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RACK > SEC Filings for RACK > Form 10-Q on 19-Aug-2013All Recent SEC Filings

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Form 10-Q for RACKWISE, INC.


19-Aug-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 infrastructure, 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 six months ended June 30, 2013 and the twelve months ended December 31, 2012, the Company generated approximately $1,486,000 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 the first six months of 2013. 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 six months ended June 30, 2013 and 2012, the Company recorded net losses of approximately $3,244,000 and $4,901,000, respectively. Through cost reduction measures, the Company decreased its net loss during the six months ended June 30, 2013 despite revenues decreasing to approximately $964,000 from approximately $1,877,000 in the prior period. During the six months ended June 30, 2013 and 2012, the Company used cash in operating activities of approximately $1,332,000 and $3,283,000, respectively. As of June 30, 2013, the Company had limited cash of approximately $162,000, a working capital deficiency of approximately $8,368,000, an accumulated deficit of approximately $46,724,000 and owes approximately $1,377,000 for payroll tax liabilities, penalties and interest which has yet to be remitted to the taxing authorities. 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 June 30, 2013, the Company completed one closing of a private placement offering in which the Company sold $190,925 of units at a price of $10,000 per unit. Each unit consists of (i) $10,000 principal amount of one year, 12% secured convertible promissory notes and (ii) a five-year warrant to purchase 267 shares of common stock at a price of $3.00 per share at any time after the maturity date of the notes. On August 14, 2013, the Company borrowed $250,000 via a short-term interest free loan from an affiliate. The loan is intended to convert into the Units Offering. The capital raised in the private placement offering 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 September 2013. If the Company is 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 and six months ended June 30, 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 condensed 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 convertible financial instruments.

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

One customer provided 50% and 39% of revenues during the three and six months ended June 30, 2012, respectively. There were no revenue concentrations during the three and six months ended June 30, 2013. All of the Company's long-lived assets are located in the United States of America.

As of June 30, 2013, receivables from four customers comprised 43%, 27%, 14% and 10% 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.

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.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 3 - Significant Accounting Policies - Continued

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 are estimated based on historical observations of cash prices paid for the Company's restricted common stock, when such sales are evident.

Stock-based compensation for directors is reflected in general and administrative expenses in the condensed 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 condensed 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 and six months ended June 30, 2013 (1) includes the weighted average impact of 1,000 shares of common stock issuable as of June 30, 2013 and (2) excludes the weighted average impact of the 10,000 shares of common stock being held in escrow (the "Escrowed Shares"). Weighted average shares outstanding for the three and six months ended June 30, 2012 excludes the weighted average impact of the Escrowed Shares. In accordance with the accounting literature, (1) the Company has given effect to the issuance of the issuable stock 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 June 30, 2013, outstanding stock options and warrants to purchase 69,480 and 292,384 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 June 30, 2012, outstanding stock options and warrants to purchase 74,028 and 169,173 shares of common stock were excluded from the calculation of diluted net loss per common share because their impact would have been anti-dilutive.

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.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 4 - Accrued Expenses



Accrued expenses consist of the following:



                              June 30,        December 31,
                                2013              2012
                            (unaudited)

Accrued commissions         $    546,754     $      508,654
Accrued payroll                  297,263            270,551
Accrued payroll taxes(1)       1,377,207          1,099,887
Accrued vacation                 211,760            219,206
Accrued professional fees         46,570             73,607

Total accrued expenses      $  2,479,554     $    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 June 30, 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"). The 5% Note was due in June 2009 and was in default at June 30, 2013 and December 31, 2012. Accrued interest related to the 5% Note was $11,390 (included in Accrued Interest) and $10,151 (included in Accrued Interest - Related Parties) at June 30, 2013 and December 31, 2012, respectively. The holder was no longer a greater than 10% beneficial owner at June 30, 2013.

12% Notes - Amended Terms

As of June 30, 2013 and December 31, 2012, $508,945 face value of 12% convertible promissory notes (the "Amended 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 $67,811 and $24,688 related to the Amended 12% Notes outstanding at June 30, 2013 and December 31, 2012, respectively. Accrued interest - related parties was $12,837 related to the $176,972 of Amended 12% Notes held by a related party (a director) outstanding at December 31, 2012. The director resigned during the second quarter of 2013.

8% Notes

On January 21, 2013, note holders elected to convert $800,000 of 8% convertible notes (the "8% Notes) plus $33,281 of accrued and unpaid interest into 28,489 shares of common stock and a five-year warrant to purchase 28,489 shares of common stock at an exercise price of $90.00 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 $29.25 (65% of $45.00) 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 2,667 shares of common stock had their exercise price adjusted to $67.50 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.

