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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, 2003
COMMISSION FILE NUMBER 0-28008
SMARTSERV ONLINE, INC.
- --------------------------------------------------------------------------------
(EXACT NAME OF SMALL BUSINESS ISSUER AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-3750708
- --------------------------------------------------------------------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
2250 BUTLER PIKE, SUITE 150, PLYMOUTH MEETING, PENNSYLVANIA 19462
- --------------------------------------------------------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(610) 397-0689
- --------------------------------------------------------------------------------
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
METRO CENTER, ONE STATION PLACE, STAMFORD, CONNECTICUT 06902
- --------------------------------------------------------------------------------
(FORMER ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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
--- ---
THE NUMBER OF SHARES OF COMMON STOCK, $.01 PAR VALUE, OUTSTANDING AS OF DECEMBER
1, 2003 WAS 2,344,635.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE):
YES NO X
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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, 2003 (unaudited) and December 31, 2002..................2
Consolidated Statements of Operations - three months ended September 30, 2003
and 2002 and nine months ended September 30, 2003 and 2002 (unaudited)..............................4
Consolidated Statement of Changes in Stockholders' Equity (Deficiency) - nine months
ended September 30, 2003 (unaudited)................................................................6
Consolidated Statements of Cash Flows - three months ended September 30, 2003
and 2002 and nine months ended September 30, 2003 and 2002 (unaudited)..............................7
Notes to Unaudited Consolidated Financial Statements................................................8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................................................24
Item 3. Controls and Procedures............................................................................35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................................36
Item 2. Changes in Securities and Use of Proceeds..........................................................36
Item 6. Exhibits and Reports on Form 8-K...................................................................40
Signatures.........................................................................................41
1
SMARTSERV ONLINE, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
---------- ----------
(UNAUDITED)
ASSETS
Current assets
Cash $ 276,363 $ 154,759
Accounts receivable 95,658 55,907
Accrued interest receivable 47,004 50,658
Prepaid compensation 382,876 117,500
Prepaid expenses 131,855 164,258
Deferred financing costs 662,868 --
---------- ----------
Total current assets 1,596,624 543,082
---------- ----------
Property and equipment, net -- 1,573,978
Other assets
Capitalized software development costs, net of
accumulated amortization of $1,097,148 at
September 30, 2003 and $208,681 at December 31, 2002 -- 888,467
Deposits 125,357 238,690
Notes receivable from a former officer, net of an
allowance for uncollectibility of $664,640 -- --
Prepaid compensation 19,583 107,708
---------- ----------
144,940 1,234,865
---------- ----------
Total Assets $1,741,564 $3,351,925
========== ==========
2
SMARTSERV ONLINE, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------ ------------
(UNAUDITED)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIENCY)
Current liabilities
Accounts payable $ 1,849,254 $ 1,307,342
Accrued liabilities 1,245,084 476,346
Accrued salaries 334,501 295,437
Notes payable 2,208,252 500,000
------------ ------------
Total current liabilities 5,637,091 2,579,125
------------ ------------
Deferred revenues 49,466 193,294
Deferred lease costs -- 242,300
Accounts payable - noncurrent -- 163,907
COMMITMENTS AND CONTINGENCIES - NOTE 9
STOCKHOLDERS' EQUITY (DEFICIENCY)
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 - 2,261,300 shares at September 30, 2003 and
1,906,040 shares at December 31, 2002 22,613 19,060
Additional paid-in capital 83,512,852 73,623,241
Notes receivable from former officers, net of an allowance for
uncollectibility of $354,471 at September 30, 2003 and $-0- at
December 31, 2002 (255,525) (609,996)
Accumulated deficit (87,224,933) (72,859,006)
------------ ------------
Total stockholders' equity (deficiency) (3,944,993) 173,299
------------ ------------
Total Liabilities and Stockholders' Equity (Deficiency) $ 1,741,564 $ 3,351,925
============ ============
See accompanying notes.
3
SMARTSERV ONLINE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
------------------------------- -------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenues $ 145,130 $ 81,847 $ 614,145 $ 146,483
------------ ------------ ------------ ------------
Costs and expenses:
Costs of services (289,055) (1,386,390) (4,080,429) (4,338,016)
Sales and marketing expenses (23,543) (454,364) (403,573) (2,698,013)
General and administrative expenses (715,353) (1,087,962) (3,075,446) (3,328,102)
Stock-based compensation (229,124) (30,290) (331,068) 122,831
------------ ------------ ------------ ------------
Total costs and expenses (1,257,075) (2,959,006) (7,890,516) (10,241,300)
------------ ------------ ------------ ------------
Loss from operations (1,111,945) (2,877,159) (7,276,371) (10,094,817)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 2,709 74,785 11,601 106,284
Interest expense and other financing costs (6,531,633) (138,439) (7,781,029) (508,184)
Gain from extinguishment of debt -- 5,679,261 305,822 5,679,261
Insurance recovery -- -- 374,000 --
Foreign exchange gains (losses) -- (521) 50 (15,977)
------------ ------------ ------------ ------------
(6,528,924) 5,615,086 (7,089,556) 5,261,384
------------ ------------ ------------ ------------
Net earnings (loss) $ (7,640,869) $ 2,737,927 $(14,365,927) $ (4,833,433)
============ ============ ============ ============
Basic earnings (loss) per share $ (3.69) $ 2.04 $ (7.15) $ (4.18)
============ ============ ============ ============
Diluted earnings (loss) per share $ (3.69) $ 1.83 $ (7.15) $ (4.18)
============ ============ ============ ============
Weighted average shares outstanding - basic 2,072,440 1,339,053 2,010,142 1,157,260
============ ============ ============ ============
Weighted average shares outstanding - diluted 2,072,440 1,494,302 2,010,142 1,157,260
============ ============ ============ ============
The following table illustrates the amount of stock-based compensation charges
that would have been
4
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
------------------------- -------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Costs of services $ (74,750) $ (7,895) $ (74,353) $ 187,413
Sales and marketing expenses -- (3,863) -- (33,525)
General and administrative expenses (154,374) (18,532) (256,715) (31,057)
--------- --------- --------- ---------
$(229,124) $ (30,290) $(331,068) $ 122,831
========= ========= ========= =========
See accompanying notes.
5
SMARTSERV ONLINE, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIENCY)
NINE MONTHS ENDED SEPTEMBER 30, 2003
(UNAUDITED)
NOTES
COMMON STOCK RECEIVABLE ADDITIONAL
PAR FROM FORMER PAID-IN ACCUMULATED
SHARES VALUE OFFICERS CAPITAL DEFICIT
------------ ------------ ------------ ------------ ------------
Balances at December 31, 2002 1,906,040 $ 19,060 $ (609,996) $ 73,623,241 $(72,859,006)
Issuance of common stock upon
exercise of employee stock
options 958 10 -- 9,649 --
Issuance of common stock upon
exercise of warrants 73,731 737 -- 375,290 --
Issuance of common stock to
vendors to satisfy debt 20,590 206 -- 163,701 --
Change in market value of
employee stock options -- -- -- (1,323) --
Issuance of common stock as
compensation for services 166,666 1,667 -- 862,330 --
Issuance of common stock
related to debt financing 93,315 933 -- 436,866 --
Issuance of warrants as
compensation for services -- -- -- 154,500 --
Allowance for uncollectibility
of loans to officers -- -- 354,471 -- --
Issuance of warrants related
to debt financing -- -- -- 6,406,572 --
Beneficial conversion features
of notes -- -- -- 1,482,026 --
Net loss for the period -- -- -- -- (14,365,927)
------------ ------------ ------------ ------------ ------------
Balances at September 30, 2003 2,261,300 $ 22,613 $ (255,525) $ 83,512,852 $(87,224,933)
============ ============ ============ ============ ============
See accompanying notes.
6
SMARTSERV ONLINE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
------------------------------- -------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
OPERATING ACTIVITIES
Net income (loss) $ (7,640,869) $ 2,737,927 $(14,365,927) $ (4,833,433)
Adjustments to reconcile net income (loss) to
net cash used for operating activities:
Gain from extinguishment of debt -- (5,679,261) (305,822) (5,679,261)
Depreciation and amortization -- 507,765 2,462,445 1,474,654
Noncash compensation costs 229,124 30,290 331,068 (122,831)
Amortization of deferred financing costs 6,297,577 -- 7,391,278 --
Deferred interest on officer's loan -- (52,467) -- (52,467)
Amortization of deferred revenues (57,567) (15,883) (391,828) (21,177)
Provision for (recovery of) losses on loans
to former officers (44,551) -- 354,471 --
Changes in operating assets and liabilities
Accounts receivable (29,984) 24,920 (39,751) (101,137)
Accrued interest receivable (2,453) (6,706) 3,654 (6,706)
Prepaid expenses 54,982 85,207 32,403 302,531
Accounts payable and accrued liabilities 431,757 403,898 1,138,236 481,555
Deferred revenues 30,000 5,949 248,000 180,000
Security deposit 75,374 247,880 113,333 231,585
------------ ------------ ------------ ------------
Net cash used for operating activities (656,610) (1,710,481) (3,028,440) (8,146,687)
------------ ------------ ------------ ------------
INVESTING ACTIVITIES
Purchase of equipment -- (1,170) -- (169,660)
Capitalization of software development costs -- (45,660) -- (185,895)
------------ ------------ ------------ ------------
Net cash used for investing activities -- (46,830) -- (355,555)
------------ ------------ ------------ ------------
FINANCING ACTIVITIES
Net proceeds from the issuance of notes 522,000 -- 3,059,500 --
Proceeds from the issuance of common stock -- 3,688,787 385,544 4,802,990
Repayment of notes receivable from officers -- 56,845 -- 56,845
Repayment of note payable -- (500,000) (295,000) (500,000)
Costs of issuing common stock -- (319,348) -- (579,348)
------------ ------------ ------------ ------------
Net cash provided by financing activities 522,000 2,926,284 3,150,044 3,780,487
------------ ------------ ------------ ------------
Increase (decrease) in cash (134,610) 1,168,973 121,604 (4,721,755)
Cash - beginning of period 410,973 641,595 154,759 6,532,323
------------ ------------ ------------ ------------
Cash - end of period $ 276,363 $ 1,810,568 $ 276,363 $ 1,810,568
============ ============ ============ ============
See accompanying notes.
7
SMARTSERV ONLINE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
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. The
Company offers application development and hosting services that allow wireless
carriers, content providers and commercial enterprises to deliver content to
their work forces and customers via wireless devices, with special emphasis on
cellular phones. SmartServ's products can deliver proprietary information, as
well as delayed and real-time financial market data, business and financial
news, national and local weather reports and other premium business and
entertainment information in a user-friendly manner.
The Company's mobile data solutions are designed to generate additional revenue,
increase operating efficiency, and extend brand awareness for wireless carriers,
enterprises and content providers and are delivered via J2ME, BREW, WAP and SMS
enabled cellular phones, as well as RIM Blackberry and Pocket PC devices.
SmartServ has previously established customer and distribution relationships
with strategic partners and wireless carriers, including Verizon Wireless, AT&T
Wireless, Nextel, ALLTEL Wireless, U.S. Cellular, QUALCOMM and Motorola, as well
as content providers, including BusinessWeek Online, S&P Comstock and The Wall
Street Journal Online (Dow Jones).
The economic downturn in general, and its impact on the telecommunications
industry in particular, have 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. In addition, many commercial enterprises 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. During 2003, the Company has continued to reduce its cost
structure through the termination of additional personnel and the relocation of
its headquarters to Plymouth Meeting, Pennsylvania. Personnel headcount has been
reduced from 66 in May 2002 to the current level of 9. These efforts have
reduced the Company's average monthly operating expenses from approximately
$1,090,000 in July 2002 to approximately $230,000 commencing September 2003,
excluding noncash stock compensation and depreciation and amortization. The
Company anticipates that it will require working capital for its proposed
acquisitions as discussed below, as well as to meet certain debt service
requirements. As a result of the factors identified above, the Company is in
need of additional capital to enable it to continue as a going concern. The
following table provides an analysis of the Company's capital requirements for
the 12 month period ending September 30, 2004 based on projected
8
revenues of $550,000:
% OF
REVENUE GOAL CAPITAL
REQUIRED
------------- -----------------------
100 $ 5,400,000
0 $ 5,900,000
No assurance can be given that the Company will be able meet its revenue
projections, maintain its cost structure as presently configured, or 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.
