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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
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
Commission file number 0-28008
SmartServ Online, Inc.
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(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 13-3750708
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
2250 Butler Pike, Suite 150, Plymouth Meeting, PA 19462
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(Address of Principal Executive Offices)
(610) 397-0689
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(Issuer's Telephone Number, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
The number of shares of common stock, $.01 par value, outstanding as of November
1, 2004 was 3,547,005.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
SmartServ Online, Inc.
Form 10-QSB
Index
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 2004 (unaudited)
and December 31, 2003................................................2
Consolidated Statements of Operations - three months ended
September 30, 2004 and 2003 and nine months ended September 30,
2004 and
2003(unaudited)......................................................4
Consolidated Statement of Changes in Stockholders' Equity
(Deficiency) - nine months ended September 30, 2004
(unaudited)..........................................................5
Consolidated Statements of Cash Flows - three months ended
September 30, 2004 and 2003 and nine months ended
September 30, 2004 and 2003(unaudited)...............................6
Notes to Unaudited Consolidated Financial Statements.................7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................20
Item 3 Controls and Procedures..............................................28
PART II. OTHER INFORMATION
Item 1 Litigation...........................................................29
Item 2. Changes in Securities and Use of Proceeds............................29
Item 3 Defaults Upon Senior Securities......................................29
Item 6. Exhibits ............................................................30
Signatures .......................................................31-34
1
SmartServ Online, Inc.
Consolidated Balance Sheets
September 30, December 31,
2004 2003
------------ ------------
(Unaudited)
Assets
Current assets
Cash $ 3,225,295 $ 139,178
Accounts receivable 105,821 103,230
Accrued interest receivable -- 47,004
Prepaid compensation -- 133,127
Prepaid expenses 66,914 86,798
Deferred financing costs -- 322,192
------------ ------------
Total current assets 3,398,030 831,529
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Property and equipment, net 97,008 --
Other assets
Goodwill and intangible assets 1,814,889 --
Security deposits 18,237 5,156
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Total Assets $ 5,328,164 $ 836,685
============ ============
See accompanying notes
2
SmartServ Online, Inc.
Consolidated Balance Sheets
September 30, December 31,
2004 2003
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(Unaudited)
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities
Current portion of notes payable $ 24,133 $ --
Accounts payable 1,277,580 1,702,768
Accrued liabilities 1,606,447 928,393
Accrued salaries 15,565 78,133
Accrued interest payable -- 218,848
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Total current liabilities 2,923,725 2,928,142
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Deferred revenues -- 37,500
Notes payable 34,687 3,340,430
Commitments and Contingencies
Stockholders' Equity (Deficiency)
Convertible Preferred stock - $0.01 par value
Authorized - 1,000,000 shares
Issued and outstanding - 876,491 shares, aggregate liquidation 2,440,267 --
preference of $13,849,995 and $0 as of September 30, 2004
and December 31, 2003, respectively
Common stock - $.01 par value
Authorized - 40,000,000 shares
Issued - 3,581,352; outstanding - 3,547,005 shares at September 30,
2004 and 2,261,300 shares at December 31, 2003 35,814 22,613
Additional paid-in capital 96,790,924 85,160,306
Notes receivable from former officers -- (255,525)
Accumulated deficit (96,733,600) (90,396,781)
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2,533,405 (5,469,387)
Treasury stock, 129,053 shares at cost (163,653) --
------------ ------------
Total stockholders' equity (deficiency) 2,369,752 (5,469,387)
------------ ------------
Total Liabilities and Stockholders' Equity (Deficiency) $ 5,328,164 $ 836,685
============ ============
See accompanying notes.
3
SmartServ Online, Inc.
Consolidated Statements of Operations
(Unaudited)
Three Months Nine Months
Ended September 30 Ended September 30
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2004 2003 2004 2003
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Revenues $ 80,474 $ 145,130 $ 268,189 $ 614,145
------------ ------------ ------------ ------------
Costs and expenses:
Costs of services (644,762) (289,055) (1,626,357) (4,080,429)
Sales and marketing expenses (156,705) (23,543) (298,925) (403,573)
General and administrative expenses (506,308) (715,353) (1,871,442) (3,075,446)
Stock-based compensation 639,107 (229,124) -- (331,068)
------------ ------------ ------------ ------------
Total costs and expenses (668,668) (1,257,075) (3,796,724) (7,890,516)
------------ ------------ ------------ ------------
Loss from operations (588,194) (1,111,945) (3,528,535) (7,276,371)
------------ ------------ ------------ ------------
Other income (expense):
Interest income 6,520 2,709 19,287 11,601
Interest expense and other financing costs (538,742) (6,531,633) (2,630,771) (7,781,029)
Legal settlement -- -- (196,800) --
Gain from extinguishment of debt -- -- -- 305,822
Insurance recovery -- -- -- 374,000
Foreign exchange gains (losses) -- -- -- 50
------------ ------------ ------------ ------------
(532,222) (6,528,924) (2,808,284) (7,089,556)
Net loss $ (1,120,416) $ (7,640,869) $ (6,336,819) $(14,365,927)
============ ============ ============ ============
Preferred stock dividend accrued (1,114,366) -- (3,130,460) --
------------ ------------ ------------ ------------
Net loss applicable to common shareholders $ (2,234,782) $ (7,640,869) $ (9,467,279) $(14,365,927)
============ ============ ============ ============
Basic and diluted loss per share $ (0.74) $ (3.69) $ (3.41) $ (7.15)
============ ============ ============ ============
Weighted average shares outstanding - basic and
diluted 3,002,167 2,072,440 2,773,669 2,010,142
============ ============ ============ ============
See accompanying notes
4
SmartServ Online, Inc.
Consolidated Statement of Changes in Stockholders' Equity (Deficiency)
Nine Months Ended September 30, 2004
(Unaudited)
Common Stock Preferred Stock
Notes
Series A Receivable Additional
Preferred from Former Paid-in
Shares Par Value Shares Stock Officers Capital
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Balances at December 31, 2003 2,261,300 $ 22,613 -- $ -- $ (255,525) $ 85,160,306
Issuance of common stock to acquire 500,002 5,000 -- -- -- 1,635,007
nReach, Inc.
Issuance of common stock related to 92,720 927 -- -- -- 689,172
financing
Issuance of common stock to vendor 60,000 600 -- -- -- 196,200
to satisfy debt
Issuance of warrants as compensation -- -- -- -- -- 447,859
for services
Issuance of warrants related to -- -- -- -- -- 1,849,697
financing
Issuance of warrants to vendor to -- -- -- -- -- 26,299
satisfy debt
Issuance of common stock pursuant to 667,330 6,674 (6,674)
an antidilution provision of a May
2000 stock purchase agreement
Treasury stock shares returned in -- -- -- -- 163,653 --
settlement of note receivable from
former officers
Allowance for uncollectibliity of 91,872 --
loan to former officer
Beneficial conversion option on -- -- -- -- -- 9,914,268
convertible Preferred Stock
Series A Preferred Stock -- -- 876,491 2,440,267 -- 9,250
Accretion of dividends on Series A -- -- -- -- -- (2,427,767)
Preferred Stock
Dividends accrued on Preferred Stock -- -- -- -- -- (702,693)
Net loss for the period -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------
Balances at September 30, 2004 3,581,352 $ 35,814 876,491 $ 2,440,267 $-0- $ 96,790,924
============ ============ ============ ============ ============ ============
Treasury Accumulated
Stock Deficit
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Balances at December 31, 2003 $ -- $(90,396,781)
Issuance of common stock to acquire -- --
nReach, Inc.
Issuance of common stock related to -- --
financing
Issuance of common stock to vendor -- --
to satisfy debt
Issuance of warrants as compensation -- --
for services
Issuance of warrants related to -- --
financing
Issuance of warrants to vendor to -- --
satisfy debt
Issuance of common stock pursuant to
an antidilution provision of a May
2000 stock purchase agreement
Treasury stock shares returned in (163,653) --
settlement of note receivable from
former officers
Allowance for uncollectibliity of
loan to former officer
Beneficial conversion option on -- --
convertible Preferred Stock
Series A Preferred Stock -- --
Accretion of dividends on Series A -- --
Preferred Stock
Dividends accrued on Preferred Stock -- --
Net loss for the period -- (6,336,819)
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Balances at September 30, 2004 $ (163,653) $(96,733,600)
============ ============
See accompanying notes.
