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ICEWEB 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 our financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and notes thereto. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs and are subject to a number of known and unknown risks and external factors that in addition to general, economic, competitive and other business conditions, could cause actual results, performance and achievements to differ materially from those described or implied in the forward-looking statements, as more fully discussed below and elsewhere in this filing. OVERVIEW IceWEB is a provider of high performance unified data storage solutions. Our storage systems make it possible to run and manage files and applications from a single device and consolidate file-based and block-based access in a single storage platform which supports Fibre Channel SAN, IP-based SAN (iSCSI), and NAS . A unified storage system simultaneously enables storage of file data and handles the block-based I/O (input/output) of enterprise applications. One advantage of unified storage is reduced hardware requirements. Instead of separate storage platforms, like NAS for file-based storage and a RAID disk array for block-based storage, unified storage combines both modes in a single device. Alternatively, a single device could be deployed for either file or block storage as required. In addition to lower capital expenditures for the enterprise, unified storage systems can also be simpler to manage than separate products. The IceWEB Storage System offers one platform for file and block data of all kinds. Whether it's Microsoft Exchange, SQL Server or Oracle databases, virtualized environments, scanned images, files, video, pictures, graphics, or voice data, IceWEB maximizes the efficiency of storage by centralizing all data on one platform secured with strong data protection capabilities. The IceWEB Storage System is an all-inclusive storage management system which includes de-duplication; unlimited snapshots; thin provisioning; local or remote, real-time or scheduled replication; capacity and utilization reporting, and integration with virtual server environments. Unified storage systems enjoy the same level of reliability as dedicated file or block storage systems. We believe our business model is highly differentiated and provides us with several competitive advantages. We sell our products through a two-tier channel sales model designed to enable us to quickly scale and cost effectively increase sales. We believe that we have built a strong internal sales team, which is spread geographically by region throughout the United States to assist our channel partners with sales calls, service and support offerings, product matter expertise, configuration and pricing, and product demonstration. We anticipate launching extensions of our product lines and services in 2013 that will not require significant additional resources. As described elsewhere herein, we experienced a significant drop in our sales, principally in the fourth quarter of fiscal 2012, following the death of our Chief Executive Officer in May 2012. Mr. Signorello was the founder of our company and the primary point of contact for many of our customers, vendors and partners. As a result of Mr. Signorello's passing, many of our customers delayed making their buying decisions until there was greater certainty about our continuing prospects. As a result of the pivotal nature of these relationships, during the last half of fiscal 2012 our Chief Executive Office, Rob Howe, and the balance of our management devoted a significant amount of time and effort to preserving these relationships as well as broadening our partner base. Based upon our efforts which we believe have met with a high level of success, we anticipate revenues for fiscal 2013 will increase due to the introduction of new products and services, including sales of our unified network storage solutions, the launch of additional cloud services offerings and other data storage products through our resellers and OEM partners. There are no assurances, however, that our revenues will return to historic levels. 21 Results of Operations FISCAL YEAR 2012 AS COMPARED TO FISCAL YEAR 2011 The following table provides an overview of certain key factors of our results of operations for fiscal year 2012 as compared to fiscal year 2011: Fiscal Year ended September 30, $ % 2012 2011 Change Change Net Revenues $ 2,640,520 $ 2,678,346 $ (37,826 ) (1.4 )% Cost of sales 1,780,246 1,751,640 28,606 1.6 % Operating Expenses: Sales and marketing 1,116,340 975,282 141,058 14.5 % Depreciation and amortization 202,130 545,890 (343,760 ) (63.0 )% Research and development 1,046,026 790,048 255,978 32.4 % General and administrative 2,722,048 2,605,999 116,049 4.5 % Loss on impairment of intangible assets - 303,859 303,859 100.0 % Total operating expenses 5,086,545 5,221,078 (134,533 ) (2.6 )% Loss from operation (4,226,271 ) (4,294,372 ) (68,101 ) (1.6 )% Total other expense (2,258,777 ) (410,919 ) (1,847,858 ) 450.0 % Net loss $ (6,485,048 ) $ (4,705,291 ) $ (1,779,757 ) 38.0 % Other Key Indicators: Fiscal Fiscal 2012 2011 Cost of sales as a percentage of sales 67.42 % 65.40 % Gross profit margin 32.58 % 34.60 % Sales and marking expense as a percentage