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RACKWISE, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and the accompanying notes included elsewhere in this Annual Report. References in this Management's Discussion and Analysis of Financial Condition and Results of Operations to "us," "we," "our," and similar terms refer to Rackwise, Inc., a Nevada corporation. This discussion includes forward-looking statements, as that term is defined in the federal securities laws, based upon current expectations that involve risks and uncertainties, such as plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors. Words such as "anticipate," "estimate," "plan," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," and similar expressions are used to identify forward-looking statements. We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. See "Note Regarding Forward-Looking Statements." Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors discussed in "Risk Factors" and elsewhere in this Annual Report. Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise. Overview We are a software development, sales and marketing company. We create applications based on the Microsoft operating system for network infrastructure administrators that provide for the modeling, planning and documentation of data centers. Our Data Center Management (DCIM) software product, Rackwise®, is used by over 125 companies worldwide. Our product provides a multi-layered set of solutions for reporting on the multiple aspects of a company's data center, including power consumption, power efficiency, carbon footprint, green grid and density requirements. This reporting allows customers to plan data center expansions and contractions as well as equipment usage more energy efficiently and cost effectively. Our product's advanced design and ability to tightly interface with other new technologies, like Intel's newest proprietary computer chips, enables it to collect more real-time information (real-time means instantaneous and continuous) associated with more data center equipment usage than products from our competitors. We intend to continue to take advantage of new technologies that will add to our competitive differentiators. 17 We have released Rackwise DCiM X.1, the latest version of our product. This new release will allow our customers to effectively manage their datacenter assets at a macro level, as well as providing real time power and thermal monitoring and management for individual servers, groups of servers, racks and IT equipment such as PDUs in their data centers. Rackwise DCiM X, is designed as a multi-layered approach to data center infrastructure management. Each layer addresses the specific needs of the various functions associated with operating a data center. Our solution provides visibility into critical and core data center operations and the underlying physical infrastructure and their associated resource costs. It allows companies to optimize their use of resources such as power, cooling, space, servers, networks, cables, etc. As reflected in our financial statements for the years ended December 31, 2013 and 2012, we have generated significant losses raising substantial doubt that we will be able to continue operations as a going concern. Our independent registered public accounting firm included an explanatory paragraph in their report for these years stating that we have not achieved a sufficient level of revenues to support our business and have suffered recurring losses from operations. Our ability to execute our business plan is dependent upon our generating cash flow sufficient to fund operations. Our business strategy may not be successful in addressing these issues. If we cannot execute our business plan, our stockholders may lose their entire investment in us. We expect that with the infusion of additional capital and with additional management we will be able to increase software and professional services sales, and to expand the breadth of our product offerings. We intend to do the following: Ÿ Continue to add interfaces to our existing product offerings, which would make us a differentiator in the market. Ÿ Establish industry partners and strategic services partners to sell our product to customers, and to perform some of the services necessary to support the installation and maintenance of our product. Ÿ Initiate specific new marketing efforts to coordinate and lead our initiatives for greater market recognition with special emphasis on contacting and educating industry analysts to spread the word of our capabilities. Ÿ Expand our product offerings to include monitoring and managing the balance of our customer's IT infrastructure. Recent Developments and Trends Business On April 7, 2014, we announced that we have entered into a four-year exclusive and strategic arrangement with Unisys Corporation, a current customer that installed our Rackwise DCiM X software in its own data centers, pursuant to which Unisys is reselling our Rackwise DCiM X to their U.S. Federal market customers and prospects. Expanding beyond the initial scope of the agreement, Unisys has begun reselling our Rackwise DCiM X software to its commercial clients worldwide. Intel Corporation ("Intel") is also a current customer that installed our Rackwise DCiM X software in connection with initiatives to consolidate and maximize the operational efficiencies of its global network of data centers. We also entered into the December 5, 2011 Software Integration and License Agreement (the "Agreement") with Intel in connection with Intel's DCM software. Effective February 19, 2014, Intel terminated the Agreement for non-payment of software license royalties in the approximate amount of $463,000. The termination