5
SmartServ Online, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Nine Months
Ended September 30 Ended September 30
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2004 2003 2004 2003
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Operating Activities
Net loss $ (1,120,416) $ (7,640,869) $ (6,336,819) $(14,365,927)
Adjustments to reconcile net loss to net cash used
for operating activities:
Gain from extinguishment of debt -- -- -- (305,822)
Depreciation and amortization 31,907 -- 31,907 2,462,445
Noncash compensation costs -- 229,124 761,280 331,068
Noncash consulting services -- -- 447,859 --
Noncash payments to vendors -- -- 223,099 --
Amortization of deferred compensation (639,107) -- -- --
Amortization of deferred revenues -- (57,567) -- (391,828)
Amortization of deferred financing costs -- 6,297,577 1,231,772 7,391,278
Provision for losses on loans to former officers 91,872 (44,551) 91,872 354,471
Changes in operating assets and liabilities
Accounts receivable (5,742) (29,984) 8,471 (39,751)
Accrued interest receivable -- (2,453) 47,004 3,654
Prepaid expenses 18,315 54,982 22,827 32,403
Prepaid compensation -- -- 133,127 --
Accounts payable and accrued liabilities 355,934 431,757 (568,815) 1,138,236
Deferred revenues -- 30,000 (37,500) 248,000
Security deposit -- 75,374 (11,212) 113,333
------------ ------------ ------------ ------------
Net cash used for operating activities (1,267,237) (656,610) (3,955,128) (3,028,440)
------------ ------------ ------------ ------------
Investing Activities
Purchase of equipment (26,153) -- (117,346) --
Purchase of nReach, Inc. -- -- (100,000) --
------------ ------------ ------------ ------------
Net cash used for investing activities (26,153) -- (217,346) --
------------ ------------ ------------ ------------
Financing Activities
Proceeds from the issuance of series A convertible
preferred stock and warrants - net -- -- 8,591,275 --
Proceeds from the issuance of notes and warrants -- 522,000 -- 3,059,500
Proceeds from the issuance of common stock -- -- -- 385,544
Repayment of notes payable and accrued interest -- -- (1,391,504) (295,000)
Notes payable (8,105) -- 58,820 --
------------ ------------ ------------ ------------
Net cash provided by financing activities (8,105) 522,000 7,258,591 3,150,044
------------ ------------ ------------ ------------
(Decrease) increase in cash (1,301,495) (134,610) 3,086,117 121,604
Cash - beginning of period 4,526,790 410,973 139,178 154,759
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Cash - end of period $ 3,225,295 $ 276,363 $ 3,225,295 $ 276,363
============ ============ ============ ============
See accompanying notes.
6
SmartServ Online, Inc.
Notes to Unaudited Consolidated Financial Statements
September 30, 2004
1. Nature of Business
SmartServ Online, Inc. (the "Company" or "SmartServ") designs, develops and
distributes software and services that enable the delivery to wireless devices
of various content, with special emphasis on cell phones. The content which the
Company provides includes premium content such as ringtones, images and games,
and dynamic changing content such as horoscopes, lottery results and weather
reports. Historically, the Company has licensed its applications, content and
related services to wireless carriers and enterprises. The Company has revenue
sharing license agreements with wireless carriers such as Verizon Wireless, AT&T
Wireless, Nextel and ALLTEL Wireless, that allow it to deliver its services and
branded content to a wide base of consumer cell phone users. For enterprises,
the Company has in the past offered solutions that deliver financial market
data, proprietary internal documents and other useful information to mobile
workers, although this no longer comprises a core part of the Company's business
or strategy.
To augment our capabilities, we acquired Colorado based nReach, Inc. on February
28, 2004 in exchange for 500,002 shares of our common stock, provided, if the
value of such 500,002 shares immediately prior to June 1, 2004 were less than
$900,000, we would issue up to 299,167 additional shares of our common stock
with respect to such difference in value. The value at such time was greater
than $900,000 and no additional shares were issued. We also agreed to an earnout
schedule to pay up to an additional 916,667 shares of our common stock in the
event we reach certain revenue targets within five fiscal quarters following the
closing of this transaction at the rate of one share of our common stock for
every dollar of our revenue in excess of $2,700,000 (the "Earnout Trigger")
during such five fiscal quarters. In addition to the liabilities set forth in
the financial statements of nReach, we assumed (i) ordinary course liabilities
since November 30, 2003, (ii) taxes accrued on earnings since December 31, 2002
which were not yet due and payable as of the closing date, (iii) expenses
incurred to accountants and attorneys in the transaction not to exceed $25,000,
and (iv) short term borrowings up to $75,000 due to an nReach shareholder.
nReach is a wireless content distribution company that offers a broad portfolio
of popular mass-market cell phone content, including ringtones, games, and
on-device images both direct to the consumer and through wireless carriers.
During July 2004, we signed a non-binding letter of intent to acquire KPCCD,
Inc., a New York City-based distributor of international prepaid calling cards.
Founded in 1998, KPCCD distributes international prepaid calling cards through a
network of hundreds of retail outlets along the East Coast. We believe that the
acquisition of KPCCD will expand our existing distribution network for our
wireless products, services and mobile content. Based on unaudited financial
information provided by KPCCD, the acquisition of KPCCD is expected to add as
much as approximately $2 million in monthly revenue. We have not completed
financial, accounting and legal due diligence with respect to KPCCD and its
financial results and operations. We plan to conduct our review and
investigation prior to closing of this transaction. The closing of this
transaction is subject to customary closing conditions for these types of
transactions, including: (i) negotiation and execution of a definitive purchase
agreement, (ii) our satisfaction with the results of our due diligence
investigation of KPCCD, and (iii) execution of employment agreements with key
individuals in KPCCD. There can be no assurance we will agree with KPCCD and its
key individuals on the terms and conditions of the purchase agreement and
employment agreements or that we will be satisfied with our due diligence
investigation of KPCCD.
We signed an agreement with Sprint during November, 2004 allowing us to purchase
cellular airtime on Sprint's national wireless network, which cellular airtime
we plan to resell to wireless customers. The agreement has a term of five years.
This will allow us to enter the prepaid wireless marketplace, including the
offer of prepaid wireless plans, and to bundle such plans with content such as
ring tones, images and games. We expect that revenues will commence during the
first quarter of 2005 from such reselling.
7
The Company has since its inception earned limited revenues and incurred
substantial recurring operating losses, including net losses of $6,336,819 for
the nine month period ended September 30, 2004 and $17,537,775 and $8,037,173
for the years ended December 31, 2003 and December 31, 2002, respectively.
Additionally, the Company had an accumulated deficit of $96,733,600 and
$90,396,781 at September 30, 2004 and December 31, 2003, respectively.
The Company began in 2002 and continued during 2003 to reduce its cost structure
through the termination of personnel and the relocation of its headquarters to
Plymouth Meeting, Pennsylvania. Personnel headcount was reduced from 66 in May
2002 to the level of 15 as of September 30, 2004. These efforts have reduced the
Company's average monthly operating expenses from approximately $1,090,000 in
July 2002 to approximately $433,000 as of September 2004, excluding noncash
stock compensation, depreciation and amortization.. Monthly operating expenses
increased to approximately $433,000 as of September 2004 from approximately
$370,000 per month earlier in the year due to the working capital requirements
of the business of nReach, as well as related to expansion of marketing and
business development efforts for all of the Company's products and services and
increased corporate overhead.
In February 2004, the Company received $10 million in gross proceeds from its
private placement of Units consisting of shares of Series A Convertible
Preferred Stock and warrants to purchase common stock. The Company has used the
net proceeds of approximately $8,600,000 from this offering to repay outstanding
obligations, including $1,391,500 that was used to repay Global Capital Funding
Group, LP, completion of a strategic acquisition and for general working capital
purposes. In particular, the Company used a significant portion of its working
capital to settle its accounts payable, which accounts payable were
approximately $1,278,000 and $1,700,000 as of September 30, 2004 and December
31, 2003, respectively.
As a result of the factors identified above, the Company believes it has
sufficient capital for approximately the next six to nine months. The Company
anticipates that it will require working capital for its proposed acquisition
and to launch into the prepaid wireless market. However, no assurance can be
given that the Company will be able meet its revenue and cash flow 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 likely be forced to seek a strategic buyer, a merger
or cease operations.
The Company is incorporated in the State of Delaware. The Company commenced
operations in August 1993, and had its initial public offering in March 1996.
The Company completed a one-for-six reverse stock split effective November 25,
2003. Unless otherwise noted, descriptions of shareholdings and convertible
securities reflect such one-for-six reverse stock split.
2. Summary of Significant Accounting Policies
Basis of Presentation
- ---------------------
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States.
Principles of Consolidation
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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
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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.
8
Revenue Recognition
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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 Certain
Transactions", and the SEC Staff Accounting Bulletin No.104, "Revenue
Recognition". Specifically, there must be (1) evidence of an arrangement, (2)
delivery of the Company's 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
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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
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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
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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
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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
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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.
9
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.
