subsequent Events). The capital raised in the private placement offerings will be utilized to fund existing operating deficits while the Company continues to develop product line(s) and enhance marketing efforts to increase revenues and eventually generate operating surpluses. The Company believes it will be successful in these efforts; however, there can be no assurance the Company will meet its revenues forecasts or, if necessary, be successful in raising additional debt or equity financing to fund its operations on terms agreeable to the Company. These matters raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if the Company were unable to continue as a going concern. The Company expects that the cash it has available will fund its operations only until June 2013. If the Companyis unable to obtain additional financing on a timely basis and, notwithstanding any request the Company may make, the Company's debt holders do not agree to convert their notes into equity or extend the maturity dates of their notes, the Company may have to delay note and vendor payments and/or initiate cost reductions, which would have a material adverse effect on the Company's business, financial condition and results of operations, and ultimately the Company could be forced to discontinue its operations, liquidate, and/or seek reorganization under the U.S. bankruptcy code.

Note 3 - Significant Accounting Policies

Accounts Receivable and Allowance for Doubtful Accounts

The Company recognizes an allowance for doubtful accounts to ensure that accounts receivable are not overstated due to uncollectibility. At the time accounts receivable are originated, the Company considers a reserve for doubtful accounts based on the creditworthiness of customers. The provision for uncollectible amounts is continually reviewed and adjusted to maintain the allowance at a level considered adequate to cover future losses. The allowance is management's best estimate of uncollectible amounts and is determined based on historical performance that is tracked by the Company on an ongoing basis. During the three months ended March 31, 2013 and 2012, the Company's losses from bad debts were not material. The losses ultimately incurred could differ materially in the near term from the amounts estimated in determining the allowance.

In addition, the Company factors its receivables with full recourse and, as a result, accounts for the factoring akin to a secured borrowing, maintaining the gross receivable asset and due to factor liability on its books and records. In connection with the factoring of its receivables, the Company estimates an allowance for factoring fees associated with the collections. These fees range from 2% to 80% depending on the actual timing of the collection. The actual recognition of such fees may differ from the estimates depending upon the timing of collections. Due to the current tax liens, the Company is currently in default of this factoring arrangement. As such, the factor could demand full repayment of the outstanding balance.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, and reported amounts of revenues and expenses in the consolidated financial statements and the accompanying notes. Actual results could differ from those estimates. The significant estimates and assumptions of the Company are stock-based compensation, the useful lives of fixed assets and intangibles, depreciation and amortization, the allowances for factoring fees and income taxes, and the fair value of derivative liabilities and warrants.

Concentration of Credit Risk and Customers

Financial instruments that potentially expose the Company to concentration of credit risk consist primarily of cash and accounts receivable. The Company's cash is deposited with major financial institutions. At times, such deposits may be in excess of the Federal Deposit Insurance Corporation insurable amount. The Company generally does not require collateral from its customers and generally requires payment in 30 days. The Company evaluates the collectability of its accounts receivable and provides an allowance for potential credit losses as necessary. Historically, such losses have been within management's expectations.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 - Significant Accounting Policies - Continued

Concentration of Credit Risk and Customers - Continued

Revenues derived from customers in the United Kingdom denominated in U.S. dollars were approximately $17,000 and $9,000 during the three months ended March 31, 2013 and 2012, respectively. Revenues derived from customers in Austria denominated in U.S. dollars were approximately $0 and $3,000 during the three months ended March 31, 2013 and 2012 respectively. Revenues derived from customers in Australia denominated in U.S. dollars were approximately $14,000 and $13,000 during the three months ended March 31, 2013 and 2012, respectively. Revenues derived from customers in Canada denominated in U.S. dollars were approximately $3,000 and $2,000 during the three months ended March 31, 2013 and 2012, respectively. All remaining revenues were derived from customers in the United States of America. All of the Company's long-lived assets are located in the United States of America. One customer provided 12% of revenues during the three months ended March 31, 2013 and a different customer provided 19% of revenues during the three months ended March 31, 2012.

As of March 31, 2013, receivables from three customers comprised 32%, 29% and 17% of total receivables, respectively. As of December 31, 2012, receivables from four customers comprised 19%, 17%, 14% and 14% of total receivables, respectively.

Intangible Assets

All of the Company's intangible assets consist of shapes acquired from a graphics designer for the Company's database library that are schematics of specific computer equipment. These shapes, having a finite life are valued at cost and are utilized in the Company's software with multiple customers in order to enable them to visualize and differentiate the specific computer equipment in their overall network. For example, the Company's software's graphical user interface displays a unique shape for each make and model of computer server. Intangible assets are recorded at cost less accumulated amortization. Amortization is computed using the straight-line method over the estimated useful lives of 2.5 years.