requires us to cease all direct or indirect exercises of license rights under the Agreement, except as necessary to support our few existing customers who have previously installed and are using the Intel DCM software. The vast majority of our customers will not be affected by the termination of the Agreement. The termination of the Agreement has no impact on Intel's use of our Rackwise DCiM X product in its data centers or otherwise. Financings In September 2013, we completed a private offering that had commenced in June 2013 (the "Units Offering") in which we sold an aggregate of $2,451,918 of units of our securities at a price of $10,000 per unit. The closings resulted in aggregate net proceeds of $771,751 ($2,451,918 of gross proceeds less $1,253,103 of debt conversions (relating to debt we previously borrowed) less $427,064 of issuance costs). Each unit (an "Offering Unit") consisted of (i) a $10,000 principal amount of one year 12% secured convertible promissory note (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"). Effective March 10, 2014, the holders of the Offering Notes converted the notes into an aggregate of 5,551,236 shares of our common stock and cancelled the Offering Warrants. 18 In August and September 2013, we borrowed an aggregate of $310,000 via short-term interest free loans from two unaffiliated shareholders. On January 22, 2014, the shareholders agreed to convert their loans into units of our securities, at a conversion rate of $0.50 per unit, with each unit consisting of one share of our common stock and (ii) one 5-year warrant to purchase one share of our common stock, exercisable at $0.50 per share. As a result, in February 2014we issued 620,000 shares of our common stock and 620,000 warrants. In connection with the Units Offering, in July 2013 a holder of our 8% Convertible Promissory Note due August 30, 2013, converted its note in the amount of $106,533 (including outstanding principal and interest) into the Units Offering. On April 12, 2013, May 15, 2013 and May 30, 2013, we borrowed $112,500, $200,035 and $150,035, respectively, via short-term interest free loans from an affiliate. The loans converted into the securities sold by us in the Units Offering. During the three months ended March 31, 2013, we completed two closings of a private placement offering pursuant to which we sold 3,334 units for gross proceeds of $150,000, at a purchase price of $45.00 per unit. We used the net proceeds of $129,999 from the closings for general working capital. In connection with the two closings, the placement agent (i) was paid aggregate cash commissions of $15,000 and (ii) received broker warrants to purchase 3,334 shares of common stock. In January 2013, we agreed to permit the holders of our 8% convertible promissory notes, which were originally issued in June through August 2012, to convert their notes in the aggregate principal amount of $800,000 (and accrued and unpaid interest thereon) into units at a conversion price of $29.25 per unit. As a result of such conversion, we issued to the holders of such notes 28,489 shares of our common stock and 28,489 PPO Warrants. In addition, as part of such conversion, we agreed to fix the exercise price of 2,667 warrants issued in connection with the purchase of 8% convertible promissory notes at $67.50 per share. As a result of the note conversions, the Company issued three-year placement agent warrants to purchase an aggregate of 1,063 shares of common stock at an exercise price of $67.50 per share. The foregoing securities were issued in reliance on the exemption from registration contained in Section 4(a)(2) of the Securities Act of 1933, as amended (the "Act") for transactions of an issuer not involving a public offering and/or Rule 506 of Regulation D or Regulation S under the Act. Revenues Revenues are generated from the licensing, subscription and maintenance of our enterprise software product and to a lesser extent professional services fees. Direct cost of revenues Direct cost of revenues includes the cost of server hosting, the cost of installing our software for new clients, commissions to third parties for installation of our software, the costs of support and operations dedicated to customer services and the costs of maintaining and amortizing our proprietary database. Sales and marketing expenses Sales expenses consist of compensation and overhead associated with our channel sales, inside sales, direct sales and product sales support functions. Marketing expenses consist primarily of compensation and overhead associated with our marketing function, trade shows and Google ads, which are used as a main source of sales leads. Research and development expenses Research and development expenses consist mainly of compensation and overhead of research and development personnel and professional services firms performing research and development functions, plus amortization of our proprietary database. 