Fair Value of Financial Instruments
- -----------------------------------
The carrying amounts of our financial instruments approximate fair value due to
their terms and maturities.
Supplemental Cash Flow Information
- ----------------------------------
The Company considers all highly liquid investments with a maturity date of
three months or less when purchased to be cash equivalents.
During the quarter ended September 30, 2004, the Company issued 9,445 shares of
common stock to Spencer Trask as finders fees related to the recent bridge
financings and 667,330 shares to TecCapital Ltd. pursuant to an antidilution
provision of a May 2000 stock purchase agreement related to the recent
financings. The issuance of shares of common stock is considered a non-cash
transaction for the purposes of the Statement of Cash Flows.
In connection with engaging a vendor to provide investor relation services, in
May 2004 we entered into an agreement to grant a warrant to purchase 50,000
shares of common stock at $2.15 per share. If issued the warrant would expire in
May of 2006. This warrant is valued at $107,657 and is considered a non-cash
transaction for the purposes of the Statement of Cash Flows.
In connection with Alpine Capital's claim for a finder's fee in connection with
the April 2003 amendment related to bridge financing, Alpine received a warrant
in July 2004 to purchase 40,000 shares of common stock at $1.50 per share
expiring July 8, 2009. This warrant is valued at $72,128 and is considered a
non-cash transaction for the purposes of the Statement of Cash Flows.
In connection with payment to a vendor to provide recruiting services in June
2004 we entered into an agreement to grant a warrant to purchase 5,000 shares of
common stock at $3.10 per share. The warrant expires in May of 2006. This
warrant is valued at $7,377 and is considered a non-cash transaction for the
purposes of the Statement of Cash Flows.
In connection with consulting services to be provided by Shai Stern, M. Ezzat
Jalled and E. Alan Scheik III, we entered into consulting agreements dated June
2004 for warrants to purchase 25,000, 100,000 and 10,000 shares of common stock
at $1.50, $1.50 and $2.50 per share, respectively and expiring in May 2006.
These warrants are valued at $45,080, $180,321 and $15,782, respectively and are
considered non-cash transactions for the purposes of the Statement of Cash
Flows.
In connection with settling a debt with a law firm, in April 2004 we granted a
warrant to purchase 1,820 shares of common stock at $3.15 per share. The warrant
expires in April of 2006. This warrant is valued at $3,730 and is considered a
non-cash transaction for the purposes of the Statement of Cash Flows.
During the quarter ended June 30, 2004, the Company issued 83,275 shares of
common stock amounting to $275,006 to Spencer Trask and Richard Berland as
finders fees for the recent bridge financings. The issuance of shares of common
stock is considered a non-cash transaction for the purposes of the Statement of
Cash Flows.
During the quarter ended March 31, 2004, the Company issued 60,000 shares of
common stock amounting to $196,800 and a cash payment of $45,000 to a vendor in
settlement of the Company's obligation to that vendor. The issuance of shares of
common stock is considered a non-cash transaction for the purposes of the
Statement of Cash Flows.
10
During the quarter ended March 31, 2004, the Company issued 500,002 shares of
common stock amounting to $1,640,007 for the acquisition of the issued and
outstanding common stock of nReach, Inc. The issuance of shares of common stock
is considered a non-cash transaction for the purposes of the Statement of Cash
Flows.
During the quarter ended March 31, 2004, the Company converted notes payable and
accrued interest amounting to $3,122,302 into Series A convertible preferred
stock and warrants. This conversion is considered a non-cash transaction 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, 2004 and 2003 were $6,118 and $-0-and for the nine
months periods ended September 30, 2004 and 2003 were $23,321 and $-0-,
respectively.
Concentration of Credit Risk
- ----------------------------
Financial instruments that potentially subject SmartServ to concentrations of
credit risk consist solely of accounts receivable. At September 30, 2004 and
December 31, 2003, accounts receivable consist 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. As of
September 30, 2004, the Company provided a reserve for doubtful accounts of
$35,200. As of December 31, 2003, the Company did not have a reserve for
doubtful accounts.
Property and Equipment
- ----------------------
Property and equipment are stated at cost, net of accumulated depreciation.
Equipment purchased under a capital lease is recorded at the present value of
the future minimum lease payments at the date of acquisition. Depreciation is
computed using the straight-line method over estimated useful lives of three to
ten years.
On an ongoing basis, SmartServ 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.
Advertising Costs
- -----------------
Advertising costs are expensed as incurred and were approximately $4,200 and
$6,000 during the nine month periods ended September 30, 2004 and 2003,
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.
11
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, 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. The adoption of
these disclosure provisions had no impact on the Company's 2003 or first, second
and third quarter of 2004 consolidated results of operations, financial position
or cash flows.
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 income (loss) and earnings (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 earnings (loss) and earnings (loss) per share are not indicative of future
years.
SmartServ's pro forma information is as follows:
Three Months Nine Months
Ended September 30 Ended September 30
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net loss $ (1,120,416) $ (7,640,869) $ (6,336,819) $(14,365,927)
Employee stock-based
compcompensation included in net loss (639,107) -- -- 1,323
Employee stock-based
compcompensation pursuant to SFAS
123/SFAS 148 (605,787) (173,324) (1,317,436) (1,761,477)
------------ ------------ ------------ ------------
Pro forma net loss $ (2,365,310) $ (7,814,193) $ (7,654,255) $(16,126,081)
============ ============ ============ ============
Basic and diluted loss per share $ (0.74) $ (3.69) $ (3.41) $ (7.15)
============ ============ ============ ============
Pro forma basic and diluted loss
per share $ (0.79) $ (3.77) $ (2.76) $ (8.02)
============ ============ ============ ============
12
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.
3. Property and Equipment
Property and equipment consist of the following:
September 30, December 31,
2004 2003
------------ ------------
Data processing equipment $ 4,620,680 $ 4,594,526
Office furniture and equipment 427,142 397,474
Display equipment 144,429 71,335
Leasehold improvements 69,852 69,852
------------ ------------
5,262,102 5,133,187
Impairment of capital assets (843,768) (843,768)
Accumulated depreciation (4,321,326) (4,289,419)
------------ ------------
$ 97,008 $ --
============ ============
4. Note Receivable From Former Officers
In December 2000, the Company's Board of Directors authorized the issuance of a
line of credit to Sebastian Cassetta, SmartServ's former Chief Executive
Officer, for an amount not to exceed $500,000. Such amount bore interest at the
prime rate and matured on March 20, 2004. Pursuant to the terms of the note,
interest for the period January 2, 2001 to June 30, 2002 had been accrued and
was payable at maturity. Commencing July 1, 2002 until maturity, interest was
payable semi-annually in arrears on January 1st and July 1st. In October 2003
the Company agreed to forgive this loan over a three-year period pursuant to Mr.
Cassetta's Separation Agreement.
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. Such reserve is classified as a reduction of stockholders'
equity. While this loan had original maturity date of December 2003, Mr.
Cassetta's ability to repay this loan and interest thereon is highly contingent
on the market value of his investment in the Company. In his separation
agreement in October 2003, the Company extended the maturity date of the
restricted stock note until September 2004. During the quarter ended September
30, 2004 an additional valuation allowance of $91,872 was provided in connection
with the potential uncollectibility of such loan from Mr. Cassetta and all
94,706 shares of stock, which were pledged as collateral, for the note were
assigned and transferred to the Company and the outstanding debt and accrued
interest of $569,670 in the aggregate was cancelled.
The Company's former Chief Technology Officer, Mario Rossi, was the obligor on a
promissory note made in favor of the Company with respect to the purchase of
34,347 shares of Company common stock, which were pledged as collateral for the
note. In January 2004, as part of his separation agreement, all shares of stock
were assigned and transferred to the Company and the outstanding debt of $68,000
was cancelled.
13
5. Notes Payable
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 bore interest at the rate of 10% per annum, and was secured by the
Company's assets, exclusive of its internally developed software products. The
note matured on February 14, 2004, contained certain antidilution provisions,
and was convertible 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 issued to Global contains certain antidilution provisions and
expires on February 14, 2006. 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 in connection with this transaction. These warrants have been valued in
accordance with SFAS No. 123 and the Black-Scholes pricing methodology and
recorded in the financial statements as deferred compensation costs. This amount
is being amortized into operations on a straight-line basis 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 $304,772 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. During the quarter ending June 30,
2003, the Company recorded a non-cash charge of $101,600 representing the
amortization of the remainder of such beneficial conversion feature. 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. In settlement of Alpine's claim
for a finder's fee in connection with the April 2003 amendment, during July 2004
Alpine received a warrant to purchase 40,000 shares of common stock at $1.50 per
share expiring July 8, 2009. In November 2003, as an inducement to obtain
Global's consent to the sale of Units in the November 2003 transaction and the
2004 private placement, the Company issued Global a warrant to purchase 16,667
shares of common stock at an exercise price of $2.40 per share. On February 13,
2004, SmartServ paid in full the principal and accrued interest due under the
Global note, which was $1,391,504.
