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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2005
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 May 1,
2005 was 5,520,605.
Transitional Small Business Disclosure Format (check one):
Yes |_| No |X|
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SmartServ Online, Inc.
Form 10-QSB
Index
PART 1. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - March 31, 2005 (unaudited) and
December 31, 2004........................................................2
Consolidated Statements of Operations - three months ended
March 31, 2005 and 2004 (unaudited)......................................4
Consolidated Statement of Changes in Stockholders' Equity -
three months
ended March 31, 2005 (unaudited).........................................5
Consolidated Statements of Cash Flows - three months ended
March 31, 2005 and 2004 (unaudited)......................................6
Notes to Consolidated Financial Statements (unaudited)...................7
Item 2. Management's Discussion and Analysis or Plan of Operation............17
Item 3. Controls and Procedures..............................................24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings....................................................24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........24
Item 3. Defaults Upon Senior Securities......................................25
Item 6. Exhibits ............................................................25
Signatures...........................................................26
1
SmartServ Online, Inc.
Consolidated Balance Sheets
March 31, December 31,
2005 2004
---------- ----------
(Unaudited)
Assets
Current assets
Cash $ 892,657 $1,792,856
Investments 100,019 99,697
Accounts receivable 4,469,565 92,496
Prepaid expenses 22,938 349,040
---------- ----------
Total current assets 5,485,179 2,334,089
---------- ----------
Property and equipment, net 65,119 73,500
Goodwill 1,743,819 --
Intangibles, net of accumulated amortization of $160,161 and 874,728 911,688
$123,201 as of March 31, 2005 and December 31, 2004,
respectively
Security deposits 18,787 18,237
---------- ----------
Total Assets $8,187,632 $3,337,514
========== ==========
See accompanying notes.
2
SmartServ Online, Inc.
Consolidated Balance Sheets
March 31, December 31,
2005 2004
------------- -------------
(Unaudited)
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable $ 4,923,256 $ 446,528
Accrued liabilities 1,782,760 1,419,248
Current portion of note payable 36,898 36,898
------------- -------------
Total current liabilities 6,742,914 1,902,674
------------- -------------
Note payable 4,798 13,415
Commitments and Contingencies (Note 7)
Stockholders' Equity
Convertible preferred stock - $0.01 par value
Authorized - 1,000,000 shares
Issued and outstanding - 851,448 and 862,282 shares,
aggregate liquidation preference of $14,315,983 and
$14,056,639 as of March 31, 2005 and December 31,2004,
respectively 8,514 8,623
Common stock - $.01 par value
Authorized - 40,000,000 shares
Issued - 5,586,785 shares and 3,978,445 shares ; outstanding -
5,457,732shares and 3,849,392 shares at March 31, 2005
and at December 31, 2004, respectively 55,868 39,785
Additional paid-in capital 106,162,113 103,877,486
Unearned compensation (1,250,493) (1,363,663)
Accumulated deficit (103,372,429) (100,977,153)
------------- -------------
1,603,573 1,585,078
------------- -------------
Treasury stock, 129,053 shares at cost (163,653) (163,653)
------------- -------------
Total stockholders' equity 1,439,920 1,421,425
------------- -------------
Total Liabilities and Stockholders' Equity $ 8,187,632 $ 3,337,514
============= =============
See accompanying notes.
3
SmartServ Online, Inc.
Consolidated Statements of Operations
(Unaudited)
Three Months Ended March 31,
-----------------------------
2005 2004
------------ ------------
Revenues $ 11,493,851 $ 73,711
------------ ------------
Costs and expenses
Direct costs of revenues (11,486,695) (316,866)
Sales and marketing expenses (260,691) (43,706)
General and administrative expenses (2,030,529) (650,949)
Stock-based compensation (113,170) (1,532,141)
------------ ------------
Total costs and expenses (13,891,085) (2,543,662)
------------ ------------
Loss from operations (2,397,234) (2,469,951)
------------ ------------
Other income (expense)
Interest income 2,567 3,221
Interest expense and other financing costs (609) (1,937,081)
Legal settlement -- (196,800)
------------ ------------
1,958 (2,130,660)
------------ ------------
Net loss $ (2,395,276) $ (4,600,611)
============ ============
Preferred stock dividend accrued (1,194,135) (913,840)
------------ ------------
Net loss applicable to common shareholders $ (3,589,411) $ (5,514,451)
============ ============
Basic and diluted loss per common share $ (0.72) $ (2.25)
============ ============
Weighted average shares outstanding - basic and diluted 4,961,319 2,447,453
============ ============
See accompanying notes.
4
SmartServ Online, Inc.