19 General and administrative expenses General and administrative expenses consist of the compensation and overhead of administrative personnel and professional services firms performing administrative functions, including management, accounting, finance and legal services, plus expenses associated with infrastructure, including depreciation, information technology, telecommunications, facilities and insurance. Interest Interest consists of fees associated with factoring our receivables and interest expense associated with our notes payable. Amortization of debt discount Amortization of debt discount represents the amortization of the debt discount over the shorter of (a) the term of the related debt, or (b) the conversion of the debt into equity instruments. Debt discount consists of the fair value of the conversion options associated with certain debt, plus the fair value of the warrants provided to certain debt holders. Amortization of deferred financing costs Amortization of deferred financing costs represents the amortization of the deferred financing costs over the shorter of (a) the term of the related debt, or (b) the conversion of the debt into equity instruments. Deferred financing costs represent the professional fees incurred in conjunction with our debt financing activities. Induced note conversion Induced note conversion expense represents the incremental value of securities received in excess of the carrying value of the debt pursuant to an inducement offer. Loss on extinguishment Costs associated with the extension of the 12% notes, primarily the incremental value of the amended warrants. Other income Other income generally represents non-recurring income. Results of Operations Year ended December 31, 2013 Compared to the Year ended December 31, 2012 Overview We reported net losses of $6,482,307 and $9,593,685 for the years ended December 31, 2013 and 2012, respectively. The decrease in net loss of $3,111,378 is primarily due to a $5,479,532 net decrease in operating expenses primarily as a result of approximately $2,750,000 of lower wages related to a reduction in headcount and decreased stock-based compensation expenses of approximately $1,330,000 partially offset by an increase of $1,055,037 in other expenses and a $1,313,117 decrease in gross profit on lower revenues. Revenues Our revenues for the year ended December 31, 2013 were $1,958,682 as compared to revenues of $3,253,436, for the year ended December 31, 2012. Revenues decreased by $1,294,754 or 40%. Licensing revenues were $323,575 as compared to $1,709,868 in the prior year, a decrease of $1,386,293, or 81%, due to new license purchases by a single customer in 2012 that did not reoccur in 2013. Maintenance revenues were $1,212,974 as compared to $1,112,136 in the prior year, an increase of $100,838, or 9%, primarily due to the recognition of revenue on increased maintenance renewals sold during the year. Subscription revenues were $121,166 as compared to $250,062, a decrease of $128,896, or 52%, due to a general decrease in subscription customers. Professional service revenues were $300,967 as compared to $181,370 in the prior year, an increase of $119,597 or 66%, as a result of the delivery of services on increased professional service contracts. 20 Direct cost of revenues The direct cost of revenues during the years ended December 31, 2013 and 2012 was $594,319 and $575,956, respectively, representing an increase of $18,363 or 3%. The direct cost of revenues as a percentage of revenues was approximately 30% and 18% for the periods ended December 31, 2013 and 2012, respectively. The increase in direct cost of revenues was primarily related to royalty expenses associated with the licensing of Intel DCM software which commenced in June of 2012. It is impractical for the Company to break out direct cost of revenues by the types of revenues cited in the revenue discussion above. Sales and marketing expenses Sales and marketing expenses decreased by $3,343,039, or 72%, in 2013 to $1,296,244 from $4,639,283 in 2012. The decrease in sales and marketing expenses was due to lower commission expense, wages and benefits (approximately $2,350,000) and stock-based compensation expense (approximately $420,000) associated with significant headcount reductions and lower revenues. Research and development expenses Research and development expenses decreased by $790,770, or 36%, in 2013 to $1,433,134 from $2,223,904 in 2012. The decrease was due primarily to lower wages and stock-based compensation expense associated with headcount reductions. While we have previously curtailed research and development expenditures due to cash constraints, we expect to ramp up research and development expenditures in the future as working capital becomes available. General and administrative expenses General and administrative expenses were $2,754,727 in 2013 as compared to $4,100,450 in 2012, a decrease of $1,345,723 or 33%. The decrease primarily resulted from a reduction in non-cash stock-based compensation expense (approximately $640,000) and a decrease in legal expenses and contracted financial services expense (approximately $270,000), and other general cost reduction measures enacted by management. Interest Interest expense was $1,204,756 for 2013 as compared to $465,815 for 2012, representing an increase of $738,941, or 159%. The increase was attributable to an increase in factor fees and interest accrued on outstanding notes payable as compared to the year ended December 31, 2012. Amortization of debt discount During 2013, we recorded $388,361 of amortization of debt discount as compared to $604,605 in 2012, representing a decrease of $216,244, or 36%, due to the timing of the recognition of debt discount expense. Amortization of deferred financing costs During 2013, we recorded $238,012 of amortization of deferred financing costs as compared to $49,662 in 2012, a decrease of $188,350, or 379%, which represents amortization of additional deferred financing costs incurred in connection with the Units Offering and other prior debt financings. Induced note conversion During 2012, we recorded $76,736 of induced note conversion expense which represents the incremental value of the securities received pursuant to the inducement offer. Loss on extinguishment During 2013, we recorded expense of $531,436 which represents the excess value of equity securities issued to converting noteholders above the carrying value of the debt. During 2012, we recorded expense of $113,925 which represents the maturity extension of the 12% convertible notes sold in May and June 2012. 