Between May and November 2003 the Company sold Units consisting of convertible
debentures and warrants to purchase common stock for $3 million in aggregate
proceeds. During February 2004, SmartServ completed a private placement of Units
for $10 million in aggregate gross proceeds, which Units consisted of Series A
Convertible Preferred Stock, $.01 par value ("Series A") and warrants to
purchase common stock. Pursuant to their terms, the principal and accrued
interest on SmartServ's convertible debentures issued in the May through
November 2003 transactions, which was approximately $3,122,302, were
automatically converted into these Units. Each Unit consisted of one share of
Series A initially convertible into ten shares of common stock and one warrant
for the purchase of ten shares of common stock. The purchase price per Unit was
$15.00. The Series A is described in more detail below under note 6 to the
financial statements.
As of December 31, 2003 the amount of the Company's debt obligations were
$4,250,010 and the unamortized discount amounted to $909,580.
As of March 31, 2004 all of the Company's debt obligations were paid in full or
converted to Series A as described above.
During the quarter ended June 30, 2004, the Company entered into a note payable
to finance kiosk equipment in the amount of $70,000. The note bears interest at
a rate of five percent per annum and has a two year term.
14
6. Equity Transactions
In February 2004, the Company completed the closing of a $10 million private
offering of investment Units consisting of shares of Series A and warrants to
purchase common stock ("2004 Private Placement"). The private offering consisted
of investment Units at the price of $15 per Unit. Each Unit consists of (i) one
share of Series A, each of which is initially convertible into 10 shares of
common stock, and (ii) one warrant for the purchase of 10 shares of common
stock. The Series A receives dividends at the rate of 8% per year payable
quarterly in cash or, in our sole discretion, in registered shares of our common
stock. The Series A is entitled to a liquidation preference equal to the
purchase price per Unit plus accrued and unpaid dividends. The Series A is not
redeemable. The warrants have an exercise price of $2.82 per share and expire in
February 2007. The Company is obligated to register the common stock underlying
the Series A and the warrants. Holders of the Series A have an optional right to
convert to fully paid and non-assessable shares of common stock on a one-for-ten
basis (subject to adjustment) at any time prior to the third anniversary date of
the final closing date of February 27, 2004 (the "Mandatory Conversion Date").
The Series A will be automatically converted into common stock on a one-for-ten
basis (subject to adjustment) upon the earliest of (i) the Mandatory Conversion
Date; or (ii) if, after two years from the date of the final closing date of
February 27, 2004, the common stock has a closing sale price of $4.00 or more
for twenty (20) consecutive trading days. The Company also completed the closing
of an additional $25,000 private offering of these Units to an accredited
investor in March 2004, which Units have the same terms as described above other
than the expiration date which will be March 2007. The Company has used and
expects to use the net proceeds of approximately $8,600,000 from this offering
for repayment of outstanding obligations (including $1,391,500 that was used to
repay Global), completion of strategic acquisitions and general working capital.
Pursuant to their terms, the principal and accrued interest on SmartServ's
convertible debentures issued in the May through November 2003 transactions,
which was approximately $3,122,302, were also automatically converted into the
Units issued in the 2004 Private Placement.
Spencer Trask Ventures, Inc. ("Spencer Trask") received warrants to purchase
1,336,666 shares of common stock at $1.50 per share and warrants to purchase
1,336,666 shares of common stock at $2.82 per share as partial compensation for
being the placement agent for the 2004 Private Placement.
SmartServ acquired all of the stock of nReach, Inc. on February 28, 2004 in
exchange for 500,002 shares of its common stock; provided, if the value of such
500,002 shares immediately prior to June 1, 2004 is less than $900,000,
SmartServ will issue up to 299,167 additional shares of its common stock with
respect to such difference in value. The value of such 500,002 shares was in
excess of $900,000 immediately prior to June 1, 2004 and, therefore, SmartServ
will not issue any additional shares of its common stock. The nReach
shareholders may also earn up to 916,667 shares of our common stock in the event
SmartServ reaches certain revenue targets within five fiscal quarters following
the closing of this transaction at the rate of one share of common stock for
every one dollar of SmartServ revenue in excess of $2,700,000 (the "Earnout
Trigger") during such five fiscal quarters.
Pursuant to a Restricted Stock Agreement dated December 28, 1998, the Company
received a promissory note in the original principal amount of $457,497 from
Sebastian E. Cassetta, its former Chairman and Chief Executive Officer, for his
purchase of restricted shares of common stock. As of June 30, 2004, the balance
due of such note was $187,525, after recording of a valuation allowance in
connection with the potential uncollectibility of such note from Mr. Cassetta.
As of September 30, 2004 the balance of such note was $-0- after recording of an
additional valuation allowance of $91,872, in connection with the potential
uncollectibility of such note from Mr. Cassetta and recording the receipt of
treasury stock after all 94,706 shares of stock, which were pledged as
collateral for the note. Such shares were assigned and transferred to the
Company and the outstanding debt and accrued interest of $569,670 in the
aggregate was cancelled.
During the quarter ended March 31, 2004, the Company issued 60,000 shares of
common stock and a cash payment of $45,000 to a vendor in settlement of the
Company's obligation to that vendor.
15
During the quarter ended June 30, 2004, the Company issued 83,275 shares of
common stock amounting to $275,006 to Spencer Trask and Richard Berland as
finders fees for the recent financings.
During the quarter ended September 30, 2004, the Company issued 9,445 shares of
common stock to Spencer Trask as finders fees related to the recent bridge
financings and 667,330 shares to TecCapital Ltd. pursuant to an antidilution
provision of a May 2000 stock purchase agreement related to the recent
financings.
Obligations to Maintain Effective Registration Statements:
- ----------------------------------------------------------
Vertical Ventures Investments, LLC holds a warrant to purchase up to 22,476
shares of common stock that is subject to registration rights. The Registration
Statement covering the shares underlying this warrant is no longer effective.
The Company had until May 14, 2003 to cause the Registration Statement to again
become effective. The Company failed to do so by May 14, 2003, and Vertical
Ventures is demanding 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.
Accredited investors in the Company's September 2002 Equity Placement acquired
warrants to purchase up to an aggregate of 249,954 shares of common stock, all
subject to registration rights requiring the Company to use its commercially
reasonable best efforts to maintain the effectiveness of the Registration
Statement covering the shares underlying the warrants. The Registration
Statement covering these securities is no longer effective.
Obligation to File a Registration Statement:
- --------------------------------------------
Global Capital Funding Group, L.P. holds warrants to purchase up to 257,333
shares of common stock. The Company was required to file a Registration
Statement covering all such shares by April 14, 2003. The Company negotiated a
cure of the penalty fee, equal to $25,000 for each month that this deficiency
remained uncured, by paying off the convertible note in February 2004. The
Company filed a Form SB-2 Registration Statement on May 13, 2004 that covered
the common stock underlying the Global warrants which Registration Statement has
not yet been declared effective by the SEC.
Pursuant to the terms of the 2004 Private Placement, the Company was required to
file a Registration Statement with the SEC and have it declared effective no
later than 120 days after April 30, 2004, or by August 29, 2004. The
Registration Statement was filed on May 13, 2004 but it has not yet been
declared effective by the SEC and as a result, the Company incurred liquidated
damages in the form of a monthly cash requirement equal to 2% of the aggregate
purchase price of the offering, or approximately $266,000 per month. Liquidated
damages are due monthly until the event of default is cured. The Company accrued
approximately $529,000 for liquidated damages and interest in the quarter ended
September 30, 2004. The Company is seeking a settlement to limit the liquidated
damages. The proposed settlement seeks to establish a pool of 1,000,000 warrants
with an exercise price of $2.50 and a two year term. The pool would be allocated
to each participant based on the investor's proportionate participation in the
2004 Private Placement. There can be no assurance that the Company will be
successful in obtaining and enforcing such settlement.
7. Stock-based Compensation
In connection with the grant of certain stock options, warrants and other
compensation arrangements, the Company has recorded charges and credits 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.
In connection with entering into an Employment Agreement with the Company on
March 12, 2004, the Company granted to Robert Pons, the Company's President and
Chief Executive Officer, an option to purchase 1,300,000 shares of common stock,
which option has an exercise price of $1.50 per share and a term of 10 years.
The option provides for 557,141 shares to vest immediately and the remaining
742,859 shares to vest in equal amounts as of the last day of each calendar
quarter commencing March 31, 2004. The option will vest immediately upon a
Change of Control (as defined in his option agreement) or in the event Mr. Pons
is terminated Other Than for Cause or he terminates employment for Good Reason
(as each is defined under the Employment Agreement).