Consolidated Statement of Changes in Stockholders' Equity
Three Months Ended March 31, 2005
(Unaudited)
Series A Convertible
Common Stock Preferred Stock
Shares Par Value Shares Par Value
------------- ------------- ------------- -------------
Balances at December 31, 2004 3,978,445 $ 39,785 862,282 $ 8,623
Issuance of common stock to acquire KPCCD, Inc. 1,000,000 10,000 -- --
Issuance of warrants as compensation for services -- -- -- --
Issuance of warrants to vendor -- -- -- --
Issuance of common stock pursuant to an antidilution
provision of a May 2000 stock purchase agreement 500,000 5,000 -- --
Series A Preferred Stock and warrants -- -- -- --
Conversion of Series A Preferred Stock 108,340 1,083 (10,834) (109)
Accretion of Series A Preferred Stock -- -- -- --
Dividends accrued on Series A Preferred Stock -- -- -- --
Common stock issuable per settlement with former
officer -- -- -- --
Amortization of unearned compensation -- -- -- --
Net loss for the period -- -- -- --
-----------------------------------------------------------
Balances at March 31, 2005 5,586,785 $ 55,868 851,448 $ 8,514
===========================================================
Additional
Paid- in Unearned Treasury Accumulated
Capital Compensation Stock Deficit
-------------------------------------------------------------
Balances at December 31, 2004 $ 103,877,486 $ (1,363,663) $ (163,653) $(100,977,153)
Issuance of common stock to acquire KPCCD, Inc. 1,707,143 -- -- --
Issuance of warrants as compensation for services 725,165 -- -- --
Issuance of warrants to vendor 12,637 -- -- --
Issuance of common stock pursuant to an antidilution
provision of a May 2000 stock purchase agreement (5,000) -- -- --
Series A Preferred Stock and warrants 934,791 -- -- --
Conversion of Series A Preferred Stock (974) -- -- --
Accretion of Series A Preferred Stock (934,791) -- -- --
Dividends accrued on Series A Preferred Stock (259,344) -- -- --
Common stock issuable per settlement with former
officer 105,000 -- -- --
Amortization of unearned compensation -- 113,170 -- --
Net loss for the period -- -- -- (2,395,276)
-------------------------------------------------------------
Balances at March 31, 2005 $ 106,162,113 $ (1,250,493) $ (163,653) $(103,372,429)
=============================================================
See accompanying notes.
5
SmartServ Online, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended March 31,
---------------------------
2005 2004
----------- -----------
Operating Activities
Net loss $(2,395,276) $(4,600,611)
Adjustments to reconcile net loss to net cash
used for operating activities
Depreciation and amortization 47,725 --
Noncash compensation costs 105,000 640,418
Provision for doubtful accounts 225,000 --
Noncash consulting services 725,165 91,641
Noncash payments to vendors 12,637 219,369
Amortization of deferred compensation 113,170 1,532,141
Amortization of deferred financing costs -- 1,231,772
Changes in operating assets and liabilities
Accounts receivable (4,602,069) 3,481
Accrued interest receivable -- 43,783
Prepaid expenses 326,102 65,765
Prepaid compensation -- 88,749
Accounts payable and accrued liabilities 4,580,896 (434,557)
Deferred revenues -- (4,167)
Security deposit (550) (11,212)
----------- -----------
Net cash used for operating activities (862,200) (1,133,428)
----------- -----------
Investing Activities
Purchase of equipment (2,384) (18,099)
Purchase of KPCCD, Inc. (26,676) (87,500)
Purchase of investments (322) --
----------- -----------
Net cash used for investing activities (29,382) (105,599)
----------- -----------
Financing Activities
Proceeds from the issuance of series A convertible preferred stock
and warrants - net -- 8,569,525
Repayment of notes payable and accrued interest (8,617) (1,391,504)
----------- -----------
Net cash (used for) provided by financing activities (8,617) 7,178,021
----------- -----------
(Decrease) increase in cash and cash equivalents (900,199) 5,938,994
Cash and cash equivalents- beginning of period 1,792,856 139,178
----------- -----------
Cash and cash equivalents- end of period $ 892,657 $ 6,078,172
=========== ===========
See accompanying notes.
6
SmartServ Online, Inc.
Notes to Unaudited Consolidated Financial Statements
March 31, 2005
1. Nature of Business and Operations
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 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.
The Company, headquartered in Plymouth Meeting, PA, is transitioning to become a
Mobile Virtual Network Operator (MVNO) that will be launching mobile phone
service in 2005 with low cost, prepaid minute plans, discounted international
long distance and the latest in mobile content such as ringtones, mobile games
and images.
SmartServ has an agreement with Sprint to utilize Sprint's Nationwide PCS
Network for its prepaid mobile phone service. Under this agreement, Sprint
wholesales wireless minutes from their network directly to SmartServ for resale
to its UPHONIA(TM) customers. SmartServ benefits from this agreement by
receiving access to Sprint's enhanced nationwide network with turnkey
reliability and performance. As an MVNO, SmartServ has the advantage of market
access without the need to build the telecom infrastructure necessary to
originate and terminate domestic wireless calls. Sprint benefits by gaining a
distribution and marketing partner that is focused on market development in a
niche that is secondary to Sprint (i.e., the immigrant, urban ethnic and youth
markets to be targeted by the Company).
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 did a one-for-six reverse stock split effective November 25, 2003.
The par value of the Company's common stock remained at $0.01 per share in
accordance with Delaware corporation law. The reverse stock split also affected
the conversion price and number of shares into which an outstanding convertible
security is convertible or exercisable. Unless otherwise noted, descriptions of
shareholdings and convertible securities reflect such one-for-six reverse stock
split.
Our financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and the settlement of liabilities and
commitments in the normal course of business. We have since our inception earned
limited revenues and have incurred substantial recurring operating losses,
including net losses of $2,395,276 for the three month period ended March 31,
2005 and $10,580,372 and $17,537,775 for the years ended December 31, 2004 and
2003, respectively. Additionally, we have an accumulated deficit of $103,372,429
at March 31, 2005.
7
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 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.
On March 30, 2005, after reviewing the Company's cash flow projections, the
board of directors approved a plan designed to enable us to have sufficient
working capital to support a reduced level of operations through March 2006. As
of March 31, 2005, the Company had $992,676 in cash and investments. Elements of
the plan include: 1) maximizing KPCCD's international calling card profits since
the acquisition of KPCCD on January 7, 2005 2) reducing the level of operating
expenses by relocating our hosting facility from an off site location to an
on-site location and 3) eliminating employee positions.
In April, 2005, the Company commenced implementing such plan and reduced our
staff to a total of 16 people. The Company also completed the relocation of its
hosting facility to its headquarters.