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, earned limited revenues and incurred substantial recurring operating
losses, including net losses of $14,365,927 for the nine month period ended
September 30, 2003, net losses of $8,037,173 and $14,819,860 for the years ended
December 31, 2002 and 2001, respectively, 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 $87,224,933 at September 30, 2003
and has debt service requirements of $1,375,000 ($4,465,000 should the Company
be unable to complete an equity offering of at least $3 million prior to
February 19, 2004) during the twelve month period ending September 30, 2004.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. 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.
Management believes that the evolution of the cellular industry is at an
important turning point, where both consumers and businesses are expecting more
functionality and features from both their cell phones and their cellular
carriers. This expectation is being driven by a number of industry trends
including highly competitive pricing packages, newer and more functional cell
phones and mobile devices, and the customers' ability to take their cell phone
number with them to a new carrier that offers them more value than the
incumbent. Competition in this environment is moving from differentiation based
on network coverage or minute rates to one based on enhanced features and
services. Management believes that as carriers' network coverage, quality of
service, and pricing plans become more-or-less equal, cell phone customers will
choose a carrier based principally on the suite of premium content and
applications that are included with its service. This environment will provide
an opportunity for SmartServ to exploit its current and planned content assets
and delivery capabilities, developed over the past nine years.
The Company's plan of operation to monetize its content assets and eliminate the
uncertainty surrounding its ability to continue as a going concern focuses on:
(1) growing the licensing of its applications and related services
to wireless carriers and enterprise firms, and
(2) the bundling of its existing and planned future premium
content with the reselling of voice services to specific
targeted affinity groups.
The Company's strategy provides access to a large number of potential
subscribers and allows SmartServ to leverage its market reach at minimal
operating costs.
9
Management believes that SmartServ has a unique combination of content assets,
including those currently owned or licensed and those that it plans to acquire,
that may allow it to take a leadership position in the market for bundled
pre-paid voice and premium content and, later, a substantial position in the
much larger market for the reselling of post-paid cell phone service. Thus, by
providing a set of products that bundle cell phone airtime with affinity-related
content delivered through its current technology infrastructure, the Company
plans to enter the emerging market for reselling wireless airtime. The Company's
existing technology and content assets not only facilitate its entry into this
new market, but may also present a barrier to entry to other organizations that
wish to compete with similar offerings in the marketplace.
SmartServ is building, through acquisition and through internal development, a
wide array of premium content that will continue to be offered through
traditional carrier-based distribution channels, as well as through bundled
offerings with pre-paid voice minutes. The premium content offered or to be
offered through the SmartServ platforms consists of:
o Dynamic mobile applications, where the information or data
content is frequently changing and, therefore, frequently
delivered to the mobile device,
o Static content, such as ring tones, graphics and games, that
are periodically delivered and reside on the mobile device,
and
o Mobile e-mail access applications and services.
To augment its capabilities, SmartServ recently signed Letters of Intent and is
negotiating definitive purchase agreements for the acquisition of two companies,
nReach, Inc. and Mobile Airwaves, Inc., whose content and content-enablement
software, respectively, will form, if acquired, key components of its bundled
product offering. nReach, Inc. is a wireless content distribution company that
sells a broad portfolio of popular mass-market cell phone content, including
ringtones, games, and on-device graphics both direct to consumer and through
wireless carriers. nReach provides direct access to a large consumer base
through existing marketing relationships with large retailers, including Best
Buy and Radio Shack.
Mobile Airwaves, Inc., operating under the brand name "Aqivo," provides a
server-based software platform that enables the delivery of e-mail over wireless
networks to practically any data-enabled cell phone. The principal target market
for Aqivo has been and will continue to be enterprises; however, it is believed
that Aqivo's e-mail enabling software will also have broad appeal, as one
component of the Company's "bundled" products, for individual cell phone users
who want to access their existing e-mail accounts from their wireless devices.
For wireless carriers, SmartServ continues to deliver data and branded content
that can increase wireless data revenue and customer retention. For enterprise
customers, SmartServ offers solutions that can increase productivity and
customer retention through the mobile delivery of proprietary data, as well as
market data and other premium content. SmartServ has the ability to customize
the information package to be offered to each customer by device.
As an example, SmartServ has launched several products on the Verizon Wireless
network. Our financial content products have been launched on Verizon's BREW
(Binary Runtime Environment for Wireless) network under the Wall Street Journal
Online brand name, while our SMS (Short Message Service) financial alert product
has been launched on Verizon's V-text portal. Additionally, SmartServ has
launched its Lottery, AreaWeather and AstroCom Horoscope lifestyle products on
Verizon's BREW network. 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 an integrated financial tool.
10
In December of this year, the Company plans to begin a retail store trial sale
of the SmartServ Toro Card Pack designed for Hispanic persons who have prepaid
cell phone service. This product bundles a prepaid airtime card for use with
most carriers and a Toro Card that entitles the purchaser, at no extra charge,
to receive three new Spanish-music ring tones, and horoscope and lottery
information in Spanish. Following this trial and anticipated broad commercial
launch of our Toro product, we expect to expand the concept into a wide variety
of similarly highly targeted affinity markets - each bundling airtime with an
offering of premium content specifically chosen for that market segment.
While management believes that its new marketing strategies, as well as its
carrier and enterprise relationships are important to SmartServ's success, no
assurance can be given that it will be able to implement its new marketing
strategies or that its carrier and enterprise relationships will be successful
in their marketing efforts or that SmartServ's products and services will be
well received in the marketplace.
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 S-B 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, 2002 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, 2002. 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 and nine months
ended September 30, 2003 are not necessarily indicative of those expected for
the year ending December 31, 2003.
The Company's stockholders approved a one-for-six reverse stock split at a
Special Meeting on November 5, 2003. Such reverse stock split became effective
on November 25, 2003. All applicable financial statement amounts and related
disclosures have been restated to give effect to this transaction.
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 the financial statements and
accompanying notes. Actual results could differ from those estimates.
REVENUE RECOGNITION
- -------------------
The Company recognizes 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
11
Certain Transactions", and the SEC Staff Accounting 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. Revenues from
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, as has been the situation to date, 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 their 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, if any, from professional
services contracts 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
- -----------------
Deferred revenues, resulting from customer prepayments, are recognized as
services are provided throughout the term of the agreement with the respective
customer.
DEFERRED FINANCING COSTS
- ------------------------
Deferred financing costs represent those costs incurred in connection with the
issuance of the Company's convertible notes. These costs are recorded at the
fair value of the consideration (cash or securities) paid to the finders in such
transactions and are amortized to operations as other financing costs over the
terms of the respective notes.
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, the Company has 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" ("SFAS No. 86"). Specifically, all
software development costs are charged to expense as incurred until
technological feasibility has been established
12
for the product. Thereafter, additional costs incurred for development are
capitalized. The Company ceased capitalizing such costs in connection with its
current product offering during the quarter ended September 2002 when the
products became available for general release to customers. Amortization of
capitalized software development costs commences with the products' general
release to customers and is provided on a product-by-product basis over the
economic life, not to exceed three years, using the greater of the straight-line
or a flow of revenue method.
On an ongoing basis, the Company reviews the future recoverability of its
capitalized software development costs for impairment whenever events or changes
in circumstances indicate that the carrying amounts may not be recoverable. When
such events or changes in circumstances do occur, an impairment loss is
recognized if the undiscounted future cash flows expected to be generated by the
asset are less than its carrying value. As a result of less than anticipated
demand for the Company's products and services, as well as its inability to
leverage certain relationships during the quarter ended June 30, 2003, the
Company recorded in accordance with SFAS No. 86, an impairment loss of $704,705
in such quarter to reduce the recorded value of the assets to their estimated
net realizable 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
- ---------------------------
The Company considers all highly liquid investments with a maturity date of
three months or less when purchased to be cash equivalents.
During the nine months ended September 30, 2003, the Company issued 20,590
shares of common stock to 5 vendors in settlement of the Company's obligations,
aggregating $164,000, to such vendors. These transactions are considered
non-cash transactions for the purposes of the Statement of Cash Flows.
Interest, debt origination and other financing costs paid during the three month
periods ended September 30, 2003 and 2002 were $-0- and $138,439, respectively,
and for the nine month periods ended September 30, 2003 and 2002 were $-0- and
$508,184, respectively.
CONCENTRATION OF CREDIT RISK
- ----------------------------
Financial instruments that potentially subject SmartServ to concentrations of
credit risk consist solely of accounts receivable. At September 30, 2003 and
December 31, 2002, accounts receivable consisted principally of amounts due from
major telecommunications carriers, as well as a financial services company. The
Company performs periodic credit evaluations of its customers and, if
applicable, provides for credit losses in the financial statements.
PROPERTY AND EQUIPMENT
- ----------------------
Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation is computed using the straight-line method over estimated useful
lives of three to ten years.
On an ongoing basis, the Company reviews the future recoverability of its
property and equipment for impairment whenever events or changes in
circumstances indicate that the carrying amounts may not be recoverable. When
such events or changes in circumstances do occur, an impairment loss is
recognized if the undiscounted future cash flows expected to be generated by the
asset are less than its carrying value. As a result of less than anticipated
demand for the Company's products and services, as well as its inability to
leverage certain relationships during the quarter ended June 30, 2003, the
Company recorded an impairment loss of $843,768 in such quarter to reduce the
recorded value of its assets to their estimated net realizable value.
13
ADVERTISING COSTS
- -----------------
Advertising costs are expensed as incurred and were approximately $6,000 and
$264,900 during the nine month periods ended September 30, 2003 and 2002,
respectively.
STOCK BASED COMPENSATION
- ------------------------
Employee Stock Option Plans
- ---------------------------
The Company maintains several stock option plans for employees and directors
that provide for the granting of stock options for a fixed number of common
shares with an exercise price equal to the fair value of the shares at the date
of grant. The Company accounts for such grants 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, which requires the Company to record
compensation expense for changes in the fair value of its common stock.
Non-Employee Compensation
- -------------------------
The Company has issued warrants to purchase common stock to non-employee
consultants as compensation for services rendered or to be rendered to the
Company. The warrants are recorded in accordance with the provisions of SFAS No.
123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), and are valued
in accordance with the Black-Scholes pricing methodology.
The Company adopted the disclosure provisions of SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure", which amends SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation, which was originally provided under SFAS No. 123. SFAS No. 148
also improves the timeliness of disclosures by requiring the information to be
included in interim, as well as annual, financial statements.
SFAS No. 123 requires companies to recognize compensation expense based on the
respective fair values of the options at the date of grant. Companies that
choose not to adopt such rules will continue to apply the existing accounting
rules contained in APB, No. 25, but are required to disclose the pro forma
effects on net loss and loss per share, as if the fair value based method of
accounting had been applied.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. As such, the pro forma
net loss and loss per share are not indicative of future years.
