U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2002
Commission file number 0-28008
SmartServ Online, Inc.
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(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 13-3750708
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
Metro Center, One Station Place, Stamford, Connecticut 06902
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(Address of Principal Executive Offices)
(203) 353-5950
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(Issuer's Telephone Number, Including Area Code)
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
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The number of shares of common stock, $.01 par value, outstanding as of November
8, 2002 was 11,148,416.
Transitional Small Business Disclosure Format (check one):
Yes X No
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================================================================================
SMARTSERV ONLINE, INC.
FORM 10-QSB
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 2002
(unaudited) and December 31, 2001....................................2
Consolidated Statements of Operations - three months ended
September 30, 2002 and 2001 and nine months ended September
30, 2002 and 2001(unaudited).........................................4
Consolidated Statement of Changes in Stockholders' Equity -
nine months ended September 30, 2002
(unaudited)..........................................................6
Consolidated Statements of Cash Flows - three months ended
September 30, 2002 and 2001 and nine months ended June 30,
2002 and 2001(unaudited).............................................7
Notes to Unaudited Consolidated Financial
Statements...........................................................8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of
Operations..........................................................16
Item 3. Controls and Procedures.............................................23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................24
Item 2. Changes in Securities and Use of Proceeds...........................24
Item 6. Exhibits and Reports on Form 8-K....................................26
Signatures..........................................................27
1
SMARTSERV ONLINE, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -----------
(UNAUDITED)
ASSETS
Current assets
Cash and cash equivalents $ 1,810,568 $ 6,532,323
Accounts receivable 141,935 40,798
Accrued interest receivable 6,706 --
Prepaid expenses 228,497 531,028
----------- -----------
Total current assets 2,187,706 7,104,149
----------- -----------
Property and equipment, net 1,954,952 3,408,776
Other assets
Capitalized software development costs, net of
accumulated amortization of $447,760 at
September 30, 2002 and $268,619 at December 31, 2001 980,348 973,594
Security deposits 242,960 474,545
Notes receivable from officer, including
accrued interest receivable 552,467 500,000
----------- -----------
1,775,775 1,948,139
----------- -----------
Total Assets $ 5,918,433 $12,461,064
=========== ===========
2
SMARTSERV ONLINE, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- -----------
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 1,318,256 $ 1,329,105
Accrued liabilities 865,462 695,134
Note payable 500,000 --
------------ ------------
Total current liabilities 2,683,718 2,024,239
------------ ------------
Deferred revenues 158,823 --
Note payable -- 6,723,156
COMMITMENTS AND CONTINGENCIES - NOTE 9
STOCKHOLDERS' EQUITY
Preferred stock - $0.01 par value
Authorized - 1,000,000 shares
Issued and outstanding - None -- --
Common stock - $.01 par value
Authorized - 40,000,000 shares
Issued and outstanding - 11,146,616 shares at September 30,
2002 and 6,263,783 shares at December 31, 2001 111,466 62,638
Additional paid-in capital 73,237,413 69,680,059
Notes receivable from officers for the purchase
of restricted stock (609,996) (666,841)
Unearned compensation (7,725) (540,354)
Accumulated deficit (69,655,266) (64,821,833)
------------ ------------
Total stockholders' equity 3,075,892 3,713,669
------------ ------------
Total Liabilities and Stockholders' Equity $ 5,918,433 $ 12,461,064
============ ============
See accompanying notes.
3
SMARTSERV ONLINE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Revenues $ 81,847 $ 824,990 $ 146,483 $ 3,272,827
------------ ------------ ------------ ------------
Costs and expenses:
Costs of services (1,386,390) (1,718,178) (4,338,016) (5,502,704)
Sales and marketing expenses (454,364) (958,092) (2,698,013) (3,801,287)
General and administrative expenses (1,087,962) (1,004,318) (3,328,102) (3,613,420)
Stock-based compensation (30,290) 202,837 122,831 (735,015)
------------ ------------ ------------ ------------
Total costs and expenses (2,959,006) (3,477,751) (10,241,300) (13,652,426)
------------ ------------ ------------ ------------
Loss from operations (2,877,159) (2,652,761) (10,094,817) (10,379,599)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 74,785 101,875 106,284 459,599
Interest expense and other financing costs (138,439) (188,072) (508,184) (410,759)
Gain on extinguishment of debt 5,679,261 -- 5,679,261 --
Foreign exchange losses (521) (2,511) (15,977) (23,319)
------------ ------------ ------------ ------------
5,615,086 (88,708) 5,261,384 25,521
------------ ------------ ------------ ------------
Net income (loss) $ 2,737,927 $ (2,741,469) $ (4,833,433) $(10,354,078)
============ ============ ============ ============
Basic earnings (loss) per share $ 0.34 $ (0.46) $ (0.70) $ (1.78)
============ ============ ============ ============
Diluted earnings (loss) per share $ 0.31 $ (0.46) $ (0.70) $ (1.78)
============ ============ ============ ============
Weighted average shares outstanding - basic 8,034,319 5,931,229 6,943,559 5,811,152
============ ============ ============ ============
Weighted average shares outstanding -
diluted 8,965,812 5,931,229 6,943,559 5,811,152
============ ============ ============ ============
4
The following table illustrates the amount of stock-based compensation
(charges)/credits that would have been recorded in the categories of the
statement of operations had stock-based compensation not been separately stated
therein:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------------------- ---------------------------------------
2002 2001 2002 2001
------------------- ------------------ ---------------- ------------------
Costs of services $ (7,895) $ 150,168 $ 187,413 $ 2,323
Selling, general and administrative expenses (22,395) 52,669 (64,582) (737,338)
------------- ------------- ------------- --------------
$ (30,290) $ 202,837 $ 122,831 $ (735,015)
============= ============= ============= ==============
See accompanying notes.
5
SMARTSERV ONLINE, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
NINE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)
COMMON STOCK NOTES
-------------------------- RECEIVABLE ADDITIONAL
PAR FROM PAID-IN UNEARNED ACCUMULATED
SHARES VALUE OFFICERS CAPITAL COMPENSATION DEFICIT
----------------------------------------------------------------------------------------------
Balances at December 31, 2001 6,263,783 $ 62,638 $ (666,841) $ 69,680,059 $ (540,354) $ (64,821,833)
Issuance of common stock upon
exercise of employee stock
options 15,200 152 -- 14,051 -- --
Conversion of 39 prepaid common
stock purchase warrants into
common stock 27,857 278 -- (278) -- --
Issuance of common stock through
private placements of securities 4,669,923 46,699 -- 4,018,365 -- --
Issuance of common stock upon
exercise of warrants 169,853 1,699 -- 142,676 -- --
Amortization of unearned
compensation over the terms of
consulting agreements -- -- -- -- 548,079 --
Warrants issued to consultants as
compensation for services
rendered and to be rendered -- -- -- 41,250 (15,450) --
Warrants to purchase common stock
issued as a condition of debt
extinguishment -- -- -- 38,000 -- --
Change in market value of employee
stock options -- -- -- (696,710) -- --
Repayment of notes receivable from
officer -- -- 56,845 -- -- --
Net loss for the period -- -- -- -- -- (4,833,433)
-----------------------------------------------------------------------------------------
Balances at September 30, 2002 11,146,616 $ 111,466 $ (609,996) $ 73,237,413 $ (7,725) $ (69,655,266)
=========================================================================================
See accompanying notes.