The Company is pursuing additional financing, through some combination of
borrowings or the sale of equity or debt securities during 2005. The Company was
pursuing the Telco Group acquisition and obtaining sufficient financing to cover
the costs of such acquisition and provide a sufficient surplus to address the
Company's liquidity requirements, however, those discussions have terminated.
As a result of the factors identified above, the Company believes that existing
cash resources and cash expected to be generated from operations will be
sufficient to support a reduced level of operations through the next twelve
months. 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 may be forced
to seek a merger or cease operations.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information, the instructions of Form 10-QSB
and Rule 310 of Regulation S-B of the Securities and Exchange Commission and,
therefore, do not include all information and notes necessary for a presentation
of results of operations, financial position and cash flows in conformity with
accounting principles generally accepted in the United States of America. The
balance sheet at December 31, 2004 has been derived from the audited
consolidated financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. The
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-KSB for the year ended December 31, 2004. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) necessary for a fair presentation of financial position and results
of operations have been made. Results of operations for the three months ended
March 31, 2005 are not necessarily indicative of those expected for the year
ending December 31, 2005.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. Significant intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Revenue Recognition
The Company recognizes revenue from the sale 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.
Prepaid International Calling Card Revenue
Prepaid international calling card revenue is derived from the sale of prepaid
international calling cards to distributors. Revenue is recognized upon shipment
or delivery of prepaid international calling cards to distributors on a
non-recourse basis.
8
Subscription Revenue
Subscription revenue consists of fixed and variable charges for the usage of the
Company's products and services provided through its relationships with wireless
telecommunications carriers and a financial services company. Such revenue is
recognized as the services are provided on a monthly basis.
Development and Integration Revenue
Development and integration fees are charged for the development of
private-labeled applications for customers that incorporate their proprietary
data into SmartServ's products and services. Such fees are recognized ratably
over the term of the agreement.
Service Revenue
Service revenue is derived from consulting or by providing other professional
services to customers. Revenue from the performance of such services is
recognized when the services are performed. Losses, if any, from professional
services contracts are recognized at the time such losses are identified.
Maintenance and support fees paid in advance are nonrefundable and are
recognized ratably over the term of the agreement, generally 12 months.
Hosting Services
Hosting service arrangements are based on a flat monthly fee or on the number of
users and may include a one-time setup fee. The one-time setup fee is recognized
over the term of the hosting arrangement, and the hosting services revenue is
recognized monthly as earned on a fixed fee or a variable rate basis.
Deferred Revenues
Deferred revenues, resulting from customer prepayments, are recognized as
services are provided throughout the term of the agreement with the respective
customer.
9
Deferred Financing Costs
Deferred financing costs represent those costs incurred in connection with the
issuance of the Company's convertible notes. These costs were recorded at the
fair value of the consideration (cash or securities) paid to the finders in such
transactions and are amortized to operations as other financing costs over the
terms of the respective notes.
Earnings Per Share
Basic earnings per share is computed based 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, warrants, or convertible
securities 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. Financial instruments are held for other than
trading purposes.
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. Therefore,
certificates of deposit have been recorded as investments.
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.
In January 2004, in connection with a settlement with a vendor, the Company
issued a warrant to purchase 22,000 shares of common stock at $1.34 per share
and expiring in January 2007. The warrant was valued at $22,569. The issuance of
warrants to purchase 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.
On January 7, 2005, the Company acquired the business of KPCCD, Inc., a prepaid
international calling card distributor. Cash paid for the business acquired is
comprised of:
Fair value of assets acquired $ 1,743,819
Liabilities assumed --
-----------
Purchase price, net of cash received 1,743,819
Common stock issued for business acquired (1,717,143)
-----------
Net cash paid for business acquired $ 26,676
===========
10
Concentration of Credit Risk
Financial instruments that potentially subject SmartServ to concentrations of
credit risk consist of cash, investments and accounts receivable. The Company
places its cash deposits, including investments in certificates of deposit, with
high credit quality institutions. From time to time, a substantial amount of the
Company's cash may exceed federal depository insurance limits. However, the
Company has not experienced any losses in this area and management believes its
cash deposits are not subject to significant credit risk. At March 31, 2005 and
December 31, 2004, accounts receivable consist principally of amounts due from
prepaid international calling card distributors and from a major
telecommunications carrier. The Company performs periodic credit evaluations of
its customers and, if applicable, provides for credit losses in the financial
statements. As of March 31, 2005 a reserve for doubtful accounts was provided in
the amount of $225,000 related to a distributor; as of December 31, 2004, the
Company did not believe a reserve for doubtful accounts was necessary.
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.
Stock Based Compensation
Employee Stock Option Plans
The Company maintains several stock option plans for employees and directors
that generally 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.
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 SFAS No. 123 may 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 (loss) and (loss) per share are not indicative of future years.
11
SmartServ's pro forma information is as follows:
Three Months Ended
March 31
-----------------------------
2005 2004
-----------------------------
Net loss as reported $(2,395,276) $(4,600,611)
Employee stock-based compensation included in net loss 113,170 1,532,141
Employee stock-based compensation pursuant to SFAS 123
(636,244) (164,785)
----------- -----------
Pro forma net loss $(2,918,350) $(3,233,255)
=========== ===========
Basic and diluted loss per share $ (0.72) $ (2.25)
----------- -----------
Pro forma basic and diluted loss per share $ (0.59) $ (1.32)
=========== ===========
The pro forma information regarding net income (loss) and income (loss) per
share required by SFAS No. 123, has been determined as if SmartServ had
accounted for its employee stock option plan under the fair value methods
described in SFAS No. 123. The fair value of options granted by the Company was
estimated at the date of grant using the Black-Scholes option pricing model.
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.
