The issuer has filed a Prospectus on April 12, 2007 with the U.S. Securities and Exchanges Commission (SEC) for the resale of Common Stock. Before you invest in the issuer’s common shares, you should read such Prospectus, and other documents the issuer has filed with the SEC for more complete information about the issuer and an investment in its common stock. You may get these documents for free by searching the SEC online database athttp://www.sec.gov.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
| x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2007
| ¨ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT |
For the transition period from to
Commission File Number: 000-51702
SENDTEC, INC.
(Exact Name Of Small Business Issuer As Specified In Its Charter)
| Delaware | 43-2053462 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
877 Executive Center Drive W., Suite 300
St. Petersburg, Florida 33702
(Address of Principal Executive Offices)
(727) 576-6630
(Issuer's Telephone Number, Including Area Code)
(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)
Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 49,843,837 shares at May 6, 2007
Transitional Small Business Disclosure Format (Check one): Yes ¨ No x
SENDTEC, INC. AND SUBSIDIARIES
FORM 10-QSB
QUARTERLY PERIOD ENDED MARCH 31, 2007
INDEX
| Page | ||||
PART I – FINANCIAL INFORMATION | ||||
Item 1 – | Condensed Consolidated Financial Statements (Unaudited) | |||
Condensed Consolidated Balance Sheet (Unaudited) As of March 31, 2007 | 3 | |||
| 4 | ||||
| 5 | ||||
| 6 | ||||
Notes to Unaudited Condensed Consolidated Financial Statements | 7 | |||
Item 2 – | 25 | |||
Item 3 – | 30 | |||
Item 1 – | 31 | |||
Item 2 – | 34 | |||
Item 3 – | 34 | |||
Item 4 – | 34 | |||
Item 5 – | 34 | |||
Item 6 – | 34 | |||
2
SENDTEC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 2007
(Unaudited)
| ASSETS | ||||
Current assets | ||||
Cash | $ | 5,146,166 | ||
Accounts receivable, less allowance for doubtful accounts of $220,000 | 10,473,343 | |||
Prepaid expenses | 310,187 | |||
Total current assets | 15,929,696 | |||
Property and equipment, net | 1,341,948 | |||
Intangible assets, net | 7,908,111 | |||
Goodwill | 32,945,787 | |||
Other assets | 15,329 | |||
Total assets | $ | 58,140,871 | ||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||
Current liabilities | ||||
Accounts payable | $ | 10,323,838 | ||
Debentures payable, net of debt discount of $10,962,006 | 23,067,994 | |||
Accrued expenses | 2,008,152 | |||
Accrued compensation | 294,962 | |||
Accrued penalty – registration rights | 43,000 | |||
Common stock put right | 266,732 | |||
Current portion of capital lease obligations | 127,592 | |||
Deferred revenue | 643,557 | |||
Total current liabilities | 36,775,827 | |||
Capital lease obligations, net of current portion | 9,564 | |||
Deferred rent | 126,583 | |||
Total liabilities | 36,911,974 | |||
Commitments and contingencies | ||||
Stockholders’ equity | ||||
Series A Convertible Preferred stock – $.001 par value; 10,000,000 authorized; no shares issued and outstanding | — | |||
Common stock – $.001 par value; 190,000,000 shares authorized; 49,065,035 shares issued and outstanding | 49,065 | |||
Additional paid in capital | 80,463,608 | |||
Accumulated deficit | (59,283,776 | ) | ||
Total stockholders’ equity | 21,228,897 | |||
Total liabilities and stockholders’ equity | $ | 58,140,871 | ||
See note to unaudited condensed consolidated financial statements.
3
SENDTEC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(Unaudited)
| 2007 | 2006 | |||||||
Revenues, net | $ | 9,192,074 | $ | 7,217,460 | ||||
Cost of revenues | 4,611,997 | 4,754,601 | ||||||
Gross profit | 4,580,077 | 2,462,859 | ||||||
Selling, general and administrative expenses | ||||||||
Salaries, wages and benefits | 3,000,597 | 1,175,585 | ||||||
Professional fees | 619,162 | 398,665 | ||||||
Other general and administrative | 1,532,018 | 864,869 | ||||||
Total operating expenses | 5,151,777 | 2,439,119 | ||||||
(Loss) Income from operations | (571,700 | ) | 23,740 | |||||
Other income (expense) | ||||||||
Registration rights penalty | — | 60,000 | ||||||
Waiver and covenant fee | — | (1,443,750 | ) | |||||
Loss on equity-method investment | — | (153,389 | ) | |||||
Interest income | 35,960 | 18,419 | ||||||
Interest expense | (3,247,753 | ) | (1,897,009 | ) | ||||
Total other expense | (3,211,793 | ) | (3,415,729 | ) | ||||
Loss from continuing operations | (3,783,493 | ) | (3,391,989 | ) | ||||
Loss from discontinued operations | — | (1,742,541 | ) | |||||
Cumulative effect of change in accounting principle | 88,500 | — | ||||||
Net loss | $ | (3,694,993 | ) | $ | (5,134,530 | ) | ||
Net loss per common share: | ||||||||
basic and diluted | ||||||||
-Continuing operations | $ | (0.07 | ) | $ | (0.09 | ) | ||
-Discontinued operations | $ | — | $ | (0.05 | ) | |||
-Cumulative effect of change in accounting principle | $ | — | $ | — | ||||
-Total | $ | (0.07 | ) | $ | (0.14 | ) | ||
Weighted average number of common shares outstanding – basic and diluted | 51,826,629 | 37,261,031 | ||||||
See note to unaudited condensed consolidated financial statements.
4
SENDTEC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2007
(Unaudited)
| Preferred Stock | Common Stock | Additional | Accumulated | Stockholders’ | |||||||||||||||||||
Number Shares | Amount | Number of Shares | Amount | ||||||||||||||||||||
Balance – January 1, 2007 | — | — | 47,495,997 | $ | 47,496 | $ | 79,541,963 | $ | (55,588,783 | ) | $ | 24,000,676 | |||||||||||
Common stock issued upon conversion of Debenture principal | — | — | 1,100,000 | 1,100 | 548,900 | — | 550,000 | ||||||||||||||||
Amortization of stock based compensation | — | — | — | — | 197,263 | — | 197,263 | ||||||||||||||||
Common stock issued as partial interest payment to Debenture Holders | — | — | 722,264 | 722 | 266,010 | — | 266,732 | ||||||||||||||||
Reclassification of shares subject to put right | — | — | — | — | (266,732 | ) | — | (266,732 | ) | ||||||||||||||
Repurchase and retirement of common stock subject to redemption | — | — | (253,226 | ) | (253 | ) | 253 | — | — | ||||||||||||||
Expiration of put rights | — | — | — | — | 175,951 | — | 175,951 | ||||||||||||||||
Net loss | — | — | — | — | — | (3,694,993 | ) | (3,694,993 | ) | ||||||||||||||
Balance – March 31, 2007 | — | — | 49,065,035 | $ | 49,065 | $ | 80,463,608 | $ | (59,283,776 | ) | $ | 21,228,897 | |||||||||||
See note to unaudited condensed consolidated financial statements.
5
SENDTEC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(Unaudited)
| 2007 | 2006 | |||||||
CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES | ||||||||
Net loss—continuing operations | $ | (3,783,493 | ) | $ | (3,391,989 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 421,046 | 212,579 | ||||||
Stock-based compensation | 197,263 | 48,616 | ||||||
Non-cash interest | 2,721,935 | 1,553,333 | ||||||
Waiver and covenant fee | — | 1,443,750 | ||||||
Provision for bad debt | 30,000 | — | ||||||
Loss on equity-method investment | — | 153,389 | ||||||
Registration rights penalty | — | (60,000 | ) | |||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (1,059,032 | ) | (2,890,049 | ) | ||||
Prepaid expenses | 16,305 | (64,658 | ) | |||||
Accounts payable | 826,894 | (1,198,924 | ) | |||||
Accrued expenses | 319,357 | (420,169 | ) | |||||
Accrued compensation | 37,323 | (185,262 | ) | |||||
Deferred rent | (5,418 | ) | (3,211 | ) | ||||
Deferred revenue | (464,413 | ) | 867,281 | |||||
Total adjustments | 3,041,260 | (543,325 | ) | |||||
Net cash used in continuing operating activities | (742,233 | ) | (3,935,314 | ) | ||||
CASH FLOWS FROM CONTINUING INVESTING ACTIVITIES | ||||||||
Cash acquired in purchase accounting | — | 9,347,155 | ||||||
Cash received in reconciliation of asset purchase | — | 318,670 | ||||||
Purchase of property and equipment | (109,141 | ) | (192,286 | ) | ||||
Investment in prospective acquiree | — | (193,385 | ) | |||||
Net cash (used in) provided by continuing investing activities | (109,141 | ) | 9,280,154 | |||||
CASH FLOWS FROM CONTINUING FINANCING ACTIVITIES | ||||||||
Net proceeds from sales of common stock | — | 675,000 | ||||||
Proceeds received upon exercise of warrants | — | 62,500 | ||||||
Repurchase and retirement of commons stock subject to redemption | (92,000 | ) | — | |||||
Principal payments on capital lease obligations | (29,248 | ) | — | |||||
Net cash (used in) provided by continuing financing activities | (121,248 | ) | 737,500 | |||||
CASH FLOWS OF DISCONTINUED OPERATIONS | ||||||||
Net cash used in operating activities | — | (920,499 | ) | |||||
Net cash used in investing activities | — | (47,907 | ) | |||||
Net cash used in discontinued operations | — | (968,406 | ) | |||||
Net (decrease) increase in cash | (972,622 | ) | 5,113,934 | |||||
Cash – beginning of period | 6,118,788 | 156,472 | ||||||
Cash – end of period | $ | 5,146,166 | $ | 5,270,406 | ||||
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION | ||||||||
Cash paid during the periods for: | ||||||||
Interest | $ | 276,262 | $ | 535,901 | ||||
Income taxes | $ | 11,675 | $ | — | ||||
Non-cash investing and financing activities | ||||||||
Issuance of common stock in connection with partial payments of interest | $ | 266,732 | $ | — | ||||
Conversion of Debentures Principal into common stock | $ | 550,000 | $ | — | ||||
Issuance of common stock in connection with consolidation | $ | — | $ | 5,306,022 | ||||
STAC Consolidation—See Note 4 | ||||||||
See note to unaudited condensed consolidated financial statements.
6
SENDTEC, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – BASIS OF PRESENTATION AND BUSINESS ORGANIZATION
Basis of presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles (‘‘GAAP’’) for interim financial information and with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and such adjustments are of a normal recurring nature. These consolidated financial statements should be read in conjunction with the financial statements for the year ended December 31, 2006 and notes thereto of SendTec, Inc., formerly RelationServe Media, Inc. (the ‘‘Company’’ or ‘‘SendTec’’) included in the Annual Report on Form 10-KSB for the fiscal year ended December 31, 2006. The results of operations for the three months ended March 31, 2007 are not necessarily indicative of the results for the full fiscal year ending December 31, 2007.
The unaudited condensed consolidated financial statements include SendTec, Inc the (“Company”) and its wholly owned subsidiaries SendTec Acquisition Corp. (“STAC”) which became a wholly-owned subsidiary under a purchase business combination completed on February 3, 2006, RelationServe Access, Inc. (“Access”) and Freindsand.com, Inc. (“Friendsand”). STAC was 23% owned by the Company for the period October 31, 2005 and through February 1, 2006. Accordingly, the accompanying statements of operations for the three months ended March 31, 2006 include the Company’s proportionate share of STAC’s losses for the period of January 1, 2006 through February 2, 2006 in accordance with the provisions of APB 18, “The Equity Method of Accounting for Investments in Common Stock.”
On June 15, 2006, the Company sold substantially all of the business and net assets of Access and ceased the operations of the business of Friendsand. The financial statements for the three months ended March 31, 2006 have been retroactively reclassified to reflect the discontinued operations. All material intercompany balances and transactions have been eliminated in the accompanying unaudited condensed consolidated financial statements.
NOTE 2 – LIQUIDITY, FINANCIAL CONDITION, GOING CONCERN AND LEGAL MATTERS
Liquidity, Financial Condition and Going Concern
The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company incurred a net loss from continuing operations of approximately $3,783,000 for the three months ended March 31, 2007, which includes an aggregate of approximately $3,370,000 in non-cash charges including non-cash interest of $2,722,000, depreciation and amortization of $421,000, stock based compensation of $197,000, and a provision for bad debts of $30,000. The Company also issued stock in payment of approximately $267,000 of contractual interest expense under its Senior Secured Convertible Debentures (the “Debentures”) described in Note 8.
The Company is required to repay its Debentures, as amended, on March 31, 2008. These Debentures have a remaining principal balance of $34,030,000 as of March 31, 2007. The Company currently does not have sufficient capital resources to repay the Debentures upon their maturity. Accordingly, the Company must either restructure this obligation or raise replacement capital in order to avoid a default. The Company is in the process of formulating a plan to restructure this obligation and believes it has access to capital resources to do so, however, no specific plan has been developed nor has an alternate source of financing been identified at this time. Settlement of the Debentures through a conversion of principal into shares of common stock is within the control of the Debenture holders. The Company’s inability to restructure this debt through any other alternative would have a material adverse affect on its business and financial condition. 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 may be necessary should the Company be unable to continue as a going concern.