21 Liquidity and Capital Resources We measure our liquidity a variety of ways, including the following: December 31, December 31, 2013 2012 Cash $ 53,078 $ 16,799 Working Capital Deficiency $ (8,270,585 ) $ (7,194,585 ) Notes Payable (Gross - Current) $ 608,945 $ 1,508,945 Due to our brief history and historical operating losses, our operations have not been a source of liquidity, and our primary sources of liquidity have been our factoring relationship, debt and proceeds from the sale of our equity securities in several private placements. Our current business plan requires us to raise additional capital in order to fund near term operating deficits, incremental legal and accounting associated with being a public company, additional product development, repayment of our factor, payment of IRS payroll tax liabilities and payment of legal settlements. During late 2013, we have relied upon our factoring relationship to fund our short term working capital requirements. This has included unsecured borrowings which are expected to be repaid from future capital raising activities. Due to the current tax liens, we are in default of our factoring arrangement. As such, the factor could demand full repayment of the outstanding balance at any time. In September 2013, we completed a private offering that had commenced in June 2013 (the "Units Offering") in which we sold an aggregate of $2,451,918 of units of our securities at a price of $10,000 per unit. The closings resulted in aggregate net proceeds of $771,751 ($2,451,918 of gross proceeds less $1,253,103 of debt conversions (relating to debt we previously borrowed) less $427,064 of issuance costs). Each unit (an "Offering Unit") consisted of (i) a $10,000 principal amount of one year 12% secured convertible promissory note (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"). Effective March 10, 2014, the holders of the Offering Notes converted the notes into an aggregate of 5,551,236 shares of our common stock and cancelled the Offering Warrants. In August and September 2013, we borrowed an aggregate of $310,000 via short-term interest free loans from two unaffiliated shareholders. On January 22, 2014, the shareholders agreed to convert their loans into units of our securities, at a conversion rate of $0.50 per unit, with each unit consisting of one share of our common stock and one 5-year warrant to purchase one share of our common stock, exercisable at $0.50 per share. As a result, in February 2014, we issued 620,000 shares of our common stock and 620,000 warrants. In connection with the Units Offering, in July 2013, a holder of our 8% Convertible Promissory Note due August 30, 2013, converted its note in the amount of $106,533 (including outstanding principal and interest) into the Units Offering. On April 12, 2013, May 15, 2013 and May 30, 2013, we borrowed $112,500, $200,035 and $150,035, respectively, via short-term interest free loans from an affiliate. The loans converted into the securities sold by us in the Units Offering. During the three months ended March 31, 2013, we completed two closings of a private placement offering pursuant to which we sold 3,334 units for gross proceeds of $150,000, at a purchase price of $45.00 per unit. We used the net proceeds of $129,999 from the closings for general working capital. In connection with the two closings, the placement agent (i) was paid aggregate cash commissions of $15,000 and (ii) received broker warrants to purchase 3,334 shares of common stock. In January 2013, holders of our 8% convertible promissory notes, which were originally issued in June through August 2012, converted their notes in the aggregate principal amount of $800,000 (and $33,281 of accrued and unpaid interest thereon) into units at a conversion price of $29.25 per unit. As a result of such conversion, we issued to the holders of such notes 28,489 shares of our common stock and 28,489 PPO Warrants. In addition, as part of such conversion, we agreed to fix the exercise price of 2,667 warrants issued in connection with the purchase of 8% convertible promissory notes at $67.50 per share. As a result of the note conversions, the Company issued three-year placement agent warrants to purchase an aggregate of 1,063 shares of common stock at an exercise price of $67.50 per share. 22 During the year ended December 31, 2012, we had three closings under an offering pursuant to which an aggregate of 14,523 Units were sold, resulting in $1,447,114 of aggregate net proceeds ($1,633,750 of gross proceeds less $186,636 of issuance costs). In connection with the closings, an aggregate of 14,523 shares of common stock and Investor Warrants to purchase 3,631 shares of common stock were issued. The Investor Warrants are redeemable in certain circumstances, are exercisable for a period of five years at an exercise price of $300.00 per full share of common stock and are subjected to weighted average anti-dilution protection. In April and May 2012, we completed and closed an offering of ninety day 12% convertible promissory notes (the "12% Notes") in which we sold an aggregate principal amount of $580,000 in notes to five investors. Each of the 12% Notes was scheduled to mature ninety days after issuance and was convertible, at the option of the holder, into Company units, at a price of $120.00 to $135.00 per unit, each unit consisting of 0.0033333 shares of our common stock and one warrant representing the right to purchase 0.0033333 shares of our common stock for a period of five years from issuance at an exercise price of $240.00 to $300.00 per share. The warrants are exercisable on a cashless basis and contain weighted average anti-dilution price protection (see Note 7 - Notes