Revenue Recognition

In accordance with ASC topic 985-605, "Software Revenue Recognition," perpetual license revenue is recognized when (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the sales price is fixed or determinable; and (iv) collectability is reasonably assured. Delivery is considered to have occurred when title and risk of loss have been transferred to the customer, which generally occurs after a license key has been delivered electronically to the customer. The Company's perpetual license agreements do not (a) provide for a right of return, (b) contain acceptance clauses, (c) contain refund provisions, or (d) contain cancellation provisions.

In the case of the Company's (a) subscription-based licenses, and (b) maintenance arrangements, when sold separately, revenues are recognized ratably over the service period. The Company defers revenue for software license and maintenance agreements when cash has been received from the customer and the agreement does not qualify for recognition under ASC Topic 985-605. Such amounts are reflected as deferred revenues in the accompanying financial statements. The Company's subscription license agreements do not (a) provide for a right of return, (b) contain acceptance clauses, (c) contain refund provisions, or (d) contain cancellation provisions.

The Company provides professional services to its customers. Such services, which include training, installation, and implementation, are recognized when the services are performed. The Company also provides volume discounts to various customers. In accordance with ASC Topic 985-605, the discount is allocated proportionally to the delivered elements of the multiple-element arrangement and recognized accordingly.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 - Significant Accounting Policies - Continued

Revenue Recognition - Continued

For software arrangements with multiple elements, which in its case are comprised of (1) licensing fees, (2) professional services, and (3) maintenance/support, revenue is recognized dependent upon whether vendor specific objective evidence ("VSOE") of fair value exists for separating each of the elements. Licensing rights are generally delivered at time of invoice, professional services are delivered within one to six months and maintenance is for a twelve month contract. Accordingly, licensing revenues are recognized upon invoice, professional services are recognized when all services have been delivered and maintenance revenue is amortized over a twelve month period. The Company determined that VSOE exists for both the delivered and undelivered elements of its multiple-element arrangements. The Company limits its assessment of fair value to either (a) the price charged when the same element is sold separately or (b) the price established by management having the relevant authority. There may be cases, however, in which there is objective and reliable evidence of fair value of the undelivered item(s) but no such evidence for the delivered item(s). In those cases, the selling price method is used to allocate the arrangement consideration, if all other revenue recognition criteria are met. Under the selling price method, the amount of consideration allocated to the delivered item(s) is calculated based on estimated selling prices.

Fair Value of Financial Instruments

The carrying amounts of financial instruments, including cash, accounts receivables, accounts payable, accrued expenses and deferred revenue, approximated fair value as of the balance sheet date presented, because of the relatively short maturity dates on these instruments. The carrying amounts of the financing arrangements issued approximate fair value as of the balance sheet date presented, because interest rates on these instruments approximate market interest rates after consideration of stated interest rates, anti-dilution protection and associated warrants.

Stock-Based Compensation

The Company has an equity plan which allows for the granting of stock options to its employees, directors and consultants for a fixed number of shares with an exercise price equal to the fair value of the shares at date of grant. The Company measures the cost of services received in exchange for an award of equity instruments based on the fair value of the award. For employees and directors, the fair value of the award is measured on the grant date and for non-employees, the fair value of the award is generally re-measured on interim financial reporting dates and vesting dates until the service period is complete. The fair value amount is then recognized over the period services are required to be provided in exchange for the award, usually the vesting period. Since the shares underlying the Company's equity are not currently registered, the fair value of the Company's restricted equity instruments was estimated based on historical observations of cash prices paid for the Company's restricted common stock.

Stock-based compensation for directors is reflected in general and administrative expenses in the consolidated statements of operations. Stock-based compensation for employees and consultants could be reflected in (a) sales and marketing expenses; (b) research and development expenses; or (c) general and administrative expenses in the consolidated statements of operations.

Net Loss Per Common Share

Basic net loss per share is computed by dividing the net loss applicable to common shares by the weighted average number of common shares outstanding during the period. Weighted average shares outstanding for three months ended March 31, 2013 (1) includes the weighted average impact of 9,698,385 shares of common stock issuable as of March 31, 2013 and (2) excludes the weighted average impact of the 3,000,000 shares of common stock being held in escrow (the "Escrowed Shares"). Weighted average shares outstanding for the three months ended March 31, 2012 excludes the weighted average impact of the 3,000,000 escrowed shares. In accordance with the accounting literature, (1) the Company has given effect to the issuance of the issuable stock and the warrants in computing basic net loss per share because the underlying shares are issuable for little or no cash consideration; and (2) the Company has excluded the impact of the Escrowed Shares because they are contingently returnable.