16
In connection with entering into an Employment Agreement with the Company on
March 12, 2004, the Company granted to Tim Wenhold, the Company's Executive Vice
President and Chief Operating Officer, an option to purchase 700,000 shares of
common stock, which option has an exercise price of $1.50 per share and a term
of 10 years. The option provides for 300,000 shares to vest immediately and the
remaining 400,000 shares to vest in equal amounts as of the last day of each
calendar quarter commencing March 31, 2004. The option will vest immediately
upon a Change of Control (as defined in his option agreement) or in the event
Mr. Wenhold is terminated Other Than for Cause or he terminates employment for
Good Reason (as each is defined under the Employment Agreement)
In April 2004, the Company granted to Len von Vital, Matthew Stecker and Daniel
Wainfan, the Company's Chief Financial Officer, Chief Technology Officer and
Vice President of Marketing, respectively, each an option to purchase 300,000,
150,000 and 100,000 shares of common stock, respectively, which options have an
exercise prices of $3.75, $1.50 and $3.25 per share respectively, and a term of
10 years. The options vest in equal amounts over four years as of the last day
of each calendar quarter commencing September 30, 2004. The options will vest
immediately upon a Change of Control (as defined in their option agreements).
In August 2004, the Company granted options to each of the three non- employee
directors pursuant to the Company's non-employee director compensation plan to
purchase 60,000 shares of common stock, which options have exercise prices of
$1.75 per share and a term of 10 years. The options vest in equal amounts as of
the last day of each calendar quarter commencing September 30, 2004. The options
will vest immediately upon a Change of Control (as defined in their option
agreements). See Note 10 Subsequent Events for additional information.
Stock-based compensation for the three months and nine months ended September
30, 2004 was for the impact of options granted at less than fair market value on
the measurement date and for the three months and nine months ended September
30, 2003 consisted primarily 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 prior
issuance of warrants to purchase common stock to various consultants.
The following table illustrates the amount of stock-based compensation charges
that would have been recorded in the categories of the statement of operations
had stock-based compensation not been separately stated therein:
Three Months Nine Months
Ended September 30 Ended September 30
------------------------ -----------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Costs of services $ 231,001 $ (74,750) $ -- $ (74,353)
General and administrative expenses 408,106 (154,374) -- (256,715)
---------- ---------- ---------- ----------
$ 639,107 $ (229,124) $ -- $ (331,068)
========== ========== ========== ==========
17
8. Earnings Per Share
The following table sets forth the computation of basic and diluted loss per
share:
Three Months Nine Months
Ended September 30 Ended September 30
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Numerator:
Net loss $ (2,234,782) $ (7,640,869) $ (9,467,279) $(14,365,927)
============ ============ ============ ============
Denominator:
Weighted average shares - basic and diluted 3,002,167 2,072,440 2,773,669 2,010,142
============ ============ ============ ============
Basic and diluted loss per common share $ (0.74) $ (3.69) $ (3.41) $ (7.15)
============ ============ ============ ============
Outstanding stock options and warrants to purchase an aggregate of 19,210,239
and 903,264 shares of common stock at September 30, 2004 and 2003, respectively,
were not included in the computations of diluted earnings per share because the
Company reported losses for the periods and, therefore their inclusion would be
antidilutive.
9. Commitments and Contingencies
During the quarter ended March 31, 2004, the Company issued 60,000 shares of
common stock amounting to $196,800 and a cash payment of $45,000 to a vendor in
settlement of the Company's obligation to that vendor.
On or about March 22, 2004, Jenkens & Gilchrist Parker Chapin, LLP, SmartServ's
former legal counsel, filed a complaint against SmantServ in the Supreme Court
of the State of New York, County of New York. The complaint seeks payment of
unpaid invoices for legal services in the amount of $599,244. While the Company
intends to vigorously defend such lawsuit, an unfavorable outcome would have a
material adverse effect on the Company's financial condition, results of
operation and cash flows.
On or about August 17, 2004, Vertical Ventures Investments LLC filed a complaint
against the Company in the Supreme Court of the State of New York, County of New
York. The complaint seeks payment of late registration penalties and attorneys
fees in the total amount of $350,000. While the Company intends to vigorously
defend such lawsuit, an unfavorable outcome would have a material adverse effect
on the Company's financial condition, results of operation and cash flows.
10. Subsequent Events
We signed an agreement with Sprint during November, 2004 allowing us to purchase
cellular airtime on Sprint's national wireless network, which cellular airtime
we plan to resell to wireless customers. The agreement has a term of five years.
This will allow us to enter the prepaid wireless marketplace, including the
offer of prepaid wireless plans, and to bundle such plans with content such as
ring tones, images and games. We expect that revenues will commence during the
first quarter of 2005 from such reselling.
Also in November 2004, the Company retained the investment banking firm
Jefferies & Company, Inc. to advise the Company's management on strategic growth
opportunities, financing and capital resources and significant merger and
acquisition candidates.
18
In August 2004, the Company granted options to each of three non- employee
directors pursuant to the Company's non-employee director compensation plan to
purchase 60,000 shares of common stock, which options had an exercise prices of
$1.75 per share and a term of 10 years. The options vest in equal amounts as of
the last day of each calendar quarter commencing September 30, 2004. In October
2004, the three non-employee directors resigned their respective directorships
and they received immediate vesting of 35,000 options to purchase common stock
and the balance of the options were cancelled.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis of our financial condition and results of
operations contain certain "forward-looking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. Actual results could
differ materially from those anticipated in these forward-looking statements for
many reasons, including the factors described in "Certain Factors That May
Affect Future Results" and elsewhere in this report. As used herein, the terms
"we", "us", "our" and the "Company" refer to SmartServ Online, Inc. and its
subsidiaries.
We design, develop and distribute software and services that enable the delivery
to wireless devices of various content, with special emphasis on cell phones.
The content that we provide includes premium content such as ringtones, images
and games, and dynamic changing content such as horoscopes, lottery results and
weather reports. Historically, we have licensed our applications, content and
related services to wireless carriers and enterprises. We have revenue sharing
license agreements with wireless carriers such as Verizon Wireless, AT&T
Wireless, Nextel and ALLTEL Wireless, that allow us to deliver our services and
branded content to a wide base of consumer cell phone users. For enterprises, we
have in the past offered solutions that deliver financial market data,
proprietary internal documents and other useful information to mobile workers,
although this no longer comprises a core part of our business or strategy.
We have since our inception earned limited revenues and incurred substantial
recurring operating losses, including net losses of $6,336,819 for the nine
month period ended September 30, 2004, and $17,537,775 and $8,037,173 for the
years ended December 31, 2003 and 2002, respectively. Additionally, we had an
accumulated deficit of $96,733,600 and $90,396,781 at September 30, 2004 and
December 31, 2003, respectively.
In February 2004, we completed the closing of a $10 million private offering of
investment Units consisting of shares of Series A Convertible Preferred Stock
and warrants to purchase common stock ("2004 Private Placement"). We also
completed the closing of an additional $25,000 private offering of these Units
to an accredited investor in March 2004. We have used the net proceeds of
approximately $8,600,000 from this offering for repayment of outstanding
obligations (including $1,391,500 that was used to repay Global Capital Funding
Group, LP), completion of a strategic acquisition and for general working
capital purposes. As a result of the factors identified above, the Company
believes it has sufficient capital for approximately the next six to nine
months. The Company anticipates that it will require working capital for its
proposed acquisition and to launch into the prepaid wireless market. However, no
assurance can be given that the Company will be able meet its revenue and cash
flow 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 likely be forced to seek a
strategic buyer, a merger or cease operations
We believe 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 appears to be moving from
differentiation based on network coverage or minute rates to one based on
enhanced features and services. We believe 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 us to exploit our current and planned content
assets and delivery capabilities, developed over the past nine years.
To augment our capabilities, we acquired the issued and outstanding common stock
of the Colorado based nReach, Inc. on February 28, 2004 in exchange for 500,002
shares of our common stock. We also agreed to an earnout schedule to pay up to
an additional 916,667 shares of our common stock in the event we reach certain
revenue targets within five fiscal quarters following the closing of this
transaction at the rate of one share of our common stock for every dollar of our
revenue in excess of $2,700,000 (the "Earnout Trigger") during such five fiscal
quarters. nReach, Inc., is a wireless content distribution company that offers a
broad portfolio of popular mass-market cell phone content, including ringtones,
games and on-device images.
20
We are building, through acquisition and through internal development, a wide
array of 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 content offered or to be offered through the
SmartServ platforms consists of:
o Premium content, such as ring tones, images and games, that are
periodically delivered and reside on the mobile device; and
o Dynamic mobile applications, where the information or data content is
frequently changing and therefore frequently delivered to the mobile
device.