The Company believes, exclusive of its obligation to repay the Debentures, that its current capital resources combined with revenues it expects to generate during the next twelve months will enable it to fund its operating activities through March 31, 2008. The Company may seek to raise additional capital to fund the growth of its business and believes it has access to capital resources; however, the Company has not secured any commitments for new financing at this time nor can the Company provide any assurance that it will be successful in its efforts to raise additional capital if considered necessary.
7
The Company is currently restricted from incurring additional indebtedness other than certain permitted indebtedness specified under the terms of a Securities Purchase Agreement described in Note 8 (the “Securities Purchase Agreement”) and is also required to attain minimum cash balances of $3,250,000 as of June 30, 2007, $3,500,000 as of September 30, 2007, and $3,750,000 as of December 31, 2007. The amended financial covenants also required the Company to attain minimum net revenues of $5,175,000, $5,450,000, and $5,700,000 for each of the three months periods ending on June 30, 2007, September 30, 2007 and December 31, 2007 respectively. The Company was required to attain minimum cash balance of $3,000,000 as of March 31, 2007, and minimum net revenues $5,025,000 for the three months ended March 31, 2007,
If the due date of the Debentures is accelerated as a result of the Company’s failure to meet the covenants, the Company will not have sufficient working capital or cash to repay the obligation. Since the Company relies on its working capital for day-to-day operations, such a default would have a material adverse effect on the business, operating results, and financial condition. In such event, the Company may be forced to restructure, file for bankruptcy, sell assets, or cease operations, any of which would put the Company, its investors and the value of its common stock, at significant risk. Further, the Company’s obligations under the Debentures are secured by substantially all of its assets. Failure to fulfill the obligations under the Debentures could lead to loss of these assets, which would be detrimental to the Company operations.
Legal Proceedings
As of March 31, 2007, the Company or its predecessors have been named as defendants in two separate claims, other than those described below, made by the Company’s customers arising in the ordinary course of the Company’s business. The Company believes it has substantial defenses and intends to vigorously defend itself against any and all actions taken by the plaintiffs in these matters. The Company, from time to time, is involved in various matters or disputes also arising in the ordinary course of the Company’s business. The Company does not believe that any potential damages that could arise from any of the matters described in this paragraph will have a material adverse effect on its financial condition or the results of its operations.
Omni Point Marketing LLC (“Omni Point”), a predecessor business of the Company, has been named as a defendant in an employment related claim which to date has not been asserted against the Company. Although the Company is not a defendant in this matter at this time, there can be no assurance that the plaintiffs will not attempt to assert this claim against the Company in the future or that such claim, if asserted, will not result in a material loss to the Company. The range of loss with respect to this matter, if any, cannot be quantified.
On April 5, 2006, Mr. Ohad Jehassi, the Company’s former Chief Operating Officer, filed an action against the Company in the Circuit Court for the 17th Judicial Circuit in Broward County, Florida in connection with his termination by the Company (the “Jehassi Complaint”). Mr. Jehassi alleged that the Company breached an Employment Agreement and owes him salary and other benefits in connection with such alleged breach. On June 21, 2006, Mr. Jehassi filed an Amended Complaint adding a claim for violation of the Florida Whistleblower’s Act, and on August 14, 2006, filed a Fourth Amended Complaint adding a claim for unpaid wages under a Florida statute. In February 2007, Mr. Jehassi filed a Fourth Amended Complaint (substantially similar to the Third Amended Complaint). Mr. Jehassi seeks damages of approximately $500,000 plus attorney’s fees, costs and expenses and shares of the Company’s common stock he alleges he is entitled to. The Company has filed an answer to the Fourth Amended Complaint denying that Mr. Jehassi is entitled to any relief and has asserted a counterclaim against Mr. Jehassi. This action is now in the discovery phase. The Company believes this action is without merit, and intends to vigorously defend itself with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
Boston Meridian, LLC v. RelationServe LLC, RelationServe Media, Inc., and Michael Brauser, Civil Action No. 1:06-CV-1041 1-MEL. On March 6, 2006 Boston Meridian LLC (“Boston Meridian”) filed a complaint in the United States District Court, District of Massachusetts, alleging that it is owed certain fees and expenses in connection with the Company’s acquisition of the business of SendTec, Inc. from theglobe.com, Inc. On April 3, 2006, Boston Meridian amended the complaint adding Michael Brauser, the then-Chairman of the Company’s Board of Directors, as an additional defendant, and alleging that Mr. Brauser interfered with Boston Meridian’s contract with the Company. Boston Meridian sought an aggregate of $917,302 in fees and expenses and 100,000 shares of the Company’s common stock as damages. The Company filed a motion to dismiss this action for lack of personal jurisdiction, improper venue, and failure to state a claim. This motion has been fully submitted to the District Court and the Company is awaiting a
8
decision. The Company intends to vigorously defend itself with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on the Company’s financial position or results of operations. The Company also filed a separate action, RelationServe Media Inc. v. Boston Meridian LLC, and Sage Capital Growth, Inc., Index No. 103857/06, in the Supreme Court of the State of New York, County of New York, against both Boston Meridian and Sage Capital Growth, Inc., alleging negligence amid breach of implied contracts, and is seeking damages in excess of $75,000. Both defendants in the New York action filed motions to dismiss this action. The Court granted Sage Capital’s motion to dismiss and withheld decision with respect to Boston Meridian’s motion to dismiss pending a decision on the motion in the Massachusetts’ action. During January 2007, the Company reached an agreement with Boston Meridian providing for settlement of the pending action upon payment of $200,000 in cash, plus the delivery of 1,200,000 shares of the Company’s common stock with a fair value of $312,000. The effectiveness of the settlement remains subject to approval by at least 75% of the holders of the Company’s Debentures. The accompanying unaudited condensed consolidated balance includes a $512,000 liability for the consideration that would be payable upon the settlement of this obligation.
On February 17, 2006, the Law Offices of Robert H. Weiss PLLC (“Weiss”) filed a complaint in the Superior Court of the District of Columbia, Civil Division, against the Company and Omni Point Marketing LLC for fraud, breach of contract, unjust enrichment, and violation of the Uniform Deceptive Trade Practices Act. Weiss sought compensatory damages in an amount no less than approximately $80,000 in addition to punitive and exemplary damages with no specified amount. The Company also had accounts receivable due from Weiss of approximately $350,000 associated with its discontinued operations which it fully reserved. The Company has reached an agreement settling this matter for $30,000 to be paid in three installments and has executed a mutual release with Weiss. During the three months ended March 31, 2007, the Company paid the amount $10,000 with respect to this settlement. The accompanying unaudited condensed consolidated balance includes a $20,000 liability for the remaining due under the settlement of this obligation.
On February 3, 2006, InfoLink Communications, Services, Inc, (InfoLink) filed a complaint against the Company and Omni Point Marketing LLC in the Circuit Court of Miami Dade County, Florida, asserting violation of the federal CAN SPAM ACT of 2003, 15 U.S.C. ss. 7701, and breach of an alleged licensing agreement between Omni Point Marketing LLC and InfoLink. InfoLink seeks actual damages in an amount of approximately $100,000 and approximately $1,500,000 in statutory damages. The Company does not believe that InfoLink has sufficiently pled any factual basis to support its claim. The Company filed a motion asking the Court to enter sanctions against InfoLink, including but not limited to dismissal of the case with prejudice, for InfoLink’s failure to comply with a court order to produce discovery materials. The Company intends to vigorously defend itself with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
On December 15, 2004, the Federal Bureau of Investigation served Omni Point Marketing LLC with a search warrant regarding the alleged use of unlicensed software and seized certain e-mail servers with a net book value of approximately $135,000. Management believes the investigation resulted from a former independent contractor of the Company using the alleged unlicensed software on the Company’s behalf and without knowledge. Management and legal counsel are currently unaware of any additional developments in the investigation. The United States Attorney’s Office had then indicated that it would contact the Company’s legal counsel as the investigation continues. The Company has not received any further communications with respect to this matter; however, there can be no assurance that this matter; if further investigated, will not have a material effect on the Company.
On or about June 15, 2006, R&R Investors Ltd. (“R&R”) commenced an action in the Supreme Court of the State of New York, County of New York, against the Company and Come & Stay S.A. asserting a claim for breach of contract related to a purported agreement concerning the sale of RelationServe Access, Inc and Friendsand, Inc. R&R initially sought an injunction enjoining the transfer of RelationServe Access, Inc. and Friendsand, Inc. stock. The Court denied R&R’s motion. R&R effectuated service of the complaint on the Company in August. The Company has served an answer to R&R’s complaint denying that R&R is entitled to any relief. This action is now in the discovery phase. The Company intends to vigorously defend itself with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
On or about April 28, 2006 LeadClick Media, Inc. commenced an action against the Company in the Superior Court for the State of California, County of San Francisco, alleging breach of contract seeking to recover $379,146, plus interest. The action has been
9
removed to federal court. The Company filed an answer with counterclaims in July 2006. The case is now in the discovery phase. The Company intends to vigorously defend itself with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
On or about August 31, 2006, an action was commenced in the United States District Court for the Southern District of Florida (Case No. 06-61327) by Richard F. Thompson as the putative class representative against the Company and certain of the Company’s former officers and directors alleging securities laws violations in connection with the purchase of the Company’s stock during the period May 24, 2005 to August 2006. The named plaintiff in the case previously filed suit against the Company, as an individual, in State Court in Indiana which action was dismissed in July 2006. The Florida District Court permitted plaintiff to file an amended complaint and on November 13, 2006, plaintiff filed a “First Amended Class Action Complaint” (the “First Amended Complaint”) adding an additional plaintiff, L. Alan Jacoby, who purportedly purchased 10,000 shares of the Company’s common stock in the open market, and naming additional former and present officers and directors of the Company and others as defendants. The First Amended Complaint, styled as a class action, alleges violations of Section 11 and Section 12(2) of the Securities Act and Section 10(b) of the Securities Exchange Act, and Rule 10b-5 promulgated thereunder. Plaintiffs claim, among other things, violations of the various acts: (a) by selling securities through persons who were not registered as agents and/or broker dealers with the Securities Exchange Commission or the States of Florida or Indiana and were not affiliated as an agent or representative of any broker/dealer; (b) by failing to disclose to purchasers of RelationServe Media, Inc. stock that they were selling securities of RelationServe stock through unregistered agents and broker/dealers was in violation of state and federal securities laws which caused a substantial contingent liability for claims of rescission by investors and exposing RelationServe to substantial legal fees, criminal and civil liability which would have a material adverse impact to the RelationServe’s financial condition; (c) by failing to disclose that in July 2005 RelationServe’s Chief Executive Officer and Chief Operating Officer received evidence of accusations of employee theft of data and employee kickbacks had been made and the matter was so material that CEO hired an outside attorney to investigate the matter; (d) failing to disclose that a former director has previously been sued by stockholders of two other corporations; and (e) by failing to disclose that financial statements beginning the third quarter of 2005 were false and misleading as senior officer of the Company, Richard Hill, had directed that finance recognize income in the third quarter in violation of Sarbanes-Oxley Act of 2002. The invoices directed to be recorded either did not exist or were otherwise untraceable, cancelled, or were never shipped, with the exception of just a few (adjustments to income that would be required as a result of the allegations, if any, relate to certain discontinued operations). In addition to the claims of securities law violations, plaintiffs claim violation of Section 20(a) of the Securities Exchange Act of 1934, as amended, as to the Company’s controlling persons, violations of the Florida Securities Act, violations of the Indiana Securities Act, sales of unregistered, non-exempt securities, violation of anti-fraud provisions under Indiana law, deception under Indiana law, and fraud. Plaintiffs seek rescission, damages, treble damages, punitive damages, compensatory damages, interest, costs, and attorney’s fees.