Diluted net loss per common share adjusts basic net loss per common share for the effects of potentially dilutive financial instruments, only in the periods in which such effects exist and are dilutive. At March 31, 2013, outstanding stock options and warrants to purchase 23,008,334 and 70,506,391 shares of common stock, respectively, were excluded from the calculation of diluted net loss per common share because their impact would have been anti-dilutive. At March 31, 2012, outstanding stock options and warrants to purchase 23,275,000 and 49,815,183 shares of common stock were excluded from the calculation of diluted net loss per common share because their impact would have been anti-dilutive.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 - Significant Accounting Policies - Continued

Recent Accounting Pronouncements

In April 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2013-07, "Presentation of Financial Statements (Topic 205) - Liquidation Basis of Accounting." This ASU addresses the requirements and methods of applying the liquidation basis of accounting and the disclosure requirements within Accounting Standards Codification ("ASC") Topic 205 for the purpose of providing consistency between the financial reporting of U.S. GAAP liquidating entities. Generally, this ASU provides guidance for the preparation of financial statements and disclosures when liquidation is imminent. This ASU is effective for periods beginning after December 15, 2013 and is only expected to have an impact on the Company's condensed consolidated financial statements or disclosures if liquidation of the Company became imminent.

Note 4 - Accrued Expenses



Accrued expenses consist of the following:



                             March 31,        December 31,
                                2013              2012
                            (unaudited)

Accrued commissions         $    540,404     $      508,654
Accrued payroll                  293,233            270,551
Accrued payroll taxes(1)       1,330,780          1,099,887
Accrued vacation                 222,113            219,206
Accrued professional fees        128,729             73,607

Total accrued expenses      $  2,515,259     $    2,171,905

(1) Includes accrual for interest and penalties.

Accrued expenses include liabilities for unpaid payroll taxes along with an estimate of related interest and penalties. Through March 31, 2013, the Internal Revenue Service ("IRS") has placed Federal tax liens aggregating approximately $771,000 against the Company in connection with these unpaid payroll taxes.

Note 5 - Notes Payable

5% Note

In December 2008, the Company issued a $50,000 5% note payable (the "5% Note") to a related party that is a greater than 10% beneficial owner. The 5% Note was due in June 2009 and was in default at March 31, 2013 and December 31, 2012. Accrued interest related to the note was $10,767 and $10,151 at March 31, 2013 and December 31, 2012 respectively, which is included in Accrued Interest - Related Parties in the accompanying consolidated balance sheets.

12% Notes - Amended Terms

As of March 31, 2013 and December 31, 2012, $508,945 face value of 12% Notes remained outstanding and were in default. Pursuant to the terms of the Amended 12% Notes, noteholders are entitled to all legal remedies in order to pursue collection and the Company is obligated to bear all reasonable costs of collection. To date, no Amended 12% Note holders have pursued collection.

Accrued interest was $18,074 and $34,510 related to the $176,972 of Amended 12% Notes held by a related party (a director) and the $331,973 of other Amended 12% Notes outstanding at March 31, 2013, respectively. Accrued interest was $12,837 and $24,688 related to the $176,973 of Amended 12% Notes held by a related party (a director) and the $331,973 of other Amended 12% Notes outstanding at December 31, 2012, respectively.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 5 - Notes Payable - Continued

8% Notes

On January 21, 2013, note holders elected to convert $800,000 of 8% Notes plus $33,281 of accrued and unpaid interest into 8,546,480 shares of common stock and a five-year warrant to purchase 8,546,480 shares of common stock at an exercise price of $0.30 per share (the "Conversion Securities"), pursuant to an offer from the Company. The 8% Notes converted into the Conversion Securities at a price equal to $0.0975 (65% of $0.15) per unit, wherein each unit consisted of one share of common stock and a warrant to purchase one share of common stock. As a result of the note conversion, Bridge Warrants to purchase 800,000 shares of common stock had their exercise price adjusted to $0.225 and their term was extended to January 21, 2016. The $1,311,172 aggregate value of the securities issued ($1,281,927 related to the Conversion Securities and $29,200 related to the incremental value of the Bridge Warrants) was credited to equity at conversion. The Company recorded $531,436 of extinguishment loss which represents the incremental value of the securities issued pursuant to the offer as compared to the carrying value of the 8% Notes, accrued interest, plus $53,545 of unamortized debt offering costs. As of March 31, 2013, 8,546,480 shares of common stock were unissued.