While we expect to retain and grow our revenues derived through existing
channels, we believe that there is a substantial opportunity to grow additional
revenue through the bundling of our existing and planned future premium content
with voice services in ways targeted to specific segments of the consumer
market. Providing a set of products that bundle cell phone airtime with premium
content, such as ringtones, images and games, delivered through our current
technology infrastructure is how we plan to enter the emerging market for
reselling wireless airtime.
Our immediate focus will be on finding channels to market to specific segments
of consumers within the pre-paid wireless marketplace. The rapidly expanding
pre-paid market parallels the track taken a decade ago for pre-paid long
distance, but has an expanded reach since pre-paid wireless users can completely
avoid the monthly costs for a traditional home landline telephone.
We signed an agreement with Sprint during November, 2004 allowing us to purchase
cellular airtime on Sprint's national wireless network, which cellular airtime
we plan to resell to wireless customers. The agreement has a term of five years.
This will allow us to enter the prepaid wireless marketplace, including the
offer of prepaid wireless plans, and to bundle such plans with content such as
ring tones, images and games. We expect that revenues will commence during the
first quarter of 2005 from such reselling.
During July 2004, we signed a non-binding letter of intent to acquire KPCCD,
Inc., a New York City-based distributor of international prepaid calling cards.
Founded in 1998, KPCCD distributes international prepaid calling cards through a
network of hundreds of retail outlets along the East Coast. We believe that the
acquisition of KPCCD will expand our existing distribution network for our
wireless products, services and mobile content. Based on unaudited financial
information provided by KPCCD, the acquisition of KPCCD is expected to add as
much as approximately $2 million in monthly revenue. We have not completed
financial, accounting and legal due diligence with respect to KPCCD and its
financial results and operations. We plan to conduct our review and
investigation prior to closing of this transaction. The closing of this
transaction is subject to customary closing conditions for these types of
transactions, including: (i) negotiation and execution of a definitive purchase
agreement, (ii) our satisfaction with the results of our due diligence
investigation of KPCCD, and (iii) execution of employment agreements with key
individuals in KPCCD. There can be no assurance we will agree with KPCCD and its
key individuals on the terms and conditions of the purchase agreement and
employment agreements or that we will be satisfied with our due diligence
investigation of KPCCD.
While we believe that our new marketing strategies, as well as our carrier and
enterprise relationships are important to our success, no assurance can be given
that we will be able to implement our new marketing strategies or that our
carrier and enterprise relationships will be successful in their marketing
efforts or that our products and services will be well received in the
marketplace. We also performed certain development projects during 2004 that
enhanced our product offerings, including development of mobile lifestyle BREW
and J2ME applications.
21
On November 24, 2003, we announced that our new trading symbol on the OTC
Bulletin Board would be SSRV effective at market opening on November 25, 2003.
NASD assigned this new trading symbol in conjunction with our one-for-six
reverse stock split, which also took effect on November 25, 2003. Under the
reverse stock split, our outstanding shares of common stock prior to the reverse
split were exchanged for new shares of common stock at a ratio of one new share
for every six pre-split shares. All of our convertible securities, such as
convertible debentures, stock options and warrants, were also subject to the
reverse split. Our convertible securities are convertible or exercisable, as the
case may be, at six times the price for one-sixth the number of shares into
which such security was previously convertible or exercisable. All share amounts
of common stock and convertible securities reported in this Form 10-QSB are
adjusted for the split.
As of September 30, 2004, SmartServ employed 15 people, all of whom were
employed in the United States. All were full-time employees.
Results of Operations
Quarter ended September 30, 2004 versus Quarter ended September 30, 2003
During the quarter ended September 30, 2004, we recorded revenues of $80,474
substantially all of which were earned through our licensing agreement with
QUALCOMM. During the quarter ended September 30, 2003, we recorded revenues of
$145,130. Of such 2003 revenues, $61,100 were earned through our licensing
agreement with wireless telecommunications carriers and $84,000 were earned
through our licensing agreement with Salomon Smith Barney. During the quarters
ended September 30, 2004 and 2003, we recognized $-0- and $53,400, respectively,
from the amortization of deferred revenues.
During the quarter ended September 30, 2004, we incurred costs of services of
$644,762, an increase of 123% over the $289,055 incurred during the quarter
ended September 30, 2003. Such costs increased primarily due to development of a
new Company web-site. Components of the costs of service category consisted
primarily of information and communication costs ($64,586), personnel costs
($311,036), consulting expenses/web-site development ($205,336), facilities
($18,780) and travel costs ($8,273). Costs associated with the operations of
nReach, that are included in the categories listed above, were $207,172 for the
quarter ended September 30, 2004. During the quarter ended September 30, 2003,
we incurred costs of services of $289,055. Components of the costs of service
category consisted 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, 2004, we incurred sales and marketing
expenses of $156,705, an increase of 566% over the $23,543 incurred for the
quarter ended September 30, 2003. Such costs increased primarily due to the
hiring of a marketing executive and increased trade show expenses. Components of
the sales and marketing category consist primarily of personnel costs ($95,138)
and trade show costs ($48,348). During the quarter ended September 30, 2003, we
incurred sales and marketing expenses of $23,543. Components of the sales and
marketing category consisted primarily of personnel costs ($19,400).
During the quarter ended September 30, 2004, we incurred general and
administrative expenses of $506,308, a decrease of 29% over the quarter ended
September 30, 2003. Such expenses decreased primarily due to personnel
reductions, reductions in professional fees and reductions in facilities costs
related to the relocation of our headquarters from Stamford, Connecticut to
Plymouth Meeting, Pennsylvania. Components of the general and administrative
category consisted primarily of personnel costs ($161,060), consulting costs
($62,436), professional fees ($94,219), facilities ($16,097), a valuation
allowance in connection with the potential uncollectibility of a loan to a
former officer
22
($91,872), write-off of an uncollectible receivable ($35,200) and insurance
($20,000). These costs were partially offset by discounts negotiated with
vendors to settle outstanding accounts payable amounting to $50,366. During the
quarter ended September 30, 2003, we incurred general and administrative
expenses of $715,353. Components of the general and administrative category
consisted 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 2004, the net noncash credit for
stock-based compensation amounted to $639,107, compared to a net noncash charge
of $229,124 during the quarter ended September 30, 2003. Such noncash costs
decreased due to changes in the fair value of our common stock related to
variable accounting. Such noncash amounts are primarily related to the valuation
of stock-based compensation in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25") and
SFAS 123 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, and therefore, compensation expense is recognized
for changes in the fair value of our common stock. Of such amounts, noncash
charges for consulting services for the quarters ended September 30, 2004 and
2003 were $-0- and $118,000, 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.
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, 2004 and 2003 amounted to
$6,520 and $2,709 respectively. Such amounts were earned primarily from our
investments in money fund accounts. During the quarters ended September 30, 2004
and 2003, interest and other financing costs were $538,742 and $6,531,633
respectively. During the quarter ended September 30, 2004, interest and other
financing costs were incurred in connection with the $10 million private
offering of investment Units in the 2004 Private Placement. 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.
Basic and diluted loss per share was $0.74 for the quarter ended September 30,
2004 compared to $3.69 loss per share for the quarter ended September 30, 2003.
The loss per share for the quarter ended September 30, 2004 includes an accrued
preferred stock dividend of $1,114,366. The weighted average shares outstanding
increased to 3,002,167 at September 30, 2004 from 2,072,440 at September 30,
2003.
Nine Months ended September 30, 2004 versus Nine Months ended September 30, 2003
During the nine months ended September 30, 2004 and 2003, we recorded revenues
of $268,189 and $614,145 respectively. Of such 2004 revenues, substantially all
were earned through our licensing agreement with QUALCOMM Of such 2003 revenues,
$126,500 were earned through our licensing agreement with wireless
telecommunications carriers, $372,500 were earned through our licensing
agreement with Salomon Smith Barney and $108,000 were earned under a one-time
purchase order from Wireless Retail, Inc. During the nine months ended September
30, 2004 and 2003, we recognized $33,333 and $240,400, respectively, from the
amortization of deferred revenues.
During the nine months ended September 30, 2004, we incurred costs of services
of $1,626,357, a decrease of 60% over the nine months ended September 30, 2003.
Such costs decreased primarily due to reductions in US personnel, the reduction
of computer depreciation and maintenance and the reduction of consulting costs
incurred in connection with the development of our systems' architecture and
application platform. Components of the costs of service category consist
primarily of costs associated with information and communication costs
($272,306), personnel costs ($808,072), consulting expenses/web-site development
($390,334) and facilities ($29,383). Costs associated with the operations of
nReach, that are included in the categories listed above, were $668,429 for the
seven months since the acquisition during the nine months ended September 30,
2004. During the nine months ended September 30, 2003, we incurred costs of
services of $4,080,429. Such costs include information and communication costs
($330,800), personnel costs
23
($1,225,000), computer hardware leases, depreciation and maintenance costs
($593,000), facilities ($186,100) and 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 to net realizable value.