3. Acquisition
On January 7, 2005, SmartServ acquired all of the issued and outstanding capital
stock of KPCCD, Inc. ("KPCCD") pursuant to a stock purchase agreement dated
December 19, 2004. The Company issued 1,000,000 shares of its common stock, $.01
par value per share, valued at $1,717,143 to the sellers as consideration for
acquiring KPCCD. KPCCD is a wholly-owned subsidiary of the Company. Founded in
1998, KPCCD distributes international prepaid calling cards through a network of
hundreds of retail outlets along the East Coast. The acquisition of KPCCD
expands the Company's distribution network for the Company's planned prepaid
wireless products and services.
The acquisition was accounted for using the purchase method of accounting and,
accordingly, the purchase price has been allocated to the assets purchased and
the liabilities assumed based upon their fair values at the date of acquisition.
The fair value of assets acquired was $1,743,819 resulting in a net purchase
price of $1,743,819.
12
SmartServ and KPCCD pro forma combined information:
Three Months Ended
March 31
-------------------------------
2005 2004
------------ ------------
Pro forma revenues $ 11,493,851 $ 5,012,514
------------ ------------
Pro forma net loss (2,395,276) (4,563,476)
Pro forma preferred stock dividend accrued (1,194,135) (913,840)
------------ ------------
Pro forma net loss applicable to common shareholders
$ (3,589,411) $ (5,477,316)
============ ============
Pro forma basic and diluted loss per share $ (0.72) $ (1.59)
------------ ------------
Pro forma weighted average shares outstanding -
basic and diluted 4,961,319 3,447,453
============ ============
4. 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 $15.00 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 upon
conversion of the Series A and exercise of 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 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.
On January 7, 2005, the Company acquired KPCCD, Inc. by issuing 1,000,000 shares
of its common stock valued at $1,717,143 in exchange for all of the outstanding
shares of KPCCD, Inc.
13
On January 10, 2005, the Company granted to the Chairman of the Board of
Directors, Paul J. Keeler, warrants to purchase 250,000 shares of the Common
Stock at an exercise price of $2.10 per share, which was the closing stock price
of the common stock on the date of grant. The warrants were valued at $424,372.
The warrants have a 5 year term and are immediately exercisable and were issued
to Mr. Keeler for serving as the Chairman of the Board. The warrants were issued
in reliance upon the exemption from registration provided by Section 4(2) of the
Securities Act.
In connection with consulting services provided by Steven Rosner and Brockington
Securities, Inc., the Company entered into consulting agreements dated March 31,
2004 for warrants to purchase 300,000 and 100,000 shares of common stock,
respectively, at $1.50 per share and expiring on March 31, 2007. The warrants
were valued at $902,367 and $300,787 respectively. During the first quarter of
2005 $225,596 and $75,198 of the warrants vested, respectively.
On January 28, 2005, SmartServ entered into an agreement with TecCapital, Ltd.
("TEC") pursuant to which TEC agreed to waive and release certain rights TEC has
under a certain stock purchase agreement dated May 12, 2000. TEC provided these
waivers and releases in consideration for the grant to TEC of 500,000 shares of
the Company's common stock. The Company believes that TEC is the beneficial
owner of more than ten percent of the Company's common stock. In the event that
both the acquisition of Telco Group is not consummated and a registration
statement covering all of TEC's shares of common stock is not declared effective
within 270 days after the date of the agreement, TEC may (in its sole
discretion) return all of the shares to the Company within 330 days from the
date of the agreement, and in such case the waivers and releases granted in the
agreement would become void and TEC could pursue any claims against the Company
as if such waivers and releases had never been granted.
In connection with paying a vendor for public relation services according to an
agreement the Company granted an exercisable warrant in March 2005 to purchase
12,857 shares of common stock at $1.40 per share. The warrant expires in March
2008. The warrant was valued at $12,637.
In March 2005, the Company recorded the obligation to issue 75,000 shares of
common stock valued at $1.40 per share related to a separation agreement with a
former officer.
The Company's inability to timely file its Form 10-KSB for its fiscal year ended
December 31, 2002 and a failure to have its SB-2 Registration Statement declared
effective by the SEC has affected the following registration rights held by some
of its shareholders and warrant holders.
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 was unable to do so by May 14, 2003, so it accrued
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.
The total amount accrued as of March 31, 2005 was $202,125.
Accredited investors in the Company's September 2002 Equity Placement hold up to
an aggregate of 616,991 shares of common stock, and warrants to purchase up to
an aggregate of 249,954 shares of common stock, all 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 of
common stock and the shares underlying the warrants. The Registration Statement
is no longer effective.
14
Obligation to File a Registration Statement:
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
proposed a settlement to limit the liquidated damages. In December 2004, in full
settlement of the default, the Company established a pool of 1,000,000 warrants
with an exercise price of $2.50 per share and a two year term. The pool of
warrants was allocated among each participant based on the investor's
proportionate participation in the 2004 Private Placement. The Company recorded
a financing expense of $1,782,125 as of December 31, 2004 related to the pool of
warrants. As of March 31, 2005, 68% of the representative warrant ownership of
the 1,000,000 warrants responded to the proposal and of that amount, 3% declined
the proposal. The remaining 29% have not responded to the offer.
In 2004, pursuant to an agreement with a vendor to whom the Company issued in
settlement 60,000 shares of common stock, the Company was obligated to file a
Registration Statement and have it declared effective within the same time frame
as required by the terms of the 2004 Private Placement. The Registration
Statement was timely filed but it has not been declared effective by the SEC. As
a result, the Company incurred late registration penalties of $2,000 per month,
or $14,000 as of March 31, 2005. The late registration penalties are due monthly
until the event of default is cured.