The First Amended Complaint repeats and re-alleges various claims made by Ohad Jehassi, our former Chief Operating Officer in a matter pending before the Circuit Court of the 17th Judicial Circuit, Broward County, Florida (Case No. 06-004597), Ohad Jehassi v. RelationServe Media, Inc., a Florida corporation, and Relationserve Media, Inc., d/b/a Sendtec Acquisition Corp., a Florida corporation (the “Jehassi Complaint”). The initial complaint filed by Jehassi on or about April 5, 2006, alleged, among other things, that we breached our employment agreement with Jehassi and owe him salary and other benefits in connection with such alleged breach. On June 21, 2006, Jehassi filed an amended complaint adding a claim for an alleged violation of Florida’s “Whistleblower’s Act,” and on August 14, 2006, filed a third amended complaint adding a claim for unpaid wages under Florida statutes. Mr. Jehassi seeks damages of approximately $500,000 plus attorney’s fees, costs, and expenses and shares of our stock he alleges he is entitled to. We have asserted that Mr. Jehassi was removed from his position with us for cause and is therefore not entitled to any of the relief he seeks and has asserted a counterclaim against Mr. Jehassi related to the shares of our common stock Jehassi claims he is entitled to. The substance of Mr. Jehassi’s whistleblower claims have been adapted in the First Amended Complaint filed by Thompson as the basis for asserting that we filed false and misleading financial statements and that we violated the Sarbanes-Oxley Act of 2002. The court dismissed the First Amended Complaint on March 6, 2007. By the terms of the court’s order, the plaintiffs were given leave to refile a new complaint on or before March 19, 2007, and on March 19, 2007, plaintiffs filed a second amended complaint. We intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
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On September 28, 2006, Wedbush Morgan Securities, Inc. (“Wedbush”) commenced arbitration against the Company seeking $521,954 in damages as a result of an alleged breach of contract. The case is now in the discovery phase and there is an arbitration hearing scheduled to commence on June 25, 2007. The Company intends to present a vigorous defense with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
On or about September 26, 2006,–the Company received copies of three consumer complaints filed by Chirag Chaman, Chief Operating Officer of MX Interactive, LLC. These complaints submitted to the SEC, the New York Attorney General, and the Florida Attorney General,–make various claims with respect to the failure to issue to MX Interactive LLC 45,454 shares of stock which claimant alleges the Company agreed to transfer pursuant to a written assignment agreement. Claimant asserts that in July 2005 a third party agreed to transfer rights to receive shares of Company stock to claimant and failed to do so, and that the Company is under an obligation to transfer such shares and satisfy the obligation under the assignment agreement.–The Company believes these claims to be substantially without merit and intends to vigorously defend itself with respect to this matter, however its outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
On November 14, 2006 the Company’s counsel-received a letter from counsel to Deborah Kamioner with an enclosed copy of a letter dated September 5, 2006. In letters dated September 5, 2006 and July 31, 2006 received from Deborah Kamioner, an investor in the Company’s Series A Preferred Stock, which automatically converted into the Company’s common stock on February 3, 2006, seeking adjustment to the number of shares purchased by Ms. Kamioner under certain anti-dilution provisions to account for: subsequent issuance of 10,081,607 warrants exercisable at $0.01 per share; 525,000 shares of common stock issued to Debenture holders in connection with a consent; the exchange of shares of STAC common stock for shares of Company common stock by STAC management; and the exchange of STAC common stock with vested shares of restricted STAC common stock for approximately 9 million shares of Company common stock. The Company believes these claims to be substantially without merit and intends to vigorously defend itself with respect to this matter, however an outcome or range of possible loss, if any, cannot be predicted at this time. The Company cannot provide any assurance that the outcome of this matter will not have a material adverse effect on its financial position or results of operations.
The Company received a letter dated August��11, 2006 from counsel to Sunrise Equity Partners, L.P., demanding return of its $750,000 investment, with interest. Subsequently, counsel to Sunrise Equity Partners, L.P. has made demands for issuance of additional shares of common stock on the same basis as the amendment to the Company’s Debentures and has threatened legal action, although, to date, no action has been taken. The Company has engaged in settlement discussions with counsel for Sunrise after the matter was referred to mediation. During February 2007, the Company reached an agreement in principal for settlement of this matter upon the issuance of 650,000 shares of its common stock with a fair value of $169,000. The effectiveness of the settlement is subject to approval by holders of the Company’s debentures. The accompanying unaudited condensed consolidated balance includes a $169,000 liability for the consideration that would be payable upon the settlement of this obligation.
NOTE 3 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of SendTec, Inc. and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Investments in which the Company has a 20% to 50% ownership interest are accounted for using the equity method.
Revenue Recognition
The Company follows the guidance of the Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) 104 for revenue recognition. In general, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the selling price to the customer is fixed or determinable, and collectibility is reasonably assured. The Company, in accordance with Emerging Issues Task Force (EITF”) Issue 99-19 “Reporting Revenue Gross as a Principal vs. Net as an Agent,” reports revenues for transactions in which it is the primary obligor on a gross basis and revenues in which it acts as an agent on and earns a fixed percentage of the sale on a net basis, net of related costs. Credits or refunds are recognized when they are determinable and estimable. The following policies reflect specific criteria for the various revenue streams of the Company:
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Internet advertising: Revenue from the distribution of internet advertising, which principally includes the placement of banner ads and e-mail transmission services, is recognized when internet users visit and complete actions at an advertiser’s website. Revenue consists of the gross value of billings to clients, including the recovery of costs incurred to acquire online media required to execute client campaigns. The Company reports these revenues gross because it is responsible for fulfillment of the service, has substantial latitude in setting price and assumes the credit risk for the entire amount of the sale, and it is responsible for the payment of all obligations incurred with media providers.
Online search: Revenue derived from search engine marketing services, such as search engine keyword buying, is recognized on a net basis in the period when the associated keyword search media is clicked on by a consumer. SendTec typically earns a media commission equal to a percentage of the keyword search media purchased for its clients. In many cases, the amount SendTec bills to clients significantly exceeds the amount of revenue that is earned due to the existence of various pass-through charges such as the cost of the search engine keyword media. Amounts received in advance of search engine keyword media purchases are deferred and included in deferred revenue in the accompanying balance sheet. The Company reports these revenues on a net basis since amounts earned are based on a fixed percentage of the selling price.
Direct response media: Revenue derived from the purchase and tracking of direct response media, such as television and radio commercials, is recognized on a net basis when the associated media is aired. In many cases, the amount the Company bills to clients significantly exceeds the amount of revenue that is earned due to the existence of various pass-through charges such as the cost of the television and radio media. Amounts received in advance of media airings are deferred and included in deferred revenue in the accompanying balance sheet. The Company reports these revenues on a net basis since amounts earned are based on a fixed percentage of the selling price.
Advertising programs: Revenue generated from the production of direct response advertising programs, such as infomercials, is recognized on the completed contract method when such programs are complete and available for airing. Production activities generally take 8 to 12 weeks and the Company usually collects amounts in advance and at various points throughout the production process. Amounts received from customers prior to completion of commercials are included in deferred revenue and direct costs associated with the production of commercials in process are also deferred and included in prepaid expenses. The Company reports these revenues gross because it is responsible for the fulfillment of the service.
Revenues by revenue stream are as follows:
| For the Three Months Ended March 31, | ||||||
| 2007 | 2006 | |||||
Internet advertising | $ | 6,194,244 | $ | 5,915,895 | ||
Online search | 1,191,148 | 180,769 | ||||
Direct response media | 598,709 | 307,576 | ||||
Advertising programs | 1,056,044 | 813,220 | ||||
Other | 151,929 | — | ||||
| $ | 9,192,074 | $ | 7,217,460 | |||
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investments with original maturities of three months or less.
Accounts Receivable
Accounts receivable are generally due 30 days from the invoice date. The Company has a policy of reserving for uncollectible accounts based on its best estimate of the amount of probable credit losses in its existing accounts receivable. The Company periodically reviews its accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Accounts are deemed past due when they are not paid in accordance with contractual terms. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. At March 31, 2007, the Company established, based on a review of its outstanding balances, an allowance for doubtful accounts in the amount of $220,000.
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Property and Equipment
Property and equipment are carried at cost. The cost of repairs and maintenance is expensed as incurred; major replacements and improvements are capitalized. When assets are retired or disposed of, the cost and accumulated depreciation are removed from the accounts, and any resulting gains or losses are included in results of operations in the year of disposition. Depreciation and amortization are computed by the straight-line method over the following estimated useful lives:
| Years | ||
Leasehold improvements | Shorter of 4 years or the Estimated Useful Life | |
Computer equipment | 3 – 5 | |
Furniture, fixtures and office equipment | 5 – 7 | |
Software | 3 |
Goodwill and Intangible Assets
The Company accounts for goodwill and intangible assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” SFAS No. 142 requires that goodwill and other intangibles with indefinite lives should be tested for impairment annually or on an interim basis if events or circumstances indicate that the fair value of an asset has decreased below its carrying value. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in business combinations. SFAS 142, requires that goodwill be tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests when circumstances indicate that the recoverability of the carrying amount of goodwill may be in doubt. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value. The Company operates a single reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, determining appropriate discount rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment.
The Company’s amortizable intangible assets include customer relationships and covenants not to compete. These costs are being amortized using the straight-line method over the following estimated useful lives:
| Years | ||
Customer relationships | 8.5 | |
Non-compete agreements | 3 – 5 |
In accordance with SFAS 144 “Long-Lived Assets”, the Company reviews the carrying value of intangibles and other long-lived assets for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of long-lived assets is measured by comparison of its carrying amount to the undiscounted cash flows that the asset or asset group is expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property, if any, exceeds its fair market value.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Significant estimates during the three months ended March 31, 2007 and 2006 include the allowance for doubtful accounts, stock-based compensation, the useful life of property and equipment and intangible assets, impairment of intangible assets and goodwill, debenture modification accounting, and loss contingencies.
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Fair Value of Financial Instruments
The carrying amounts reported in the balance sheet for cash, accounts receivable, prepaid expenses, accounts payable and accrued expenses approximate fair value based on the short-term maturity of these instruments. The carrying amounts of the Company’s convertible debentures approximate fair value as such instruments have effective yields that are consistent with instruments of similar risk, when taken together with equity instruments issued to the investors of these instruments.
Convertible Debentures
The Company accounts for conversion options embedded in convertible notes in accordance with SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”). SFAS 133 generally requires companies to bifurcate conversion options embedded in convertible notes from their host instruments and to account for them as free standing derivative financial instruments in accordance with EITF 00-19. SFAS 133 provides for an exception to this rule when convertible notes, as host instruments, are deemed to be conventional as that term is described in the implementation guidance under Appendix A to SFAS 133 and further clarified in EITF 05-2 “The Meaning of “Conventional Convertible Debt Instrument” in Issue No. 00-19 and when conversion options are considered equity.
The Company accounts for convertible notes (deemed conventional) in accordance with the provisions of EITF (“EITF”) 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features,” (“EITF 98-5”), and EITF 00-27 “Application of EITF 98-5 to Certain Convertible Instruments.” Accordingly, the Company records, as a discount to convertible notes, the intrinsic value of such conversion options based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. Debt discounts under these arrangements are amortized over the term of the related debt to their earliest date of redemption.
Common Stock Purchase Warrants and Other Derivative Financial Instruments
The Company accounts for the issuance of Common Stock purchase warrants and other freestanding derivative financial instruments in accordance with the provisions of EITF 00-19. Based on the provisions of EITF 00-19, the Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) gives the Company a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement). The Company classifies as assets or liabilities any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the control of the Company) or (ii) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement).
Registration Rights Agreements
Effective January 1, 2007, the Company adopted FSP EITF 00-19-2, “Accounting for Registration Payment Arrangements.” FSP EITF 00-19-2 addresses an issuer’s accounting for registration payment arrangements. This pronouncement specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument, should be separately recognized and accounted for as a contingency in accordance with SFAS 5 “Accounting for Contingencies.” The adoption of this pronouncement did not have a material effect on the Company’s financial statements.
The Company is currently obligated under two registration rights agreements requiring it maintain the effectiveness of a registration statement covering the resale of shares underlying previous placements of preferred stock and convertible debt with warrants through at least March 31, 2008 or until all shares have been sold by the selling stockholders in these registrations. The maximum amount of penalty that Company could incur (payable in cash) as of March 31, 2007 is not substantially different than the amount the Company has recorded. On January 1, 2007, the Company reduced the carrying amount of its liability for estimated penalties in accordance with FSP EITF 00-19-02 by approximately $89,000 to $43,000, which is included in the accompanying unaudited condensed consolidated balance sheet. The reduction in the carrying amount of the registration rights liability upon the adoption of FSP EITF 00-19-2 is presented as a cumulative effect of a change in accounting principle in the accompanying statement of operation of the quarter ended March 31, 2007.
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Net Loss Per Share
In accordance with SFAS No. 128 “Earnings Per Share,” Basic net loss per share is computed by dividing net loss by the weighted average number of shares of Common Stock outstanding during the period. Diluted net loss per share is computed by dividing net loss by the weighted average number of shares of Common Stock, Common Stock equivalents and potentially dilutive securities outstanding during each period. Diluted loss per common share is not presented because it is anti-dilutive. The Company’s Common Stock equivalents at March 31, 2007 include the following:
Options | 6,160,500 | |
Warrants | 8,697,487 | |
Convertible Debentures | 68,060,000 | |
Total common stock equivalents | 82,917,987 | |
The Company included 3,230,730 common stock purchase warrants exercisable at $0.01 per share, in the table above in its determination of basic and diluted loss per share for the year ended December 31, 2006, since warrants are exercisable for nominal consideration.
Income Taxes
The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”). SFAS No. 109 requires the recognition of deferred tax assets and liabilities for both the expected impact of differences between the financial statements and tax basis of assets and liabilities and for the expected future tax benefit to be derived from tax loss and tax credit carry forwards. SFAS No. 109 additionally requires the establishment of a valuation allowance to reflect the likelihood of realization of deferred tax assets.
The Company has not recognized any income tax expense (benefit) in the accompanying financial statements for the three months ended March 31, 2007 and 2006. Deferred tax assets, which principally arise from net operating losses, are fully reserved due to management’s assessment that it is more likely than not that the benefit of these assets will not be realized in future periods.
As described in Note 12, the Company adopted the Company adopted FASB Interpretation No. 48 – “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”),effective January 1, 2007. A discussion of the effect of having adopted FIN 48 is also described in Note 12.