Payable in the accompanying financial statements for more details). In June, July and August 2012, we completed and closed on $1,050,000 of Bridge Units which consists of a twelve month 8% convertible note (the "8% Notes") and a warrant (the "Bridge Warrant"). Through December 31, 2013, $900,000 of the convertible notes, plus accrued interest have been exchanged for an aggregate of 31,967 shares of common stock and a warrant to purchase 31,967 shares of common stock at an exercise price of $90.00 per share, pursuant to an inducement offer. An additional $100,000 of convertible notes were exchanged into the aforementioned Units Offering. As of December 31, 2013, $50,000 of 8% Notes remain outstanding. During the year ended December 31, 2012, we had seven closings of a private offering that commenced on September 1, 2012 (the "PPO"), pursuant to which an aggregate of 23,142 PPO Units were sold at a price of $45.00 per PPO Unit, resulting in $878,051 of aggregate net proceeds ($1,041,350 of gross proceeds less $163,299 of issuance costs). Each PPO Unit consists of 0.0033333 shares of common stock and a PPO Warrant, such that investors received an aggregate of 23,142 shares of common stock and PPO Warrants to purchase 23,142 shares of our common stock. The proceeds from these financing activities were used to support the general working capital needs of the business. We do not currently anticipate any material capital expenditures. Availability of Additional Funds As a result of the above developments, we raised additional cash and converted most of our indebtedness into equity. Although we do not currently anticipate any material capital expenditures, as of the filing date of this Annual Report, we still need to raise additional capital to meet our liquidity needs for operating expenses, product development, repayment of our factor, payment of IRS payroll tax liabilities and payment of legal settlements. If we are unable to obtain adequate funds on reasonable terms, we may be required to significantly curtail or discontinue operations. Years Ended December 31, 2013 and 2012 Operating Activities Net cash used in operating activities for the years ended December 31, 2013 and 2012 amounted to $3,570,535 and $4,779,046 respectively. During the year ended December 31, 2013, the net cash used in operating activities was primarily attributable to the net loss of $6,482,307, partially offset by $1,539,020 of net non-cash expenses and $1,372,752 was generated from changes in operating assets and liabilities. During the year ended December 31, 2012, the net cash used in operating activities was primarily attributable to the net loss of $9,593,685, partially offset by $2,851,097 of net non-cash expenses and $1,963,542 was generated from changes in operating assets and liabilities. Investing Activities Net cash used in investing activities for the years ended December 31, 2013 and 2012 amounted to $10,744 and $378,788, respectively. Acquisition of intangible assets (shapes acquired from a graphic designer for our database library that are schematics of specific computer equipment) for the years ended December 31, 2013 and 2012 amounted to $6,839 and $96,341, respectively. Acquisition of tangible assets (property and equipment) for the years ended December 31, 2013 and 2012 amounted to $3,905 and $291,348 (primarily related to expenditures for technology for new hires and furniture for the Folsom, California office in 2012), respectively. Cash constraints caused the Company to limit its acquisition of tangible and intangible assets during the year ended December 31, 2013. 23 Financing Activities Net cash provided by financing activities for the years ended December 31, 2013 and 2012 amounted to $3,617,558 and $4,561,190, respectively. For the year ended December 31, 2013, the net cash provided by financing activities resulted primarily from the $1,206,206 net proceeds from debt financings (gross proceeds of $1,661,385 less $455,179 of issuance costs), $1,971,353 of net advances from our factor, $310,000 in proceeds from short term advances and $129,999 net proceeds from equity financings (gross proceeds of $150,000 less $20,001 of issuance costs). For the year ended December 31, 2012, the net cash provided by financing activities resulted primarily from $2,325,164 net proceeds from equity financings (gross proceeds of $2,675,100 less $349,936 of issuance costs), $1,507,769 net proceeds from debt financings (gross proceeds of $1,630,000 less $122,231 of issuance costs) and $712,208 of net advances from our factor. Liquidity, Going Concern and Management's Plans The accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. As discussed in Note 2 to the accompanying consolidated financial statements, we have not achieved a sufficient level of revenues to support our business and have suffered substantial recurring losses from operations since our inception, which conditions raise substantial doubt that we will be able to continue operations as a going concern. The accompanying consolidated financial statements do not include any adjustments that might be necessary if we were unable to continue as a going concern. In addition, as of April 11, 2014, we have unpaid payroll taxes relating to the third and fourth quarters of 2010, the first quarter of 2011, the third and fourth quarters of 2012, and the first and second quarters of 2013 in the aggregate amount of approximately $1,567,000. The IRS had placed federal tax liens against us that aggregate to approximately $1,567,000 in connection with the unpaid payroll taxes. The IRS had begun collection proceedings against us and has moved forward in placing a levy against our bank accounts. On April 11, 2014, the IRS agreed to suspend further