14
SmartServ's pro forma information is as follows:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
------------------------------------- -----------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- -------------
Net income (loss) as reported $ (7,640,869) $ 2,737,927 $ (14,365,927) $ (4,833,433)
Employee stock-based compensation
(charges) credits included in net loss -- (22,519) 1,323 701,420
Employee stock-based compensation
charges pursuant to SFAS 123 (173,324) (1,136,000) (1,761,477) (3,142,212)
---------------- --------------- ---------------- -------------
Pro forma net earnings (loss) $ (7,814,193) $ 1,579,408 $ (16,126,081) $ (7,274,225)
================ =============== ================ =============
Basic earnings (loss) per share $ (3.69) $ 2.04 $ (7.15) $ (4.18)
================ =============== ================ =============
Diluted earnings (loss) per share $ (3.69) $ 1.83 $ (7.15) $ (4.18)
================ =============== ================ =============
Proforma basic earnings (loss) per share $ (3.77) $ 1.18 $ (8.02) $ (6.29)
================ =============== ================ =============
Pro forma diluted earnings (loss) per share $ (3.77) 1.06 $ (8.02) $ (6.29)
================ =============== ================ =============
FOREIGN CURRENCY TRANSLATION
- ----------------------------
The financial statements of the Company's foreign subsidiaries whose functional
currencies are other than the U.S. dollar, have been translated into U.S.
dollars in accordance with SFAS 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.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections". The Company adopted SFAS No. 145
in 2002. Accordingly, the Company's gain on extinguishment of debt has been
recorded in "Other income" in the consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with an Exit or Disposal Activity". SFAS No. 146 revised the accounting for exit
and disposal activities under Emerging Issues Task Force 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. SFAS No. 146 is effective prospectively for exit or disposal
activities initiated after December 31, 2002. The Company adopted SFAS No. 146
on January 1, 2003, as required, and 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.
15
In 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("Interpretation No. 45"). Interpretation No. 45
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. It also clarifies that a guarantor is required to recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. Interpretation No. 45 does not prescribe a
specific approach for subsequently measuring the guarantor's recognized
liability over the term of the related guarantee. Interpretation No. 45 also
incorporates, without change, the guidance in FASB Interpretation No. 34,
"Disclosure of Indirect Guarantees of Indebtedness of Others", which is being
superseded. Interpretation No. 45 has no effect on the Company.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
(ARB) No. 51, Consolidated Financial Statements" ("Interpretation No. 46").
Interpretation No. 46 significantly alters the consolidation requirements
governing an entity's inclusion in the consolidated financial statements of its
sponsors, transferors, or investors. Interpretation No. 46 introduces a new
consolidation model--the variable interests model--which determines control (and
consolidation) based on potential variability in gains and losses of the entity
being evaluated for consolidation. Interpretation No. 46 provides guidance for
determining whether an entity lacks sufficient equity or its equity holders lack
adequate decision-making ability. These variable interest entities are covered
by the Interpretation No. 46 and are to be evaluated for consolidation based on
their variable interests. Interpretation No. 46 has no effect on the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for classifying and measuring as liabilities certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. SFAS No. 150 represents a
significant change in practice in the accounting for a number of financial
instruments, including mandatorily redeemable equity instruments and certain
equity derivatives that frequently are used in connection with share repurchase
programs. At this time SFAS No. 150 has no effect on the Company.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
----------- -----------
Data processing equipment $ 4,840,737 $ 4,842,941
Office furniture and equipment 151,263 151,263
Display equipment 71,335 71,335
Leasehold improvements -- 69,852
----------- -----------
5,063,335 5,135,391
Accumulated depreciation (5,063,335) (3,561,413)
----------- -----------
$ -- $ 1,573,978
=========== ===========
On an ongoing basis, the Company reviews the future recoverability of its
property and equipment for impairment whenever events or changes in
circumstances indicate that the carrying amounts may not be recoverable. When
such events or changes in circumstances do occur, an impairment loss is
recognized if the undiscounted future cash flows expected to be generated by the
asset are less than its carrying value. As a result of less than anticipated
demand for the Company's products and services, as well as its inability to
leverage certain relationships during the quarter ended June 30, 2003, the
Company recorded
16
an impairment loss of $843,768 in such quarter to reduce the recorded value of
its assets to their estimated net realizable value.
4. NOTES RECEIVABLE FROM OFFICERS
In December 2000, the Company's Board of Directors authorized the issuance of a
line of credit to Sebastian Cassetta, SmartServ's then 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 has been accrued and is payable
at maturity. Commencing July 1, 2002 until maturity, interest is payable
semi-annually in arrears on January 1st and July 1st. The financial statements
at September 30, 2003 contain a valuation allowance for a potential loss of
$552,467, relating to the collectibility of Mr. Cassetta's note and the interest
accrued thereon through June 30, 2002.
In January 2000, the Company issued to Mr. Cassetta 103,040 shares of restricted
common stock in exchange for Mr. Cassetta's note in the amount of $457,500. Such
note is secured by the common stock issued to Mr. Cassetta. During the year
ended December 31, 2002, the Company recorded a charge of $112,173 relating to
the potential uncollectibilty of interest earned by the Company pursuant to the
note between the Company and Mr. Cassetta. During the quarter ended June 30,
2003, the Company recorded a charge to earnings in the amount of $270,000,
representing the potential uncollectibility of the note as a result of the
diminution of the value of the Company's collateral.
Mr. Cassetta left the employ of the Company in August 2003. See Note 10 -
Subsequent Events for a description of the terms of Mr. Cassetta's Separation
Agreement.
In January 2000, the Company issued to Mario Rossi, SmartServ's then Executive
Vice President and Chief Technology Officer, 34,347 shares of restricted common
stock in exchange for Mr. Rossi's note in the amount of $152,500. Such note is
secured by the common stock issued to Mr. Rossi. During the quarter ended June
30, 2003, the Company recorded a charge to earnings in the amount of $129,000,
representing the potential uncollectibility of the note and interest accrued
thereon as a result of the diminution of the value of the Company's collateral.
During the quarter ended September 30, 2003, the Company recorded a partial
recovery aggregating $44,500 in connection with Mr. Rossi's note. Mr. Rossi left
the employ of the Company in August 2003. See Note 10 - Subsequent Events for a
description of the terms of Mr. Rossi's Separation Agreement.
5. NOTES PAYABLE
In May 2000, the Company 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 8,333 shares of common stock and (iv) repayment of $500,000 of the amended
obligation on September 10, 2002. The remaining $500,000 obligation was
evidenced by a note, bearing an interest rate of 11%, secured by the Company's
assets exclusive of its internally developed software products, and was
satisfied through a partial repayment in February 2003. The Company recorded a
gain of $305,822 resulting from the Company's partial repayment of the note in
February 2003.
17
In February 2003, the Company issued a convertible note to Global Capital
Funding Group, LP ("Global") in consideration for the receipt of $1 million. The
note bears interest at the rate of 10% per annum, and is secured by the
Company's assets, exclusive of its internally developed software products. The
note matures on February 14, 2004, contains certain antidilution provisions, and
may be converted into shares of SmartServ common stock at $6.60 per share. As
additional consideration, the Company issued Global a warrant for the purchase
of 33,333 shares of its common stock at an exercise price of $9.66 per share.
The note and the warrant have been recorded in accordance with APB No. 14,
"Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants".
The warrant has been valued in accordance with the Black-Scholes pricing
methodology and is netted against the outstanding obligation in the financial
statements. Such amount is being amortized into operations as interest expense
and other financing costs over the life of the obligation. Alpine Capital
Partners, Inc. ("Alpine") received a finder's fee of $70,000, representing 7% of
the aggregate purchase price of the convertible note and a warrant to purchase
15,167 shares of common stock exercisable at $9.66 per share, expiring on
February 14, 2005, in connection with this transaction. This warrant has been
valued in accordance with SFAS No. 123 and the Black-Scholes pricing methodology
and recorded in the financial statements as deferred financing costs. This
amount is being amortized into operations on a straight-line basis as interest
expense and other financing costs over the life of the obligation. Also in
connection with the 10% convertible notes, the Company has recorded a non-cash
charge for other financing costs of $406,400, representing a portion of the
intrinsic value of the beneficial conversion feature of the notes. Emerging
Issues Task Force ("EITF") Issue No. 98-5, "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios" ("Issue No. 98-5") as more fully described in EITF Issue No.
00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments",
defines the beneficial conversion feature as the non-detachable conversion
feature that is "in-the-money" at the date of issuance. Issue No. 98-5 requires
the recognition of the intrinsic value of the conversion feature as the
difference between the conversion price and the fair value of the common stock
into which the notes are convertible. In April 2003, the Company borrowed an
additional $250,000 from Global and amended the convertible note to include such
amount. As additional consideration, the Company issued Global a warrant for the
purchase of 3,333 shares of its common stock at an exercise price of $7.20 per
share. Alpine is to receive a finder's fee of $17,500 in connection with the
April amendment. The warrants issued to Global and Alpine contain certain
antidilution provisions and expire on February 14, 2006.
In May 2003, the Company, in consideration of $358,000, issued 3.58 units
consisting of convertible notes and warrants to purchase common stock ("May
Units") to 8 investors. Each May Unit consists of a $100,000 convertible note
and a warrant to purchase 33,333 shares of the Company's common stock. The
convertible notes bear interest at 8% per annum, are convertible into the
Company's common stock at $4.464 (the average of the closing bid prices of the
Company's common stock for the 5 days prior to the closing of the transaction)
per share and were to mature on the earlier of November 19, 2003 or the closing
of an equity placement of not less than $3 million. The warrants are exercisable
at $4.464 per share and expire on May 19, 2006. In June 2003, the Company in
consideration of $1,142,000 issued 11.42 units ("June Units") [each May or June
Unit referred to individually as a "Unit"] to 20 accredited investors. Each June
Unit also consists of a $100,000 convertible note and a warrant to purchase
33,333 shares of the Company's common stock. The convertible notes bear interest
at 8% per annum, are convertible into the Company's common stock at $4.764 (the
average of the closing bid prices of the Company's common stock for the 5 days
prior to the closing of the transaction) per share and were to mature on the
earlier of November 19, 2003 or the closing of an equity placement of not less
than $3 million. The warrants are exercisable at $4.764 per share and expire on
June 13, 2006. The Units have been recorded in accordance with APB No. 14. The
warrants have been valued in accordance with the Black-Scholes pricing
methodology and are netted against the outstanding obligation in the financial
statements. Such amount is being amortized into operations as interest expense
and other financing costs over the life of the obligation. Also in connection
with the 8% convertible notes, the
18
Company has recorded a non-cash charge for other financing costs of $81,400,
representing a portion of the intrinsic value of the beneficial conversion
feature of the notes. EITF Issue No. 98-5, as more fully described in EITF Issue
No. 00-27, defines the beneficial conversion feature as the non-detachable
conversion feature that is "in-the-money" at the date of issuance. Issue No.
98-5 requires the recognition of the intrinsic value of the conversion feature
as the difference between the conversion price and the fair value of the common
stock into which the notes are convertible. In November 2003, the Company, as an
inducement to extend the maturity date of the notes to February 19, 2004,
offered the note holders a warrant to purchase additional shares of common stock
in an amount equal to 25% of the number of shares into which the notes purchased
in the Unit are convertible. We have received written consents to extend the
maturity date from holders of $1,390,000 of the notes and expect to receive the
consents from the holders of the remaining $110,000 notes. If we do not receive
the additional consents, we may be in default of our obligation under the notes.
Spencer Trask Ventures, Inc. ("Spencer Trask"), Steven B. Rosner and Richard
Berland, acted as finders for the May and June 2003 transactions. As
consideration therefor, the finders received their proportionate share of a cash
fee of $150,000, or 10% of the aggregate purchase price of the Units sold and
(i) Unit Purchase Warrants to purchase an aggregate of three Units ("Unit
Purchase Warrant") and (ii) 33,333 shares of unregistered common stock per Unit
sold. Each Unit Purchase Warrant entitles the holder to purchase one Unit, for
the price of $100,000 per Unit through June 13, 2008. In addition, Spencer Trask
received a non-accountable expense allowance of $45,000, or 3% of the aggregate
proceeds of all Units sold in the May and June 2003 transactions. The warrants
have been valued in accordance SFAS No. 123 and the Black-Scholes pricing
methodology and recorded in the financial statements as deferred financing
costs. Such costs are being amortized into operations on a straight-line basis
as interest expense and other financing costs over the life of the obligation.