6
SMARTSERV ONLINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) $ 2,737,927 $ (2,741,469) $ (4,833,433) $(10,354,078)
Adjustments to reconcile net income (loss) to net
cash used for operating activities:
Gain on debt extinguishment (5,679,261) -- (5,679,261) --
Depreciation and amortization 507,764 664,991 1,474,654 1,869,665
Noncash compensation costs 26,428 (510,892) (696,710) (176,150)
Noncash consulting services 3,863 308,055 573,879 911,165
Deferred interest on officer's loan (52,467) -- (52,467) --
Amortization of deferred revenues (15,883) (644,243) (21,177) (2,576,981)
Amortization of deferred financing costs -- 50,000 -- 150,000
Changes in operating assets and liabilities
Accounts receivable 24,920 74,927 (101,137) 122,946
Accrued interest receivable (6,706) -- (6,706) --
Prepaid expenses 85,207 (722,928) 302,531 (697,264)
Accounts payable and accrued liabilities 403,898 22,125 481,555 1,384,426
Deferred revenues 5,949 -- 180,000 --
Security deposit 247,880 5,323 231,585 (269,370)
------------ ------------ ------------ ------------
Net cash used for operating activities (1,710,481) (3,494,111) (8,146,687) (9,635,641)
------------ ------------ ------------ ------------
INVESTING ACTIVITIES
Purchase of equipment (1,170) (15,428) (169,660) (152,310)
Capitalization of software development costs (45,660) (79,478) (185,895) (362,526)
Loan to officer -- -- -- (500,000)
------------ ------------ ------------ ------------
Net cash used for investing activities (46,830) (94,906) (355,555) (1,014,836)
------------ ------------ ------------ ------------
FINANCING ACTIVITIES
Repayment of notes receivable from officers 56,845 -- 56,845 --
Repayment of note payable (500,000) -- (500,000) --
Proceeds from the issuance of notes -- 670,381 -- 862,373
Proceeds from the issuance of common stock 3,688,787 250,076 4,802,990 271,185
Costs of issuing common stock (319,348) -- (579,348) --
------------ ------------ ------------ ------------
Net cash provided by financing activities 2,926,284 920,457 3,780,487 1,133,558
------------ ------------ ------------ ------------
Increase (decrease) in cash and cash equivalents 1,168,973 (2,668,560) (4,721,755) (9,516,919)
Cash and cash equivalents - beginning of period 641,595 12,323,759 6,532,323 19,172,118
------------ ------------ ------------ ------------
Cash and cash equivalents - end of period $ 1,810,568 $ 9,655,199 $ 1,810,568 $ 9,655,199
============ ============ ============ ============
See accompanying notes.
7
SMARTSERV ONLINE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
1. NATURE OF BUSINESS
SmartServ Online, Inc. ("SmartServ" or the "Company") commenced operations on
August 20, 1993, and had its initial public offering on March 21, 1996. We offer
wireless applications, development and hosting services that allow enterprises,
wireless carriers and financial services firms to deliver content to their work
forces and customers. Our products deliver proprietary information, as well as
delayed and real-time financial market data, business and financial news,
national weather reports and other business and entertainment information in a
user-friendly manner.
We deliver mobile data solutions designed to generate additional revenue,
increase operating efficiency, and extend brand awareness for wireless carriers,
enterprises and content providers. We offer standard and custom-built
applications designed for a vast array of wireless platforms and devices. Our
applications can be delivered via JAVA, BREW, WAP and SMS, as well as RIM
Blackberry and Pocket PC devices.
The Company's financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. The Company has, since its
inception, incurred substantial recurring operating losses, including a net loss
of $4,833,433 for the nine month period ended September 30, 2002, a net loss of
$14,819,860 for the year ended December 31, 2001, and net losses of $30,993,559
and $7,124,126 for the years ended June 30, 2000 and 1999, respectively.
Additionally, it had an accumulated deficit of $69,655,266 at September 30,
2002. These conditions raise substantial doubt about the Company's ability to
continue as a going concern. Such concern was expressed by our auditors, Ernst &
Young LLP, in their audit report regarding the financial statements included in
our Form 10-KSB for the year ended December 31, 2001. The financial statements
do not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of these uncertainties.
Our plan of operation to eliminate the uncertainty surrounding the Company's
ability to continue as a going concern focuses on licensing our applications and
related services to wireless carriers and financial services firms. For wireless
carriers, we deliver data and branded content that can increase wireless data
revenue and customer retention. For financial services firms, we offer solutions
that can increase productivity and customer retention through the mobile
delivery of proprietary data, as well as market data and other useful content.
Management believes that SmartServ's primary source of revenues will be derived
from revenue-share licensing contracts with its wireless carrier and financial
services customers.
As an example, the Company has launched two products on the Verizon Wireless
network. Our financial content product has been launched on Verizon's BREW
(Binary Runtime Environment for Wireless) network under the Forbes.com brand
name, while our SMS (Short Message Service) financial alert product has been
launched on Verizon's Vtext portal. Similarly, the Company has launched its
Forbes.com branded application on AT&T Wireless' m-Mode network. A MobileMarkets
real-time product is also offered to wireless subscribers on Telus Mobility's
network in Canada, as well as on AT&T Wireless' network in the US. Additionally,
Salomon Smith Barney, in conjunction with SmartServ, has launched a wireless
version of its GEO (Global Equities Online) product. GEO combines Salomon's
proprietary data, such as morning call notes, with SmartServ's financial data
products to form a fully integrated financial
8
tool. While management believes that these relationships are important to the
Company's success, no assurance can be given that these customers will be
successful in their marketing efforts or that the Company's products and
services will be well received in the marketplace.
The economic downturn in general, and its impact on the telecommunications
industry in particular, has caused telecommunications service providers to
reduce capital spending, personnel and debt, as well as new service
introductions. This has resulted in delays in the build-out of high speed
carrier data networks and availability of data-enabled wireless devices, causing
the market for SmartServ's financial data and transaction services to be
lackluster until now. In addition, many financial services firms have curtailed
new product development to focus on data security and recovery. Consequently,
the potential demand for the Company's products and services has been
significantly delayed. Such delays have had a very detrimental effect on the
Company's operations and have resulted in the Company's inability to implement
its business plan and related marketing strategies. Consequently, in May 2002,
the Company commenced an effort to realign its infrastructure and related
overhead to correlate with reductions in projected revenue. As part of this
effort, management closed the Company's UK and Hong Kong sales offices and
downsized its domestic operations through staff reductions to a level sufficient
to support the Company's projected operations through the remainder of 2002.
Personnel headcount has been reduced from 66 in May to the current level of 43.
These efforts have reduced the Company's average operating expenses from
approximately $1,141,000 to $675,000 per month, excluding non-cash stock
compensation and amortization and depreciation. As a result of the factors
identified above, the Company is in need of additional capital to enable it
continue as a going concern. The Company has engaged investment bankers to
assist it with the sale of equity to private investors that understand the
wireless industry and the current state of the technology; however, no assurance
can be given that the Company will be able to raise additional capital on
satisfactory terms. Should the Company be unable to raise additional debt or
equity financing, it will be forced to seek a merger or cease operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
- ---------------------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information, the instructions of Form 10-QSB and Rule 310
of Regulation SB and, therefore, do not include all information and notes
necessary for a presentation of results of operations, financial position and
cash flows in conformity with accounting principles generally accepted in the
United States. The balance sheet at December 31, 2001 has been derived from the
audited financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. The financial statements
should be read in conjunction with the Company's Annual Report on Form 10-KSB
for the period ended December 31, 2001. In the opinion of the Company, all
adjustments (consisting of normal recurring accruals) necessary for a fair
presentation have been made. Results of operations for the three month and nine
month periods ended September 30, 2002 are not necessarily indicative of those
expected for the year ending December 31, 2002.
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly-owned. Significant intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in
9
the financial statements and accompanying notes. Actual results could differ
from those estimates.
Revenue Recognition
- -------------------
The Company earns revenue from the use of its products and services in
accordance with American Institute of Certified Public Accountants' ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition", SOP 98-9,
"Modification of SOP 97-2, Software Recognition, With Respect to Certain
Transactions", and the SEC Staff Accountant Bulletin No.101, "Revenue
Recognition in Financial Statements". Specifically, there must be (1) evidence
of an arrangement, (2) delivery of our products and services, (3) fixed and
determinable fees and (4) probable collectibility of such fees. Multi-element
revenue agreements are recognized based on vendor specific objective evidence of
individual components or if the elements in the arrangement cannot be separated,
recognized as one element ratably over the term of the agreement.
Subscription Revenue
- --------------------
Subscription revenue consists of fixed and variable charges for the usage of the
Company's products and services provided through its relationships with wireless
telecommunications carriers and a financial services company. Such revenue is
recognized as the services are provided on a monthly basis.