5. Stock-based Compensation
In connection with the grant of certain stock options, warrants and other
compensation arrangements, the Company has recorded charges to earnings that are
noncash in nature. Certain of these stock option grants are subject to the
variable plan requirements of APB No. 25 that require the Company to record
compensation expense for changes in the fair value of its common stock.
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).
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 December 2004, the Company granted to Messrs. Pons and Wenhold options to
purchase 400,000 and 250,000 shares of common stock, respectively, which options
have an exercise price of $2.07 per share and a term of 10 years. The options
vest monthly over three years commencing December 31, 2004. The options will
vest immediately upon a Change of Control (as defined in their option
agreements).
In January 2005, the Company issued 8,000 incentive stock options to employees.
15
Stock-based compensation for the three months ended March 31, 2005 and 2004
relate to the impact of options granted at less than fair market value on the
measurement date. 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 Ended March 31,
-----------------------------
2005 2004
----------- -----------
Direct costs of revenues $ (36,563) $ (536,251)
General and administrative expenses (76,607) (995,890)
----------- -----------
$ (113,170) $(1,532,141)
=========== ===========
6. Earnings Per Share
The following table sets forth the computation of basic and diluted loss per
share:
Three Months Ended March 31,
-----------------------------
2005 2004
----------- -----------
Numerator:
Net loss applicable to common shareholders $(3,589,411) $(5,514,451)
=========== ===========
Denominator:
Weighted average shares - basic and diluted 4,961,319 2,447,453
=========== ===========
Basic and diluted loss per common share $ (0.72) $ (2.25)
=========== ===========
Outstanding employee stock options and other warrants to purchase an aggregate
of 21,149,918 and 18,769,788 shares of common stock at March 31, 2005 and 2004,
respectively, were not included in the computations of diluted earnings per
share and neither were convertible preferred stock, convertible into 8,514,480
and 8,764,910 shares of common stock at March 31, 2005 and 2004, respectively,
because the Company reported losses for the periods and therefore their
inclusion would be antidilutive.
7. Commitments and Contingencies.
On or about February 29, 2000, Commonwealth Associates, L.P. ("Commonwealth")
filed a complaint against the Company in the Supreme Court of the State of New
York, County of New York. The complaint alleged that in August of 1999,
Commonwealth and SmartServ entered into an engagement letter that provided for a
nonrefundable fee to Commonwealth of $15,000 payable in cash or common stock at
SmartServ's option. The complaint alleged that SmartServ elected to pay the fee
in stock and, as a result, Commonwealth sought 2,222 shares of common stock or
at least $1,770,000 together with interest and costs. In SmartServ's defense,
SmartServ denied that it elected to pay in stock. On March 4, 2003, SmartServ
received a favorable decision in this matter after a trial held in the Supreme
Court of the State of New York. The decision holds that, consistent with
SmartServ's defense, SmartServ is required to pay Commonwealth a retainer fee of
only $13,439, plus interest and certain costs. Commonwealth's time to appeal has
not yet expired.
On or about March 22, 2004, Jenkens & Gilchrist Parker Chapin, LLP, our former
legal counsel, filed a complaint against us in the Supreme Court of the State of
New York, County of New York. The complaint requested payment of unpaid invoices
for legal services in the amount of $599,244. In November 2004, the claim was
settled in full for $300,000.
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 sought 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.
During 2003 and 2004 former employees of SmartServ filed complaints against the
Company for unpaid wages arising from salary reductions implemented by the
Company in 2002. These claims, totaling $215,000, are currently pending before
the Connecticut Department of Labor and the Connecticut Superior Court.
Management believes these claims have no merit and intends to defend the claims
vigorously.
16
Item 2. Management's Discussion and Analysis or Plan of Operation
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 risks faced by us described in "Certain Factors That
May Affect Future Results" and elsewhere in this report.
We are a Mobile Virtual Network Operator (MVNO) which is a mobile operator that
does not own or operate supporting infrastructure such as cell towers and
related support systems. We intend to launch an innovative prepaid wireless
service in 2005 under the brand name UPHONIA(TM). We intend to give consumers a
better choice in mobile phone service by bundling flexible prepaid minute plans,
free mobile content and discounted international long distance. With our
UPHONIA(TM) mobile phone service, prepaid customers will get the premium
features not usually available at the micro-retailers where they shop:
o Our UPHONIA(TM) brand will provide consumers flexible prepaid minute
plans - UPHONIA(TM) customers do not sign up for one preset monthly
contract, but instead are able to decide how many minutes they want
each time they purchase additional minutes.
o UPHONIA(TM) customers can personalize their cell phones with
thousands of ringtones, images, games and graphics. SmartServ makes
it easy for UPHONIA(TM) customers to download mobile content for
free - online at the UPHONIA(TM).com mobile content website,
in-stores from UPHONIA(TM) mobile content kiosks, or right from
their UPHONIA(TM) phones.
o UPHONIA(TM) customers will also be able to access discounted
international long distance through their UPHONIA(TM) phones.
We have an agreement with Sprint to utilize Sprint's Nationwide PCS Network for
its prepaid mobile phone service. Under this agreement, Sprint wholesales
wireless minutes from their network directly to SmartServ for resale to its
UPHONIA(TM) customers. SmartServ benefits from this agreement by receiving
access to Sprint's enhanced nationwide network with turnkey reliability and
performance. As an MVNO, SmartServ has the advantage of market access without
the need to build the telecom infrastructure necessary to originate and
terminate domestic wireless calls. Sprint benefits by gaining a distribution and
marketing partner that is focused on market development in a niche that is
secondary to Sprint (i.e., the immigrant, urban ethnic and youth markets). The
agreement requires $1,000,000 in the form of a letter of credit to secure our
obligations under the Sprint contract which we have yet to provide.
We also 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 which 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.