Stock-Based Compensation
Effective January 1, 2006, the Company adopted SFAS No. 123R “Share Based Payments”. This statement is a revision of SFAS No. 123, and supersedes APB Opinion No. 25, and its related implementation guidance. SFAS 123R addresses all forms of share based payment (“SBP”) awards including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Under SFAS 123R, SBP awards result in a cost that is measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest. The Company adopted the modified prospective method with respect to accounting for its transition to SFAS 123(R) and measured unrecognized compensation cost as described in Note 15.
Advertising
The Company expenses the cost of advertising, which includes print advertising and online advertising, in accordance with the AICPA Accounting Standards Executive Committee’s Statement of Position (“SOP”) 93-7, “Reporting on Advertising Costs” (“SOP 93-7”). Advertising costs are expensed the first time the advertisement runs. Online marketing fees and print media placement costs are expensed in the month the advertising appears.
Advertising and promotional expenses are net of amounts reimbursed to the Company by its partners. Advertising costs were $53,493 and $28,409 for the three months ended March 31, 2007 and 2006, respectively, and are included in other operating expenses in the unaudited condensed consolidated statements of operations.
Concentration of Credit Risk
The Company maintains its cash in bank deposit accounts, which, at times, exceed federally insured limits. At March 31, 2007, the Company had approximately $5,146,000 in United States bank deposits, which exceed federally insured limits. The Company has not experienced any losses in such accounts through March 31, 2007.
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Recent Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments-an amendment of SFAS No. 133 and 140” (“SFAS 155”). SFAS 155 addresses the following: a) permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; c) establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and e) amends SFAS 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. The Company adopted SFAS 155 on January 1, 2007. The adoption of this pronouncement did not have a material effect on the Company’s financial statements.
In March 2006, the FASB issued SFAS 156 “Accounting for Servicing of Financial Assets – an amendment of SFAS No. 140” (“SFAS 156”). SFAS 156 is effective for the first fiscal year beginning after September 15, 2006. SFAS 156 changes the way entities account for servicing assets and obligations associated with financial assets acquired or disposed of. The Company adopted SFAS 156 on January 1, 2007. The adoption of this pronouncement did not have an effect on the Company’s financial statements.
In September 2006, the FASB issued SFAS 157 “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective for the first fiscal year beginning after November 2007. The Company is currently evaluating the impact of adopting SFAS 157 on its financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin SAB 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for the first fiscal year ending after November 15, 2006. The adoption of SAB 108 did not impact the Company’s financial statements.
In November 2006, the EITF reached a final consensus in EITF Issue 06-6 “Debtor’s Accounting for a Modification (or Exchange) of Convertible Debt Instruments” (“EITF 06-6”). EITF 06-6 addresses the modification of a convertible debt instrument that changes the fair value of an embedded conversion option and the subsequent recognition of interest expense for the associated debt instrument when the modification does not result in a debt extinguishment pursuant to EITF 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments.” The consensus is applicable to modifications or exchanges of debt instruments occurring in interim or annual periods beginning after November 29, 2006. The adoption of EITF 06-6 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In November 2006, the FASB ratified EITF Issue No. 06-7, Issuer’s Accounting for a Previously Bifurcated Conversion Option in a Convertible Debt Instrument When the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities (“EITF 06-7”). At the time of issuance, an embedded conversion option in a convertible debt instrument may be required to be bifurcated from the debt instrument and accounted for separately by the issuer as a derivative under FAS 133, based on the application of EITF 00-19. Subsequent to the issuance of the convertible debt, facts may change and cause the embedded conversion option to no longer meet the conditions for separate accounting as a derivative instrument, such as when the bifurcated instrument meets the conditions of Issue 00-19 to be classified in stockholders’ equity. Under EITF 06-7, when an embedded conversion option previously accounted for as a derivative under FAS 133 no longer meets the bifurcation criteria under that standard, an issuer shall disclose a description of the principal changes causing the embedded conversion option to no longer require bifurcation under FAS 133 and the amount of the liability for the conversion option reclassified to stockholders’ equity. EITF 06-7 is applicable to all previously bifurcated conversion options in convertible debt instruments that no longer meet the bifurcation criteria in FAS 133 in interim or annual periods beginning after December 15, 2006, regardless of whether the debt instrument was entered into prior or subsequent to the effective date of EITF 06-7. The adoption of EITF 06-7 did not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is in the process of evaluating the impact of the adoption of this statement on the Company’s results of operations and financial condition.
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Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.
NOTE 4 – ACQUISITION OF SENDTEC
On August 9, 2005, the Company entered into an asset purchase agreement (the “Asset Purchase Agreement”), as amended on August 23, 2005, with theglobe.com, Inc. and its wholly-owned subsidiary, SendTec. The Asset Purchase Agreement provided for the Company to purchase, through SendTec Acquisition Corp. (“STAC”), the business and assets of SendTec (the “Asset Purchase”). The Asset Purchase Agreement ( as amended), and certain other contemporaneous agreements, including the Securities Purchase Agreement described in Note , provided for the mandatory consolidation of STAC, as defined in the Securities Purchase Agreement (the “Consolidation”) with the Company upon the attainment of certain contractual milestones (the “Consolidation Milestones”). The Company owned 23% of STAC (which acquired SendTec from the globe.com, Inc. in October 31, 2005) for the period of October 31, 2005 through February 3, 2006, the date in which the Company satisfied the Consolidation Milestones and completed its acquisition of 100% of SendTec through STAC. As described in Note 1, the Company accounted for its investment in STAC, through the date of the consolidation under the equity method prescribed in APB 18. Accordingly, the Company recorded a $1,034,102 charge for its proportionate share of STAC’s losses for the period of November 1, 2005 through December 31, 2005, and a $153,389 charge for its proportionate share of STAC’s losses for the period of January 1, 2006 through February 3, 2006.
The purchase consideration paid by STAC to theglobe.com, Inc. on October 31, 2005 plus transaction expenses amounted to an aggregate of $40,430,000. SendTec’s tangible net assets amounted to $2,744,909. The excess of the purchase consideration plus transaction expenses, which amounted to $37,685,091 was allocated as follows:
Purchase price in excess of net assets acquired | $ | 37,685,091 | |
Allocated to: | |||
Customer relationships | 8,729,000 | ||
Covenant not to compete | 590,000 | ||
Goodwill | $ | 28,366,091 | |
A reconciliation of the amount of goodwill recorded by STAC upon its acquisition of SendTec on October 31, 2005 to the amount recorded by the Company upon its consolidation with STAC on February 3, 2006, is as follows:
Excess of purchase price over net assets acquired by STAC at October 31, 2005 allocated to goodwill | $ | 28,366,091 | ||
Net Losses of STAC for the period of November 1, 2005 through January 31, 2006, net of equity loss recognized by the Company of $1,187,491 | 3,975,513 | |||
Consolidation Date adjustments to the fair values of : | ||||
Senior Secured Convertible Debentures | (486,224 | ) | ||
Non-compete agreements | (117,666 | ) | ||
Company Transaction Expenses | 1,273,086 | |||
Assumption of registration rights obligation at fair value | 250,000 | |||
Dividend paid to STAC Preferred Stockholders | 3,737 | |||
Excess of purchase price over net assets acquired at February 3, 2006 allocated to goodwill | 33,264,537 | |||
Less cash received in March 2006 under a purchase price adjustment | (318,750 | ) | ||
Excess of purchase price over net assets acquired as of March 31, 2007 allocated to goodwill | $ | 32,945,787 | ||
On the date of the Consolidation, STAC’s tangible net assets amounted to $6,079,780, including cash of $9,347,155, which is presented as cash acquired in business combination in the accompanying unaudited condensed consolidated statement of cash flows for the three months ended March 31, 2006.
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The following unaudited pro-forma information reflects the results of continuing operations of the Company, as if the acquisition had been consummated as of January 1, 2006:
| For the three months ended March 31, 2006 | ||||
Revenues | $ | 10,093,000 | ||
Net Loss – continuing operations | (3,600,000 | ) | ||
Net Loss per share – basic and diluted | (0.10 | ) | ||
NOTE 5 – PROPERTY AND EQUIPMENT
At March 31, 2007, property and equipment consist of the following:
Equipment | $ | 875,018 | ||
Furniture and fixtures | 255,838 | |||
Leasehold improvements | 28,894 | |||
Software | 657,939 | |||
Property and equipment | 1,817,689 | |||
Less accumulated depreciation | (475,741 | ) | ||
Property and equipment, net | $ | 1,341,948 | ||
Depreciation expense was approximately $119,000 and $71,000 for the three months ended March 31, 2007 and 2006, respectively.
Fixed assets include $241,500 of equipment purchases that were financed under capital lease obligations as of March 31, 2007, all of which were purchased during 2006. The accumulated depreciation on these assets amounted to $74,800 as of March 31, 2007.
NOTE 6 – GOODWILL AND AMORTIZABLE INTANGIBLE ASSETS
At March 31, 2007, goodwill and other intangible assets consist of the following:
Goodwill | $ | 32,945,787 | ||
Amortizable Intangible Assets: | ||||
Customer relationships | $ | 8,729,000 | ||
Non-compete agreements | 590,000 | |||
Less accumulated amortization | (1,410,889 | ) | ||
Intangible assets, net | $ | 7,908,111 | ||
The Company, as of March 31, 2007, evaluated the carrying amount of its goodwill in accordance with SFAS 142 to determine whether circumstances indicate that the carrying amount of the goodwill exceeds its net realizable value. The Company also evaluated the carrying amounts of its amortizable intangible assets in accordance with SFAS 144 to determine whether such carrying amounts exceed net realizable value. The Company does not believe that any material events or changes in its circumstances that occurred during the three months ended March 31, 2007 that would indicate that the carrying amount of its goodwill or amortizable intangibles exceed their fair value.
Making estimates about the carrying values of intangible assets requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect on the financial statements of a condition, situation, or set of circumstances that existed at the date of the financial statements, which management considered in formulating its estimate could change in the near term due to one or more future confirming events. Accordingly, the actual results regarding estimates of the carrying value of these intangibles could differ materially from the Company’s estimates.
Amortization expense with respect to the customer relationships and non-compete agreements amounted to approximately $302,000 and $78,000 for the three months ended March 31, 2007 and 2006, respectively. Amortization expense subsequent to March 31, 2007 is as follows:
Period from April 1, 2007 through December 31, 2007 | $ | 907,001 | |
Years ending December 31: | |||
2008 | 1,186,303 |
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2009 | 1,071,152 | ||
2010 | 1,063,783 | ||
2011 | 1,026,941 | ||
2012 | 1,026,941 | ||
2013 | 1,026,941 | ||
2014 | 599,049 | ||
| $ | 7,908,111 | ||
NOTE 7 – ACCRUED EXPENSES
As of March 31, 2007, accrued expenses are comprised of the following:
Legal contingencies liability | $ | 721,119 | |
Branded media costs | 691,879 | ||
Interest | 337,196 | ||
Other | 257,958 | ||
Total accrued expenses | $ | 2,008,152 | |
NOTE 8 – DEBENTURES
As described in Note 4, STAC financed its purchase of SendTec, in part, by issuing the Senior Secured Convertible Debentures in the original principal amount of $34,950,000 with an original maturity date of October 30, 2009. The STAC Debenture provided, among other things, for the Company to assume liability for the STAC Debentures on the date of Consolidation. Accordingly, the Company is obligated under the terms of the Securities Purchase Agreement, as amended, to repay $34,030,000 of the remaining principal balance due on the STAC Debentures on March 31, 2008. Under the terms modified terms of the Securities Purchase Agreement, these debentures bear interest at 6% per annum and are convertible into shares of the Company’s common stock at $.50 per share at the option of the Debenture Holders.
A summary of the remaining carrying amount of the Debentures at March 31, 2007, after giving effect to $920,000 of principal converted to 1,840,000 shares of common stock, is as follows:
Remaining Principal (due March 31, 2008 with interest at 6% per annum) | $ | 34,030,000 | ||
Less unamortized discount | (10,962,006 | ) | ||
Net Carrying Value | $ | 23,067,994 | ||
The difference between the carrying value of the modified debt instrument and the mandatory redemption amount is being accreted as interest expense over the term of the amended Securities Purchase Agreement through March 31, 2008.
The financial covenants require the Company to attain minimum net revenues of $5,025,000, $5,175,000, $5,450,000, and $5,700,000 for the first, second, third, and fourth quarters of 2007. The Company must also attain minimum cash balances of $3,000,000 at the end of the first quarter of 2007, $3,250,000 at the end of the second quarter of 2007, $3,500,000 at the end of the third quarter of 2007, and $3,750,000 at the end of the fourth quarter of 2007.
The Debentures were amended on November 10, 2006 to provide for a (i) reduction in the conversion price from $1.50 per share to $.50 per share and (ii) change the maturity date from October 31, 2009 March 31, 2008, in exchange for a release of previous instances of non-compliance with certain financial covenants. The modification of the Debentures resulted in a constructive extinguishment of this instrument under its terms prior to the date of the modification. The Debentures, under the original terms, were fully discounted at the time they were assumed by the Company concurrent with its Consolidation of STAC on February 3, 2006. Accordingly, interest expense for the three months ended March 31, 2006 includes $1,553,333 , for the difference between the carrying value of the Debentures under their original terms and their mandatory redemption amount that was being accreted as interest expense through October 31, 2009 under the original terms of the Securities Purchase Agreement. Interest expense for the three months ended March 31, 2006 also includes $129,011 for the amortization of deferred financing fees that were written-off upon the modification of the Debentures on November 10, 2006 as a result of having constructively extinguished the original debt instrument.