of sales 42.28 % 36.41 % General and administrative expenses as a percentage of sales 103.09 % 97.30 % Total operating expenses as a percentage of sales 192.63 % 194.94 % Sales The decrease in fiscal 2012 net sales from fiscal 2011 is primarily due to the impact of economic uncertainty on our customers' budgets and IT spending capacity, as well as the uncertainty caused by the untimely passing of John Signorello, our Chief Executive Officer, in May, 2012. Cost of Sales and Gross Profit Our cost of sales consists primarily of products purchased to manufacture our storage products. The increase in costs of sales as a percentage of sales and the corresponding decrease in our gross profit margin for fiscal 2012 as compared to fiscal 2011 was the result of an increased competition and the increase in the cost of certain components that go into our systems in fiscal 2012. We anticipate that our cost of sales as a percentage of revenue will return to the 55% to 65% range in fiscal 2013, as we introduce new higher margin products and solutions to augment our storage business. 22 Total Operating Expenses Our total operating expenses decreased approximately 2.6% for fiscal 2012 as compared to fiscal 2011. The decrease is primarily due to increased headcount in sales and marketing, increased headcount and investment in research and development, and increased investor relations expense, offset by lower depreciation expense, and the one-time expense in fiscal 2011 for the loss on the impairment of intangible assets. The changes include: 23 • Sales and Marketing. Sales and marketing expense includes salaries, commission, occupancy, telephone, travel, and entertainment expenses for direct sales personnel. For the fiscal year 2012, sales and marketing increased approximately 14.5% from fiscal year 2011. The increase was due primarily to increased marketing headcount during fiscal year 2012. • Depreciation and amortization expense. For fiscal 2012, depreciation and amortization expense decreased approximately 63% from fiscal 2011, as many of our assets became fully depreciated during the fiscal year. Amortization expense is related to the customer relationships and manufacturing GSA schedule which are intangible assets that we generated through our acquisition of Inline Corporation. The GSA schedule was being amortized on a straight-line basis over three years. Amortization expense was $0 for fiscal 2012 and $243,090 for fiscal 2011. • Research and development expense. For fiscal 2012, research and development expenses increased approximately 32.4% from fiscal 2011. This increase is related to increased research and development efforts related to our storage products. We anticipate the spending on research and development in fiscal 2013 will be approximately $220,000 per quarter related to developing and enhancing our storage solutions and pursuing intellectual property patentswhen we believe it is warranted. • General and administrative expense. For fiscal 2012, general and administrative expenses increased approximately 4.5% from fiscal 2011. This increase is primarily attributable to lower employee compensation expense, and lower occupancy expense, offset by higher legal and professional fees and higher investor relations expense. For fiscal 2012 and 2011, general and administrative expenses consisted of the following: Fiscal Fiscal 2012 2011 Occupancy $ 37,311 $ 50,208 Consulting 76,730 87,238 Employee compensation 874,719 1,117,737 Professional fees 452,904 325,105 Internet/Phone 7,916 20,479 Travel/Entertainment 46,493 34,002 Investor Relations 978,332 676,915 Insurance 18,727 35,203 Other 228,915 259,112 $ 2,722,047 $ 2,605,999 The principal changes in fiscal 2012 as compared to fiscal 2011 include: • For fiscal 2012, occupancy expense decreased approximately 25.7% from fiscal 2011. • For fiscal 2012, salaries and related taxes and benefits decreased $243,018, or approximately 22% from fiscal 2011. The decrease was primarily attributable to a decrease in salary expense of $127,206, a decrease in stock based compensation, and expense recorded in accordance with ASC Topic 718, "Compensation - Stock Compensation (Formerly SFAS No. 123 (R), "Share-Based Payments"), for fiscal 2012 of $115,812, a decrease of 37%. • For fiscal 2012, professional fees increased $127,799, or approximately 39.3% from fiscal 2011. The increase was primarily attributable to an increase in legal fees incurred and the settlement of lawsuits against us in fiscal 2012 versus 2011. • For fiscal 2012, other expense decreased approximately 11.6% from fiscal 2011. The decrease is primarily due to a decrease in bad debt expense of $100,691 and hosting fees of $12,934, offset by the write off of stock subscription receivable of $83,000, which relates to the 2009 sale of 2,000,000 shares of common stock at a per share price of $0.042, valued at $83,000 to Florence Signorello, who is the mother of John Signorello, our former chief executive officer. 