There were $150,000 and $950,000 of outstanding 8% Notes, plus $7,167 and $33,832 of accrued interest, at March 31, 2013 and December 31, 2012, respectively.

Note 6 - Equity

Consulting Agreement

On January 7, 2013, the Company entered into a twelve-month agreement for investor relations services. In consideration of the services to be rendered, the Company agreed to provide $75,000 of freely-tradable common stock upon completion of the initial 45-day test campaign. Pursuant to the agreement, upon receipt of the results of the test campaign, future services and payment terms are to be agreed upon by both parties. As of March 31, 2013, the services anticipated under the agreement have yet to have been performed.

Private Offerings

Third Private Offering

During the three months ended March 31, 2013, the Company had two additional closings in connection with a prior private offering that commenced on September 1, 2012 (the "Third Private Offering"), pursuant to which an aggregate of 1,000,000 investor units ("Third Units") were sold at a price of $0.15 per Third Unit, resulting in $129,999 of aggregate net proceeds ($150,000 of gross proceeds less $20,001 of issuance costs). Each Third Unit consists of one share of common stock and a redeemable warrant to purchase one share of common stock. In addition, the placement agent was paid cash commissions of $15,000 (a component of issuance costs) and was issued five-year Third Broker Warrants to purchase 100,000 shares of the Company's common stock at an exercise price of $0.15 per share. The closings resulted in warrants, which are classified within equity, to purchase 201,167 shares of common stock having their exercise price reduced to $0.30 per share, including warrants to purchase 101,167 and 100,000 shares whose original exercise price was $0.625 per share and $1.00 per share, respectively.

The Third Investor Warrants are exercisable for a period of five years at an exercise price of $0.30 per share of common stock, are subject to weighted average anti-dilution protection and possess piggy-back registration rights. The Third Investor Warrants are redeemable at a price of $0.0001 per share upon the provision of adequate notice, if and only if (a) the common stock's average closing bid price exceeds $1.00 for five of any ten consecutive days; and (b) the twenty-day average daily volume exceeds 20,000 shares and there is no more than one single day of no volume. The Third Broker Warrants are identical to the Third Investor Warrants in all material respects except that (i) the resale of the common stock underlying them is not covered by a registration statement; and
(ii) they have an exercise price of $0.15 per share of common stock. The Company determined that all warrants issued in conjunction with the Third Private Offering were equity instruments.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 6 - Equity - Continued

Unissued Common Stock

As of March 31, 2013, the Company had not issued instructions to its transfer agent to issue (a) 8,546,480 shares of common stock to the January 2013 converting noteholders; (b) 426,905 remaining shares of common stock to the November 2012 converting noteholders; and (c) 725,000 shares of common stock due to service providers (of which, 200,000 shares were earned during the three months ended March 31, 2013 and as a result, the Company accrued the equity issuance liability of $24,750 at March 31, 2013 with a corresponding charge to stock-based compensation expense). Subsequent to March 31, 2013, the Company issued 9,398,385 shares of the above unissued shares of common stock.

Stock Warrants



A summary of the stock warrant activity during the three months ended March 31,
2013 is presented below:



                                                                 Weighted
                                                Weighted         Average
                                                Average         Remaining
                               Number of        Exercise           Life         Intrinsic
                                Warrants         Price           In Years         Value

Balance, December 31, 2012      60,541,103     $    0.566
Issued                           9,965,288          0.296
Exercised                                -              -
Cancelled                                -              -
Balance, March 31, 2013         70,506,391     $    0.522 [1]         4.01     $         -

Exercisable, March 31, 2013     70,506,391     $    0.522 [1]         4.01     $         -

[1] - Investor warrants to purchase 150,000 shares of common stock had a variable exercise price as of March 31, 2013. These warrants are excluded from the weighted average exercise price.

The following table presents information related to stock warrants at March 31, 2013:

    Warrants Outstanding               Warrants Exercisable
                                     Weighted
                Outstanding          Average          Exercisable
 Exercise        Number of        Remaining Life       Number of
   Price          Warrants           In Years           Warrants

$     0.150          794,234                 4.60          794,234
      0.225        1,218,808                 2.79        1,218,808
      0.250        1,012,000                 3.54        1,012,000
      0.300       20,529,875                 4.56       20,529,875
      0.375          580,253                 3.75          580,253
      0.625       38,528,720                 3.49       38,528,720
      0.660        6,000,000                 5.65        6,000,000
      1.000        1,692,501                 4.43        1,692,501
   Variable          150,000                 2.40          150,000
. . .
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