Development and Integration Revenue
- -----------------------------------
Development and integration fees are charged for the development of
private-labeled applications for customers that incorporate our customers'
proprietary data into SmartServ's products and services. Such fees are
recognized ratably over the term of the agreement.
Service Revenue
- ---------------
Service revenue is derived from consulting or by providing other professional
services to customers. Revenue from the performance of such services is
recognized when the services are performed. Losses from professional services
contract, if any, are recognized at the time such losses are identified.
Maintenance and support fees paid in advance are nonrefundable and are
recognized ratably over the term of the agreement, generally 12 months.
Hosting Services
- ----------------
Hosting service arrangements are based on a flat monthly fee or on the number of
users and may include a one-time setup fee. The one-time setup fee is recognized
over the term of the hosting arrangement, and the hosting services revenue is
recognized monthly as earned on a fixed fee or variable rate basis.
Deferred revenues, resulting from customer prepayments, are recognized as
services are provided throughout the term of the agreement with the respective
customer. Deferred revenues resulting from our agreement with Data Transmission
Network Corporation ("DTN") were amortized over the anticipated future revenue
stream, a period of 42 months, commencing June 1, 1999. We amended our agreement
with DTN such that, effective September 1, 2000, SmartServ performed maintenance
and enhancement services through December 2000 and provided operational support
through August 2001. Therefore, commencing September 1, 2000, deferred revenues
were amortized to income on a straight-line basis over the period through August
2001.
10
Earnings Per Share
- ------------------
Basic earnings per share is computed on the weighted average number of common
shares outstanding; however, it does not include the unvested portion of
restricted shares in accordance with Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings Per Share". Diluted earnings per share reflects the
increase in the weighted average common shares outstanding that would result
from the assumed exercise of outstanding stock options calculated using the
treasury stock method when dilutive.
Capitalized Software Development Costs
- --------------------------------------
In connection with certain contracts entered into between SmartServ and its
customers, as well as other development projects, we have capitalized costs
related to certain product enhancements and application development in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed." Specifically, all software development
costs are charged to expense as incurred until technological feasibility has
been established for the product. Thereafter, additional costs incurred for
development are capitalized. Capitalization ceases when the product is available
for general release to customers. Amortization of capitalized software
development costs is provided on a product-by-product basis over the economic
life, not to exceed three years, of the product using the straight-line method.
Amortization of capitalized software development costs commences with the
products' general release to customers.
On an ongoing basis, SmartServ reviews the future recoverability of its
capitalized software development costs for impairment or whenever events or
changes in circumstances indicate that the carrying amounts may not be
recoverable. When such events or changes in circumstances do occur, we recognize
an impairment loss if the undiscounted future cash flows expected to be
generated by the asset are less than its carrying value. The impairment loss
reduces the asset to its fair value.
Fair Value of Financial Instruments
- -----------------------------------
The carrying amounts of our financial instruments approximate fair value due to
their terms and maturities.
Supplemental Cash Flow Data
- ---------------------------
We consider all highly liquid investments with a maturity date of three months
or less when purchased to be cash equivalents.
Interest, debt origination and other financing costs paid during the three month
periods ended September 30, 2002 and 2001 were $138,439 and $138,072,
respectively, and for the nine month periods ended September 30, 2002 and 2001
were $508,184 and $260,759, respectively.
Concentration of Credit Risk
- ----------------------------
Financial instruments that potentially subject SmartServ to concentrations of
credit risk consist primarily of its commercial paper investments and accounts
receivable. It is management's policy to invest in only those companies with a
AAA credit rating. At September 30, 2002, accounts receivable consist
principally of amounts due from a major financial services company. We perform
periodic credit evaluations of our customers and, if applicable, provide for
credit losses in the financial statements.
Property and Equipment
- ----------------------
Property and equipment are stated at cost. Equipment purchased under a capital
lease is recorded at the present value of the future minimum lease payments at
the date of acquisition. Depreciation is computed using the straight-line method
over the estimated useful lives of three to ten years.
Advertising Costs
- -----------------
Advertising costs are expensed as incurred and were approximately $28,000 and
$18,800 during the three month periods ended September 30, 2002 and 2001,
respectively, and $264,900 and $47,400 during the nine month periods ended
September 30, 2002 and 2001, respectively.
11
Stock Based Compensation
- ------------------------
We maintain several stock option plans for employees and non-employee directors
that provide for the granting of stock options for a fixed number of shares with
an exercise price equal to the fair value of the shares at the date of grant. We
account for these stock compensation plans in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25"). Accordingly, compensation expense is recognized to the extent
that the fair value of the stock exceeds the exercise price of the option at the
measurement date. Certain options, which have been repriced, are subject to the
variable plan requirements of APB No. 25 that require us to record compensation
expense for changes in the fair value of our common stock.
Foreign Currency Translation
- ----------------------------
The financial statements of foreign subsidiaries have been translated into U.S.
dollars in accordance with FASB Statement No. 52, "Foreign Currency
Translation". All balance sheet accounts have been translated using the exchange
rates in effect at the balance sheet date. Income statement amounts have been
translated using the average rate for the year. Gains and losses resulting from
the changes in exchange rates from year to year are reported in other
comprehensive income.
Recent Accounting Pronouncements
- --------------------------------
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141
"Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible Assets."
SFAS No. 141 requires the use of the purchase method of accounting for business
combinations initiated after June 30, 2001, while SFAS No. 142 requires that the
amortization of goodwill and certain other intangible assets cease and the
related asset values be reviewed annually for impairment. The Company does not
anticipate any material impact on its consolidated results of operations,
financial position or cash flows related to the implementation of SFAS No. 141
and No. 142.
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which provides a single accounting
model for measuring impairment of long-lived assets and the disposal of such
assets. The adoption of SFAS No. 144 had no impact on the Company's consolidated
results of operations, financial position or cash flows.
In April 2002, the Financial Accounting Standards Board issued SFAS No. 145,
"Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No.
13, and Technical Corrections". The Company has early adopted SFAS No. 145.
Accordingly, the Company's gain on extinguishment of debt has been recorded in
"Other Income" in the consolidated financial statements.
In July 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with an Exit or Disposal Activity". SFAS No.
146 revises the accounting for exit and disposal activities under Emerging
Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)", by potentially spreading out the
reporting of expenses related to restructuring activities. A commitment to a
plan to exit an activity or dispose of long-lived assets will no longer be
sufficient to record a one-time charge for most restructuring activities.
Instead, companies will record exit or disposal costs when they are incurred and
can be measured at fair value. In addition, the resultant liabilities will be
subsequently adjusted for changes in estimated cash flows. SFAS No. 146 is
effective prospectively for exit or disposal activities initiated after December
31, 2002. Companies may not restate previously issued financial statements for
the effect of the provisions of SFAS No. 146, and liabilities that a company
previously recorded under EITF Issue 94-3 are grandfathered. The Company will
adopt SFAS No. 146 on January 1, 2003, and it does not believe that the adoption
of this new standard will have a material effect on its consolidated results of
operations, financial position or cash flows.
12
RECLASSIFICATIONS
- -----------------
Certain amounts reported in the consolidated financial statements for the three
and nine month periods ended September 30, 2001 have been reclassified to
conform to the 2002 presentation.
3. Property and Equipment
Property and equipment consist of the following:
September 30, December 31,
2002 2001
------------------- -----------------
Data processing equipment $ 4,599,724 $ 5,033,498
Data processing equipment purchased under a capital lease 246,211 246,211
Office furniture and equipment 151,263 151,263
Display equipment 71,335 71,335
Leasehold improvements 69,852 55,570
--------------- ---------------
5,138,385 5,557,877
Accumulated depreciation, including $246,211 at September 30,
2002 and $229,797 at December 31, 2001 for equipment
purchased under a capital lease (3,183,433) (2,149,101)
--------------- ---------------
$ 1,954,952 $ 3,408,776
=============== ===============
4. NOTES RECEIVABLE FROM OFFICER
In December 2000, the Company's Board of Directors authorized the issuance of a
line of credit to Sebastian Cassetta, SmartServ's Chief Executive Officer, for
an amount not to exceed $500,000. Such amount bears interest at the prime rate
and matures on March 20, 2004. Pursuant to the terms of the note, interest for
the period January 2, 2001 to June 30, 2002, shall accrue and be payable at
maturity. Commencing July 1, 2002 until maturity, interest shall be payable
semi-annually in arrears on January 1st and July 1st.