On September 16, 2003, SmartServ issued 7.4 Units in a financing transaction
consisting of an offering of up to 12 Units comprised of a $50,000 convertible
note and a warrant to purchase 16,667 shares of SmartServ's common stock. On
September 19, 2003, SmartServ issued the remaining 4.6 Units of the financing
transaction (collectively the "September Transaction"). The Units were sold to
18 investors for an aggregate of $600,000. Holders of the notes have the right
to convert the notes into shares of common stock at a price equal to $1.896 per
share for the notes issued on September 16, 2003 and $1.920 per share for the
notes issued on September 19, 2003. The maturity date of the notes was to be the
earlier of November 19, 2003 or the completion of an equity placement of at
least $3 million, at which time the notes will automatically convert into the
equity placement. Holders of the warrants have the right to exercise the
warrants into shares of common stock at a price equal to $1.500 per share.
Spencer Trask and Richard Berland acted as finders for the September
transaction. As consideration therefor, the finders received their proportionate
share of (i) a cash fee of $60,000, or 10% of the aggregate purchase price of
all of the Units; (ii) warrants to purchase a number of shares of common stock
equal to 20% of the shares of common stock underlying the securities in the
Units sold and (iii) 2,778 shares of unregistered common stock per Unit sold. In
addition, Spencer Trask received a non-accountable expense allowance of $18,000,
or 3% of the aggregate proceeds of all Units sold in the September Transaction.
All of the notes and the warrants have full ratchet anti-dilution protection. In
November 2003, the Company, as an inducement to extend the maturity date of the
notes to February 19, 2004, offered the note holders a warrant to purchase
additional shares of common stock in an amount equal to 25% of the warrants
purchased in the Unit. We have received written consents to extend the maturity
date from holders of $475,000 of the notes and expect to receive the consents
from the holders of the remaining $125,000 notes. If we do not receive the
additional consents, we may be in default of our obligation under the notes.
The September Transaction required the consent of Global, the holder of $1.25
million of SmartServ's convertible notes issued in February and April 2003, and
of the holders of 51% or more of SmartServ's $1.5 million convertible notes
issued in connection with the bridge financings in
19
May and June 2003. As an inducement to obtain their consent, such holders
received (a) a change in the conversion price of their convertible notes equal
to the lowest conversion price of the notes issued in the September financings
($1.896 per share) and (b) an increase in the number of shares purchasable
pursuant to the warrant to reflect a full ratchet dilution formula with a
decrease in the exercise price of the warrants to the exercise price of the
warrants issued in the September financing ($1.500). Such amendment, as it
pertains to the holders of convertible notes issued in the May and June 2003
bridge financings, was effective on November 25, 2003, coincident with the
effective date of a one-for-six reverse stock split. SmartServ recorded a charge
in the amount of $4,828,000 as "Other Financing Costs" for the fair value of the
consideration granted to these note holders for such consent.
At September 30, 2003, the face amount of the Company's debt obligations is
$3,350,000 and the unamortized discount amounted to $1,141,748.
6. EQUITY TRANSACTIONS
During the nine months ended September 30, 2003, the Company issued 73,731
shares of common stock to investors upon the exercise of warrants to purchase
such shares. Proceeds from the exercise of these warrants were $376,000.
In February 2003, the Company issued an aggregate of 20,590 shares of common
stock to 5 vendors in satisfaction of obligations for services rendered to the
Company aggregating $164,000.
In May 2003, the Company entered into a Corporate Finance Consulting Agreement
("Consulting Agreement") with Spencer Trask, whereby Spencer Trask agreed to
render services to the Company as its corporate finance consultant, financial
advisor and investment banker. As compensation for such services, the Company
has issued Spencer Trask 83,333 shares of its common stock. The value of such
compensation has been recorded in the financial statements as prepaid
compensation and is being amortized over the one year term of the Consulting
Agreement.
The Company's failure to timely file its Form 10-KSB for the year ended December
31, 2002 has affected the following registration rights held by some of its
stockholders and warrant holders. The Company is working to cure these
deficiencies:
Obligations to Maintain Effective Registration Statements:
- ----------------------------------------------------------
Vertical Ventures Investments, LLC holds a warrant to purchase up to 75,017
shares of common stock that have registration rights. The Registration Statement
covering the shares underlying this warrant is no longer effective. The Company
is required to pay a fee of $8,250 for the first month of the deficiency and a
fee of $16,500 for each month thereafter until the shares underlying the warrant
are registered.
Investors in the Company's September 2002 Equity Placement hold up to an
aggregate of 616,991 shares of common stock, and warrants to purchase up to an
aggregate of 249,954 shares of common stock, all with registration rights
requiring the Company to use its commercially reasonable best efforts to
maintain the effectiveness of the Registration Statement covering the shares of
common stock and the shares underlying the warrants.
Obligation to File a Registration Statement:
- --------------------------------------------
Global holds warrants to purchase up to 247,333 shares of common stock, and a
convertible note convertible into 833,333 shares of common stock. The Company
was required to file a Registration Statement covering all such shares on April
14, 2003. The Company has not yet filed the Registration Statement, and is
subject to a penalty fee equal to $25,000 for each month that this deficiency
remains uncured.
20
At September 30, 2003, the Company has recorded an aggregate of $213,000 for
penalties in connection with the aforementioned registration requirements. Such
amounts are included in accrued expenses on the Company's balance sheet.
7. STOCK-BASED COMPENSATION
In connection with the grant of certain stock options, warrants and other
compensation arrangements, the Company has 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 the Company to record
compensation expense for changes in the fair value of its common stock.
Stock-based compensation for the three and nine months ended September 30, 2003
and 2002 consisted 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 and the amortization of deferred costs associated with the issuance of
warrants to purchase common stock to various consultants.
8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30 ENDED SEPTEMBER 30
------------------------------ -------------------------------
2003 2002 2003 2002
------------- ----------- -------------- -----------
Numerator:
Net earnings (loss) $ (7,640,869) $ 2,737,927 $ (14,365,927) $(4,833,433)
============= =========== ============== ===========
Denominator
Denominator for basic earnings (loss)
per share - weighted average shares 2,072,440 1,339,053 2,010,142 1,157,260
Dilutive effect of warrants to
purchase common stock -- 148,502 -- --
Dilutive effect of employee stock
options and restricted shares -- 6,747 -- --
------------- ----------- -------------- -----------
Denominator for diluted earnings
(loss) per share 2,072,440 1,494,302 2,010,142 1,157,260
============= =========== ============== ===========
Basic earnings (loss) per common share
$ (3.69) $ 2.04 $ (7.15) $ (4.18)
============= =========== ============== ===========
Diluted earnings (loss) per common share
$ (3.69) $ 1.83 (7.15) $ (4.18)
============= =========== ============== ===========
Outstanding employee stock options and other warrants to purchase an aggregate
of 5,419,586 and 1,016,167 shares of common stock at September 30, 2003 and
2002, respectively, were not included in
21
the computations of diluted loss per share for the nine months then ended
because the Company reported losses for the periods, and therefore their
inclusion would be antidilutive. Similarly, an aggregate of 5,419,586 shares of
common stock at September 30, 2003 were not included in the computation of
diluted loss per share for the three months then ended because the Company
reported a loss for the period, and therefore their inclusion would be
antidilutive.
9. COMMITMENTS AND CONTINGENCIES
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 alleged that in August of 1999, Commonwealth
and SmartServ entered into an engagement letter that provided for a
nonrefundable fee to Commonwealth of $15,000 payable in cash or common stock at
SmartServ's option. The complaint alleged that SmartServ elected to pay the fee
in stock and, as a result, Commonwealth sought 13,333 shares of common stock or
at least $1,770,000 together with interest and costs. In our defense, we denied
that we elected to pay in stock. On March 4, 2003, SmartServ received a
favorable decision in this matter after a trial held in the Supreme Court of the
State of New York. The decision holds that, consistent with SmartServ's defense,
SmartServ is required to pay Commonwealth a retainer fee of only $13,439, plus
interest and certain costs. Commonwealth's time to appeal has not yet expired
because a notice to enter the judgment has not yet been filed. While the Company
intends to vigorously defend any appeal of the decision, the unfavorable outcome
of such an appeal could have a material adverse effect on the Company's
financial condition, results of operations and cash flows.
In August 2003, SmartServ entered into a Stipulation of Arbitration with
Brauning Inc., Mike Silva and Todd Peterson, former consultants to SmartServ
(collectively, the "Claimants") pursuant to which SmartServ and the Claimants
agreed to resolve, in a binding arbitration proceeding, the Claimants' demand
for damages resulting from an alleged breach of contract and a failure by
SmartServ to timely register the shares of common stock underlying certain
consulting warrants issued by SmartServ to the Claimants. Although SmartServ
believes that the shares underlying the warrants were timely registered, and
that the Claimants' demand is without merit, SmartServ has reached an agreement
in principle to settle this matter in order to avoid the uncertainties of
litigation. Under the terms of the contemplated settlement agreement, SmartServ
will issue to Claimants 60,000 shares of common stock and by no later than
February 29, 2004, pay Claimants $45,000 for certain wireless industry
consulting reports. SmartServ's failure to comply with these settlement terms
would entitle Claimants to reassert their claims. In such case, although we
would vigorously defend the action, there can be no assurance that we would be
successful.
SmartServ is currently in default of its premises lease on its former
headquarters in Stamford, Connecticut. The Company has an agreement in principle
pursuant to which SmartServ will agree to pay a settlement amount of $175,000,
as well as issue the former landlord a warrant to purchase 22,000 shares of the
Company's common stock. There can be no assurance that the Company will be able
to finalize this agreement or that it will be able to satisfy its obligation
thereunder. In such case, the Company could be subject to litigation with the
former landlord that could have a material adverse impact on the Company's
financial position and results from operations.
10. SUBSEQUENT EVENTS
SmartServ entered into a Separation Agreement with Sebastian E. Cassetta, its
former Chairman and Chief Executive Officer, effective as of October 21, 2003
(the "Cassetta Separation Agreement"). The Cassetta Separation Agreement
terminated Mr. Cassetta's rights under his employment agreement, including
without limitation, any rights to compensation and severance, in exchange for
the consideration
22
set forth therein, including the following: (i) a cash payment for unpaid base
salary and accrued vacation of $18,990, (ii) forgiveness of certain loans in the
original principal amount of $500,000 plus accrued interest, (iii) extension of
the put right contained in Mr. Cassetta's Restricted Stock Agreement dated
December 28, 1998, allowing Mr. Cassetta 1 year instead of 60 days to either
repay a promissory note in the original principal amount of $457,497 plus
accrued interest, or return 94,707 restricted shares of SmartServ Common Stock
in full satisfaction of such promissory note.
In connection with his retirement, SmartServ entered into a Separation Agreement
with Mario Rossi, its former Executive Vice President, Chief Technology Officer,
and Director, effective as of October 21, 2003 (the "Rossi Separation
Agreement"). The Rossi Separation Agreement terminated Mr. Rossi's rights under
his employment agreement, including without limitation, any rights to
compensation and severance, in exchange for the consideration set forth therein,
including the following: (i) a cash payment for unpaid base salary and vacation
of $16,667, (ii) a cash payment for unpaid contractual base salary of $112,500,
of which $81,371 will be offset against Mr. Rossi's obligation to SmartServ of
$47,004 in accrued interest on a restricted stock note in the original principal
amount of $152,500 (the "Rossi Note"), and the remaining $31,129 will be paid in
two equal installments on April 21, 2004 and October 21, 2004, (iii) a warrant
to purchase 41,667 shares of SmartServ common stock at not less than $2.40 per
share, and (iv) pursuant to Mr. Rossi's rights under a Restricted Stock
Agreement, cancellation of the principal amount of the Rossi Note upon delivery
by Mr. Rossi to SmartServ of the 34,347 shares of restricted stock securing the
Rossi Note.