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Contractual interest expense on the Debentures amounted to $517,962 and $343,676 during the three months ended March 31, 2007 and March 31, 2006, respectively.
NOTE 9 – CAPITAL LEASE OBLIGATIONS
During April 2006, the Company entered into various capital leases with an aggregate present value of $241,500. In accordance with SFAS 13, “Accounting for Leases” (“SFAS 13”), the present value of the minimum lease payments was calculated using discount rates ranging from 14% to 17%. Lease payments, including amounts representing interest, amounted to $34,735 for the three months ended March 31, 2007. The leases require monthly payments of approximately $11,600 including interest at discount rates ranging from 14% to 17% and are due at various times through April 2008.
Minimum lease payments due subsequent to March 31, 2007 are as follows:
Period from April 1, 2007 through December 31, 2007 | $ | 104,206 | ||
Year ending December 31, 2008 | 44,431 | |||
Total minimum lease payments | 148,637 | |||
Less amounts representing interest | (11,481 | ) | ||
Present value of minimum lease payments | 137,156 | |||
Less current portion | (127,592 | ) | ||
Long-term portion | $ | 9,564 | ||
NOTE 10 – SIGNIFICANT CUSTOMERS
A significant portion of the Company’s revenue is attributable to a small number of customers. During the three months ended March 31, 2007, one customer’s sales represented approximately 27.2% of the Company’s net revenue. Two customers represented approximately 22.8% of total accounts receivable at March 31, 2007.
During the three months ended March 31, 2006, three customer’s sales represented approximately 9.3%, 14.6%, and 25.1%, respectively, of the Company’s net revenues.
NOTE 11 – RELATED PARTY TRANSACTIONS
The CEO and Chairman of the Board of Directors of the Company also serves on the board of directors of a company that is a customer of SendTec. There were no revenues from this customer during the three months ended March 31, 2007 and 2006, and there was no accounts receivable from this customer as of March 31, 2007.
The Company pays fees and commissions to a company whose management includes someone who is a member of the Company’s Board of Directors. For the three months ended March 31, 2007 and 2006 the Company incurred $32,172 and $16,115, respectively, in fees and commissions. At March 31, 2007 $13,265 of such fees and commissions were included in accrued expenses in the accompanying unaudited condensed consolidated balance sheet.
The Company pays fees and commissions to a company whose principle shareholder is a member of the Company’s Board of Directors. For the three months ended March 31, 2007 and 2006 the Company incurred $2,000 and $8,000, respectively, in fees and commissions. At March 31, 2007 there were no fees and commissions that remained outstanding.
NOTE 12 – INCOME TAXES
As describe in Note 1, the Company adopted FIN 48 Effective January 1, 2007. FIN 48 requires companies to recognize in their financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and disclosure.
The Company and its subsidiaries file consolidated federal and various state income tax returns in which the initial period of tax reporting for these entities occurred during the year ended December 31, 2005. These income tax return have not been examined by the applicable Federal and State tax authorities. The Company has also not yet filed its income tax returns for the year ended December 31, 2006.
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Management does not believe that the Company has any material uncertain tax position requiring recognition or measurement in accordance with the provisions of FIN 48. Accordingly, the adoption of FIN 48 did not have a material effect on the Company financial statements. The Company’s policy, is to classify penalties and interest associated with uncertain tax positions, if required as a component of its income tax provision.
The Company has approximately $8 million of net deferred tax assets, a substantial portion of which includes the tax effects of approximately $18.8 million of net operating loss carry forwards that will expire between the years 2025 and 2026. The utilization of any net operating losses that the Company has generated to date may become, in future periods, subject to substantial limitations due to the “change in ownership” provisions under Section 382 of the Internal Revenue Code and similar state provisions.
NOTE 13 – COMMITMENTS AND CONTINGENCIES
Legal matters
The Company is involved in various matters that are described in Note 2.
Stock Registration Rights Agreements
The Company is obligated to maintain the effectiveness of certain registration statements it has filed with the SEC under Registration Rights Agreement with the investors of its Series A Preferred Stock (converted into common stock on February 3, 2006) and the Securities Purchase Agreement described in Note 8. As described in Note 2, the Company adopted FSP EITF 00-19-2 on January 1, 2006. At March 31, 2007, the Company reduced its reserve for estimated penalties under registration rights agreements by approximately $89,000 to $43,000, which is included in the accompanying unaudited condensed consolidated balance sheet.
Operating leases
The Company leases its office facilities under two non-cancelable leases expiring in February 2010 and December 2009, respectively. Minimum annual lease payments due to March 31, 2007 are approximately as follows:
Period from April 1, 2007 through December 31, 2007 | $ | 320,900 | |
Years ending December 31: | |||
2008 | 415,400 | ||
2009 | 426,900 | ||
2010 | 60,100 | ||
Total minimum lease payments | $ | 1,223,300 | |
Rent expense for the three months ended March 31, 2007 and 2006 was approximately $97,200 and $50,100, respectively, including $3,700 and $4,300, respectively, for a share of operating expenses. Rent expense is being recorded on the straight line basis over the term of the lease in accordance with SFAS No. 13, Accounting for Leases.
NOTE 14 – STOCKHOLDERS’ EQUITY
Common Stock Purchase Warrants
The Company, upon its Consolidation with STAC, issued to the Debentures investors, seven year Warrants to purchase an aggregate of 10,081,607 shares of the Company’s Common Stock exercisable at $0.01 per share in amounts proportionate to the face amount of the Debentures. The Warrants are exercisable from February 3, 2006 through October 30, 2012. The Warrants feature a cashless exercise provision, which provides (a) the holder with the right, any time after one year from their date of issuance through their date of termination (and only in the event that there is not an effective registration or prospectus covering the resale of the underlying stock), to exercise such Warrants using the cashless exercise feature and/or (b) for an automatic cashless exercise on the date of termination. The Company can consent to a cashless exercise of the Warrants at the request of the holder at anytime. A cashless exercise will result in a net share settlement of the Warrants based on a formula in which the net shares issuable is based upon the
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then fair value of the Company’s common stock. The Company evaluated the classification of these Warrants at the date of consolidation and at March 31, 2006 in accordance with EITF 00-19 and determined that they are equity instruments because (a) net share settlement is within the Company’s control and (b) the cashless exercise feature does not potentially result in the issuance of an indeterminate number of shares.
As described below, Debenture Holders to date have elected to exercise an aggregate of 6,850,877 of their common stock purchase warrants resulting in the issuance of an aggregate of 6,821,460 of common stock, including the effects of having net-share settled certain of the warrants through the holders’ use of the cashless exercise feature. At March 31, 2007, 3,230,730 warrants remained outstanding with respect to this financing transaction.
On September 27, 2006 the Company issued five year warrants to purchase an aggregate of 250,000 shares of the Company’s Common Stock exercisable at $0.60 per share with an aggregate fair value of $57,500. The Company estimated the fair value of the Warrants using the Black Scholes pricing model with the following assumptions: Fair Value of Common Stock $0.36, Risk Free Interest Rate 4.56%, Volatility 90%, Term 5 years. The warrants are exercisable from September 27, 2006 through September 26, 2011, either through a cash exercise or by use of a cashless exercise provision. The warrants were issued to a consultant for corporate financial advisory services.
As of March 31, 2007, the Company has 8,697,487 common stock purchase warrants outstanding with a weighted average exercise price of $0.53 per share. A summary of the Company’s outstanding common stock purchase warrants granted through and changes during the period is as follows:
Common Stock
On January 31, 2007, a Debenture holder exercised conversion rights on $250,000 of principal, and the Company issued 500,000 shares of the Company’s Common Stock.
On February 1, 2007, the Company issued an aggregate of 722,264 shares of Common Stock to Debenture holders representing payment of $266,732 of interest.
On February 12, 2007, a Debenture holder exercised conversion rights on $300,000 of principal, and the Company issued 600,000 shares of the Company’s Common Stock.
On March 31, 2007, two Debenture holders exercised their rights to require the Company to repurchase 253,226 shares of its common stock since a registration statement covering the resale of such shares was not yet effective, Accordingly, the Company repurchased and retired these shares for an aggregate price of $93,933, including interest of $1,933.
NOTE 15 – SHARE BASED PAYMENTS
The Company, since its inception has granted non-qualified stock options to various employees and non-employees at the discretion of the Board of Directors. Substantially all options granted to date have exercise prices equal to the fair value of underlying stock at the date of grant and terms of ten years. Vesting periods range from fully vested at the date of grant to three years.
A description of each the Company’s plans that are in effect during the reporting period, including the number of shares reserved for issuance and shares that remain available for grant as of December 31, 2006 is as follows:
2005 Incentive Stock Plan
On June 21, 2005, the Company adopted the 2005 Incentive Stock Plan (the “2005 Plan”), which was approved by its stockholders on August 9, 2005. The Plan provides for the grant of options and the issuance of restricted shares. An aggregate of 3,300,000 shares of common stock is reserved for issuance under the Plan. Both incentive and nonqualified stock options may be granted under the Plan. The Plan terminates on June 21, 2015. The exercise price of options granted pursuant to this plan may not be less than 100% of the fair market value of the Company’s common stock on the date of grant and the term of options granted under this plan may not exceed 10 years. For holders of 10% or more of the combined voting power of all classes of the Company’s stock, options may not be granted at less than 110% of the fair value of the Company’s common stock on the date of grant and the term of such options may not exceed 5 years. As of March 31, 2007, an aggregate of 2,465,000 shares and options have been granted under the plan, leaving an aggregate of 835,000 shares available for future issuance.
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2005 Directors Plan
On August 9, 2005, by written consent, a majority of the Company’s stockholders approved the Company’s 2005 Non-Employee Directors Stock Option Plan (the “2005 Directors Plan”). The Directors Plan provides for the grant of up to 2,000,000 non-qualified stock options to non-employee directors of the Company. The plan also provides for (a) each newly elected or appointed director (other than the Chairman) to be granted options to purchase 50,000 shares of common stock, of which 50% would become exercisable on the date which is one year from the date of grant and the remaining 50% would become exercisable on the date which is two years from the date of grant, and (b) for each such director to be an granted an additional option to purchase 50,000 shares of common stock on the second anniversary of their initial election or appointment of which 50% would become exercisable on the date which is one year from the date of grant and the remaining 50% would become exercisable on the date which is two years from the date of grant. All options granted under the Directors Plan have a maximum term of ten years, subject to accelerated vesting in the event of a change in control of the Company. As of March 31, 2007, an aggregate of 1,200,000 options have been granted under the plan, leaving an aggregate of 800,000 shares available for future issuance.
2006 Incentive Stock Plan
The 2006 Incentive Plan was adopted by the Board of Directors on March 3, 2006 (the “2006 Plan”) and received stockholder approval on July 10, 2006. An aggregate of 2,700,000 shares of Common Stock have been reserved for issuance under the 2006 Incentive Plan. Under the 2006 Incentive Plan, the Company is authorized to issue incentive stock options intended to qualify under Section 422 of the Code, non-qualified stock options and restricted stock. The 2006 Incentive Plan is currently administered by the Compensation Committee of the Board of Directors. As of March 31, 2007, an aggregate of 2,495,500 shares and options have been granted under the plan, leaving an aggregate of 204,500 shares available for future issuance.
2007 Incentive Stock Plan
The Company’s Board of Directors adopted the 2007 Incentive Stock Plan A and the 2007 Incentive Stock Plan B on November 15, 2006, (the “2007 Plans”). The 2007 Plans are subject to stockholder approval and the Company has not made any grants under such plans.
Share based payments made during the three months ended March 31, 2007 are as follows:
On January 16, 2007, the Company granted (under its 2005 Director’s Plan) options to purchase an aggregate of 50,000 shares of Common Stock to a director of the Company at an exercise price of $0.35 per share. These options vest as to 50% one year from the date of grant, and 50% on the second anniversary of the date of grant, and expire on January 15, 2016 or earlier due to board termination.
On January 16, 2007, the Company granted (under its 2006 Incentive Plan) options to purchase an aggregate of 250,000 shares of Common Stock to an officer of the Company at an exercise price of $0.35 per share. The options vest as to 33% one year from the date of grant, 33% and 34% on the second and third anniversaries of the date of grant, respectively, and expire on January 15, 2016 or earlier due to employment termination.
The weighted-average grant-date fair value of options granted during the three months ended March 31, 2007 is $0.27.
Weighted average assumptions relating to the estimated fair value of stock options that the Company granted during the three months ended March 31, 2007, are as follows: risk–free interest rate of 4.75%; expected dividend yield zero percent; expected option life of six years and six and one half years, respectively; and expected volatility of 90%.
The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The Company has not paid dividends to date and does not expect to pay dividends in the foreseeable future due to its substantial accumulated deficit. Accordingly, expected dividends yields are currently zero. Historical cancellations and forfeitures of stock options have been insignificant. Based on available data, the Company has assumed that approximately 85% of outstanding options will vest annually. Unamortized compensation cost relating to options granted prior to January 1, 2006 has been adjusted to reflect this assumption. No options have been exercised to date. The Company continuously monitors its employee terminations, exercises and other factors that could affect its expectations relating to the vesting of options in future periods. The Company policy is to adjust its assumptions relating to its expectations of future vesting and the terms of options at such times that additional data indicates that changes in these assumptions are necessary. Expected volatility is partly on the historical volatility of the Company’s stock and a comparison of the Company’s volatility rate stock price volatilities of similarly situated companies in the marketplace.