5. NOTE PAYABLE
In May 2000, we entered into a Business Alliance Agreement with Hewlett-Packard
Company ("HP") whereby the companies agreed to jointly market their respective
products and services, and to work on the build-out of SmartServ's domestic and
international infrastructure. In furtherance of these objectives, HP provided
the Company with a line of credit of up to $20,000,000 for the acquisition of
approved hardware, software and services. On September 10, 2002, the Company and
HP amended the terms of the promissory note to provide for the (i) reduction of
SmartServ's aggregate outstanding principal and accrued interest amount of
$7,045,000 to $1,000,000, (ii) return of certain unused hardware by SmartServ,
(iii) issuance by SmartServ of a warrant for the purchase of 50,000 shares of
common stock and (iv) repayment of $500,000 of the amended obligation on
September 10, 2002. The remaining obligation is evidenced by a note, bearing an
interest rate of 11%, secured by the Company's assets exclusive of its
internally developed software products, that may be converted into our common
stock at $33.56 per share and that is to be repaid as follows: $200,000 on
December 31, 2002, $200,000 on January 28, 2003 and $100,000 on February 27,
2003. The warrant expires on September 9, 2005 and has an exercise price of
$1.166, determined as 110% of the average closing bid price of the common stock
for the five trading days prior to September 10, 2002. In connection therewith,
the Company recorded a charge to earnings of $38,000 representing the fair value
of the warrant as determined in accordance with the Black-Scholes pricing model.
13
The restructuring of the obligation resulted in a net gain of $5,679,261 which
has been recorded as "Other Income" in the consolidated financial statements.
6. STOCKHOLDERS' EQUITY
During the nine month period ended September 30, 2002, the Company issued
warrants to purchase 17,000 shares of our common stock to certain marketing
consultants as partial compensation for services rendered and to be rendered to
SmartServ. The warrants have exercise prices of $5.01 and $5.38, expire on April
29, 2005, and have been recorded in the consolidated financial statements at
fair market value as determined in accordance with the Black-Scholes pricing
model.
In June 2002, SmartServ issued 785,714 shares of its common stock to two
accredited investors ("June Investors") at a purchase price of $1.40 per share.
Gross proceeds from this transaction amounted to $1,100,000. First Albany
Securities Corporation, the placement agent, received a commission of $66,000
and reimbursement of direct expenses of $2,000 in connection with this
transaction. Each of the June Investors received a fee of $50,000 in connection
with the performance of due diligence related to their investment in the
Company. Additionally, the Company issued to the June Investors warrants,
callable under certain conditions, for the purchase of an aggregate of 1,428,571
shares of common stock at an exercise price of $1.40 per share through the
expiration date on June 5, 2007, as well as non-callable warrants for the
purchase of an aggregate of 196,429 shares of common stock, subject to
antidilution adjustments upon the occurrence of certain events, at an exercise
price of $1.47 per share through June 5, 2007. The callable warrants provided
that upon exercise the June Investors would receive non-callable warrants for
the purchase of an aggregate of 357,142 shares of common stock at an exercise
price of $1.47 per share. In August 2002, pursuant to the terms of the callable
warrants, the Company provided the June Investors with a notice, calling such
warrants. In September 2002, the callable warrants expired unexercised.
In September 2002, SmartServ issued units consisting of 3,884,209 shares of its
common stock and warrants to purchase 1,942,109 shares of common stock
exercisable at $0.85 per share through September 8, 2007 to 22 accredited
investors at a purchase price of $0.9125 per unit. Gross proceeds from this
transaction amounted to $3,544,346. SmartServ paid fees consisting of $249,050,
an expense allowance of $25,000, and issued warrants to purchase 438,046 shares
of common stock at an exercise price of $0.85 per share, expiring on September
8, 2007, as compensation to certain individuals and entities that acted as
finders. Pursuant to the terms of the Securities Purchase Agreement, the Company
has filed a registration statement with the Securities and Exchange Commission
requesting registration of the common stock issued in this transaction, as well
as those shares issuable upon exercise of the warrants to purchase common stock.
In September 2002, SmartServ issued 169,853 shares of common stock upon the
exercise, by a June Investor, of warrants to purchase such shares at an exercise
price, after anti-dulution adjustments, of $0.85 per share. Proceeds from the
issuance were $144,375.
14
7. STOCK-BASED COMPENSATION
In connection with the grant of certain stock options, warrants and other
compensation arrangements, we have recorded charges to earnings that are noncash
in nature. Certain of these stock option grants are subject to the variable plan
requirements of APB No. 25 that require us to record compensation expense for
changes in the fair value of our common stock.
The following table illustrates the amount of stock-based compensation
(charges)/credits that would have been recorded in the categories of the
statement of operations had stock-based compensation not been separately stated
therein:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
------------------------------------------------
2002 2001 2002 2001
--------- --------- --------- ----------
Costs of services $ (7,895) $ 150,168 $ 187,413 $ 2,323
Selling, general and
administrative expenses $ (22,395) $ 52,669 $ (64,582) $(737,338)
--------- --------- --------- ---------
$ (30,290) $ 202,837 $ 122,831 $(735,015)
========= ========= ========= =========
Stock-based compensation for the three and nine month periods ended September
30, 2002 and 2001 consists of the impact of changes in the market value of the
Company's common stock on the value of options to purchase common stock issued
to employees, as well as the amortization of deferred costs associated with the
issuance of warrants to purchase common stock.
8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted income
(loss) per share:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
--------------------------- ---------------------------
2002 2001 2002 2001
------------ ----------- ----------- ------------
Numerator
Net earnings (loss) $ 2,737,927 $(2,741,469) $(4,833,433) $(10,354,078)
============ =========== =========== ============
Denominator
Denominator for basic
earnings per share - weighted
average shares 8,034,319 5,931,229 6,943,559 5,811,152
Dilutive effect of warrants to
purchase common stock 891,012 -- -- --
Dilutive effect of employee
stock options and restricted
shares 40,481 -- -- --
------------ ----------- ----------- ------------
15
Denominator for diluted
earnings per share 8,965,812 5,931,229 6,943,559 5,811,152
============ =========== =========== ============
Basic earnings (loss) per
common share $ 0.34 $ (0.46) $ (0.70) $ (1.78)
============ =========== =========== ============
Diluted earnings (loss) per
common share $ 0.31 $ (0.46) $ (0.70) $ (1.78)
============ =========== =========== ============
Outstanding employee stock options and other warrants to purchase an aggregate
of 6,850,100 shares of common stock at September 30, 2002 were not included in
the computation of diluted earnings per share for the nine month period ended
September 30, 2002, because the Company reported a loss for the period and,
therefore their inclusion would be antidilutive.
9. COMMITMENTS AND CONTINGENCIES
On or about June 4, 1999, Michael Fishman, our former Vice President of Sales,
commenced an action against us, Sebastian E. Cassetta (our Chairman of the Board
and Chief Executive Officer), Steven Francesco (our former President) and four
others in the Connecticut Superior Court for the Judicial District of
Stamford/Norwalk at Stamford alleging breach of his employment contract, breach
of duty of good faith and fair dealing, fraudulent misrepresentation, negligent
misrepresentation, intentional misrepresentation and failure to pay wages. The
defendants have answered the complaint and filed counterclaims for fraudulent
inducement and breach of contract. The fraud and misrepresentation claims have
been dismissed. The parties have filed motions for summary judgment that will be
subject to oral argument in December of 2002. Although we are vigorously
defending this action, there can be no assurance that we will be successful. The
unfavorable outcome of such action could have a material adverse effect on our
consolidated results of operations, financial condition and cash flows.