On November 11, 2003, SmartServ issued 18 Units in a financing transaction, each
Unit comprised of a $50,000 convertible note ("November Note") and a warrant
("November Warrant") to purchase 16,667 shares of SmartServ's common stock. The
Units were sold to 20 investors for an aggregate of $900,000. Holders of the
notes have the right to convert the November Note into shares of Common Stock at
a price equal to $2.10 per share for the November Note. The maturity date of the
November Notes is the earlier of December 19, 2003 or the completion of an
equity placement of at least $3 million, at which time the November Notes will
automatically convert into the equity placement. Holders of the November
Warrants have the right to exercise the November Warrants into shares of Common
Stock at a price equal to $1.500 per share. Finders' compensation to Spencer
Trask and Richard Berland, for the financing transaction consisted of (i) a cash
fee of $90,000, or 10% of the aggregate purchase price of all of the Units; (ii)
warrants to purchase a number of shares of common stock equal to 20% of the
shares of common stock underlying the securities in the Units sold and (iii)
2,778 shares of unregistered common stock per Unit sold. In addition, Spencer
Trask earned a non-accountable expense allowance of $27,000, or 3% of the
aggregate proceeds of all Units sold in the November transaction. All of the
November Notes and the November Warrants have full ratchet anti-dilution
protection.
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SmartServ Online, Inc. commenced operations on August 20, 1993 and had its
initial public offering on March 21, 1996. The Company offers application
development and hosting services that allow wireless carriers, content providers
and commercial enterprises to deliver content to their work forces and customers
via wireless devices, with special emphasis on cellular phones. SmartServ's
products can deliver proprietary information, as well as delayed and real-time
financial market data, business and financial news, national and local weather
reports and other premium business and entertainment information in a
user-friendly manner.
The Company's mobile data solutions are designed to generate additional revenue,
increase operating efficiency, and extend brand awareness for wireless carriers,
enterprises and content providers and are delivered via J2ME, BREW, WAP and SMS
enabled cellular phones, as well as RIM Blackberry and Pocket PC devices.
SmartServ has established customer and distribution relationships with strategic
partners and wireless carriers, including Verizon Wireless, AT&T Wireless,
Nextel, ALLTEL Wireless, U.S. Cellular, QUALCOMM and Motorola, as well as
content providers, including BusinessWeek Online, S&P Comstock and The Wall
Street Journal Online (Dow Jones).
Due to the substantial expenses and negative cash flows from operations that we
have incurred, Ernst & Young LLP, in their report contained in our December 31,
2002 financial statements, have indicated that there is substantial doubt about
our ability to continue as a going concern. The Company has, since its
inception, earned limited revenues and has incurred substantial recurring
operating losses, including net losses of $14,365,927 for the nine month period
ended September 30, 2003, net losses of $8,037,173 and $14,819,860 for the years
ended December 31, 2002 and 2001, respectively, and net losses of $30,993,559
and $7,124,126 for the years ended June 30, 2000 and 1999, respectively.
Additionally, the Company had an accumulated deficit of $87,224,933 at September
30, 2003 and has debt service requirements of $1,375,000 ($4,465,300 should the
Company be unable to complete an equity financing of at least $3 million prior
to February 19, 2004) during the 12 month period ending September 30, 2004.
Although 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, unless we are
able to increase revenue and raise additional capital from investors, we will
not be able to support our operations.
Management believes that the evolution of the cellular industry is at an
important turning point, where both consumers and businesses are expecting more
functionality and features from both their cell phones and their cellular
carriers. This expectation is being driven by a number of industry trends
including highly competitive pricing packages, newer and more functional cell
phones and mobile devices, and the customers' ability to take their cell phone
number with them to a new carrier that offers them more value than the
incumbent. Competition in this environment is moving from differentiation based
on network coverage or minute rates to one based on enhanced features and
services. Management believes that as carriers' network coverage, quality of
service, and pricing plans become more-or-less equal, cell phone customers will
choose a carrier based principally on the suite of premium content and
applications that are included with its service. This environment will provide
an opportunity for SmartServ to exploit its current and planned content assets
and delivery capabilities, developed over the past nine years.
The Company's plan of operation to monetize its content assets and eliminate the
uncertainty surrounding its ability to continue as a going concern focuses on:
24
(1) growing the licensing of its applications and related services
to wireless carriers and enterprise firms, and
(2) the bundling of its existing and planned future premium
content with the reselling of voice services to specific
targeted affinity groups.
The Company's strategy provides access to a large number of potential
subscribers and allows SmartServ to leverage its market reach at minimal
operating costs.
Management believes that SmartServ has a unique combination of content assets,
including those currently owned or licensed and those that it plans to acquire,
that may allow it to take a leadership position in the market for bundled
pre-paid voice and premium content and, later, a substantial position in the
much larger market for the reselling of post-paid cell phone service. Thus, by
providing a set of products that bundle cell phone airtime with affinity-related
content delivered through its current technology infrastructure, the Company
plans to enter the emerging market for reselling wireless airtime. The Company's
existing technology and content assets not only facilitate its entry into this
new market, but also present a barrier to entry to other organizations that wish
to compete with similar offerings in the marketplace.
SmartServ is building, through acquisition and through internal development, a
wide array of premium content that will continue to be offered through
traditional carrier-based distribution channels, as well as through bundled
offerings with pre-paid voice minutes. The premium content offered or to be
offered through the SmartServ platforms consists of:
o Dynamic mobile applications, where the information or data
content is frequently changing and, therefore, frequently
delivered to the mobile device,
o Static content, such as ring tones, graphics and games, that
are periodically delivered and reside on the mobile device,
and
o Mobile e-mail access applications and services.
To augment its capabilities, SmartServ recently signed Letters of Intent and is
negotiating definitive purchase agreements for the acquisition of two companies,
nReach, Inc. and Mobile Airwaves, Inc., whose content and content-enablement
software, respectively, will form, if acquired, key components of its bundled
product offering. nReach, Inc. is a wireless content distribution company that
sells a broad portfolio of popular mass-market cell phone content, including
ringtones, games, and on-device graphics both direct to consumer and through
wireless carriers. nReach provides direct access to a large consumer base
through existing marketing relationships with large retailers, including Best
Buy and Radio Shack.
Mobile Airwaves, Inc., operating under the brand name "Aqivo," provides a
server-based software platform that enables the delivery of e-mail over wireless
networks to practically any data-enabled cell phone. The principal target market
for Aqivo has been and will continue to be enterprises; however, it is believed
that Aqivo's e-mail enabling software will also have broad appeal, as one
component of the Company's "bundled" products, for individual cell phone users
who want to access their existing e-mail accounts from their wireless devices.
For wireless carriers, SmartServ continues to deliver data and branded content
that can increase wireless data revenue and customer retention. For enterprise
customers, SmartServ offers solutions that can increase productivity and
customer retention through the mobile delivery of proprietary data, as well as
market data and other premium content. SmartServ has the ability to customize
the information package to be offered to each customer by device.
25
As an example, SmartServ has launched several products on the Verizon Wireless
network. Our financial content products have been launched on Verizon's BREW
(Binary Runtime Environment for Wireless) network under the Wall Street Journal
Online brand name, while our SMS (Short Message Service) financial alert product
has been launched on Verizon's V-text portal. Additionally, SmartServ has
launched its Lottery, AreaWeather and AstroCom Horoscope lifestyle products on
Verizon's BREW network. 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 an integrated financial tool.
In December of this year, the Company plans to begin a retail store trial sale
of the SmartServ Toro Card Pack designed for Hispanic persons who have prepaid
cell phone service. This product bundles a prepaid airtime card for use with
most carriers and a Toro Card that entitles the purchaser, at no extra charge,
to receive three new Spanish-music ring tones, and horoscope and lottery
information in Spanish. Following this trial and anticipated broad commercial
launch of our Toro product, we expect to expand the concept into a wide variety
of similarly highly targeted affinity markets - each bundling airtime with an
offering of premium content specifically chosen for that market segment.
While management believes that its new marketing strategies, as well as its
carrier and enterprise relationships are important to SmartServ's success, no
assurance can be given that it will be able to implement its new marketing
strategies or that its carrier and enterprise relationships will be successful
in their marketing efforts or that SmartServ's products and services will be
well received in the marketplace.
As of September 30, 2003, SmartServ employed 9 people, all of whom were employed
in the United States. SmartServ does not anticipate that staffing requirements
associated with the implementation of its plan of operation will require the
addition of any people during the year ending December 31, 2003.
RESULTS OF OPERATIONS
QUARTER ENDED SEPTEMBER 30, 2003 VERSUS QUARTER ENDED SEPTEMBER 30, 2002
During the quarter ended September 30, 2003, we recorded revenues of $145,130.
Of such revenues, $61,100 were earned through our licensing agreements with
wireless telecommunications carriers and $84,000 were earned through our
licensing agreement with Salomon Smith Barney ("Salomon"). During the quarter
ended September 30, 2002, we recorded revenues of $81,847. Substantially all of
such revenues were earned through our licensing agreement with Salomon. During
the quarters ended September 30, 2003 and 2002, we recognized $53,400 and
$15,800, respectively, from the amortization of deferred revenues associated
with this agreement. Although the licensing agreement with Salomon for GEO
expired on November 30, 2003, the Company continues to support the GEO
initiative. The Company is working with Salomon to augment the GEO offering with
new service introductions and extend the operating agreement; however, no
assurance can be given that the Company will be successful in negotiating an
extension of the Salomon licensing agreement.
26
During the quarter ended September 30, 2003, we incurred costs of services of
$289,055, a decrease of 79% from the quarter ended September 30, 2002. Such
costs decreased primarily due to personnel reductions ($403,600) and the
reduction of computer hardware leases, depreciation and maintenance costs
($443,900). Components of the costs of service category consist primarily of
information and communication costs ($123,200) and personnel costs ($202,700),
offset by the partial recovery ($44,500) of a loan extended to a former officer.
During the quarter ended September 30, 2002, we incurred costs of services of
$1,386,390. Such costs 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
quarters ended September 30, 2003 and 2002, we capitalized $-0- and $45,700, 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" ("Statement No. 86").
During the quarter ended September 30, 2003, we incurred sales and marketing
expenses of $23,543, a decrease of 95% from the quarter ended September 30,
2002. Such costs decreased primarily due to travel and personnel reductions
associated with the closing of the Company's Hong Kong and London sales offices,
U.S. personnel reductions, reductions in advertising and trade shows and
reductions in professional fees. Components of the sales and marketing category
consist primarily of personnel costs ($19,400). During the quarter ended
September 30, 2002, we incurred sales and marketing expenses of $454,364. 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, 2003, we incurred general and
administrative expenses of $715,353, a decrease of 34% from the quarter ended
September 30, 2002. Such costs decreased primarily due to personnel reductions
($359,700) and reductions in professional fees ($170,400), insurance costs
($44,800) and computer hardware leases, depreciation and maintenance costs
($48,900), offset by an increase in facilities costs ($175,100). Components of
the general and administrative category consist primarily of personnel costs
($26,200), professional fees ($126,700), facilities ($302,500), insurance
($61,700) and consulting costs ($31,000). During the quarter ended September 30,
2002, we incurred general and administrative expenses of $1,087,962. General and
administrative costs were incurred primarily for personnel costs ($385,900),
travel and lodging ($24,200), professional fees ($297,100), facilities
($127,400), insurance ($106,500), and computer hardware leases, depreciation and
maintenance costs ($54,000).
During the quarter ended September 30, 2003, a net noncash charge for
stock-based compensation amounted to $229,124 compared to a net noncash charge
of $30,290 during the quarter ended September 30, 2002. Of such amounts, noncash
charges for consulting services for the quarters ended September 30, 2003 and
2002 were $118,000 and $3,900, respectively, resulting primarily from the
amortization of deferred costs associated with the prior issuance of warrants to
purchase common stock to various financial, marketing and technical consultants.
Stock-based compensation is valued in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25")
and SFAS No. 123, "Accounting for Stock-Based Compensation" ("Statement No.
123"). Certain employee stock 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. The
value of substantially all of such common stock purchase warrants has been
recorded in accordance with the Black-Scholes pricing methodology.
Interest income for the quarters ended September 30, 2003 and 2002 amounted to
$2,709 and $74,785, respectively. The decrease of $72,076 or 97% was caused by
the use of working capital to fund the Company's operations. Such amounts were
earned primarily from our investments in money fund accounts and a note
receivable from an officer. During the quarters ended September 30, 2003 and
2002,
27
interest and other financing costs were $6,531,633 and $138,439, respectively.