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A summary of the status of the Company’s outstanding stock options as of March 31, 2007 and changes during the three months ended March 31, 2007 are as follows:
| Number of options | Weighted average exercise price | Weighted average remaining | ||||||
Outstanding at January 1, 2007 | 6,030,000 | $ | 1.42 | |||||
Granted | 300,000 | $ | 0.35 | |||||
Exercised | — | — | ||||||
Forfeited or Expired | (169,500 | ) | $ | 0.96 | ||||
Outstanding at March 31, 2007 | 6,160,500 | $ | 1.38 | 8.24 | ||||
Options exercisable at March 31, 2007 | 2,264,975 | $ | 2.03 | 6.94 | ||||
At March 31, 2007, there was no intrinsic value of options outstanding based on the March 31, 2007 closing price of the Company common stock ($0.26 per share).
NOTE 16 – SUBSEQUENT EVENTS
Issuance of Securities
On April 4, 2007, a Debenture holder exercised conversion rights on $400,000 of principal, and the Company issued 800,000 shares of the Company’s Common Stock.
On April 9, 2007, a Debenture holder exercised their rights to require the Company to repurchase 21,198 shares of its common stock since a registration statement covering the resale of such shares was not yet effective, Accordingly, the Company repurchased and retired these shares for an aggregate price of $7,863, including interest of $196.
Registration of Securities
In connection with the Company’s registration rights agreements with the purchasers of the Company’s common stock and the Debenture holders, the Company’s registration statement to register shares underlying debenture conversions and stock option plans became effective on April 12, 2007.
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FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-QSB for the quarterly period ended March 31, 2007 contains ‘‘forward-looking statements’’ within the meaning of Section 27A of the Securities Act of 1933, as amended. Generally, the words ‘‘believes’’, ‘‘anticipates,’’ ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘expect,’’ ‘‘intend,’’ ‘‘estimate,’’ ‘‘continue,’’ and similar expressions or the negative thereof or comparable terminology are intended to identify forward-looking statements which include, but are not limited to, statements concerning the Company’s expectations regarding its working capital requirements, financing requirements, business prospects, and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. Such statements are subject to certain risks and uncertainties, including the matters set forth in this Quarterly Report or other reports or documents the Company files with the SEC from time to time, which could cause actual results or outcomes to differ materially from those projected. Undue reliance should not be placed on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update these forward-looking statements. In addition, the forward-looking statements in this Quarterly Report on Form 10-QSB involve known and unknown risks, uncertainties and other factors that could cause the actual results, performance or achievements of the Company to differ materially from those expressed in or implied by the forward-looking statements contained herein.
An investment in the Company’s Common Stock involves a high degree of risk. Stockholders and prospective purchasers should carefully consider the risk factors in the Company’s Annual Report on Form 10-KSB for the fiscal year ended December 31, 2006, filed with the SEC on March 29, 2007, and other pertinent information contained in the Registration Statement on Form SB-2 of the Company, as amended, filed with the SEC which became effective on April 12, 2007, as well as other information contained in the Company’s other periodic filings with the SEC. If any of the risks described therein actually occur, the Company’s business could be materially harmed.
| ITEM 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS |
Overview
We are a holding company organized for the purpose of acquiring, owning, and managing various marketing and advertising businesses, primarily involving the Internet. Since February 2006 the SendTec direct response marketing services business of our wholly-owned subsidiary, SendTec Acquisition Corp. (“STAC”), has been our sole line of business. On March 17, 2006, our Board of Directors authorized us to change our name to SendTec, Inc. and on July 10, 2006 our stockholders approved the name change. Our results of operations for the three months ended March 31, 2007 consist of STAC and the Company.
The unaudited condensed consolidated financial statements contained herein include commencing February 1, 2006 the results of STAC which became our wholly-owned subsidiary on February 3, 2006. On October 31, 2005, STAC acquired the assets of SendTec, Inc. from theglobe.com, Inc. As of October 31, 2005 and through February 1, 2006 we retained approximately 23% of the total voting interests in STAC. Accordingly from October 31, 2005 through February 1, 2006, we accounted for our investment in STAC in accordance with the provisions of APB 18, ‘‘The Equity Method of Accounting for Investments in Common Stock,’’ which provides for companies to record, in results of operations, their proportionate share of earnings or losses of investees when they are deemed to influence but not control the affairs of the investee enterprise. We recorded a $153,389 charge for our proportionate share of STAC’s losses for the month ended January 31, 2006. The results of operations for the three months ended March 31, 2006 of RelationServe Access, Inc. (“Access”), and Friendsand.com, Inc. (“Friendsand”) have been reflected as discontinued operations in our statement of operations.
Results of Operations
Three months ended March 31, 2007 compared to three months ended March 31, 2006
Our unaudited condensed consolidated statements of operations for the three months ended March 31, 2007 contain three months of operations of STAC, whereas the three months ended March 31, 2006 contain two months of operations of STAC, which became our wholly-owned subsidiary on February 3, 2006. Primarily for this reason, each category of our results of operations for the three months ended March 31, 2007 is higher than the comparative year period.
Net revenues were approximately $9.2 million for the three months ended March 31, 2007, as compared to net revenues of $7.2 million for the three months ended March 31, 2006, an increase of $2.0 million or 27.4%. The principal reason for the increase is that March 31, 2007 includes three months of net revenues of STAC while March 31, 2006 includes two months of net revenues of STAC. For the three months ended March 31, 2007, net revenues from our internet advertising were $6.2 million, or approximately 67.4 % of net revenues. Net revenues from our other revenue sources were $1.2 million from online search, $0.6 million from direct response
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media, $0.1 million from branded media, and $1.1 million from offline advertising programs. For the three months ended March 31, 2006, net revenues from our internet advertising were $5.9 million, or 82.0% of net revenues. Net revenues from our other revenue sources were $0.2 million from online search, $0.3 million from direct response media, and $0.8 million from offline advertising programs.
Costs of revenues were approximately $4.6 million for the three months ended March 31, 2007. Costs of revenues principally include the costs of media providers and direct production costs. The cost of revenues of our internet advertising was $4.3 million, and $0.3 million was from our offline advertising programs. There are no costs of revenues from online search, direct response media, and branded media, since those revenue streams are reported as revenue net of related costs. Costs of revenues were approximately $4.8 million for the three months ended March 31, 2006. The cost of revenues of our internet advertising was $4.6 million, and $0.2 million was from our offline advertising programs.
Gross profit increased $2.1 million to $4.6 million for the three months ended March 31, 2007 from gross profit of $2.5 million for the comparable year period. Gross profit was approximately $4.6 million for the three months ended March 31, 2007, or 49.8% of net revenues. Gross profit from our internet advertising business was $1.8 million, or 29.8% of our internet advertising net revenues for the three months ended March 31, 2007, while our gross profit from offline advertising programs was $0.8 million, or 75.0% of offline advertising program net revenue. Gross profit from our other revenue sources were $1.2 million for online search, $0.6 million for direct response media, and $0.2 million for branded media. Gross profit was approximately $2.5 million for the three months ended March 31, 2006, or 34.1% of net revenues. Gross profit from our internet advertising business was $1.3 million, or 22.3% of our internet advertising net revenues for the three months ended March 31, 2006, while our gross profit from offline advertising programs was $0.7 million, or 80.6% of offline advertising program net revenue. Gross profit from our other revenue sources were $0.2 for online search and $0.3 million for direct response media.
Salaries, wages and benefits expenses were approximately $3.0 million for the three months ended March 31, 2007, as compared to $1.2 million for the comparable year period, an increase of $1.8 million. The increase is primarily due to two months of operations of STAC in 2006 versus three months in 2007, and that the Company significantly increased its staff in the areas of sales, account management, operations, and information technology. As a percentage of net revenues, salaries, wages and benefits increased to 32.6% of net revenues for the three months ended March 31, 2007 from 16.3% of net revenues for the comparable year period.
Professional fees increased approximately $0.2 million to $0.6 million for the three months ended March 31, 2007 as compared to $0.4 million for the comparable prior year period. The increase is primarily due to two months of operations of STAC in 2006 versus three months in 2007.
Other general and administrative expenses increased approximately $0.6 million to $1.5 million for the three months ended March 31, 2007 as compared to $0.9 million for the comparable year period. Our other general and administrative expenses as a percentage of net revenues were 16.7% for the three months ended March 31, 2007, as compared to 12.0% of net revenues for the comparable year period.
The components of other general and administrative expenses were as follows:
| For the three months ended March 31, | ||||||
| 2007 | 2006 | |||||
Depreciation and amortization | $ | 421,046 | $ | 212,579 | ||
Travel | 108,776 | 64,847 | ||||
Marketing expenses | 53,493 | 28,409 | ||||
Rent | 97,249 | 54,869 | ||||
Internet bandwidth | 133,416 | 14,958 | ||||
Commissions | 149,675 | 56,772 | ||||
Contract labor | 44,811 | 42,064 | ||||
Other | 523,552 | 390,371 | ||||
Total other general and administrative expenses | $ | 1,532,018 | $ | 864,869 | ||
Operating (loss) income decreased $0.6 million to an operating loss of $0.6 million for the three months ended March 31, 2007, from operating income of $24,000 for the three months ended March 31, 2006. The increase in the operating loss is the result of the increase in gross profit of $2.1 million reduced by the increase in our selling, general and administrative expenses of $2.7 million.
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Other income (expense) decreased $0.2 million to $3.2 million for the three months ended March 31, 2007 from $3.4 million for the comparable year period. It is comprised of the following:
| • | Registration rights penalty – we entered into an agreement to register the resale of the shares of common stock held by holders of our Senior Secured Convertible Debentures, as amended, (the “Debentures”) and preferred stockholders as well as those shares that would be issuable if the Debenture holders converted the Debentures and warrants that they hold into shares of our common stock. The agreement stipulated that if the registration statement was not filed and declared effective within certain contractual timeframes we would be subject to a registration rights penalty. The registration statement for the shares was declared effective on July 14, 2006. A new registration statement for the additional shares of common stock issuable upon conversion of the Debentures as a result of the restructuring described above was declared effective on April 12, 2007. As of March 31, 2007, management believes the probability of such penalty is minimal and has reduced the estimated amount of the penalty by $89,000 to $43,000. During the three months ended March 31, 2006 we recognized income of $60,000 in connection with the registration rights agreement. The reduction in the registration rights penalty for the three months ended March 31, 2007 has been presented as a cumulative effect of a change in accounting principal in the accompanying unaudited condensed consolidated statement of operations. |
| • | Waiver and covenant penalty – There was no waiver and covenant penalty for the three months ended march 31, 2007. We were not in compliance with certain covenants in the debenture agreement for the fourth quarter of 2005. As a result, on February 3, 2006 we issued 525,000 shares of Common Stock with a fair value of approximately $1.4 million to the Debenture holders, and reflected an expense for the three months ended March 31, 2006. This expense is non-cash in nature. |
| • | Loss on equity-method investment – There was no loss on the equity-method investment for the three months ended March 31, 2007. Prior to consolidation of SendTec on February 3, 2006, we owned 23% of SendTec and accounted for this investment by the equity method, in which we recorded 23% of SendTec’s net loss for January 2006, resulting in an expense of approximately $153,000. This expense is non-cash in nature, and has been recorded as an expense in the three months ended March 31, 2006. |
| • | Interest income – we earned approximately $36,000 in interest on bank deposits for the three months ended March 31, 2007 as compared to $18,000 for the three months ended March 31, 2006. |
| • | Interest expense – interest expense increased $1.3 million to $3.2 million for the three months ended March 31, 2007 from $1.9 million for the comparable year period. The increase is primarily due to two months of operations of STAC in 2006 versus three months in 2007, and as a result of the restructuring of the Debentures in November 2006. We incurred total interest expense on the debentures of approximately $3.2 million for the three months ended March 31, 2007. Included in interest expense is $0.5 million of interest that will require payment to the Debenture holders and a non-cash interest charge of $2.7 million to amortize the debt discount. We incurred total interest expense on the debentures of approximately $1.9 million for the three months ended March 31, 2006. Included in interest expense is $0.3 million of interest that will require payment to the Debenture holders and a non-cash interest charge of $1.6 million to amortize the fair value of the warrants issued in conjunction with the debentures and the deferred finance fees. |
Our provision for income taxes (benefits) is zero in both periods. For the three months ended March 31, 2007 and 2006 a provision for tax income tax benefits was not made because after evaluating all available evidence, we believe that a valuation allowance is necessary to offset against any potential tax assets.
We reported a loss from continuing operations of approximately $3.8 million for the three months ended March 31, 2007 compared to a loss from continuing operations of approximately $3.4 million for the three months ended March 31, 2006. Continuing operations included the operations of SendTec and the Company. Included in the loss from continuing operations for the three months ended March 31, 2007 and 2006 are non-cash expenses totaling $3.4 million and $3.4 million, respectively.
In June 2006, we sold the business and substantially all of the net assets of Access, and ceased the operations of Friendsand. The operations of Access and Friendsand for the three months ended March 31, 2006 was a net loss of approximately $1.7 million, which is presented as discontinued operations for comparability.