17
We have since our inception earned limited revenues and have incurred
substantial recurring operating losses, including net losses of $2,395,276,
$10,580,372 and $17,537,775 for the quarter ended March 31, 2005 and the years
ended December 31, 2004 and 2003, respectively. Additionally, we have an
accumulated deficit of $103,372,429 at March 31, 2005.
As of March 30, 2005, after reviewing the Company's cash flow projections, the
Company adopted a plan designed to enable us to have sufficient working capital
to support a reduced level of operations through March 2006. As of March 31,
2005 we had cash and investments of $992,676. Elements of the plan include: 1)
maximizing of KPCCD's international calling card profits since the acquisition
of KPCCD on January 7, 2005, 2) reduce the level of operating expenses by
relocating our hosting facility from an off site location to an on-site
location, and 3) elimination of employee positions.
In April , 2005, the Company commenced implementing such plan and reduced our
staff to a total of 16 people. The Company also completed the relocation of its
hosting facility to its headquarters.
The Company was pursuing the Telco Group acquisition and obtaining sufficient
financing to cover the costs of such acquisition and provide a sufficient
surplus to address the Company's liquidity requirements, however, those
discussions have terminated.
In addition, the Company is pursuing action items to improve its liquidity in
conjunction with beginning to execute its business strategy. The action items
include pursuing sources of through some combination of borrowings or the sale
of equity or debt securities during 2005.
However, no assurance can be given that the Company will be able meet its
revenue and cash flow projections, reduce its cost structure as presently
configured or that unforeseen liabilities or expenses will not arise, or raise
additional capital on satisfactory terms. Should the Company be unable to raise
additional debt or equity financing, it will be forced to seek a 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.
18
To augment our capabilities, we acquired 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. Management believes that due to
nReach's performance issues to date the Earnout Trigger will not be paid. 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.
On January 7, 2005, we acquired 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 distribution network for our planned prepaid wireless products and
services. The acquisition of KPCCD added approximately $11.4 million in revenues
during the first quarter ended March 31, 2005. In connection with the closing of
the transaction on January 7, 2005, KPCCD, the sellers of KPCCD and Prima
Communications, Inc. ("Prima"), a company controlled by the sellers, entered
into a Master Vendor Agreement ("Vendor Agreement"). Under the Vendor Agreement,
Prima will sell to KPCCD at cost all of KPCCD's requirements of international
prepaid calling cards for up to one year after January 7, 2005. The Company has
guaranteed the obligations of KPCCD under the Vendor Agreement. The Vendor
Agreement can be terminated prior to its one year term under certain conditions.
On November 17, 2004, we also signed a non-binding letter of intent to acquire
Telco Group, Inc., and affiliates. Telco Group, Inc. is a New York-based
provider of pay-as-you-go wireless telecommunications services, prepaid
international long distance, nationwide dial around long distance and nationwide
dial up high speed internet services. The letter of intent has expired and the
acquisition discussions have terminated.
While we continued to support our lifestyle offerings of BREW and J2ME
applications in 2004, we augmented this set of offerings with the ability to
deliver static content (ringtones, graphics, and games). In August 2004, we
launched a consumer web site to sell this static content
(http://www.uphonia.com). Our ability to deliver this type of static content
allows us to sell directly to the consumer, removing the necessity of having to
broker these transactions through the wirelesses carriers. Additionally, it is
our expectation that this static content will become a key feature of our
branded wireless service when we launch our planned MVNO service in 2005. While
we maintain our BREW and J2ME infrastructure we have not undertaken the expense
to certify these applications for new phones since June, 2004.
As part of our cost reduction plan, we reduced the number of employees, as of
April 30, 2005, to a total of 16 people, all of whom were employed in the United
States. Ten employees are at SmartServ headquarters in Plymouth Meeting, PA and
6 are employed at KPCCD in Jackson Heights, NY. If we are able to raise
additional capital to launch our MVNO business, we anticipate that staffing
requirements associated with the implementation of our plan of operation will
require the addition of approximately 3 people and the replacement of our
terminated headquarters employees.
19
Results of Operations
Quarter Ended March 31, 2005 versus Quarter Ended March 31, 2004
During the quarter ended March 31, 2005, we recorded revenues of $11,493,851.
Sales of prepaid international calling cards through our master distributor,
KPCCD Inc. which we acquired on January 7, 2005, represented $11,410,586 of that
amount. Revenues of $61,801 were earned through our licensing agreement with
QUALCOMM and $21,464 came from other sources. During the quarter ended March 31,
2004, we recorded revenues of $73,711 all of which were earned through our
licensing agreement with QUALCOMM.
During the quarter ended March 31, 2005 we incurred direct costs of revenues,
including prepaid international calling cards of $11,162,684 since the
acquisition of KPCCD, Inc on January 7, 2005. Also included within direct costs
of revenues during the quarter ended March 31, 2005, were costs of services of
$324,011, a slight increase compared to the $316,866 for the quarter ended March
31, 2004. Components of the costs of services for the period ended March 31,
2005 consisted primarily of costs associated with, information and communication
costs ($71,941), personnel costs ($150,983), consulting expenses ($84,000), and
travel costs ($1,402). Components of the costs of service category for the
period ended March 31, 2004 consisted primarily of costs associated with the
operations of the nReach, Inc. acquisition ($122,167), information and
communication costs ($35,000), personnel costs ($100,525), consulting expenses
($38,000), facilities ($4,799) and travel costs ($8,619).