During the quarter ended September 30, 2003, interest and other financing costs
were incurred in connection with the convertible notes issued in February, May,
June and September 2003. Such 2002 costs were incurred primarily in connection
with the $20 million line of credit facility with Hewlett-Packard Company
("HP").
In September 2002, the Company and HP amended the terms of the promissory note
from the Company to HP 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 8,333 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 loss per share was $3.69 per share for the three months ended September
30, 2003 versus earnings of $2.04 per share for the three months ended September
30, 2002. Diluted loss per share for the three months ended September 30, 2003
was $3.69 per share versus earnings of $1.83 per share for the three months
ended September 30, 2002. Basic weighted average shares outstanding increased to
2,072,440 at September 30, 2003 from 1,339,053 at September 30, 2002. Diluted
weighted average shares outstanding increased to 2,072,440 at September 30, 2003
from 1,494,302 at September 30, 2002.
NINE MONTHS ENDED SEPTEMBER 30, 2003 VERSUS NINE MONTHS ENDED SEPTEMBER 30, 2002
During the nine months ended September 30, 2003 we recorded revenues of
$614,145, an increase of 320% over the nine months ended September 30, 2002. Of
such 2003 revenues, $126,500 were earned through our licensing agreements with
wireless telecommunications carriers, $372,500 were earned through our licensing
agreement with Salomon and $108,000 were earned under a one-time purchase order
from Wireless Retail, Inc. Revenues generated in 2002 amounted to $146,483,
substantially all of which were earned through our licensing agreement with
Salomon . During the nine months ended September 30, 2003 and 2002, we
recognized $240,400 and $21,200, respectively, from the amortization of deferred
revenues associated with this agreement. Although the licensing agreement with
Salomon for GEO expired on November 30, 2003, the Company continues to support
the GEO initiative. The Company is working with Salomon to augment the GEO
offering with new service introductions and extend the operating agreement;
however, no assurance can be given that the Company will be successful in
negotiating an extension of the Salomon licensing agreement.
28
During the nine months ended September 30, 2003, we incurred costs of services
of $4,080,429 a decrease of 6% over the nine months ended September 30, 2002.
Such costs decreased primarily due to personnel reductions ($840,000) and the
reduction of computer hardware leases, depreciation and maintenance costs
($810,200), offset by a charge ($84,500) in connection with the potential
uncollectibility of a loan to a former officer and an impairment loss
($1,440,600) recorded to adjust the value of the Company's property and
equipment and capitalized software costs to net realizable value. Components of
the costs of service category consist primarily of information and communication
costs ($330,800), personnel costs ($1,225,000), computer hardware leases,
depreciation and maintenance costs ($593,000), facilities ($186,100),
amortization expenses relating to capitalized software development costs
($183,800), a charge for the potential uncollectibility of a loan to a former
officer ($84,500) and an impairment loss ($1,440,600) recorded to adjust the
value of the Company's property and equipment and capitalized software costs to
net realizable value. During the nine months ended September 30, 2001, we
incurred costs of services of $4,338,016. Such costs consisted primarily of
information and communication costs ($621,000), personnel costs ($2,065,000),
computer hardware leases, depreciation and maintenance costs ($1,403,200), and
amortization expenses relating to capitalized software development costs
($179,800). During the nine months ended September 30, 2003 and 2002, we
capitalized $-0- and $185,900, respectively, of development costs in accordance
with Statement No. 86.
During the nine months ended September 30, 2003, we incurred sales and marketing
expenses of $403,573, a decrease of 85% from the nine months ended September 30,
2002. Such costs decreased primarily due to travel and personnel reductions
associated with the closing of the Company's Hong Kong and London sales offices,
U.S. personnel reductions, reductions in advertising and trade shows and
reductions in professional fees. Components of the costs of the sales and
marketing category consist primarily of personnel costs ($321,000), advertising
and trade shows ($10,900), consulting fees ($17,800) and travel and lodging
($33,900). During the nine months ended September 30, 2002, we incurred sales
and marketing expenses of $2,698,013. Sales and marketing expenses were incurred
primarily for personnel costs ($1,471,600), advertising and trade shows
($606,100), facilities ($112,900), consulting fees ($187,600), and travel and
lodging ($214,600).
During the nine months ended September 30, 2003, we incurred general and
administrative expenses of $3,075,446 a decrease of 7% from the nine months
ended September 30, 2002. Such costs decreased primarily due to personnel
reductions and a reduction of insurance costs offset by a charge ($270,000) in
connection with the potential uncollectibility of a loan to an officer and an
impairment loss ($108,000) recorded to adjust the value of the Company's
property and equipment to net realizable value. Components of the costs of the
general and administrative category consist primarily of personnel costs
($698,400), professional fees ($740,000), facilities ($546,700), insurance
($190,700), computer hardware leases, depreciation and maintenance costs
($81,300), communications costs ($46,500), consulting costs ($31,000), a charge
for the potential uncollectibility of a loan to a former officer (270,000) and
an impairment loss ($108,000) recorded to adjust the value of the Company's
property and equipment to net realizable value. During the nine months ended
September 30, 2002, we incurred general and administrative expenses of
$3,328,102. 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, 2003, a net noncash charge for
stock-based compensation amounted to $331,068 compared to net noncash credits of
$122,831 during the nine months ended September 30, 2002. Of such amounts,
noncash charges for professional fees for the nine months ended September 30,
2003 and 2002 were approximately $221,200 and $573,879, 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. Stock-based compensation is valued in accordance with APB
No. 25 and Statement No. 123. Certain employee stock options are
29
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. The value of such common stock purchase warrants has been
recorded in accordance with the Black-Scholes pricing methodology.
Interest income for the nine months ended September 30, 2003 and 2002 amounted
to $11,601 and $106,284, respectively. Such amounts were earned primarily from
our investments in money fund accounts and a note receivable from an officer.
During the nine months ended September 30, 2003 and 2002, interest and other
financing costs were $7,781,029 and $508,184, respectively. During the nine
months ended September 30, 2003, interest and other financing costs were
incurred in connection with the convertible notes issued in February, May, June
and September 2003. Such 2002 costs were incurred primarily in connection with
the $20 million line of credit facility with HP.
During the nine months ended September 30, 2003, the Company recorded a gain of
$305,822 resulting from the partial repayment, in full settlement, of the
amended promissory note issued to HP. Also during the nine months ended
September 30, 2003, the Company recorded an insurance recovery of $374,000 for
legal costs incurred in connection with a favorable trial decision in the matter
of Michael Fishman v. SmartServ Online, Inc., et al.
Basic and diluted loss per share was $7.15 for the nine months ended September
30, 2003, compared to $4.18 per share for the nine months ended September 30,
2002. The weighted average shares outstanding increased to 2,010,142 at
September 30, 2003 from 1,157,260 at September 30, 2002.
CAPITAL RESOURCES AND LIQUIDITY
At September 30, 2003 and December 31, 2002, the Company had cash of $276,363
and $154,759, respectively. Net cash used in operations was $3,028,440 for the
nine months ended September 30, 2003 compared to $8,146,687 during the nine
months ended September 30, 2002. The primary reasons for this reduction were the
Company's initiative to close the Hong Kong and United Kingdom sales offices,
reduce its U.S. personnel and trim its operations. Other uses of cash during the
nine months ended September 30, 2003 were primarily for the partial repayment of
our obligation to HP in the amount of $225,000 and the repayment of a $70,000
note issued in January 2003.
During the nine months ended September 30, 2003, the Company issued convertible
notes in the amount of $3,350,000 and a note in the amount of $70,000 to provide
liquidity. Additionally, warrant holders provided funds aggregating
approximately $376,000 through the exercise of warrants.
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. In September 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 8,333 shares of common stock and (iv) repayment
of $500,000 of the amended obligation on September 10, 2002. The remaining
obligation was evidenced by a note, bearing an interest rate of 11%, 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 $6.996 per share. As a result of the September 2002
transaction, the Company recorded a charge to earnings of $38,000 during the
quarter ended September 30, 2002, representing the fair value of the
30
warrant as determined in accordance with the Black-Scholes model. Additionally,
the Company recognized a net gain of $5,679,261 resulting from the
extinguishment of this obligation. In February 2003, the Company and HP amended
the terms of their amended promissory note to provide for the settlement of
SmartServ's outstanding obligation of $530,800, inclusive of accrued interest of
$30,800, in consideration of the payment by SmartServ of $225,000. As a result,
during the quarter ended March 31, 2003, the Company recognized an additional
gain of $305,822, resulting from the extinguishment of this obligation.
In June 2002, First Albany Corporation, acting as placement agent for SmartServ,
completed a private placement of units consisting of 130,952 shares of common
stock and warrants to purchase common stock in consideration of $8.40 per unit
to two accredited investors. The net proceeds of $823,500 from the issuance of
these units were used for general working capital requirements. The investors
received warrants, callable under certain conditions, for the purchase of an
aggregate of 238,095 shares of common stock at an exercise price of $8.40 per
share through the expiration date on June 5, 2007, as well as non-callable
warrants for the purchase of an aggregate of 32,738 shares of common stock,
subject to antidilution adjustments, upon the occurrence of certain events, at
an exercise price of $8.82 per share through June 5, 2007. In August 2002,
pursuant to the terms of the callable warrants, the Company provided the
investors with a notice calling the callable warrants. In September 2002, the
callable warrants expired unexercised. Subsequent to June 2002, non-callable
warrants for the purchase of 34,142 shares of common stock were exercised.
Proceeds from such exercises were $176,500.
In September 2002, SmartServ issued units consisting of 647,368 shares of its
common stock and warrants to purchase 323,685 shares of common stock,
exercisable at $5.10 per share through September 8, 2007, to 22 accredited
investors at a purchase price of $5.475 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 $25,000, and issued warrants to purchase
73,008 shares of common stock at an exercise price of $5.10 per share, expiring
on September 8, 2007, as compensation to certain individuals and entities that
acted as finders. Additionally, the Company incurred costs and other fees of
$28,000 in connection with this transaction. Subsequent to December 31, 2002,
warrants for the purchase of 73,731 shares of common stock were exercised.
Proceeds from such exercises were $376,000.
During the period January 1, 2000 through December 31, 2002, the Company issued
344,167 shares of common stock to investors upon the exercise of warrants to
purchase such shares. Proceeds from the exercise of these warrants were
$6,014,600. Substantially all of these warrants were exercised during the 12
months ended December 31, 2000 when the market value of the Company's common
stock was significantly greater than it is currently.
During the quarter ended December 2002, the Company recorded a valuation
allowance of $664,640 in connection with the potential uncollectibility of loans
made to Mr. Sebastian Cassetta, the Company's then Chairman and Chief Executive
Officer. Additionally, during the quarter ended June 30, 2003, the Company
recorded a valuation allowance of $270,000 in connection with the potential
uncollectibility of a loan made to Mr. Cassetta for the purchase of SmartServ
restricted stock. While these loans do not mature until December 2003 and
January 2004, Mr. Cassetta's ability to repay these loans and interest thereon
is highly contingent on the market value of his investment in the Company.
During the quarter ended June 30, 2003, the Company recorded a valuation
allowance of $129,000 in connection with the potential uncollectibility of a
loan made to Mr. Mario Rossi, the Company's then Executive Vice President and
Chief Technology Officer, for the purchase of SmartServ restricted stock. During
the quarter ended September 30, 2003, the Company recorded a partial recovery
amounting to $44,500 in connection with such obligation. While this loan does
not mature until December 2003, Mr. Rossi's ability to repay this loan and
interest thereon is highly contingent on the market value of his investment in
the Company.
31
At December 31, 2002, the Company had outstanding 287,500 public warrants
(SSOLW) and 50,000 warrants with terms identical to the public warrants. These
warrants were convertible into our common stock at the ratio of 15 warrants per
share of common stock at an exercise price of $63 per share. These warrants were
redeemable by SmartServ upon satisfaction of certain conditions. These warrants
expired on March 20, 2003.
In January 2003, the Company borrowed $70,000 from Steven B. Rosner, which was
used for working capital. The debt was evidenced by an unsecured note bearing an
interest rate of 12% per annum and was repaid in February 2003.