On or about February 29, 2000, Commonwealth Associates, L.P. ("Commonwealth")
filed a complaint against us in the Supreme Court of the State of New York,
County of New York. The complaint alleges that on or about August 19, 1999,
Commonwealth and SmartServ entered into an engagement letter pursuant to which
Commonwealth was to provide financial advisory and investment banking services
to SmartServ in connection with a possible combination between SmartServ and
Data Link Systems Corporation. The engagement letter provided for a
nonrefundable fee of $15,000 payable in cash or common stock at SmartServ's
option. The complaint alleges that SmartServ elected to pay the fee in stock and
seeks 13,333 shares of common stock or at least $1,770,000 together with
interest and costs. We have denied the material allegations of the complaint,
including the allegation that we elected to pay in stock. A trial was held in
New York Supreme Court on November 7 and 8, 2002. The parties have until
December 16, 2002 to file post-trial pleadings and a decision is expected soon
thereafter. Although we are vigorously defending this action, there can be no
assurance that we will be successful. The unfavorable outcome of such action
could have a material adverse effect on our consolidated results of operations,
financial condition and cash flows.
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
SmartServ commenced operations on August 20, 1993, and had its initial public
offering on March 21, 1996. We offer wireless applications, development and
hosting services that allow enterprises, wireless carriers and financial
services firms to deliver content to their work forces and customers. Our
products deliver proprietary information, as well as delayed and real-time
financial market data, business and financial news, national weather reports and
other business and entertainment information in a user-friendly manner.
We deliver mobile data solutions designed to generate additional revenue,
increase operating efficiency, and extend brand awareness for wireless carriers,
enterprises and content providers. We offer standard and custom-built
applications designed for a vast array of Web and wireless platforms and
devices. Our applications can be delivered via JAVA, BREW, WAP and SMS, as well
as RIM Blackberry and Pocket PC devices.
RESULTS OF OPERATIONS
QUARTER ENDED SEPTEMBER 30, 2002 VERSUS QUARTER ENDED SEPTEMBER 30, 2001
During the quarters ended September 30, 2002 and 2001, we recorded revenues of
$81,847 and $824,990, respectively. Revenues generated in 2002 were derived from
the licensing of our wireless data products to a financial services institution
while substantially all revenues in 2001 were earned through our licensing
agreement with Data Transmission Network Corporation ("DTN"). During the
quarters ended September 30, 2002 and 2001, we recognized $0 and $644,243,
respectively, from the amortization of deferred revenues associated with the DTN
agreement.
During the quarter ended September 30, 2002, we incurred costs of services of
$1,386,390. Such costs decreased $331,800 or 19.3% compared to the corresponding
quarter of 2001 due primarily to a reduction in services for technical
consultants and the reduction of amortization of capitalized software
development costs. Capitalized software development costs associated with the
products licensed to DTN were amortized on a straight-line basis over the life
of the agreement and were fully amortized at August 31, 2001, the termination
date of the agreement. Costs of services consisted primarily of information and
communication costs ($225,900), personnel costs ($606,300), computer hardware
leases, depreciation and maintenance costs ($443,900), and amortization expenses
relating to capitalized software development costs ($87,600). During the quarter
ended September 30, 2001, we incurred costs of services of $1,718,178. Such
costs consisted primarily of information and communication costs ($234,800),
personnel costs ($592,600), systems consultants ($148,600), computer hardware
leases, depreciation and maintenance costs ($434,800), and amortization expenses
relating to capitalized software development costs ($285,200). During the
quarters ended September 30, 2002 and 2001, we capitalized $45,700 and $79,500,
respectively, of development costs in accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed".
During the quarter ended September 30, 2002, we incurred general and
administrative expenses of $1,087,962. Such costs increased $83,700 or 8.3%
compared to the corresponding quarter of 2001 due primarily to an increase in
personnel costs and professional fees. General and administrative costs were
17
incurred primarily for personnel costs ($385,900), travel and lodging ($24,200),
professional fees ($297,100), facilities ($127,400), insurance ($106,500),
computer hardware leases, depreciation and maintenance costs ($54,000), and
communication costs ($12,300). During the quarter ended September 30, 2001, we
incurred general and administrative expenses of $1,004,318. Such costs were
incurred primarily for personnel costs ($337,500), travel and lodging ($33,100),
professional fees ($263,700), facilities ($113,000), insurance ($134,600),
computer hardware leases, depreciation and maintenance costs ($39,500), and
communication costs ($12,200).
During the quarter ended September 30, 2002, we incurred sales and marketing
expenses of $454,364. Such costs decreased $503,700 or 52.6% compared to the
corresponding quarter of 2001 due primarily to a reduction of personnel. During
the second quarter of 2002, the Company commenced the closing of its sales
offices in Hong Kong and the United Kingdom thereby eliminating a substantial
portion of the costs of such sales offices from the quarter ended September 30,
2002. Sales and marketing expenses were incurred primarily for personnel costs
($292,500), facilities ($32,000), consulting fees ($29,800), communication costs
($17,400), advertising and trade shows ($43,000), and travel and lodging
($32,100). During the quarter ended September 30, 2001, we incurred sales and
marketing expenses of $958,092. Such costs were incurred primarily for personnel
costs ($648,600), advertising and trade shows ($44,500), communication costs
($37,500) consulting fees ($40,700), travel and lodging ($84,300) and facilities
($29,200).
During the quarter ended September 30, 2002, a net noncash charge for
stock-based compensation amounted to $30,290 compared to a net noncash credit of
$202,837 during the quarter ended September 30, 2001. Such noncash amounts are
primarily related to the valuation of stock-based compensation in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB No. 25"). Certain options are subject to the variable plan
requirements of APB No. 25, as they were repriced, and therefore, compensation
expense is recognized for changes in the fair value of our common stock. Noncash
charges for professional fees for the quarters ended September 30, 2002 and 2001
were $3,900 and $308,100, respectively, resulting primarily from the
amortization of deferred costs associated with the issuance of warrants to
purchase common stock to various financial, marketing and technical consultants.
The value of substantially all of such common stock purchase warrants has been
recorded in accordance with the Black-Scholes pricing model.
Interest income for the quarters ended September 30, 2002 and 2001 amounted to
$74,785 and $101,875, respectively. The decrease of 27,090 or 26.6% was caused
by the use of working capital to fund the Company's operations. Such amounts
were earned primarily from our investments in highly liquid commercial paper and
money fund accounts. During the quarters ended September 30, 2002 and 2001,
interest and other financing costs were $138,439 and $188,072, respectively.
Such costs were incurred primarily in connection with the $20 million line of
credit facility with Hewlett-Packard Company ("HP") and decreased in 2002
compared to 2001 due to the restructuring of such obligation on September 10,
2002.
In September 2002, the Company and HP amended the terms of the promissory note
between the companies to provide for the (i) reduction of SmartServ's aggregate
outstanding principal and accrued interest amount of $7,045,000 to $1,000,000,
(ii) return of certain unused hardware by SmartServ, (iii) issuance by SmartServ
of a warrant for the purchase of 50,000 shares of common stock and (iv)
repayment of $500,000 of the amended obligation on September 10, 2002. The
restructuring of the obligation resulted in a net gain to the Company of
$5,679,261, inclusive of a charge to earnings of $38,000 representing the fair
value of the warrant as determined in accordance with the Black-Scholes pricing
model.
Basic earnings were $0.34 per share for the three months ended September 30,
2002 versus a loss of $0.46 per share for the three months ended September 30,
2001. Diluted earnings for the three months ended
18
September 30, 2002 were $0.31 per share versus a loss of $0.46 per share for the
three months ended September 30, 2001. Basic weighted average shares outstanding
increased to 8,034,319 at September 30,2002 from 5,931,229 at September 30,
2001. Diluted weighted average shares outstanding increased to 8,965,812 at
September 30, 2002 from 5,931,229 at September 30, 2001.
NINE MONTHS ENDED SEPTEMBER 30, 2002 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 2001
During the nine months ended September 30, 2002 and 2001, we recorded revenues
of $146,483 and $3,272,827, respectively. Revenues generated in 2002 were
derived from the licensing of our wireless data products to a financial services
institution while substantially all revenues in 2001 were earned through our
licensing agreement with DTN. During the nine months ended September 30, 2002
and 2001, we recognized $0 and $2,577,000, respectively, from the amortization
of deferred revenues associated with the DTN agreement.