There were $150,000 and $950,000 of outstanding 8% Notes, plus $10,156 and $33,832 of accrued interest, at June 30, 2013 and December 31, 2012, respectively. See Note 9 - Subsequent Events regarding the conversion of $100,000 of the 8% Notes. The remaining $50,000 of 8% Notes is past due as of the filing date and is ranked senior to the Offering Notes. During the three and six months ended June 30, 2013, the Company recorded amortization of deferred financing costs of $2,518 and $13,960, respectively.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 5 - Notes Payable - Continued

Short-Term Loans

On April 12, May 15, and May 30, 2013, the Company borrowed $112,500, $200,035 and $150,035, respectively, via short-term interest free loans from a principal shareholder (the "Short-Term Loans"). On June 11, 2013, the Short-Term Loans were converted into the Units Offering. See below for details.

Units Offering

During the six months ended June 30, 2013, the Company had two closings of a private offering that commenced on June 11, 2013, pursuant to which the Company sold an aggregate of $2,146,960 in units at a price of $10,000 per unit to Navesink RACK, LLC and Black Diamond Financial Group LLC and their affiliates (collectively, the "Purchasers" and the Company's principal shareholders) (the "Units Offering"). The Company is offering up to $5,000,000 in units. Each unit (an "Offering Unit") consists of (i) $10,000 principal amount of 12% secured convertible promissory notes (the "Offering Notes") and (ii) a five-year warrant to purchase 267 shares of common stock at a price of $3.00 per share at any time after the maturity date of the Offering Notes (the "Offering Warrants"), such that the Purchasers were issued Offering Warrants to purchase an aggregate of 57,253 shares of common stock. There was $2,146,960 of Offering Notes, plus $11,354 of accrued interest, outstanding at June 30, 2013.

The closings of the Units Offering resulted in aggregate net proceeds of $622,000 ($2,146,960 of gross proceeds less $1,146,570 of debt conversions less $378,390 of financing costs). Issuance costs of $378,390 were capitalized as deferred financing costs and are being amortized over the term of the Offering Notes. During the three and six months ended June 30, 2013, the Company recorded amortization of deferred financing costs of $15,766. The closings included the conversion of $1,146,570 of Company debt ($462,570 of Short-Term Loans and $684,000 previously owed to the Company's factor which was assumed by an affiliate) incurred by the Company or assumed by the Purchasers during the second quarter of 2013. See Note 9 - Subsequent Events for details of closings subsequent to June 30, 2013.

The Offering Notes mature one year from the date of issuance. Pursuant to an amended agreement, the Purchasers may, individually, on a one-time basis, as the result of making a collective investment in excess of $1,500,000 in the aggregate, at any time during the term of the Offering Notes, convert the Offering Notes, including all accrued interest due thereon, into 1,275,629 shares (collectively 2,551,258 shares) of the Company's common stock (the "Conversion Shares") which represents 42.5% each (collectively 85%) of the Company's issued and outstanding common shares as of August 2, 2013, the date of the Reverse Split. The Company is in the process of increasing the Company's authorized common stock from 1,000,000 shares to 300,000,000 shares, which has already been approved by the Company's Board of Directors and a majority of the Company's common stockholders. By agreement, the Purchasers will each receive 50% of the Conversion Shares without regard to their respective subscription amounts. The Purchasers may determine to convert the Offering Notes prior to the completion of the offering. In such event, subscriptions for additional Offering Units otherwise issuable to the Purchasers in connection with subsequent subscriptions will be treated as contributions to capital. In conjunction with such a conversion and the issuance of the Conversion Shares, the Offering Warrants shall be cancelled.

Pursuant to the terms of the Unit Offering, each Purchaser will either (a) utilize the conversion option (to obtain 1,275,629 shares of the Company's common stock) or (b) will retain the Offering Warrants; but each Purchaser cannot avail itself of both. The Company determined that the embedded conversion options were equity instruments and should not be bifurcated and accounted for as a derivative. Accordingly, a debt discount of $189,961 was established (with a credit to additional paid-in capital), which represents the greater of the relative fair value of the Offering Warrants or the beneficial conversion feature attributable to the conversion option. The debt discount is being amortized over the term of the Offering Notes. During the three and six months ended June 30, 2013, the Company recorded amortization of debt discount of $7,915.

As collateral security for the Company's obligations under the Offering Notes and related documents executed in connection with the offering, the Company and Visual Network Design, Inc., a Delaware corporation and the Company's wholly-owned subsidiary ("VNDI"), granted the Purchasers a security interest in all of the Company's and VNDI's assets pursuant to the terms of a security agreement, dated as of June 11, 2013 (the "Security Agreement"). To further secure the Company's obligations, VNDI executed a guaranty, dated as of June 11, 2013 (the "Guaranty"), pursuant to which VNDI agreed to guaranty the Company's obligations owed to the Purchasers. The Offering Notes are junior in priority to the Company's indebtedness to its factor, trade debt and a $50,000 8% Note.

Rackwise, Inc. and Subsidiary

Notes to Condensed Consolidated Financial Statements

(unaudited)

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 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 June 30, 2013, the services anticipated under the agreement have yet to have been performed and no shares have been issued.

Private Offerings

Third Private Offering

During the six months ended June 30, 2013, the Company had two additional closings in connection with a prior private offering that commenced on September . . .

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