In February 2003, the Company issued a convertible note to Global Capital
Funding Group, LP ("Global") in consideration for the receipt of $1 million. The
note bears interest at the rate of 10% per annum, and is secured by the
Company's assets, exclusive of its internally developed software products. The
note matures on February 14, 2004, contains certain antidilution provisions, and
may be converted into shares of SmartServ common stock at $6.60 per share. As
additional consideration, the Company issued Global a warrant for the purchase
of 33,333 shares of its common stock at an exercise price of $9.68 per share.
Alpine Capital Partners, Inc. ("Alpine") received a finder's fee of $70,000,
representing 7% of the aggregate purchase price of the convertible note and a
warrant to purchase 15,167 shares of common stock exercisable at $9.66 per
share, expiring on February 14, 2005, in connection with this transaction. In
April 2003, the Company borrowed an additional $250,000 from Global and amended
the convertible note to include such amount. As additional consideration, the
Company issued Global a warrant for the purchase of 3,333 shares of its common
stock at an exercise price of $7.20 per share. Alpine is to receive a finder's
fee of $17,500 in connection with the April amendment. The warrants issued to
Global and Alpine contains certain antidilution provisions and expire on
February 14, 2006. Proceeds from the notes were used for working capital
purposes.
In February 2003, the Company issued 20,590 shares of common stock to 5 vendors
in settlement of the Company's obligations, aggregating $164,000, to such
vendors.
In May 2003, the Company in consideration of $358,000 issued 3.58 units
consisting of convertible notes and warrants to purchase common stock ("May
Units") to 8 investors. Each May Unit consists of a $100,000 convertible note
and a warrant to purchase 33,333 shares of the Company's common stock. The
convertible notes bear interest at 8% per annum, are convertible into the
Company's common stock at $4.464 (the average of the closing bid prices of the
Company's common stock for the 5 days prior to the closing of the transaction)
per share and were to mature on the earlier of November 19, 2003 or the closing
of an equity placement of not less than $3 million. The warrants are exercisable
at $4.464 per share and expire on May 19, 2006. In June 2003, the Company in
consideration of $1,142,000 issued 11.42 units ("June Units") to 20 accredited
investors. Each June Unit also consists of a $100,000 convertible note and a
warrant to purchase 33,333 shares of the Company's common stock. The convertible
notes bear interest at 8% per annum, are convertible into the Company's common
stock at $4.764 (the average of the closing bid prices of the Company's common
stock for the 5 days prior to the closing of the transaction) per share and were
to mature on the earlier of November 19, 2003 or the closing of an equity
placement of not less than $3 million. The warrants are exercisable at $4.764
per share and expire on June 13, 2006. Spencer Trask Ventures, Inc. ("Spencer
Trask"), Steven B. Rosner and Richard Berland acted as finders for the May and
June 2003 transactions. As consideration therefor, the finders received their
proportionate share of a cash fee of $150,000, or 10% of the aggregate purchase
price of the Units sold and (i) Unit Purchase Warrants to purchase an aggregate
of three Units ("Unit Purchase Warrant") and (ii) 33,333 shares of unregistered
common stock per Unit sold. Each Unit Purchase Warrant entitles the holder to
purchase one Unit, for the price of $100,000 per Unit through June 13, 2008. In
addition, Spencer Trask received a non-accountable expense allowance of $45,000,
or 3% of the aggregate proceeds of all Units sold in the May
32
and June 2003 transactions. Proceeds from the sale of the Units were used for
working capital purposes. In November 2003, the Company, as an inducement to
extend the maturity date of the notes to February 19, 2004, offered the note
holders a warrant to purchase additional shares of common stock in an amount
equal to 25% of the number of shares into which the notes purchased in the Unit
are convertible. We have received written consents to extend the maturity date
from holders of $1,390,000 of the notes and expect to receive the consent from
the holders of the remaining $110,000 notes. If we do not receive the additional
consents, we may be in default of our obligation under the notes.
On September 16, 2003, SmartServ issued 7.4 Units in a financing transaction
consisting of an offering of up to 12 Units comprised of a $50,000 convertible
note and a warrant to purchase 16,667 shares of SmartServ's common stock. On
September 19, 2003, SmartServ issued the remaining 4.6 Units of the financing
transaction (collectively the "September Transaction"). The Units were sold to
accredited investors for an aggregate of $600,000. Holders of the notes have the
right to convert the notes into shares of common stock at a price equal to
$1.896 per share for the notes issued on September 16, 2003 and $1.920 per share
for the notes issued on September 19, 2003. The maturity date of the notes is
the earlier of November 19, 2003 or the completion of an equity placement of at
least $3 million, at which time the notes will automatically convert into the
equity placement. Holders of the warrants have the right to exercise the
warrants into shares of common stock at a price equal to $1.500 per share.
Finders' compensation to two accredited investors for the September Transaction
consisted of (i) a cash fee of $60,000, or 10% of the aggregate purchase price
of all of the Units; (ii) warrants to purchase a number of shares of common
stock equal to 20% of the shares of common stock underlying the securities in
the Units sold and (iii) 2,778 shares of unregistered common stock per Unit
sold. In addition, Spencer Trask received a non-accountable expense allowance of
$18,000, or 3% of the aggregate proceeds of all Units sold in the September
Transaction. All of the notes and the warrants have full ratchet anti-dilution
protection. In November 2003, the Company, as an inducement to extend the
maturity date of the notes to February 19, 2004, offered the noteholders a
warrant to purchase additional shares of common stock in an amount equal to 25%
of the number of shares into which the notes purchased in the Unit are
convertible. We have received written consents to extend the maturity date from
holders of $475,000 of the notes and expect to receive the consent from the
holders of the remaining $125,000 notes. If we do not receive the additional
consents, we may be in default of our obligation under the notes.
The September Transaction required the consent of Global, the holder of $1.25
million of SmartServ's convertible notes issued in February and April 2003, and
of 51% or more of the holders of SmartServ's $1.5 million convertible notes
issued in connection with the bridge financings in May and June 2003. As an
inducement to obtain their consent, such holders received (a) a change in the
conversion price of their convertible notes equal to the lowest conversion price
of the notes issued in the September financings ($1.896 per share) and (b) an
increase in the number of shares purchasable pursuant to the warrant to reflect
a full ratchet dilution formula with a decrease in the exercise price of the
warrants to the exercise price of the warrants issued in the September financing
($1.500). Such amendment, as it pertains to the holders of convertible notes
issued in the May and June 2003 bridge financings, was effective on November 25,
2003, coincident with the effective date of a one-for-six reverse stock split.
SmartServ recorded a charge in the amount of $4,828,000 as "Other Financing
Costs" for the fair value of the consideration granted to these note holders for
such consent.
On November 11, 2003, SmartServ issued 18 Units in a financing transaction
comprised of a $50,000 convertible note ("November Note") and a warrant
("November Warrant") to purchase 16,667 shares of SmartServ's common stock. The
Units were sold to 20 investors for an aggregate of $900,000. Holders of the
November Notes have the right to convert the November Notes into shares of
common stock at a price equal to $2.10 per share. The maturity date of the
November Notes is the earlier of December 19, 2003 or the completion of an
equity placement of at least $3 million, at which time the November Notes will
automatically convert into the equity placement. Holders of the November
Warrants have the right to exercise the November Warrants into shares of common
stock at a price equal
33
to $1.500 per share. Finders' compensation to Spencer Trask and Richard Berland
consisted of (i) a cash fee of $90,000, or 10% of the aggregate purchase price
of all of the Units; (ii) warrants to purchase a number of shares of common
stock equal to 20% of the shares of common stock underlying the securities in
the Units sold and (iii) 2,778 shares of unregistered common stock per Unit
sold. In addition, Spencer Trask received a non-accountable expense allowance of
$27,000, or 3% of the aggregate proceeds of all Units sold in the September
Transaction. All of the November Notes and the November Warrants have full
ratchet anti-dilution protection.
While the warrants to purchase common stock issued during the twelve months
ended September 2003 and thereafter represent an additional source of capital,
they expire between May 2006 and November 2008 and are not callable by the
Company. Therefore, they cannot be relied upon by the Company as a definite
source of capital. The warrant holders may choose to exercise their warrants if
the market price of the Company's common stock exceeds the exercise price of the
warrant.
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, earned limited revenues and incurred substantial recurring operating
losses, including net losses of $14,365,927 for the nine months ended September
30, 2003, net losses of $8,037,173 and $14,819,860 for the years ended December
31, 2002 and 2001, respectively, 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 $87,224,933 at September 30, 2003 and has debt service
requirements of $1,375,000 ($4,465,300 should the Company be unable to complete
an equity funding of not less than $3 million prior to February 19, 2004) during
the twelve month period ending September 30, 2004. These conditions raise
substantial doubt about the Company's ability to continue as a going concern.
Such concern was expressed by Ernst & Young LLP in their audit report regarding
the financial statements included in our Form 10-KSB for the year ended December
31, 2002. 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.
The economic downturn in general, and its impact on the telecommunications
industry in particular, have 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. 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. In both March and May 2003, the Company
again reduced its cost structure through the termination of additional
personnel. Personnel headcount has been reduced from 66 in May 2002 to the
current level of 9. These efforts have reduced the Company's average monthly
operating expenses from approximately $1,090,000 in July 2002 to approximately
$230,000 commencing September 2003, excluding noncash stock compensation and
depreciation and amortization. The Company anticipates that it will require
working capital for its previously discussed proposed acquisitions, as well as
to meet certain debt service requirements. 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 following chart provides an analysis of the Company's capital
requirements for the 12 month period ending September 30, 2004
34
based on projected revenues of $550,000:
% OF
REVENUE CAPITAL
GOAL REQUIRED
-------------------------------------
100 $ 5,400,000
0 $ 5,900,000
No assurance can be given that the Company will be able meet its revenue
projections, maintain its cost structure as presently configured, or 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.
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 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
The Company maintains a system of disclosure controls and procedures that is
designed to provide reasonable assurance that information that is required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is accumulated and communicated to
management in a timely manner. The Company's Interim Chief Executive Officer and
Chief Financial Officer have evaluated this system of disclosure controls and
procedures as of the end of the period covered by this quarterly report, and
believe that the system is operating effectively to ensure appropriate
disclosure. There have been no changes in the Company's internal control over
financial reporting during the most recent fiscal year that have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
35
PART 2. OTHER INFORMATION
SMARTSERV ONLINE, INC.
ITEM 1. LEGAL PROCEEDINGS
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 alleged that in August of 1999, Commonwealth
and SmartServ entered into an engagement letter that provided for a
nonrefundable fee to Commonwealth of $15,000 payable in cash or common stock at
SmartServ's option. The complaint alleged that SmartServ elected to pay the fee
in stock and, as a result, Commonwealth sought 13,333 shares of common stock or
at least $1,770,000 together with interest and costs. In our defense, we denied
that we elected to pay in stock. On March 4, 2003, SmartServ received a
favorable decision in this matter after a trial held in the Supreme Court of the
State of New York. The decision holds that, consistent with SmartServ's defense,
SmartServ is required to pay Commonwealth a retainer fee of only $13,439, plus
interest and certain costs. Commonwealth's time to appeal has not yet expired
because a notice to enter the judgment has not yet been filed. While we intend
to vigorously defend any appeal of the decision in the Commonwealth matter, the
unfavorable outcome of such an appeal could have a material adverse effect on
our financial condition, results of operations and cash flows.