During the nine months ended September 30, 2002, we incurred costs of services
of $4,338,016. Such costs decreased $1,164,700 or 21.2% compared to the
corresponding quarter of 2001 due primarily to a reduction in services for
technical consultants and the reduction of amortization of capitalized software
development costs partially offset by an increase in personnel costs.
Capitalized software development costs associated with the products licensed to
DTN were amortized on a straight-line basis over the life of the agreement and
were fully amortized at August 31, 2001, the termination date of the agreement.
Costs of services consisted primarily of information and communication costs
($621,000), personnel costs ($2,065,000), computer hardware leases, depreciation
and maintenance costs ($1,403,500), and amortization expenses relating to
capitalized software development costs ($179,800). During the nine months ended
September 30, 2001, we incurred costs of services of $5,502,704. Such costs
consisted primarily of information and communication costs ($667,900), personnel
costs ($1,766,100), systems consultants ($971,700), computer hardware leases,
depreciation and maintenance costs ($1,277,300), and amortization expenses
relating to capitalized software development costs ($746,000). During the nine
months ended September 30, 2002 and 2001, we capitalized $185,900 and $362,500,
respectively, of development costs in accordance with Statement of Financial
Accounting Standards No. 86, "Accounting for the Costs of Computer Software to
be Sold, Leased or Otherwise Marketed".
During the nine months ended September 30, 2002, we incurred general and
administrative expenses of $3,328,102. Such costs decreased $285,300 or 7.9%
compared to the corresponding quarter of 2001 due primarily to a decrease in
personnel costs and professional fees. General and administrative costs were
incurred primarily for personnel costs ($1,120,600), professional fees
($899,800), facilities ($399,000), insurance ($432,700), travel and lodging
($66,100), computer hardware leases, depreciation and maintenance costs
($137,900), and communication costs ($53,300). During the nine months ended
September 30, 2001, we incurred general and administrative expenses of
$3,613,420. Such costs were incurred primarily for personnel costs ($1,201,700),
professional fees ($1,028,800), facilities ($387,100), insurance ($385,200),
travel and lodging ($110,800), computer hardware leases, depreciation and
maintenance costs ($116,000), and communication costs ($46,600).
During the nine months ended September 30, 2002, we incurred sales and marketing
expenses of $2,698,013. Such costs decreased $1,103,300 or 29.0% compared to the
corresponding quarter of 2001 due primarily to the reduction of personnel,
marketing consultants and travel costs associated therewith, partially offset by
an increase in costs incurred for trade shows during the period October 2001
through April 2002. During the second quarter of 2002, the Company commenced the
closing of its sales offices in Hong Kong and the United Kingdom thereby
eliminating a substantial portion of the costs of such sales offices from the
quarter ended September 30, 2002. Sales and marketing expenses were incurred
primarily for personnel costs ($1,471,600), advertising and trade shows
($606,100), facilities ($112,900), consulting
19
fees ($187,600), and travel and lodging ($214,600). During the nine months ended
September 30, 2001,we incurred sales and marketing expenses of $3,801,287. Such
costs were incurred primarily for personnel costs ($2,116,600), consulting fees
($528,600), travel and lodging ($372,000), advertising and trade shows
($356,800), communication costs ($79,000) and facilities ($95,600).
During the nine months ended September 30, 2002, a net noncash credit for
stock-based compensation amounted to $122,831 compared to a $735,015 charge
during the nine months ended September 30, 2001. Such noncash amounts are
primarily related to the valuation of stock-based compensation in accordance
with APB No. 25. Certain options are subject to the variable plan requirements
of APB No. 25, as they were repriced, and therefore, compensation expense is
recognized for changes in the fair value of our common stock. Noncash charges
for professional fees for the nine months ended September 30, 2002 and 2001,
were $573,879 and $911,165, respectively, resulting primarily from the
amortization of deferred costs associated with the issuance of warrants to
purchase common stock to various financial, marketing and technical consultants.
The value of substantially all of such common stock purchase warrants has been
recorded in accordance with the Black-Scholes pricing model.
Interest income for the nine months ended September 30, 2002 and 2001 amounted
to $106,284 and $459,599, respectively. The decrease of $353,315 or 76.9% was
caused by the use of working capital to fund the Company's operations. Such
amounts were earned primarily from our investments in highly liquid commercial
paper and money fund accounts. During the nine months ended September 30, 2002
and 2001, interest and other financing costs were $508,184 and $410,759,
respectively. Such costs were incurred primarily in connection with the $20
million line of credit facility with HP which was restructured on September 10,
2002.
In September 2002, the Company and HP amended the terms of the promissory note
between the companies to provide for the (i) reduction of SmartServ's aggregate
outstanding principal and accrued interest amount of $7,045,000 to $1,000,000,
(ii) return of certain unused hardware by SmartServ, (iii) issuance by SmartServ
of a warrant for the purchase of 50,000 shares of common stock and (iv)
repayment of $500,000 of the amended obligation on September 10, 2002. The
restructuring of the obligation resulted in a net gain to the Company of
$5,679,261, inclusive of a charge to earnings of $38,000 representing the fair
value of the warrant as determined in accordance with the Black-Scholes pricing
model.
The basic and diluted loss per share was $0.70 for the nine months ended
September 30, 2002 versus $1.78 per share for the nine months ended September
30, 2001. Basic and diluted weighted average shares outstanding increased to
6,943,559 at September 30, 2002 from 5,811,152 at September 30, 2001.
20
CAPITAL RESOURCES AND LIQUIDITY
At September 30, 2002, the Company had $1.8 million in cash. Net cash used in
operations was $1.7 million for the three-month period ended September 30, 2002
compared to $3.5 million during the three-month period ended September 30, 2001.
Net cash used in operations during the nine-month period ended September 30,
2002 was $8.1 million compared to $9.6 million during the nine-month period
ended September 30, 2001. The Company's initiative to close the Hong Kong and
United Kingdom sales offices and adjust its US personnel and operations to focus
its resources on meeting the growing demand for its products and services
throughout North America was the primary reason for the reduction.
The other uses of cash during the nine-month period ended September 30, 2002
were primarily for the partial repayment of our obligation to HP in the amount
of $500,000, the purchase of computer equipment and related software in the
amount of $165,000 and the capitalization of software development costs in the
amount of $186,000. This compares to $152,000 for computer equipment and related
software, $363,000 for software development costs and $500,000 for a loan to the
Company's Chairman and Chief Executive Officer during the nine month period
ended September 30, 2001.
In May 2000, we entered into a Business Alliance Agreement with HP whereby the
companies agreed to jointly market their respective products and services and to
work on the build-out of SmartServ's domestic and international infrastructure.
In furtherance of these objectives HP provided us with a line of credit of up to
$20,000,000 for the acquisition of approved hardware, software and services. As
of September 28, 2001, the expiration date of the facility, HP had advanced us
$6,723,156 thereunder. On September 10, 2002, the Company and HP amended the
terms of the promissory note to provide for the (i) reduction of SmartServ's
aggregate outstanding principal and accrued interest amount of $7,045,000 to
$1,000,000, (ii) return of certain unused hardware by SmartServ, (iii) issuance
by SmartServ of a warrant for the purchase of 50,000 shares of common stock and
(iv) repayment of $500,000 of the amended obligation on September 10, 2002. The
remaining obligation is evidenced by a note, bearing an interest rate of 11%,
secured by the Company's assets, exclusive of its internally developed software
products, may be converted into our common stock at $33.56 per share and is to
be repaid as follows: $200,000 on December 31, 2002, $200,000 on January 28,
2003 and $100,000 on February 27, 2003. The warrant expires on September 9, 2005
and has an exercise price of $1.166 per share. In connection therewith, the
Company recorded a charge to earnings of $38,000 representing the fair value of
the warrant as determined in accordance with the Black-Scholes model. The
Company would receive gross proceeds of $58,300 from the exercise of the
warrants. The Company recognized a net gain of $5,679,261 resulting from the
extinguishment of this obligation.