During the nine months ended September 30, 2004, we incurred sales and marketing
expenses of $298,925, a decrease of 26% over the nine months ended September 30,
2003. Such costs decreased primarily due to US personnel reductions, reductions
in travel and reductions in advertising and trade shows. Components of the sales
and marketing category consist primarily of personnel costs ($165,098),
consulting ($15,556), trade show costs ($70,892), travel ($12,080) and public
relations costs ($34,324). During the nine months ended September 30, 2003, we
incurred sales and marketing expenses of $403,573. Components of the costs of
the sales and marketing category consisted 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, 2004, we incurred general and
administrative expenses of $1,871,442 a decrease of 39% over the nine months
ended September 30, 2003. Such expenses decreased primarily due to personnel
reductions, reductions in professional fees and reductions in facilities costs
related to the relocation of our headquarters from Stamford, Connecticut to
Plymouth Meeting, Pennsylvania. Components of the general and administrative
category consist primarily of personnel costs ($428,115), consulting fees
($816,338), professional fees ($512,405), facilities ($63,092) insurance
($73,671), a valuation allowance in connection with the potential
uncollectibility of a loan to a former officer ($91,872) and the write-off of an
uncollectible receivable ($35,200). These costs were partially offset by
discounts negotiated with vendors to settle outstanding accounts payable
amounting to $336,048. During the nine months ended September 30, 2003, we
incurred general and administrative expenses of $3,075,446. Components of the
costs of the general and administrative category during the nine months ended
September 30, 2003 consisted 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) and 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, 2004, the net noncash charge for
stock-based compensation amounted to $-0- compared to a net noncash charge of
$331,068 during the nine months ended September 30, 2003. Such noncash costs
decreased due to the issuance and vesting of employee stock options to
management at a price that was less than the fair market value of our common
stock on the grant date. Such noncash amounts are primarily related to the
valuation of stock-based compensation in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25").
Certain 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. Of such amounts,
noncash charges for professional fees for the nine months ended September 30,
2004 and 2003 were $-0- and $221,200, respectively, resulting primarily from the
issuance of warrants to purchase common stock to financial, marketing and
investor relations consultants. Stock-based compensation is valued in accordance
with APB No. 25 and Statement No. 123. Certain employee stock options are
subject to 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 nine months ended September 30, 2004 and 2003 amounted
to $19,287 and $11,601 respectively. Such amounts were earned primarily from our
investments in money fund accounts. During the nine months ended September 30,
2004 and 2003, interest and other financing costs were $2,630,771 and
$7,781,029, respectively. During the nine months ended September 30, 2004 and
2003, interest and other financing costs were incurred primarily in connection
with the completion, in February 2004, of a $10 million private offering of
investment Units in the 2004 Private Placement and in connection with the
convertible notes issued in February, May, June and September 2003.
24
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 Hewlett-Packard Company. 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 $3.41 for the nine months ended September
30, 2004 compared to $7.15 loss per share for the nine months ended September
30, 2003. The weighted average shares outstanding increased to 2,773,669 at
September 30, 2004 from 2,010,142 at September 30, 2003.
Capital Resources and Liquidity
At September 30, 2004 and December 31, 2003, the Company had cash of $3,225,295
and $139,178, respectively. Net cash used in operations was $3,955,128 for the
nine months ended September 30, 2004 compared to $3,028,440 during the nine
months ended September 30, 2003. The primary reason for this increase was the
Company's reduction of its accounts payables through payment and negotiated
settlements with vendors.
In March 2004, we completed the acquisition of all of the outstanding stock of
nReach, Inc., based in Lakewood, Colorado, in exchange for 500,002 shares of our
common stock, the assumption and payment of $100,000 of certain obligations of
nReach's stockholders and an earn out schedule that may require our payment of
up to an additional 916,667 shares of common stock based on certain revenue
targets.
In February 2004, we completed the closing of a $10 million private offering of
investment Units consisting of shares of Series A Convertible Preferred Stock
and warrants to purchase common stock ("2004 Private Placement"). The private
offering consisted of investment Units at the price of $15 per Unit. Each Unit
consists of (i) one share of Series A convertible preferred stock, $.01 par
value, each of which is initially convertible into 10 shares of common stock,
and (ii) one warrant for the purchase of 10 shares of common stock. The Series A
receives dividends at the rate of 8% per year payable quarterly in cash or, in
our sole discretion, in registered shares of our common stock. The warrants have
an exercise price of $2.82 per share and expire in February 2007. We also
completed the closing of an additional $25,000 private offering of these Units
to an accredited investor in March 2004, which Units have the same terms as
described above other than the expiration date which will be March 2007. The
Series A is entitled to a liquidation preference equal to the purchase price per
Unit plus accrued and unpaid dividends. The Series A is not redeemable. Spencer
Trask, the placement agent for the 2004 Private Placement, received compensation
consisting of (i) a cash fee of $1,002,500, or 10% of the aggregate purchase
price of all of the Units acquired for cash, (ii) a non-accountable expense
allowance of $300,750, or 3% of the aggregate proceeds of all Units sold for
cash in the transaction, and (iii) 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 for cash, constituting in the aggregate warrants to
purchase 1,336,666 shares of common stock at $1.50 per share and warrants to
purchase 1,336,666 shares of common stock at $2.82 per share. These warrants
were issued in reliance upon the exemption from registration provided by Section
4(2) of the Securities Act. We have used and expect to use the net proceeds of
approximately $8,600,000 from this offering for repayment of outstanding
obligations (including $1,391,500 that was used to repay Global Capital Funding
Group, LP), completion of strategic acquisitions and general working capital. We
also used a significant portion of our working capital to settle our accounts
payable, which accounts payable were approximately $1,278,000 and $1,700,000 as
of September 30, 2004 and December 31, 2003, respectively.
In February 2004, the convertible notes issued in our May, June, September and
November 2003 bridge financings were automatically converted into the Units
issued in connection with the 2004 Private Placement. The conversion took place
at the rate of $15 per Unit. This resulted in the conversion of the aggregate
outstanding amount of debt owing from these convertible notes ($3,122,302 -
representing principal and accrued interest) into 208,147 Units from the 2004
Private Placement, which in the aggregate consists of 208,147 shares of Series A
Convertible Preferred Stock and warrants to purchase 2,081,470 shares of common
stock at an exercise price $2.82 per share. These warrants expire in February
2007.
25
During the year ended December 31, 2002, we recorded a valuation allowance of
$664,640 in connection with the potential uncollectibility of outstanding loans
made to Mr. Sebastian Cassetta, our then Chairman and Chief Executive Officer,
which included a loan used by him to purchase our restricted stock and loans in
the aggregate original principal amount of $500,000. Additionally, during the
quarter ended June 30, 2003, we recorded a valuation allowance of $270,000 in
connection with the potential uncollectibility of the loan made to Mr. Cassetta
for the purchase of our restricted stock. In his separation agreement in October
2003, we extended the maturity date of the loan for the restricted stock until
September 2004 and forgave over a three-year term the loans in the aggregate
original principal amount of $500,000, plus the accrued interest thereon.
Additionally, during the quarter ended September 30, 2004, we recorded a
valuation allowance of $91,872 in connection with the potential uncollectibility
of the loan made to Mr. Cassetta for the purchase of our restricted stock As of
September 30, 2004 the balance of such loan was $-0- after recording the
allowance and treasury stock when all 94,706 shares of stock, which were pledged
as collateral for the note, were assigned and transferred to the Company and the
outstanding debt and accrued interest of $569,670 in the aggregate was
cancelled.
Our failure to timely file or keep registration statements effective has
affected the registration rights held by certain of our stockholders and warrant
holders. As of September 30, 2004, we recorded an aggregate of $202,125 for
potential claims for penalties in connection with the aforementioned
registration requirements. Such amounts are included in accrued expenses on our
balance sheet. We filed a Form SB-2 Registration Statement on May 13, 2004. It
has not yet been declared effective by the Securities and Exchange Commission
("SEC").
In addition, this 2004 Private Placement offering required the Company to file a
Registration Statement with the SEC and have it declared effective no later than
120 days after April 30, 2004, or by August 29, 2004. The Registration Statement
was filed on May 13, 2004 but it has not yet been declared effective by the SEC.