24 • For fiscal 2012, consulting expense decreased by approximately 12% from fiscal 2011. The decrease was primarily due to non-recurring consulting fees related to human resources recruiting fees incurred in 2011 but not in fiscal 2012. • For fiscal 2012, investor relations expense increased approximately 44.5% from fiscal 2011. The increase was attributable to an increase in general investor relations activity versus fiscal 2011. We expect that in fiscal 2013 our investor relations activity and related expense should decrease to fiscal 2011 levels or less. • For fiscal 2012, internet and telephone expense decreased approximately 61%. The decrease was attributable to non-recurring costs incurred during the fiscal year 2011. • For fiscal 2012, travel and entertainment expense increased approximately 36.7%. The increase was attributable to an increase in general business, and travel-related investor relations activity. • For fiscal 2012, insurance expense decreased approximately 46.8% from fiscal 2011. The decrease was attributable to lower premiums paid for general business and directors and officer's insurance. LOSS FROM OPERATIONS Our loss from operations improved approximately 1.6% in fiscal year 2012 as compared to fiscal year 2011. TOTAL OTHER INCOME (EXPENSES) Interest Expense. For fiscal 2012, interest expense increased approximately 606.78%. The increase in interest expense is primarily attributable to the amortization of loan fees, debt discount, and derivative discount, offset by lower interest-bearing average outstanding note balances during fiscal 2012. Gain on change in derivative liability. For fiscal 2012 we had a gain on the change in derivative liability of $645,501, which represents the change in the value of the derivative liability based on the Black-Scholes value of our outstanding variably-priced warrants. NET LOSS Our net loss was $6,485,048 for fiscal 2012 compared to $4,705,291 for fiscal 2011, a decrease of $1,779,757 or approximately 38%. 25 LIQUIDITY AND CAPITAL RESOURCES Liquidity is the ability of a company to generate adequate amounts of cash to meet its needs for cash. At September 30, 2012, we had a working capital deficit of $2,904,559 compared to a working capital deficit of $1,713,336 at September 30, 2011, an increase of $1,086,051. The increase in the deficit is primarily attributable to the increases in derivative liability of $1,104,499, a non-cash liability, and the increase in our current notes payable of $87,038, offset by the decrease in accounts payable of $1,362,563. Also contributing was the decrease in subscription receivable of $1,171,520, and in accounts receivable of $618,740, offset by an increase in cash. Net cash used in operating activities was $4,067,538 for fiscal 2012 as compared to net cash used in operating activities of $2,285,893 for fiscal 2011, an increase of $114,645. For fiscal 2012, our cash used in operations of $4,067,538 consisted of a net loss of $6,485,048 offset by non-cash items totaling $2,227,124 including items such as depreciation and amortization of $202,130, stock based compensation of $310,250, the amortization of deferred compensation of $62,228, interest on the amortization of debt discount of $2,315,337, the change in fair value of derivative liability of $645,501, and other non-cash items of $100,319. Additionally, during fiscal 2012 we had a decrease in operating liabilities and an increase in operating assets which incremented our net loss. This change in operating assets and liabilities primarily consisted of a decrease in accounts receivable of $618,740, and a decrease in prepaid expenses of $10,545, offset by an increase in net inventory of $226,250, a decrease in accounts payable and accrued liabilities of $1,362,562 and an increase in deferred revenue of $19,993. For fiscal 2011, our cash used in operations of $2,285,893 consisted of a net loss of $4,705,291 offset by non-cash items totaling $2,419,397 including items such as depreciation and amortization of $545,890, stock based compensation of $369,385, the amortization of deferred compensation of $131,680 and other non-cash items of $1,068,583. Additionally, during fiscal 2011 we had a decrease in operating liabilities and an increase in operating assets which incremented our net loss. This change in operating assets and liabilities primarily consisted of a decrease in accounts receivable of $284,423, and an increase in prepaid expenses of $982, offset by a decrease in net inventory of $6,216, an increase in accounts payable and accrued liabilities of $538,439 and a decrease in deferred revenue of $54,678. Net cash used in investing activities for fiscal 2012 was $482,082 as compared to net cash used in investing activities of $136,759 for fiscal 2011. During fiscal 2012 we used cash of $449,082 for property and equipment purchases and $33,000 for the purchase of VOIS common stock. During fiscal 2011 we used cash of $136,759 for property and equipment purchases. 