In June 2002, First Albany Corporation, acting as placement agent for SmartServ,
completed a private placement of 785,714 shares of common stock at $1.40 a
share. The net proceeds of $840,000 from the issuance of these shares were used
for general working capital requirements. Additionally, the Company issued to
the June Investors warrants, callable under certain conditions, for the purchase
of an aggregate of 1,428,571 shares of common stock at an exercise price of
$1.40 per share through the expiration date on June 5, 2007, as well as
non-callable warrants for the purchase of an aggregate of 196,429 shares of
common stock, subject to antidilution adjustments upon the occurrence of certain
events, at an exercise price of $1.47 per share through June 5, 2007. In August
2002, pursuant to the terms of the callable warrants, the Company provided the
June Investors with a notice, calling such warrants. In September 2002 the
callable warrants expired unexercised.
In September 2002, SmartServ issued units consisting of 3,884,209 shares of its
common stock and warrants to purchase 1,942,109 shares of common stock
exercisable at $0.85 through September 8, 2007 to 22 accredited investors at a
purchase price of $0.9125 per unit. Gross proceeds from this transaction
amounted to $3,544,346. SmartServ agreed to pay fees consisting of $249,050, an
expense allowance of
21
$25,000, and warrants to purchase 438,046 shares of common stock at an exercise
price of $0.85 per share, expiring on September 8, 2007, as compensation to
certain individuals and entities that acted as finders. While the warrants to
purchase common stock represent an additional source of capital, they by their
terms mature in September 2007 and are not callable by the Company. Therefore,
they cannot be relied upon by the Company as a definite source of capital. The
warrantholders may choose to exercise their warrants should there be a
significant increase in the market value of the Company's common stock or should
the Company amend the terms of the warrants to provide an inducement to the
warrantholders to exercise such warrants.
During the period January 1, 2000 through September 30, 2002, we issued
1,857,433 shares of common stock to investors upon the exercise of warrants to
purchase such shares. Proceeds from the exercise of these warrants were
$3,402,000. Substantially all of these warrants were exercised during the 18
months ended June 30, 2001 when the market value of the Company's common stock
was significantly greater that it is currently.
The Company's financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. The Company has, since its
inception, incurred substantial recurring operating losses, including a net loss
of $4,892,606 for the nine months ended September 30, 2002, a net loss of
$14,819,860 for the year ended December 31, 2001, and net losses of $30,993,559
and $7,124,126 for the years ended June 30, 2000 and 1999, respectively.
Additionally, it had an accumulated deficit of $69,714,439 at September 30,
2002. These conditions raise substantial doubt about the Company's ability to
continue as a going concern. Such concern was expressed by our auditors, Ernst &
Young LLP, in their audit report regarding the financial statements included in
our Form 10-KSB for the year ended December 31, 2001. The financial statements
do not include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of these uncertainties.
Our plan of operation to eliminate the uncertainty surrounding the Company's
ability to continue as a going concern focuses on licensing our applications and
related services to wireless carriers and financial services firms. For wireless
carriers, we deliver data and branded content that can increase wireless data
revenue and customer retention. For financial services firms, we offer solutions
that can increase productivity and customer retention through the mobile
delivery of proprietary data, as well as market data and other useful content.
Management believes that SmartServ's primary source of revenues will be derived
from revenue-share licensing contracts with its wireless carrier and financial
services customers.
As an example, the Company has launched two products on the Verizon Wireless
network. Our financial content product has been launched on Verizon's BREW
(Binary Runtime Environment for Wireless) network under the Forbes.com brand
name, while our SMS (Short Message Service) financial alert product has been
launched on Verizon's Vtext portal. Similarly, the Company has launched its
Forbes.com branded application on AT&T Wireless' m-Mode network. A MobileMarkets
real-time product is also offered to wireless subscribers on Telus Mobility's
network in Canada, as well as on AT&T Wireless' network in the US. Additionally,
Salomon Smith Barney, in conjunction with SmartServ, has launched a wireless
version of its GEO (Global Equities Online) product. GEO combines Salomon's
proprietary data, such as morning call notes, with SmartServ's financial data
products to form a fully integrated financial tool. While management believes
that these relationships are important to the Company's success, no assurance
can be given that these customers will be successful in their marketing efforts
or that the Company's products and services will be well received in the
marketplace.
The economic downturn in general, and its impact on the telecommunications
industry in particular, has caused telecommunications service providers to
reduce capital spending, personnel and debt, as well as new
22
service introductions. This has resulted in delays in the build-out of high
speed carrier data networks and availability of data-enabled wireless devices,
causing the market for SmartServ's financial data and transaction services to be
lackluster until now. In addition, many financial services firms have curtailed
new product development to focus on data security and recovery. Consequently,
the potential demand for the Company's products and services has been
significantly delayed. Such delays have had a very detrimental effect on the
Company's operations and have resulted in the Company's inability to implement
its business plan and related marketing strategies. Consequently, in May 2002,
the Company commenced an effort to realign its infrastructure and related
overhead to correlate with reductions in projected revenue. As part of this
effort, management closed the Company's UK and Hong Kong sales offices and
downsized its domestic operations through staff reductions to a level sufficient
to support the Company's projected operations through the remainder of 2002.
Personnel headcount has been reduced from 66 in May to the current level of 43.
These efforts have reduced the Company's average operating expenses from
approximately $1,141,000 to $675,000 per month. As a result of the factors
identified above, the Company is in need of additional capital to enable it
continue as a going concern. The Company has engaged investment bankers to
assist it with the sale of equity to private investors that understand the
wireless industry and the current state of the technology; however, no assurance
can be given that the Company will be able to raise additional capital on
satisfactory terms. Should the Company be unable to raise additional debt or
equity financing, it will be forced to seek a merger or cease operations.
SUMMARY OF CRITICAL ACCOUNTING POLICIES
The preparation of the consolidated financial statements, in conformity with
accounting principles generally accepted in the United States, requires that
management make critical decisions regarding accounting policies and judgments
concerning their application. Materially different amounts could be reported
under different circumstances and conditions.
Capitalized Software Development Costs
- --------------------------------------
In connection with certain contracts entered into between SmartServ and its
customers, as well as other development projects, the Company capitalizes costs
related to certain product enhancements and application development.
Specifically, all software development costs are charged to expense as incurred
until technological feasibility has been established for the product.
Thereafter, additional costs incurred for development are capitalized.
Capitalization ceases when the product is available for general release to
customers. The Company has entered into several contracts with wireless
telecommunications carriers which will need to generate revenues for the Company
to support the carrying amount of capitalized software development costs.
Amortization of software development costs is provided on a product-by-product
basis over the economic life, not to exceed three years, of the product using
the straight-line method. Amortization of capitalized software development costs
commences with the products' general release to customers. The determination of
estimated useful economic lives and whether or not these assets are impaired
involves significant judgments. Changes in strategy and/or market conditions
could significantly impact these judgments and require adjustments to recorded
asset balances.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
- ----------------------------------------------
Forward-looking statements in this document and those made from time-to-time by
our employees are made under the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements concerning
future plans or results are necessarily only estimates and actual results could
differ materially from expectations. Certain factors that could cause or
contribute to such differences include, and are not limited to, potential
fluctuations in quarterly results, the size and timing of awards and performance
on contracts, dependence on large contracts and a limited number of customers,
dependence on wireless and/or internet networks of third-parties for certain
products and services, lengthy sales and implementation cycles, availability and
cost of key components, market acceptance of new or enhanced products and
services, proprietary technology and changing technology, competitive
conditions, system
23
performance, management of growth, the risk that our current and future products
and services may contain errors or be affected by technical problems that would
be difficult and costly to detect and correct, dependence on key personnel and
general economic and political conditions and other factors affecting spending
by customers, and other risks described in this Quarterly Report on Form 10-QSB
and our other filings with the Securities and Exchange Commission.
Item 3. Controls and Procedures
(a) Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with the participation of
our Chief Executive Officer and our Chief Financial Officer of the effectiveness
of the design and operation of our disclosure controls and procedures, as
defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended.
Based upon the evaluation, the Chief Executive Officer and the Chief Financial
Officer have concluded that these disclosure controls and procedures are
effective.
(b) There have been no significant changes in our internal controls or in
other factors that could significantly affect the internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
24
PART 2. OTHER INFORMATION
SMARTSERV ONLINE, INC.