During the quarter ended March 31, 2005, we incurred sales and marketing
expenses of $260,691, an increase of 496% over the $43,706 incurred during the
quarter ended March 31, 2004. Such costs increased primarily due to US personnel
additions, and public relations expenses. Components of the sales and marketing
category for the quarter ended March 31, 2005 consisted primarily of personnel
costs ($228,319) and public relations costs ($21,956). Components of the sales
and marketing category for the quarter ended March 31, 2004 consisted of
personnel costs ($25,433), consulting costs ($9,763) and trade show costs
($8,510). During the quarter ended March 31, 2005, we incurred general and
administrative expenses of $2,030,529, an increase of 212% over the $650,949
incurred during the quarter ended March 31, 2004. Such expenses increased
primarily due to noncash costs which consisted of the following: warrants issued
for services ($725,165), investment banking fees related to the proposed Telco
transaction ($268,750), amortization of intangibles ($36,960), depreciation
($10,765), a provision for doubtful accounts related to a distributor ($225,000)
and settlement of an employment dispute with a former officer by issuing shares
of common stock ($105,000). Also, the increase includes the cost of a due
diligence technical/operational report related to the proposed Telco transaction
($100,000). In addition, components of the general and administrative category
for the quarter ended March 31, 2005 included primarily personnel costs
($150,913), professional fees ($211,913), director fees ($22,500), facilities
($13,533) and insurance ($20,000). Components of the general and administrative
category for the quarter ended March 31, 2004 consisted primarily of personnel
costs ($84,740), consulting fees ($247,325), professional fees ($234,554),
facilities ($41,880) and insurance ($29,688).
During the quarter ended March 31, 2005, the net noncash charge for stock-based
compensation amounted to $113,170, compared to a net noncash charge of
$1,532,141 during the quarter ended March 31, 2004. Such noncash costs for the
quarter ended March 31, 2005 resulted from the vesting of employee stock options
issued 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"). Noncash charges for consulting services for the quarter ended
March 31, 2005 were $725,165 resulting primarily from the issuance of warrants
to the Company's Chairman of the Board for his services and the prior issuance
and vesting of warrants to purchase common stock to financial consultants.
20
Interest income for the quarters ended March 31, 2005 and 2004 amounted to
$2,567 and $3,221, respectively. Such amounts were earned primarily from our
investments in money fund accounts. During the quarter ended March 31, 2004,
interest and other financing costs were $1,937,081 incurred in connection with
the completion, in February 2004, of a $10 million private offering of
investment Units in the 2004 Private Placement. Basic and diluted loss per share
was $0.72 for the quarter ended March 31, 2005 compared to $2.25 per share for
the quarter ended March 31, 2004. The loss per share for the quarters ended
March 31, 2005 and March 31, 2004 included an accrued preferred stock dividend
of $1,194,135 and $913,840, respectively. The weighted average shares
outstanding increased to 4,961,319 at March 31, 2005 from 2,447,453 at March 31,
2004.
Capital Resources and Liquidity
Cash Flow
At March 31, 2005 and December 31, 2004, the Company had cash of $892,657 and
$1,792,856, respectively. Net cash used in operations was $862,200 for the
quarter ended March 31, 2005 compared to $1,133,428 during the quarter ended
March 31, 2004. The primary reason for this decrease was due to the Company's
accounts payable settlement negotiations with vendors. Additionally the increase
in accounts receivable of $4,602,069 and the increase of accounts payable of
$4,476,728 are primarily due to the acquisition of KPCCD, Inc. Net cash used for
investing activities amounted to $29,382 for the purchase of equipment and the
acquisition of KPCCD, Inc. during the quarter ended March 31, 2005. Net cash
used by financing activities was $8,617 for the repayment of a note payable
during the quarter ended March 31, 2005 compared to $7,178,021 during the
quarter ended March 31, 2004. During the quarter ended March 31, 2004, details
of financing activities included cash in the amount of $1,391,504 used for the
repayment of notes payable and accrued interest while net cash provided by
financing activities included $8,569,525 from the sale of Series A and related
warrants.
Capital Raising and Other Transactions
In February 2004, the convertible notes issued in the May, June, and September
and November 2003 bridge financings were automatically converted into the Units
issued in connection with the 2004 Private Placement (as defined below). The
conversion took place at the rate of $15.00 per Unit, which is the price at
which the Units were sold in the 2004 Private Placement. 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. A description of the 2004 Private
Placement is set forth below.
21
In February 2004, we completed the closing of a $10 million private offering of
investment Units at the price of $15.00 per Unit ("2004 Private Placement").
Each Unit consists of (i) one share of Series A convertible preferred stock,
$.01 par value ("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. Dividends accrued on the Series A preferred stock amounted to $1,162,681
as of March 31, 2005. While these dividends have not been paid, we intend to pay
these dividends with registered shares of common stock when we have a
registration statement declared effective by the SEC, which would equal 735,471
shares of common stock as of March 31, 2005. 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 warrants are callable
on 30 days prior written notice in the event that the closing bid price of our
common stock is at least 250% of their respective exercise prices for a period
of 10 consecutive trading days. 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. 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.
While the warrants to purchase common stock issued during the years ended
December 31, 2003 and 2004 (excluding warrants issued pursuant to the 2004
Private Placement described above) represent an additional source of capital,
they expire between April 2006 and February 2009 and are not callable by us.
Therefore, they cannot be relied upon by us 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. The warrants issued in
the 2004 Private Placement, as described above, are callable on 30 days prior
written notice in the event that the closing bid price of our common stock is at
least 250% of their respective exercise prices for a period of 10 consecutive
trading days.
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. Management believes that based on performance issues that the
additional shares will not come due.