As a result, the Company incurred liquidated damages in the form of a cash
requirement equal to 2% of the aggregate purchase price of the offering, or
approximately $266,000 per month. Liquidated damages are due monthly until the
event of default is cured. The Company accrued approximately $529,000 for
liquidated damages and interest in the quarter ended September 30, 2004. The
Company is seeking a settlement to limit the liquidated damages. The proposed
settlement seeks to establish a pool of 1,000,000 warrants with an exercise
price of $2.50 and a two year term. The pool would be allocated to each
participant based on the investor's proportionate participation in the 2004
Private Placement There can be no assurance that the Company will be successful
in obtaining and enforcing such settlement
The economic downturn in general, and its impact on the telecommunications
industry in particular, caused telecommunications service providers to reduce
capital spending, personnel and debt, as well as new service introductions. This
had resulted in delays in the build-out of high-speed carrier data networks and
availability of data-enabled wireless devices, causing the market for our
financial data, lifestyle and transaction services to be lackluster. In
addition, many financial services firms curtailed new product development to
focus on data security and recovery. Consequently, the potential demand for our
products and services has been significantly delayed. Such delays have had a
very detrimental effect on our operations and have resulted in our inability to
implement our business plan and related marketing strategies. Consequently, in
2002 we commenced an effort to realign our infrastructure and related overhead
to correlate with reductions in projected revenue. As part of this effort, we
closed our UK and Hong Kong sales offices and downsized our domestic operations
through staff reductions to a level sufficient to support our projected
operations. In both March and May 2003, we reduced our cost structure through
the termination of additional personnel. Personnel headcount has been reduced
from 66 in May 2002 to the current level of 15 as of September 30, 2004.. These
efforts have reduced our average monthly operating expenses from approximately
$1,090,000 in July 2002 to approximately $433,000 as of September 2004,
excluding noncash stock compensation, depreciation and amortization. Monthly
operating expenses increased to approximately $433,000 as of September from
approximately $370,000 per month earlier in the year due to the working capital
requirements of the business of nReach, as well as related to expansion of
marketing and business development efforts for all of the Company's products and
services and increased corporate overhead.
We have approximately 16,400,000 of warrants outstanding for our underlying
shares of common stock that are currently being registered and they expire for
the most part between May 2006 and March 2009. The warrants, for the most part,
are callable if the closing price is at least 250% of the exercise price for 10
consecutive trading days and if
26
the resale of such underlying shares are covered by an effective Registration
Statement. Exercise prices range for the most part, from $1.50 to $2.82 and we
would receive approximately $40 million if all the warrants underlying the
shares of common stock being registered were exercised. While the warrants to
purchase common stock represent an additional source of capital, 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 our common stock
exceeds the exercise price of the warrant however, we do not anticipate such
Registration Statement becoming effective in the short term.
We signed an agreement with Sprint during November, 2004 allowing us to purchase
cellular airtime on Sprint's national wireless network, which cellular airtime
we plan to resell to wireless customers. The agreement has a term of five years.
This will allow us to enter the prepaid wireless marketplace, including the
offer of prepaid wireless plans, and to bundle such plans with content such as
ring tones, images and games. We expect that revenues will commence during the
first quarter of 2005 from such reselling.
We are required pursuant to our agreement with Sprint to obtain during December
2004 a letter of credit in Sprint's favor in the amount of $1,000,000. We expect
that we will be required to provide the bank issuing such letter of credit with
$1,000,000 of our available cash as security. The letter of credit is intended
to provide an alternative source of payments for Sprint should we fail to pay
Sprint in accordance with the terms of our agreement. When we commence sales and
marketing during the first quarter of 2005 we will incur significant working
capital requirements. There can be no assurance that we will have sufficient
liquidity to meet our business requirements, or that such requirements for cash
may increase and adversely impact our ability to fund and continue our
operations.
Should we complete the acquisition of KPCCD we will incur estimated professional
fees for legal and auditing and accounting services of approximately $75,000.
While we do not expect to use our cash to fund KPCCD's operations, there can be
no assurance that we will not be required to do so, and any such funding could
have a material adverse effect on our liquidity.
We believe we have sufficient working capital for approximately the next six to
nine months based on our business operating at its current level. The use of
$1,000,000 of our available cash to cause a letter of credit to be issued to
Sprint as described above, as well as working capital requirements to launch our
business to sell prepaid wireless airtime and handsets, will result in us having
sufficient working capital for significantly less than six months. As a result,
we may not be able to grow our business due to limits on the amount of available
working capital. In the short run, we intend to seek bridge financing in some
form to assist us in providing the letter of credit to Sprint, although there
can be no assurance that we can obtain such bridge financing, or whether the
terms will be acceptable. In addition to any bridge financing we will require
additional funding in order to execute on our business strategy.
Should the Company be unable to raise additional debt or equity financing, it
will be forced to seek a strategic buyer, 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. These forward-looking statements
involve certain known and unknown risks, uncertainties and other factors which
may cause our actual results, performance or achievements to be materially
different from any future results, performance or achievements expressed or
implied by these forward-looking statements. Certain factors that could cause or
contribute to such differences include, and are not limited to: We may not have
sufficient working capital to continue operations after approximately six to
nine months. ; We have never been profitable and if we do not achieve
profitability we may not be able to continue our business; We have significant
accounts payable obligations; We will not be able to complete or successfully
integrate acquisitions that we seek to pursue, or achieve the desired results of
such acquisitions; Only one of our four major customers from 2003 will continue
to generate revenues for us in 2004; We plan to pursue new streams of revenue
from the resale of prepaid wireless airtime bundled with wireless data content,
and revenues from
27
such business may not materialize; We have a new CEO and executive management
team; The market for our business is in the development stage and may not
achieve the growth we expect; Spencer Trask may be able to affect and exercise
some manner of control over us; The market price of our common stock may
decrease because we have issued, and will likely continue to issue, a
substantial number of securities convertible or exercisable into our common
stock; and other risks described in this Quarterly Report on Form 10-QSB, our
Annual Report on Form 10-KSB/A for the year ended December 31, 2003 (including
the risks described under "Risk Factors") and our other filings with the
Securities and Exchange Commission. You can identify forward-looking statements
by the fact that they do not relate strictly to historical or current facts. The
words "believe," "expect," "anticipate," "intend" and "plan" and similar
expressions are often used to identify forward-looking statements. We caution
you not to place undue reliance on these forward-looking statements. We
undertake no obligation to update or revise any forward-looking statements or to
publicly announce the result of any revisions to any of the forward-looking
statements in this document to reflect future events or developments.
Item 3. Controls and Procedures
We maintain a system of disclosure controls and procedures that is designed to
provide reasonable assurance that information that is required to be disclosed
by us in the reports that we file or submit under the Securities and Exchange
Act of 1934, as amended, is accumulated and communicated to management in a
timely manner. Our 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 each believes that the system is
operating effectively to ensure appropriate disclosure at a reasonable level of
assurance. There have been no changes during the third fiscal quarter in our
internal control over financial reporting, to the extent that elements of
internal control over financial reporting is subsumed within disclosure controls
and procedures, that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
28
PART II. OTHER INFORMATION
SmartServ Online, Inc.
Item 1. Litigation
On or about August 17, 2004, Vertical Ventures Investments LLC filed a complaint
against the Company in the Supreme Court of the State of New York, County of New
York. The complaint seeks payment of late registration penalties and attorneys
fees in the total amount of $350,000. While the Company intends to vigorously
defend such lawsuit, an unfavorable outcome would have a material adverse effect
on the Company's financial condition, results of operation 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/A, all quarterly and periodic
reports filed subsequent to such Form 10-KSB/A and the Company's most recent
proxy materials.
During the quarter ended September 30, 2004, the Company issued 9,445 shares of
common stock to Spencer Trask as finders fees related to the recent bridge
financings and 667,330 shares to TecCapital Ltd. pursuant to an antidilution
provision of a May 2000 stock purchase agreement related to the recent
financings. These shares were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
Item 3. Defaults Upon Senior Securities
In February 2004, the Company completed the 2004 Private Placement. The Series A
preferred stock receives dividends at the rate of 8% per year payable quarterly
in cash or, in our sole discretion, in registered shares of our common stock.
Dividends accrued on the Series A preferred stock amounted to $702,693 as of
September 30, 2004. At the Company's discretion, the dividends are to be paid in
the form of 444,847 shares of common stock when the Company's pending
Registration Statement is declared effective by the SEC.
29
Item 6. Exhibits
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002+
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002+
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002+
+
30
SmartServ Online, Inc.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SmartServ Online, Inc.
(Registrant)
By:
Date: November 15, 2004 /s/ Robert M. Pons
----------------- -----------------------------------------
Robert M. Pons
Chief Executive Officer
Date: November 15, 2004 /s/ Len von Vital
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Len von Vital
Chief Financial Officer
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