26 Net cash provided by financing activities for fiscal 2012 was $4,815,094 as compared to $1,886,616 for fiscal 2011, an increase of $1,261,478. In fiscal 2012, we received proceeds from the sale of convertible notes of $1,750,000, proceeds from subscriptions receivable of $1,171,520, proceeds from the conversion of warrants of $275,001, proceeds from the exercise of common stock options of $255,717, the proceeds from the sale of common stock of $2,249,861, and proceeds from note payable of $395,233, offset by payments on convertible notes payable with common stock of $1,848,031, payments on note payable of $308,195, and the payment of deferred financing costs of $876,012. In fiscal 2011 we received proceeds from the exercise of common stock options of $1,275,102, proceeds from the sale of restricted stock of $1,459,632, and proceeds from note payable of $836,024, offset by payments on note payableof $512,621. At September 30, 2012 we had an accumulated deficit of $40,813,128 and the report from our independent registered public accounting firm on our audited financial statements at September 30, 2012 contained an explanatory paragraph regarding doubt as to our ability to continue as a going concern as a result of our net losses in operations. In spite of our sales, there is no assurance that we will be able to maintain or increase our sales in fiscal 2013 or that we will report net income in any future periods. On November 2, 2012 IceWEB, Inc. entered into a Loan Agreement with IWEB Growth Fund, LLC, a Virginia limited liability company ("IWEB Growth Fund") which was recently established by Messrs. Compton, Bush, Carosi, Pirtle and Stavish and General Soyster, our independent directors. Ms. My Le Phuong, an employee of our company, serves as manager of the IWEB Growth Fund. Under the terms of the Loan Agreement, IWEB Growth Fund agreed to make one or more loans to us up to the total principal amount of $1.5 million. The lending of any amounts under the Loan Agreement is conditioned upon the negotiation of notes and related loan documents which contain terms and conditions that are acceptable to the lender to be determined at the time of the loans. We agreed to grant IWEB Growth Fund a security interest in our assets as collateral for these loans, which such security interest is subordinate to the interest of our primary lender Sand Hill Finance, LLC. In the event we should default under the terms of the Loan Agreement, IWEB Growth Fund is entitled to declare all amounts advanced under the various notes immediately due and payable. An event of default includes a breach by us of any covenant, representation or warranty in the Loan Agreement or a default under any note entered into with the lender. Between November 9, 2012 and November 13, 2012, IWEB Growth Fund lent us an aggregate of $111,000.00 under the terms of 6 separate Confession of Judgment Promissory Notes. These notes, which are identical in their terms other than the dates and principal amounts, are for a one year term and bear interest at 12% per annum payable at maturity. Embodied in each of the notes is a confession of judgment which means that should we default upon the payment of the note, we have agreed to permit IWEB Growth Fund to enter a judgment against us in the appropriate court in Virginia before filing suit against us for collection of the amounts. Pursuant to the terms of the Loan Agreement, we paid IWEB Growth Fund's expenses of $1,500 for the preparation of the Loan Agreement and related documents. We are using the net proceeds from these initial loans for general working capital. Historically, our sales have not been sufficient to fund our operations and we have relied on capital provided through the sale of equity securities, and various financing arrangements and loans from related parties. At September 30, 2012 we had cash on hand of $269,594. In addition to the cash necessary to fund our operating losses, research and development, marketing and general growth, we will need cash to satisfy certain obligations. In fiscal 2006, we entered into a receivable factoring agreement with Sand Hill Finance, LLC under which we can sell certain accounts receivable to the lender on a full recourse basis at 80% of the face amount of the receivable up to an aggregate of $1.8 million. This financing agreement was amended in fiscal 2009 to increase the line amount to $2,750,000. As of September 30, 2012, we had $690,418 available under the line of credit facility. Our working capital needs in future periods depend primarily on the rate at which we can increase our sales while controlling our expenses and decreasing the use of cash to fund operations. Additional capital may be needed to fund acquisitions of additional companies or assets, although we are not a party to any pending agreements at this time and, accordingly, cannot estimate the amount of capital which may be necessary, if any, for acquisitions. 27 As long as our cash flow from operations remains insufficient to completely fund operations, we will continue depleting our financial resources and seeking additional capital through equity and/or debt financing. Under the terms of the financing agreement with Sand Hill Finance, LLC we agreed not to incur any additional indebtedness other than trade credit in the ordinary course of business. These covenants may also limit our ability to raise capital in future periods. There can be no assurance that acceptable financing can be obtained on suitable terms, if at all. Our ability to continue our existing operations and to fund our working capital needs will suffer if we are unable to raise the additional funds on acceptable terms which will have the effect of adversely affecting our ongoing operations and limiting our ability to increase our sales and maintain profitable operations in the future. If we are unable to secure the necessary additional working capital as needed, we may be forced to curtailsome or all of our operations. 