Effective January 1, 2006, we adopted FSP EITF 00-19-2, “Accounting for Registration Payment Arrangements.” The adoption of this pronouncement did not have a material effect on our financial statements. As a result of the adoption, we recorded a reduction in the registration rights penalty of $88,500.
We reported a net loss of approximately $3.7 million for the three months ended March 31, 2007 compared to a net loss of $5.1 million for the three months ended March 31, 2006. Included in the net loss for the three months ended March 31, 2007 are non-cash expenses totaling $3.4 million. Included in the net loss for the three months ended March 31, 2006 are non-cash expenses totaling $3.4 million and a loss from discontinued operations of $1.7 million.
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Liquidity and Capital Resources
We incurred approximately a $3.8 million loss from continuing operations for the three months ended March 31, 2007, which includes an aggregate of approximately $3.4 million in non-cash charges relating to non-cash interest of $2.7 million, depreciation and amortization of $0.4 million, and stock based compensation of $0.2 million, net of non-cash income of $0.1million from the reduction of the registration rights penalty. We also issued stock in payment of approximately $0.3 million of contractual interest expense under our Senior Secured Convertible Debentures.
We are also required to repay the Senior Secured Convertible Debentures on March 31, 2008. These Debentures have a face value of $34,030,000 as of March 31, 2007. We are in the process of formulating a plan to restructure this obligation and believes we have access to capital and other resources to do so, however, no specific plan or alternate source of financing has been developed at this time. Our inability to restructure this debt, if not successful, would have a material adverse affect on our business and financial condition. These matters raise substantial doubt about our Company’s ability to continue as a going concern. Our financial statements do not include any adjustments that may be necessary should our Company be unable to continue as a going concern.
We integrated our newly acquired business, STAC, into our existing operations and believe that our current capital resources and resources available from STAC will enable us to sustain operations through March 31, 2008, exclusive of Debenture repayments. We may look to raise additional capital to fund the expansion of our business and believe we have access to capital resources; however, we have not secured any commitments for new financing at this time nor can we provide any assurance that we will be successful in our efforts to raise additional capital if considered necessary, in the near term.
In July 2006 and April 2007, we successfully completed registrations for resale of certain shares of common stock as required pursuant to our agreements with the Debenture holders and holders of the Series A Preferred Stock. We are required to maintain the effectiveness of these registration statements through at least March 31, 2008 or until such time that all of the registered shares have been sold by the selling stockholders. As a result, we expect to see cost savings in the area of registration costs. We are restricted from incurring additional indebtedness other than certain permitted indebtedness as long as the Debentures remain outstanding.
We were not in compliance with certain financial covenants we were required to maintain under the terms of our Securities Purchase Agreement with the Debenture holders. On November 10, 2006, our stockholders approved an increase in our authorized capital to meet the requirements of all potential conversions of the Debentures and other derivate instruments into common stock, which had the effect of making the revised Debenture agreement effective.
The amended financial covenants required us to attain minimum net revenues of $4,675,000 for each of the third and fourth quarters of 2006, which requirements were satisfied. We are required to attain $5,025,000, $5,175,000, $5,450,000, and $5,700,000 for the first, second, third, and fourth quarters of 2007. We were also required to attain minimum cash balances of $3,000,000 as of March 31, 2007, $3,250,000 as of June 30, 2007, $3,500,000 as of September 30, 2007, and $3,750,000 as of December 31, 2007.
If the due date of the Debentures is accelerated as a result of our failure to meet the covenants, we will not have sufficient working capital or cash to repay the obligation. Since we rely on our working capital for our day-to-day operations, such a default would have a material adverse effect on our business, operating results, and financial condition. In such event, we may be forced to restructure, file for bankruptcy, sell assets, or cease operations, any of which would put us, our investors and the value of our common stock, at significant risk. Further, our obligations under the Debentures are secured by substantially all of our assets. Failure to fulfill our obligations under the Debentures and related agreements could lead to loss of these assets, which would be detrimental to our operations.
We anticipate that we will seek to raise additional capital during 2007 and 2008 to fund additional growth of the business and provide cash for operations if necessary; however, there are no specific financing transactions planned at this time. We also cannot provide any assurance that in the event we seek to raise additional capital that such capital will be available on acceptable terms, if at all.
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Net cash flows used in operating activities for the three months ended March 31, 2007 were $0.7 million as compared to net cash used in operating activities of $3.9 million for the three months ended March 31, 2006. For the three months ended March 31, 2007, our net loss from continuing operations of approximately $3.8 million, adjusted for non-cash items totaling $3.4 million, including depreciation and amortization of $0.4 million, stock-based compensation of $0.2 million, and non-cash interest of $2.7 million, net of non-cash income of $0.1 from the reduction of the registration rights penalty used $0.4 million in cash. Changes in assets and liabilities used $0.3 million in cash. For the three months ended March 31, 2006, our net loss from continuing operations of approximately $3.4 million, adjusted for non-cash items totaling $3.4 million, including depreciation and amortization of $0.2 million, stock-based compensation of $0.1 million, stock issued to satisfy a waiver and covenant fee of $1.4 million, non-cash interest of $1.6 million, and a loss on an equity-method investment of $0.2 million, net of non-cash income of $0.1 from the reduction of the registration rights penalty did not provide nor use cash. Changes in assets and liabilities used $3.9 million in cash.
Net cash flows used in investing activities for the three months ended March 31, 2007 were $0.1 million as compared to net cash provided by investing activities of $9.3 million for the three months ended March 31, 2006. For the three months ended March 31, 2007 we used cash to purchase $0.1 million of property and equipment. For the three months ended March 31, 2006 we acquired $9.4 million of cash in the SendTec consolidation, and received $0.3 million in the reconciliation of the purchase of net assets of SendTec, Inc. from theglobe.com, Inc. We used cash to purchase property and equipment of $0.2 million, and incurred $0.2 in transaction expenses.
Net cash flows used in financing activities for the three months ended March 31, 2007 were $0.1 million as compared to net cash provided by financing activities of $0.8 million for the three months ended March 31, 2006. For the three months ended March 31, 2007, we repurchased and retired common stock that was subject to redemption of $0.1 million, and we made principal payments on capital lease obligations of $29,000. For the three months ended March 31, 2006 we received net proceeds from the sale of Common Stock and exercise of warrants of $0.7 million.
There were no discontinued operations for the three months ended March 31, 2007. Discontinued operations used $0.9 million of net cash in operating activities and used $0.1 million from investing activities for the three months ended March 31, 2006.
We reported a net decrease in cash for the three months ended March 31, 2007 of $1.0 million as compared to a net increase in cash of $5.1 million for the three months ended March 31, 2006. At March 31, 2007 we had cash on hand of $5.1 million.
Critical Accounting Policies
Our financial statements and accompanying notes are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”), which requires management to exercise its judgment. We exercise considerable judgment with respect to establishing sound accounting policies and in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and disclosure of commitments and contingencies at the date of the financial statements.
On an ongoing basis, we evaluate our estimates and judgments. Areas in which we exercise significant judgment include, but are not limited to, our valuation of accounts receivable, revenue recognition, depreciation, amortization, recoverability of long-lived assets, income taxes, equity transactions and contingencies. We have also adopted certain policies with respect to our recognition of revenue that we believe are consistent with the guidance provided under Securities and Exchange Commission Staff Bulletin No. 104.
We base our estimates and judgments on a variety of factors including our historical experience, knowledge of the business and industry, current and expected economic conditions, the attributes of our products and services, regulatory environment, and in certain cases, the results of outside appraisals. We periodically re-evaluate our estimates and assumptions with respect to these judgments and modify our approach when circumstances indicate that modifications are necessary.
While we believe that the factors we evaluate provide us with a meaningful basis for establishing and applying sound accounting policies, we cannot guarantee that the results will always be accurate. Since the determination of these estimates requires the exercise of judgment, actual results could differ from such estimates.
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A description of significant accounting policies that require us to make estimates and assumptions in the preparation of our consolidated financial statements is as follows:
Revenue Recognition – We follow the guidance of the SEC’s Staff Accounting Bulletin 104 for revenue recognition. In general, we record revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectibility is reasonably assured. Certain of our revenue is reported on a gross basis, while certain other revenue is reported on a net basis, net of related costs. Credits or refunds are recognized when they are determinable and estimable. The following policies reflect specific criteria for our various revenues streams:
Internet advertising: Revenue from the distribution of internet advertising, which principally includes the placement of banner ads and e-mail transmission of services is recognized when internet users visit and complete actions at an advertiser’s website. Revenue consists of the gross value of billings to clients, including the recovery of costs incurred to acquire online media required to execute client campaigns. We report these revenues gross because it is responsible for fulfillment of the service, has substantial latitude in setting price and assumes the credit risk for the entire amount of the sale, and it is responsible for the payment of all obligations incurred with media providers.
Online search: Revenue derived from search engine marketing services, such as search engine keyword buying, is recognized on a net basis in the period when the associated keyword search media is clicked on by a consumer. We typically earn a media commission equal to a percentage of the keyword search media purchased for our clients. In many cases, the amount we bill to clients significantly exceeds the amount of revenue that is earned due to the existence of various pass-through charges such as the cost of the search engine keyword media. Amounts received in advance of search engine keyword media purchases are deferred and included in deferred revenue in the accompanying balance sheet.
Direct response media: Revenue derived from the purchase and tracking of direct response media, such as television and radio commercials, is recognized on a net basis when the associated media is aired. In many cases, the amount we bill to clients significantly exceeds the amount of revenue that is earned due to the existence of various pass-through charges such as the cost of the television and radio media. Amounts received in advance of media airings are deferred and included in deferred revenue in the accompanying balance sheet.
Advertising programs: Revenue generated from the production of direct response advertising programs, such as infomercials, is recognized on the completed contract method when such programs are complete and available for airing. Production activities generally take eight to 12 weeks and we usually collect amounts in advance and at various points throughout the production process. Amounts received from customers prior to completion of commercials are included in deferred revenue and direct costs associated with the production of commercials in process are deferred and included within other current assets in the accompanying balance sheet. We report these revenues gross because it is responsible for the fulfillment of the service.
Intangible assets consist of customer relationships, covenants not to compete, and deferred financing fees. Non-compete agreements are amortized straight-line over the lives of the underlying employment agreements. Deferred financing fees are amortized straight-line over the life of the debentures. We review the carrying value of intangibles and other long-lived assets for impairment at least annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. With respect to the valuation of our goodwill, we considered a variety of factors including our market capitalization adjusted for a control premium and a discounted cash flow forecast to determine the enterprise value of our business using the income approach. Recoverability of long-lived assets is measured by comparison of its carrying amount to the undiscounted cash flows that the asset or asset group is expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the property, if any, exceeds its fair market value.
Stock Based Compensation – Effective January 1, 2006, we adopted FASB Statement of Financial Accounting Standard (“SFAS”) No. 123R “Share Based Payment.”. This statement is a revision of SFAS Statement No. 123, and supersedes APB Opinion No. 25, and its related implementation guidance. SFAS 123R addresses all forms of share based payment (“SBP”) awards including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Under SFAS 123R, SBP awards result in a cost that will be measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest that will result in a charge to operations. Consequently, during the year ended December 31, 2006 we recognized approximately $1,099,000 in expenses.
| ITEM 3. | CONTROLS AND PROCEDURES |
Our principal executive officer and principal financial and accounting officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial and accounting officer have concluded that our controls and procedures are effective.
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There was no change in our internal controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934), that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
| ITEM 1. | LEGAL PROCEEDINGS |
As of March 31, 2007, we or our predecessors have been named as defendants in two separate claims made by customers arising in the ordinary course of its business. The Company believes it has substantial defenses and intends to vigorously defend itself against any and all actions taken by the plaintiffs in these matters. We are from time to time involved in various matters or disputes also arising in the ordinary course of business. We do not believe that any potential damages that could arise from any of these matters will have a material adverse effect on our financial condition or the results of its operations.
Omni Point Marketing LLC, a predecessor company, has been named as a defendant in an employment related claim which to date has not been asserted against our company. Although we are not a defendant in this matter at this time, there can be no assurance that the plaintiffs will not attempt to assert this claim against us in the future or that such claim, if asserted, will not result in a material loss to us. The range of loss with respect to this matter, if any, cannot be quantified.