On January 7, 2005, the Company acquired the prepaid international calling card
business of KPCCD, Inc. The Company issued 1,000,000 shares of its common stock
valued at $1,717,143 in exchange for all of the outstanding shares of KPCCD, Inc
Our inability to timely file or keep registration statements effective has
affected the registration rights held by certain of our stockholders and warrant
holders. As of March 31, 2005 and 2004, we recorded an aggregate of $202,125,
and $177,375, respectively for penalties in connection with the aforementioned
registration requirements. Such amounts are included in accrued expenses on our
balance sheet as of March 31, 2005 and March 31, 2004. While we intend to cure
these deficiencies during 2005, penalties may continue to accrue in certain
circumstances.
22
In December 2004, in connection with a proposed settlement for liquidated
damages related to a failure to have the Company's SB-2 Registration Statement
declared effective by the SEC, we established a pool of warrants to purchase
1,000,000 shares of common stock at $2.50 per share for allocation among our
shareholders that participated in our bridge and the 2004 Private Placement
financings. The warrants expire in December 2006. These warrants were valued at
$1,782,125. As of March 31, 2005, 68% of the representative warrant ownership of
the 1,000,000 warrants have accepted the proposal, 29% of the representative
warrant ownership of the 1,000,000 warrants have not responded to the proposal
and 3% of such representative warrant ownership of the 1,000,000 warrants
declined the proposal.
Pursuant to an agreement with a vendor to whom we issued in settlement 60,000
shares of common stock, we were obligated to file a Registration Statement and
have it declared effective within the same time frames as required by the terms
of the 2004 Private Placement. The Registration Statement was timely filed but
it has not been declared effective by the SEC. As a result, we incurred late
registration penalties of $2,000 per month, or $14,000 as of March 31, 2005. The
late registration penalties are due monthly until the event of default is cured.
Future Capital Needs
Our financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and the settlement of liabilities and
commitments in the normal course of business. We have since our inception earned
limited revenues and have incurred substantial recurring operating losses,
including net losses of $2,395,276 for the quarter ended March 31, 2005 and
$10,580,372 and $17,537,775 for the years ended December 31, 2004 and 2003,
respectively. Additionally, we have an accumulated deficit of $103,372,429 at
March 31, 2005.
As of March 30, 2005, after reviewing the Company's cash flow projections, the
Company adopted a plan designed to enable us to have sufficient working capital
to support a reduced level of operations through March 2006. As of March 31,
2005 we had $992,676 in cash and investments. Elements of the plan include: 1)
maximizing of KPCCD's international calling card profits since the acquisition
of KPCCD on January 7, 2005, 2) reduce the level of operating expenses by
relocating our hosting facility from an off site location to an on-site
location, and 3) elimination of employee positions.
The Company signed an agreement with Sprint during November, 2004 allowing the
Company to purchase cellular airtime on Sprint's national wireless network for
resale to our wireless customers. The agreement has a term of five years. This
will allow the Company to enter the prepaid wireless marketplace and to offer
plans that bundle prepaid wireless airtime with discounted international long
distance and premium mobile content such as ringtones, images and games. The
Company is required to provide Sprint with a $1,000,000 letter of credit to
secure our obligations relating to this agreement prior to Sprint giving us
access to its network.
The Company is pursuing additional financing, through some combination of
borrowings or the sale of equity or debt securities during 2005.
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 may be forced
to seek a merger or cease operations.
23
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 in the long term; We have never been profitable and
if we do not achieve profitability we may not be able to continue our business;
any new capital will dilute existing shareholders. We may 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 continued to generate revenues for us in 2004 and 2005; we
plan to pursue new streams of revenue from the resale of prepaid wireless
airtime bundled with wireless data content, and revenues from 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 for the
year ended December 31, 2004 (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 first fiscal quarter of 2005 in
our internal control over financial reporting, to the extent that elements of
internal control over financial reporting are subsumed within disclosure
controls and procedures, that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
At the time of issuance, each investor or recipient of unregistered securities
was either an accredited investor or a sophisticated investor. Each investor had
access to SmartServ's most recent Form 10-KSB, all quarterly and periodic
reports filed subsequent to such Form 10-KSB and the Company's most recent proxy
materials.
On January 10, 2005, the Board granted to the current Chairman of the Board of
Directors, Paul J. Keeler, a warrant to purchase 250,000 shares of the common
stock at an exercise price of $2.10 per share, which was the closing stock price
of the common stock on the date of grant. These warrants, which have a 5 year
term and are immediately exercisable, were issued to Mr. Keeler for serving as
the Chairman of the Board. This warrant was issued in reliance upon the
exemption from registration provided by Section 4(2) of the Securities Act.
24
In connection with paying a vendor for public relation services according to an
agreement SmartServ granted an exercisable warrant in March 2005 to purchase
12,857 shares of common stock at $1.40 per share. The warrant expires in March
2008. This warrant was 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 $1,168,681 as of
March 31, 2005. At the Company's discretion, the dividends are to be paid in the
form of 735,471 shares of common stock when the Company's pending Registration
Statement is declared effective by the SEC.
Item 6. Exhibits
(a) Exhibits:
10.1 Master Vendor Agreement dated January 7, 2005 by and among KPCCD,
Inc., Nimesh Patel, Ashok Patel, Kala Patel and Prima
Communications, Inc.+
10.2 Warrant dated January 10, 2005 issued to Paul J. Keeler+
10.3 Letter Agreement dated January 28, 2005 between TecCapital, Ltd. and
SmartServ+
10.4 Letter Agreement between Robert M. Pons and SmartServ, amending
Employment Agreement dated March 12, 2004+
10.5 Letter Agreement between Timothy G. Wenhold and SmartServ, amending
Employment Agreement dated March 12, 2004+
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+
25
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: May 16, 2005 /s/ Robert M. Pons
------------ --------------------------------------
Robert M. Pons
Chief Executive Officer
Date: May 16, 2005 /s/ Len von Vital
------------ --------------------------------------
Len von Vital
Chief Financial Officer
26