In August of 2003, SmartServ entered into a Stipulation of Arbitration with
Brauning Inc., Mike Silva and Todd Peterson, former consultants to SmartServ
(collectively, the "Claimants") pursuant to which SmartServ and the Claimants
agreed to resolve, in a binding arbitration proceeding, the Claimants' demand
for damages resulting from an alleged breach of contract and a failure by
SmartServ to timely register the shares of common stock underlying certain
consulting warrants issued by SmartServ to the Claimants. Although SmartServ
believes that the shares underlying the warrants were timely registered, and
that the Claimants' demand is without merit, SmartServ has reached an agreement
in principle to settle this matter in order to avoid the uncertainties of
litigation. Under the terms of the contemplated settlement agreement, SmartServ
will issue to Claimants 60,000 shares of common stock and by no later than
February 29, 2004, pay Claimants $45,000 for certain wireless industry
consulting reports. SmartServ's failure to comply with these settlement terms
would entitle Claimants to reassert their claims. In such case, although we
would vigorously defend the action, there can be no assurance that we would 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
At the time of issuance, each investor or recipient of unregistered securities
was either an accredited investor or a sophisticated investor. Each investor had
access to SmartServ's most recent Form 10-KSB, all quarterly and periodic
reports filed subsequent to such Form 10-KSB and the Company's most recent proxy
materials.
In January 2003, the Company issued 36,530 shares of common stock to Robert
Gorman, an accredited investor in the September 2002 financing, upon the
exercise of warrants to purchase such shares. Proceeds from the exercise of
these warrants were $186,301. In February 2003, the Company issued 5,883 shares
of common stock to Frazier
36
Investments, an accredited investor in the September 2002 financing, upon the
exercise of warrants to purchase such shares. Proceeds from the exercise of
these warrants were $30,000. In March 2003, the Company issued 21,515 shares of
common stock to Frazier Investments, an accredited investor in the September
2002 financing, upon the exercise of warrants to purchase such shares. Proceeds
from the exercise of these warrants were $109,726. In April 2003, the Company
issued 9,804 shares of common stock to Joel Rotter, an accredited investor in
the September 2002 financing, upon the exercise of warrants to purchase such
shares. Proceeds from the exercise of these warrants were $50,000. No sales
commissions were paid in connection with the above transactions. These shares
and warrants were issued in reliance upon the exemption from registration
provided by Section 4 (2) of the Securities Act of 1933 ("Securities Act").
In February 2003, the Company issued a convertible note to Global Capital
Funding Group, LP ("Global"), an accredited investor, in consideration for the
receipt of $1 million. The note bears interest at the rate of 10% per annum and
is secured by the Company's assets, exclusive of its internally developed
software products. The note matures on February 14, 2004, contains certain
antidilution provisions, and may be converted into shares of SmartServ common
stock at $6.60 per share. As additional consideration, the Company issued Global
a warrant for the purchase of 33,333 shares of its common stock at an exercise
price of $9.66 per share. The warrant contains certain antidilution provisions
and expires on February 14, 2006. Alpine Capital Partners, Inc. ("Alpine"), an
accredited investor, received a finder's fee of $70,000, representing 7% of the
aggregate purchase price of the convertible note and warrants to purchase 15,167
shares of common stock at $9.66 per share expiring on February 14, 2006 in
connection with this transaction. In April 2003, the Company borrowed an
additional $250,000 from Global and amended the convertible note to include such
amount. As additional consideration, the Company issued Global a warrant for the
purchase of 3,333 shares of its common stock at an exercise price of $7.20 per
share. Alpine is to receive a finder's fee of $17,500 in connection with the
April amendment. In August 2003, the Company issued Global a warrant to purchase
16,667 shares of common stock at an exercise price of $2.40 per share as
consideration for its consent allowing the Company to complete the May and June
2003 bridge financings. The warrants contain certain antidilution provisions and
expire on February 14, 2006. The note, amended note and the warrants were issued
in reliance upon the exemption from registration provided by Section 4 (2) of
the Securities Act.
In February 2003, the Company issued 4,275 shares of common stock to G. S.
Schwartz & Company, a sophisticated investor, in full satisfaction of a $33,854
obligation to G. S. Schwartz & Company for services rendered to the Company. No
sales commissions were paid in connection with such transaction. The shares were
issued in reliance upon the exemption from registration provided by Section 4
(2) of the Securities Act.
In February 2003, the Company issued 10,417 shares of common stock to Vox, Inc.,
an accredited investor, in full satisfaction of an $82,500 obligation to Vox,
Inc. for services rendered to the Company. No sales commissions were paid in
connection with such transaction. The shares were issued in reliance upon the
exemption from registration provided by Section 4 (2) of the Securities Act.
In February 2003, the Company issued 2,096 shares of common stock to Creative
Management Services dba MC2, an accredited investor, in full satisfaction of a
$16,600 obligation to MC2 for services rendered to the Company. No sales
commissions were paid in connection with such transaction. The shares were
issued in reliance upon the exemption from registration provided by Section 4
(2) of the Securities Act.
In February 2003, the Company issued 2,017 shares of common stock to NexVue
Information Systems, a sophisticated investor, in satisfaction of a $15,953
obligation to NexVue Information Systems for services rendered to the Company.
No sales commissions were paid in connection with such transaction. The shares
were issued in reliance upon the exemption from registration provided by Section
4 (2) of the Securities Act.
In May 2003, the Company entered into a consulting agreement with Spencer Trask
Ventures, Inc.
37
("Spencer Trask") whereby Spencer Trask will render services to the Company as
its corporate finance consultant, financial advisor and investment banker. As
compensation for such services, the Company issued 83,333 shares of common stock
to Spencer Trask. These shares were issued in reliance upon the exemption from
registration provided by Section 4 (2) of the Securities Act.
In May 2003, the Company in consideration of $358,000 issued 3.58 units
consisting of convertible notes and warrants to purchase common stock ("May
Units") to 8 accredited investors. Each May Unit consists of a $100,000
convertible note and a warrant to purchase 33,333 shares of the Company's common
stock. The convertible notes bear interest at 8% per annum, are convertible into
the Company's common stock at $4.464 (the average of the closing bid prices of
the Company's common stock for the 5 days prior to the closing of the
transaction) per share and were to mature on the earlier of November 19, 2003 or
the closing of an equity placement of not less than $3 million. The warrants are
exercisable at $4.464 per share and expire on May 19, 2006. In June 2003, the
Company in consideration of $1,142,000 issued 11.42 units ("June Units") [each
May or June Unit referred individually as a "Unit"] to 20 accredited investors.
Each June Unit also consists of a $100,000 convertible note and a warrant to
purchase 33,333 shares of the Company's common stock. The convertible notes bear
interest at 8% per annum, are convertible into the Company's common stock at
$4.764 (the average of the closing bid prices of the Company's common stock for
the 5 days prior to the closing of the transaction) per share and were to mature
on the earlier of November 19, 2003 or the closing of an equity placement of not
less than $3 million. The warrants are exercisable at $4.764 per share and
expire on June 13, 2006. Spencer Trask, Steven B. Rosner and Richard Berland,
each an accredited investor, acted as finders for this transaction. As
consideration therefor, the finders received their proportionate share of a cash
fee of $150,000, or 10% of the aggregate purchase price of the Units sold and
(i) Unit Purchase Warrants to purchase an aggregate of three Units ("Unit
Purchase Warrant") and (ii) 5,556 shares of unregistered common stock per Unit
sold. Each Unit Purchase Warrant entitles the holder to purchase one Unit, for
the price of $100,000 per Unit through June 13, 2008. In addition, Spencer Trask
received a non-accountable expense allowance of $45,000, or 3% of the aggregate
proceeds of all Units sold in the offerings. These convertible notes, shares and
warrants were issued in reliance upon the exemption from registration provided
by Section 4 (2) of the Securities Act.
On September 16, 2003, SmartServ issued 7.4 Units in a financing transaction
consisting of an offering of up to 12 Units comprised of a $50,000 convertible
note and a warrant to purchase 16,667 shares of SmartServ's common stock. On
September 19, 2003, SmartServ issued the remaining 4.6 Units of the financing
transaction (collectively the "September Transaction"). The Units were sold to
accredited investors for an aggregate of $600,000. Holders of the notes have the
right to convert the notes into shares of common stock at a price equal to
$1.896 per share for the notes issued on September 16, 2003 and $1.920 per share
for the notes issued on September 19, 2003. The maturity date of the notes was
to be the earlier of November 19, 2003 or the completion of an equity placement
of at least $3 million, at which time the notes will automatically convert into
the equity placement. Holders of the warrants have the right to exercise the
warrants into shares of common stock at a price equal to $1.500 per share.
Finders' compensation to Spencer Trask and Richard Berland, each an accredited
investor, for the September Transaction consisted of (i) a cash fee of $60,000,
or 10% of the aggregate purchase price of all of the Units; (ii) warrants to
purchase a number of shares of common stock equal to 20% of the shares of common
stock underlying the securities in the Units sold and (iii) 2,778 shares of
unregistered common stock per Unit sold. In addition, Spencer Trask received a
non-accountable expense allowance of $18,000, or 3% of the aggregate proceeds of
all Units sold in the September Transaction. All of the notes and the warrants
have full ratchet anti-dilution protection.
The September Transaction required the consent of Global, the holder of $1.25
million of SmartServ's convertible notes issued in February and April 2003, and
of 51% or more of the holders of SmartServ's $1.5 million convertible notes
issued in connection with the bridge financings in May and June 2003. As an
inducement to obtain their consent, such holders received (a) a change in the
conversion price of their
38
convertible notes equal to the lowest conversion price of the notes issued in
the September financings ($1.896 per share) and (b) an increase in the number of
shares purchasable pursuant to the warrant to reflect a full ratchet dilution
formula with a decrease in the exercise price of the warrants to the exercise
price of the warrants issued in the September Transaction ($1.500). Such
amendment, as it pertains to the holders of convertible notes issued in the May
and June 2003 bridge financings, became effective on November 25, 2003, the
effective date of a one-for-six reverse stock split.
Additionally, in November 2003, the Company, as an inducement to extend the
maturity date of the notes issued in May, June and September 2003 from November
19, 2003 to February 19, 2004, offered the noteholders a warrant to purchase
additional shares of common stock in an amount equal to 25% of the number of
shares into which the notes purchased in the Unit are convertible. We have
received written consents to extend the maturity date from holders of $1,865,000
of the notes and expect to receive the consent from the holders of the remaining
$235,000 notes. If we do not receive the additional consents, we may be in
default of our obligation under the notes.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4.1 Form of Warrant for the Investors in the September 2003
Placement (the "September Investors")
4.2 Form of Registration Rights Agreement between SmartServ and
the September Investors
4.3 Form of Warrant for the Investors in the November 2003
Placement (the "November Investors")
4.4 Form of Registration Rights Agreement between SmartServ and
the November Investors
10.1 Form of Securities Purchase Agreement between SmartServ and
the September Investors
10.2 Form of Convertible Debenture for the September Investors
10.3 Form of Securities Purchase Agreement between SmartServ and
the November Investors
10.4 Form of Convertible Debenture for the November Investors
10.5 Separation Agreement between SmartServ and Sebastian E.
Cassetta
10.6 Separation Agreement between SmartServ and Mario Rossi
31.1 Certification required by Section 15d-14(a) of the Rules and
Regulations under the Securities Exchange Act of 1934
31.2 Certification required by Section 15d-14(a) of the Rules and
Regulations under the Securities Exchange Act of 1934
32.1 Certification required by 18 U.S.C. Section 1350
(b) REPORTS ON FORM 8-K
On August 29, 2003, the Company filed a report on Form 8-K under Items
5 and 7 thereof referencing a press release dated August 28, 2003,
announcing the appointment of L. Scott Perry as Chairman of the Board
of Directors and Robert Pons as Interim Chief Executive Officer and a
director.
On November 14, 2003, the Company filed a report on Form 8-K under
Items 4 and 7 thereof, indicating that Ernst & Young LLP resigned as
SmartServ's independent auditor.
On December 2, 2003, the Company filed a report on Form 8-K under Item
4 thereof, indicating that Grant Thornton LLP had been appointed as
SmartServ's independent auditor.
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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: December 11, 2003 /S/ ROBERT M. PONS
----------------- ----------------------------------------------
Robert M. Pons
Interim Chief Executive Officer
Date: December 11, 2003 /S/ THOMAS W. HALLER
----------------- -----------------------------------------------
Thomas W. Haller
Sr. Vice President, Chief Financial Officer,
Treasurer
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