2012 Financing In June and July, 2012 we sold approximately 13,455,958 restricted stock units at $0.12/unit. Each unit consists of one share of common stock and a warrant exercisable for one share of common stock. The warrants have a five year life, an exercise price of $0.15/share, and are callable if the Company's common stock trades over $0.25/share for ten consecutive trading days. Meyers and Associates, LP acted as the placement agent in connection with the sale the securities and as compensation received a cash fee of approximately $161,472, and warrants to purchase approximately 1,345,596 shares of the Company's common stock at a price per share of $0.15. The sale of the Shares and the Warrants was made pursuant to Section 4(2) of the Securities Act for transactions not involving a public offering and/or Regulation D, as promulgated by the SEC under the Securities Act, and in reliance upon exemptions from registration under applicable state securities laws. In July and August, 2012 we issued 2,434,871 shares of restricted common stock at an average per share price of $0.094, valued at $228,250, in lieu of pay to five of our employees, including three of our executive officers. The recipients were accredited investors and the issuances were exempt from registration under the Securities Act of 1933 in reliance on exemptions provided by Section 4(2) of that act. On November 23, 2011, we entered into a Securities Purchase Agreement with three accredited investors pursuant to which we sold $2,012,500 in principal amount of senior convertible notes and issued the investors Series O, Series P and Series Q warrants to purchase up to an aggregate of 35,514,789 shares of our common stock for an aggregate purchase price of $1,750,000 in a private transaction exempt from registration under the Securities Act. We issued the senior convertible notes at an original issue discount of 13%. We also entered into a Registration Rights Agreement with investors in which we agreed to register the shares underlying the senior convertible notes and the warrants. We paid Rodman & Renshaw, LLC, a broker-dealer and member of FINRA who acted as the exclusive placement agent for us in the offering, a cash commission of $155,000, issued it warrants to purchase an aggregate of 911,765 shares of our common stock with an exercise price of $0.17 per share which are identical to the Series O warrants, and reimbursed it for legal expenses of $20,000. We reimbursed Iroquois Master Fund Ltd., an investor in the offering, $60,000 for its non-accountable expenses related to the investment. We are using the net proceeds from this offeringfor general working capital. Off Balance Sheet Arrangements. None. 28 Recent Accounting Pronouncements In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income ("ASU 2011-05"). This update requires that the components of net income, the components of other comprehensive income and the total of comprehensive income be presented as a single continuous financial statement or in two separate but consecutive statements. The option of presenting other comprehensive income in the statement of stockholders' equity is eliminated. This update also requires the presentation on the face of the financial statements of reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statements where the components of net income and the components of other comprehensive income are presented. In December 2011, the FASB issued ASU 2011-12, which deferred the guidance on whether to require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement where net income is presented and the statement where other comprehensive income is presented for both interim and annual financial statements. ASU 2011-12 reinstated the requirements for the presentation of reclassifications that were in place prior to the issuance of ASU 2011-05 and did not change the effective date for ASU 2011-05. For public entities, the amendments in ASU 2011-05 and ASU 2011-12 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and should be applied retrospectively. The adoption of this guidance in fiscal 2012 concerned disclosure only and did not have an impact on the Company's consolidated financial position or results of operations. In September 2011, the FASB issued ASU No. 2011-08, Testing for Goodwill Impairment ("ASU 2011-08"). ASU 2011-08 amends existing guidance by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the performance of the two-step goodwill impairment test, as currently prescribed by ASC Topic 350, is required. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company does not currently expect the adoption of this update in fiscal 2013 will have a significant effect on its consolidated financial statements and related disclosures. In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment ("ASU 2012-02"). ASU 2012-02 amends existing guidance by giving an entity the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. If an entity determines that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, then the performance of the quantitative impairment test, as currently prescribed by ASC Topic 350-30, is required. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company does not currently expect the adoption of this update in fiscal 2013 will have a significant effect on its consolidated financial statements and related disclosures. |