On April 5, 2006, Mr. Ohad Jehassi, our former Chief Operating Officer, filed an action against us in the Circuit Court for the 17th Judicial Circuit in Broward County, Florida in connection with his termination by the Company (the “Jehassi Complaint”). Mr. Jehassi alleged that we breached an Employment Agreement and owe him salary and other benefits in connection with such alleged breach. On June 21, 2006, Mr. Jehassi filed an Amended Complaint adding a claim for violation of the Florida Whistleblower’s Act, and on August 14, 2006, filed a Fourth Amended Complaint adding a claim for unpaid wages under a Florida statute. In February 2007, Mr. Jehassi filed a Fourth Amended Complaint (substantially similar to the Third Amended Complaint). Mr. Jehassi seeks damages of approximately $500,000 plus attorney’s fees, costs and expenses and shares of our common stock he alleges he is entitled to. We have filed an answer to the Third Amended Complaint denying that Mr. Jehassi is entitled to any relief and have asserted a counterclaim against Mr. Jehassi. This action is now in the discovery phase. We believe this action is without merit, and intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
Boston Meridian, LLC v. RelationServe LLC, RelationServe Media, Inc., and Michael Brauser, Civil Action No. 1:06-CV-1041 1-MEL. On March 6, 2006 Boston Meridian LLC (“Boston Meridian”) filed a complaint in the United States District Court, District of Massachusetts, alleging that it is owed certain fees and expenses in connection with our acquisition of the business of SendTec, Inc. from theglobe.com, Inc. On April 3, 2006, Boston Meridian amended the complaint adding Michael Brauser, then-Chairman of our Board of Directors, as an additional defendant, and alleging that Mr. Brauser tortuously interfered with Boston Meridian’s contract with us. Boston Meridian sought an aggregate of $917,302 in fees and expenses and 100,000 shares of our common stock as damages. We filed a motion to dismiss this action for lack of personal jurisdiction, improper venue, and failure to state a claim. This motion has been fully submitted to the District Court and we are awaiting a decision. We intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations. We also filed a separate action, RelationServe Media Inc. v. Boston Meridian LLC, and Sage Capital Growth, Inc., Index No. 103857/06, in the Supreme Court of the State of New York, County of New York, against both Boston Meridian and Sage Capital Growth, Inc., alleging negligence amid breach of implied contracts, and seeking damages in excess of $75,000. Both defendants in the New York action filed motions to dismiss this action. The court granted Sage Capital’s motion to dismiss and withheld decision with respect to Boston Meridian’s motion to dismiss pending a decision on the motion in the Massachusetts action. During January 2007, we reached an agreement with Boston Meridian providing for settlement of the pending action upon payment of $200,000 in cash, plus delivery of 1,200,000 shares of our common stock with a fair value of $312,000. The effectiveness of the settlement remains subject to approval by at least 75% of the holders of the Company’s 6% Senior Secured Convertible Debentures. A loss contingency in the amount of $512,000 is included in the Company’s balance sheet at March 31, 2007.
On February 17, 2006, the Law Offices of Robert H. Weiss PLLC (“Weiss”) filed a complaint in the Superior Court of the District of Columbia, Civil Division, against us and Omni Point Marketing LLC for fraud, breach of contract, unjust enrichment, and violation of the Uniform Deceptive Trade Practices Act. Weiss sought compensatory damages in an amount no less than approximately $80,000
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in addition to punitive and exemplary damages with no specified amount. We also had accounts receivable due from Weiss of approximately $350,000 associated with discontinued operations which we have fully reserved. We have reached an agreement settling of this matter for $30,000 to be paid in three installments and have executed a mutual release with Weiss. We recorded the amount as a loss contingency in our statement of operations for the year ended December 31, 2006.
On February 3, 2006, InfoLink Communications, Services, Inc, (InfoLink) filed a complaint against us and Omni Point Marketing LLC in the Circuit Court of Miami Dade County, Florida, asserting violation of the federal CAN SPAM ACT of 2003, 15 U.S.C. ss. 7701, and breach of an alleged licensing agreement between Omni Point Marketing LLC and InfoLink. InfoLink seeks actual damages in an amount of approximately $100,000 and approximately $1,500,000 in statutory damages. We do not believe that InfoLink has sufficiently pled any factual basis to support its claim. We filed a motion asking the court to enter sanctions against InfoLink, including but not limited to dismissal of the case with prejudice, for InfoLink’s failure to comply with a court order to produce discovery materials. We intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
On December 15, 2004, the Federal Bureau of Investigation served Omni Point Marketing LLC with a search warrant regarding the alleged use of unlicensed software and seized certain e-mail servers with a net book value of approximately $135,000. Management believes the investigation resulted from a former independent contractor of Omni Point Marketing LLC using the alleged unlicensed software on its behalf and without its knowledge. Management and legal counsel are currently unaware of any additional developments in the investigation. The United States Attorney’s Office had then indicated that it would contact our legal counsel as the investigation continues. We have not received any further communications with respect to this matter; however, there can be no assurance that this matter; if further investigated, will not have a material effect us.
On or about June 15, 2006, R&R Investors Ltd. (“R&R”) commenced an action in the Supreme Court of the State of New York, County of New York, against us and Come & Stay S.A. asserting a claim for breach of contract related to a purported agreement concerning the sale of RelationServe Access, Inc and Friendsand, Inc. R&R initially sought an injunction enjoining the transfer of RelationServe Access, Inc. and Friendsand, Inc. stock. The Court denied R&R’s motion. R&R effectuated service of the complaint on us in August. We have served an answer to R&R’s complaint denying that R&R is entitled to any relief. This action is now in the discovery phase. We intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
On or about April 28, 2006 LeadClick Media, Inc. commenced an action against us in the Superior Court for the State of California, County of San Francisco, alleging breach of contract seeking to recover $379,146, plus interest. The action has been removed to federal court. We filed an answer with counterclaims in July 2006. The case is now in the discovery phase. We intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
On or about August 31, 2006, an action was commenced in the United States District Court for the Southern District of Florida (Case No. 06-61327) by Richard F. Thompson as the putative class representative against us and certain of our former officers and directors alleging securities laws violations in connection with the purchase of our stock during the period May 24, 2005 to August 2006. The named plaintiff in the case previously filed suit against us, as an individual, in state court in Indiana which action was dismissed in July 2006. The Florida District Court permitted plaintiff to file an amended complaint and on November 13, 2006, plaintiff filed a “First Amended Class Action Complaint” (the “First Amended Complaint”) adding an additional plaintiff, L. Alan Jacoby, who purportedly purchased 10,000 shares of our common stock in the open market, and naming additional former and present officers and directors of our company and others as defendants. The First Amended Complaint, styled as a class action, alleges violations of Section 11 and Section 12(2) of the Securities Act and Section 10(b) of the Securities Exchange Act, and Rule 10b-5 promulgated thereunder. Plaintiffs claim, among other things, violations of the various acts: (a) by selling securities through persons who were not registered as agents and/or broker dealers with the Securities Exchange Commission or the States of Florida or Indiana and were not affiliated as an agent or representative of any broker/dealer; (b) by failing to disclose to purchasers of RelationServe Media, Inc. stock that they were selling securities of RelationServe stock through unregistered agents and broker/dealers was in violation of state and federal securities laws which caused a substantial contingent liability for claims of rescission by investors and exposing RelationServe to substantial legal fees, criminal and civil liability which would have a material adverse impact to the RelationServe’s financial
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condition; (c) by failing to disclose that in July 2005 RelationServe’s Chief Executive Officer and Chief Operating Officer received evidence of accusations of employee theft of data and employee kickbacks had been made and the matter was so material that CEO hired an outside attorney to investigate the matter; (d) failing to disclose that a former director has previously been sued by stockholders of two other corporations; and (e) by failing to disclose that financial statements beginning the third quarter of 2005 were false and misleading as a senior officer Richard Hill, had directed that finance recognize income in the third quarter in violation of the Sarbanes-Oxley Act of 2002. The invoices directed to be recorded either did not exist or were otherwise untraceable, cancelled, or were never shipped, with the exception of just a few (adjustments to income that would be required as a result of the allegations, if any, relate to certain discontinued operations). In addition to the claims of securities law violations, plaintiffs claim violation of Section 20(a) of the Securities Exchange Act of 1934, as amended as to our controlling persons, violations of the Florida Securities Act, violations of the Indiana Securities Act, sales of unregistered, non-exempt securities, violation of anti-fraud provisions under Indiana law, deception under Indiana law, and fraud. Plaintiffs seek rescission, damages, treble damages, punitive damages, compensatory damages, interest, costs, and attorney’s fees.
The First Amended Complaint repeats and re-alleges various claims made by Ohad Jehassi, our former Chief Operating Officer in a matter pending before the Circuit Court of the 17th Judicial Circuit, Broward County, Florida (Case No. 06-004597), Ohad Jehassi v. RelationServe Media, Inc., a Florida corporation, and Relationserve Media, Inc., d/b/a Sendtec Acquisition Corp., a Florida corporation (the “Jehassi Complaint”). The initial complaint filed by Jehassi on or about April 5, 2006, alleged, among other things, that we breached our employment agreement with Jehassi and owe him salary and other benefits in connection with such alleged breach. On June 21, 2006, Jehassi filed an amended complaint adding a claim for an alleged violation of Florida’s “Whistleblower’s Act,” and on August 14, 2006, filed a third amended complaint adding a claim for unpaid wages under Florida statutes. Mr. Jehassi seeks damages of approximately $500,000 plus attorney’s fees, costs, and expenses and shares of our stock he alleges he is entitled to. We have asserted that Mr. Jehassi was removed from his position with us for cause and is therefore not entitled to any of the relief he seeks and has asserted a counterclaim against Mr. Jehassi related to the shares of our common stock Jehassi claims he is entitled to. The substance of Mr. Jehassi’s whistleblower claims have been adapted in the First Amended Complaint filed by Thompson as the basis for asserting that we filed false and misleading financial statements and that we violated the Sarbanes-Oxley Act of 2002. The court dismissed the First Amended Complaint on March 6, 2007. By the terms of the court’s order, the plaintiffs were given leave to refile a new complaint on or before March 19, 2007, and on March 19, 2007, plaintiffs filed a second amended complaint. We intend to vigorously defend ourselves with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
On September 28, 2006, Wedbush Morgan Securities, Inc. (“Wedbush”) commenced an arbitration against us seeking $521,953.89 in damages as a result of an alleged breach of contract. The case is now in the discovery phase and there is an arbitration hearing scheduled to commence on June 25, 2007. We intend to present a vigorous defense with respect to this matter; however, its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
On or about September 26, 2006 we received copies of three consumer complaints filed by Chirag Chaman, Chief Operating Officer of MX Interactive, LLC. These complaints submitted to the Securities and Exchange Commission the New York Attorney General, and the Florida Attorney General, make various claims with respect to the failure to issue to MX Interactive LLC 45,454 shares of stock which claimant alleges we agreed to transfer pursuant to a written assignment agreement. Claimant asserts that in July 2005 a third party agreed to transfer rights to receive shares of our common stock to claimant and failed to do so, and that we are under an obligation to transfer such shares and satisfy the obligation under the assignment agreement. We believe these claims to be substantially without merit and intend to vigorously defend ourselves with respect to this matter, however its outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
On November 14, 2006 our counsel received a letter from counsel to Deborah Kamioner with an enclosed copy of a letter dated September 5, 2006. In letters dated September 5, 2006 and July 31, 2006 received from Deborah Kamioner, an investor in our Series A Preferred Stock, which automatically converted into our common stock on February 3, 2006, seeking adjustment to the number of shares purchased by Ms. Kamioner under certain anti-dilution provisions to account for: subsequent issuance of 10,081,607 warrants exercisable at $0.01 per share; 525,000 shares of common stock issued to Debenture holders in connection with a consent; the exchange of shares of STAC common stock for shares of Company common stock by STAC management; and the exchange
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of STAC common stock with vested shares of restricted STAC common stock for approximately 9 million shares of Company common stock. We believe these claims to be substantially without merit and intend to vigorously defend ourselves with respect to this matter, however an outcome or range of possible loss, if any, cannot be predicted at this time. We cannot provide any assurance that the outcome of this matter will not have a material adverse effect on our financial position or results of operations.
We received a letter dated August 11, 2006 from counsel to Sunrise Equity Partners, L.P., demanding return of its $750,000 investment, with interest. Subsequently, counsel to Sunrise Equity Partners, L.P. has made demands for issuance of additional shares of common stock on the same basis as the amendment to our Debentures and has threatened legal action, although, to date, no action has been taken. During February 2007, the Company reached an agreement in principle for settlement of this matter upon issuance of 650,000 shares of our common stock. The effectiveness of the settlement is subject to entry into a definitive agreement and approval by holders of our Debentures.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
On January 31, 2007, a Debenture holder exercised conversion rights on $250,000 of principal, and the Company issued 500,000 shares of the Company’s Common Stock.
On February 1, 2007, the Company issued an aggregate of 722,264 shares of Common Stock to Debenture holders representing payment of $266,732 of interest.
On February 12, 2007, a Debenture holder exercised conversion rights on $300,000 of principal, and the Company issued 600,000 shares of the Company’s Common Stock.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. |
None.
| ITEM 5. | OTHER INFORMATION. |
On April 12, 2007, a registration statement covering the resale of 128,940,395 shares of our common stock, including shares underlying the Debentures, was declared effective by the Securities and Exchange Commission.
| ITEM 6. | EXHIBITS |
A. Exhibits
31.1 | Section 302 Certification of the Chief Executive Officer* | |
31.2 | Section 302 Certification of the Chief Financial Officer* | |
32.1 | Section 906 Certification of Chief Executive Officer* | |
32.2 | Section 906 Certification of Chief Financial and Accounting Officer* | |
| * | Filed herewith |
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SendTec, Inc. | ||||
May 15, 2007 | By: | /s/ Paul Soltoff | ||
| Paul Soltoff | ||||
| Chief Executive Officer | ||||
| (Principal Executive Officer) | ||||
May 15, 2007 | By: | /s/ Donald Gould | ||
| Donald Gould | ||||
| (Principal Financial Officer) | ||||
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