collection efforts until July 15, 2014, in order to allow us time to file an installment payment agreement for their approval. In addition, due to the current tax liens, we are in default of our factoring arrangement. As such, the factor could demand full payment repayment of the outstanding balance at any time. We presently have enough cash on hand to sustain our operations for approximately forty-five days. We require additional capital to meet our liquidity needs to sustain our operations, pay our obligations and execute our business plan. We are currently in discussions with alternative sources in that regard and anticipate that we will be successful in raising necessary additional capital but there can be no assurance that it will occur. If we are unable to obtain additional financing on a timely basis and, notwithstanding any request we may make our debt holders do not agree to convert their notes into equity or extend the maturity dates of their notes, we may have to delay note and vendor payments and/or initiate cost reductions, which would have a material adverse effect on our business, financial condition and results of operations, and ultimately we could be forced to discontinue our operations, liquidate and/or seek reorganization under the U.S. bankruptcy code. As a result, our auditors have issued a going concern opinion in conjunction with their audit of our December 31, 2013 consolidated financial statements. Off-Balance Sheet Arrangements None. Contractual Obligations Not applicable. Critical Accounting Policies and Estimates Use of Estimates The preparation of financial statements in conformity with the generally accepted accounting principles in the United States of America ("U.S. GAAP") requires us 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 financial statements and the accompanying notes. Actual results could differ from those estimates. Our significant estimates and assumptions relate to stock-based compensation, the useful lives of fixed assets and intangibles, valuation allowance for income taxes, bad debts and factoring fees, and fair value of convertible financial instruments. 24 Capitalized Software Development Costs We capitalize software development costs in accordance with Financial Accounting Standards Board ("FASB") issued Accounting Standards Codification ("ASC") topic 985, "Software". Capitalization of software development costs begins upon the determination of technological feasibility. The determination of technological feasibility and the ongoing assessment of the recoverability of these costs requires considerable judgment by us with respect to certain external factors, including anticipated future gross product revenues, estimated economic life and changes in hardware and software technology. Historically, software development costs incurred subsequent to the establishment of technological feasibility have not been material. Intangible Assets All of our intangible assets consist of shapes acquired from a graphics designer for our database library that are schematics of specific computer equipment. These shapes are utilized in our software with multiple customers in order to enable them to visualize and differentiate the specific computer equipment in their overall network. For example, our software's graphical user interface displays a unique shape for each make and model of a 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. Our 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 our (a) subscription-based licenses, and (b) maintenance arrangements, when sold separately, revenues are recognized ratably over the service period. We defer 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. Our 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. We provide professional services to our customers. Such services, which include training, installation, and implementation, are recognized when the services are performed. We also provide 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 our 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 issuance of invoice, professional services are recognized when all services have been delivered and maintenance revenue is amortized over a twelve month period. We determined that VSOE exists for both the delivered and undelivered elements of our multiple-element arrangements. We limit our 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. 25 Debt Discount and Amortization of Debt Discount Debt discount represents the fair value of embedded conversion options of various convertible debt instruments and attached convertible equity instruments issued in connection with debt instruments. The debt discount is amortized over the earlier of (i) the term of the debt or (ii) conversion of the debt, using the straight-line method which approximates the interest method. The amortization of debt discount is included as a component of other expenses in our accompanying statements of operations. 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 our consolidated financial statements or disclosures if liquidation of the Company became imminent. In July 2013, the FASB issued ASU No. 2013-11, "Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." This ASU addresses the requirements regarding the financial statement presentation of an unrecognized tax benefit within ASC Topic 740 for the purpose of providing consistency between the financial reporting of U.S. GAAP entities. Generally, this ASU provides guidance for the preparation of financial statements and disclosures when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This ASU is effective for periods beginning after December 15, 2013 and is not expected to have a material impact on our consolidated financial statements or disclosures. |