ITEM 1. LEGAL PROCEEDINGS
On or about June 4, 1999, Michael Fishman, our former Vice President of Sales,
commenced an action against us, Sebastian E. Cassetta (our Chairman of the Board
and Chief Executive Officer), Steven Francesco (our former President) and four
others in the Connecticut Superior Court for the Judicial District of
Stamford/Norwalk at Stamford alleging breach of his employment contract, breach
of duty of good faith and fair dealing, fraudulent misrepresentation, negligent
misrepresentation, intentional misrepresentation and failure to pay wages. The
defendants have answered the complaint and filed counterclaims for fraudulent
inducement and breach of contract. The fraud and misrepresentation claims have
been dismissed. The parties have filed motions for summary judgment that will be
subject to oral argument in December of 2002. Although we are vigorously
defending this action, there can be no assurance that we will be successful. The
unfavorable outcome of such action could have a material adverse effect on our
results of operations, financial condition and cash flows.
On or about February 29, 2000, Commonwealth Associates, L.P. ("Commonwealth")
filed a complaint against us in the Supreme Court of the State of New York,
County of New York. The complaint alleges that on or about August 19, 1999,
Commonwealth and SmartServ entered into an engagement letter pursuant to which
Commonwealth was to provide financial advisory and investment banking services
to SmartServ in connection with a possible combination between SmartServ and
Data Link Systems Corporation. The engagement letter provided for a
nonrefundable fee of $15,000 payable in cash or common stock at SmartServ's
option. The complaint alleges that SmartServ elected to pay the fee in stock and
seeks 13,333 shares of common stock or at least $1,770,000 together with
interest and costs. We have denied the material allegations of the complaint,
including the allegation that we elected to pay in stock. A trial was held in
New York Supreme Court on November 7 and 8, 2002. The parties have until
December 16, 2002 to file post-trial pleadings and a decision is expected soon
thereafter. Although we are vigorously defending this action, there can be no
assurance that we will be successful. The unfavorable outcome of such action
could have a material adverse effect on our results of operations, financial
condition and cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In March 2002, 39 Prepaid Warrants were converted into an aggregate of 27,857
shares of common stock. No sales commissions were paid in connection with such
conversion. The shares were issued in reliance upon the exemption from
registration provided by Section 3 (a) (9) of the Securities Act.
In April 2002, SmartServ issued a warrant to purchase an aggregate of 5,000
shares of common stock to Pertti Johansson as partial consideration for
consulting services to be provided to SmartServ. The warrant is exercisable at
an exercise price of $5.38 per share, vests equally on the first and second
anniversaries of issuance, and expires on April 29, 2005. No sales commissions
were paid in connection with such transaction. This warrant was issued in
reliance upon the exemption from registration provided by Section 4 (2) of the
Securities Act.
25
In April 2002, SmartServ issued a warrant to purchase an aggregate of 10,000
shares of common stock to Jeffrey Braile as partial consideration for consulting
services to be provided to SmartServ. The warrant is exercisable at an exercise
price of $5.01 per share and expires on April 29, 2005. No sales commissions
were paid in connection with such transaction. This warrant was issued in
reliance upon the exemption from registration provided by Section 4 (2) of the
Securities Act.
In May 2002, SmartServ issued a warrant to purchase an aggregate of 2,000 shares
of common stock to Pertti Johansson as partial consideration for consulting
services to be provided to SmartServ as a member of its Advisory Board. The
warrant is exercisable at an exercise price of $5.01 per share and expires on
April 29, 2005. No sales commissions were paid in connection with such
transaction. This warrant was issued in reliance upon the exemption from
registration provided by Section 4 (2) of the Securities Act.
In June 2002, SmartServ issued 785,714 shares of common stock to two accredited
investors at a purchase price of $1.40 per share. Gross proceeds from the
issuance of these shares were $1,100,000. Additionally, the Company issued the
investors warrants, callable under certain conditions, for the purchase of an
aggregate of 1,428,571 shares of common stock at an exercise price of $1.40 per
share through the expiration date on June 5, 2007, as well as non-callable
warrants for the purchase of an aggregate of 196,429 shares of common stock,
subject to antidilution adjustments upon the occurrence of certain events, at an
exercise price of $1.47 per share through June 5, 2007. In August 2002, pursuant
to the terms of the callable warrants, the Company provided the June Investors
with a notice, calling such warrants. In September 2002 the callable warrants
expired unexercised. First Albany Securities Corporation, the placement agent,
received a commission of $66,000 and reimbursement of direct expenses of $2,000
in connection with this transaction. The shares and the warrants were issued in
reliance upon the exemption from registration provided by Section 4 (2) of the
Securities Act.
In September 2002, SmartServ issued 169,853 shares of common stock upon the
exercise, by an investor in the June 2002 financing, of warrants to purchase
such shares at an exercise price, after antidilution adjustments, of $0.85 per
share. Proceeds from the issuance were $144,375. These shares were issued in
reliance upon the exemption from registration provided by Section 4 (2) of the
Securities Act.
In September 2002, SmartServ issued units consisting of 3,884,209 shares of its
common stock and warrants to purchase 1,942,109 shares of common stock
exercisable at $0.85 per share through September 8, 2007 to 22 accredited
investors at a purchase price of $0.9125 per unit. Gross proceeds from this
transaction amounted to $3,544,346. Steven B. Rosner, a consultant to the
Company, received a finder's fee of $192,500, representing 7% of the aggregate
purchase price of the shares purchased by investors introduced to the Company by
Mr. Rosner, an unaccountable expense allowance of $25,000 in connection with
such transaction and warrants to purchase 301,370 shares of our common stock at
an exercise price of $0.85 per share. America First Associates Corp. received a
finder's fee of $7,550, representing 8% of the aggregate purchase price of the
shares purchased in the offering by investors introduced to the Company by
America First Associates Corp. and warrants to purchase 5,170 shares of our
common stock at an exercise price of $0.85 per share. Alpine Capital Partners,
Inc. received a finder's fee of $49,000, representing 7% of the aggregate
purchase price of the shares purchased in the offering by investors introduced
to the Company by Alpine Capital Partners, Inc. and warrants to purchase 131,507
shares of our common stock at an exercise price of $0.85 per share. These shares
and warrants were issued in reliance upon the exemption from registration
provided by Section 4 (2) of the Securities Act.
26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
(b) REPORTS ON FORM 8-K
On September 10, 2002, the Company filed a report on Form 8-K under
Item 5 thereof referencing a press release, dated September 10, 2002,
announcing the completion of a $3.5 million equity financing from a
group of accredited investors, the restructuring of the $7 million
obligation to Hewlett-Packard Company, as well as the closing of its
sales offices in Hong Kong and the United Kingdom in an effort to
focus its resources on meeting the growing demand for its products and
services throughout North America.
27
SMARTSERV ONLINE, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SmartServ Online, Inc.
(Registrant)
By:
Date: November 18 , 2002 /s/ SEBASTIAN E. CASSETTA
------------------ -----------------------------------------------
Sebastian E. Cassetta
Chairman of the Board & Chief Executive Officer
Date: November 18, 2002 /s/ THOMAS W. HALLER
----------------- -----------------------------------------------
Thomas W. Haller
Sr. Vice President, Chief Financial Officer &
Treasurer
28
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Sebastian E. Cassetta, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of SmartServ Online,
Inc. ("Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. Evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to filing date of
this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent functions);
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ SEBASTIAN E. CASSETTA
------------------------------------
Sebastian E. Cassetta
Chief Executive Officer
Dated: November 18, 2002
29
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Thomas Haller, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of SmartServ Online,
Inc. ("Registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Registrant as of, and for, the periods presented in this
quarterly report;
4. The Registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a. Designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. Evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to filing date of
this quarterly report (the "Evaluation Date"); and
c. Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit
committee of Registrant's board of directors (or persons performing the
equivalent functions);
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to
record, process, summarize and report financial data and have
identified for the Registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the Registrant's internal
controls; and
6. The Registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ THOMAS W. HALLER
------------------------------------
Thomas W. Haller
Senior Vice President and
Chief Financial Officer
Dated: November 18, 2002
30
Exhibit Index
Exhibit No. Description
- ----------- -----------
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002