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U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2004
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Commission file number 0-28008
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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
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The number of shares of common stock, $.01 par value, outstanding as of April
15, 2004 was 2,878,840.
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, 2004 (unaudited) and December 31,
2003......................................................................2
Consolidated Statements of Operations - three months ended March 31, 2004
and 2003 (unaudited)......................................................4
Consolidated Statement of Changes in Stockholders' Equity (Deficiency) -
three months ended March 31, 2004 (unaudited).............................5
Consolidated Statements of Cash Flows - three months ended March 31, 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...............................................17
Item 3 Controls and Procedures.............................................25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................25
Item 2. Changes in Securities and Use of Proceeds...........................26
Item 6. Exhibits and Reports on Form 8-K....................................29
Signatures..........................................................31
1
SmartServ Online, Inc.
Consolidated Balance Sheets
March 31, December 31,
2004 2003
---------- ----------
(Unaudited)
Assets
Current assets
Cash $6,078,172 $ 139,178
Accounts receivable 110,811 103,230
Accrued interest receivable 3,221 47,004
Prepaid compensation 44,378 133,127
Prepaid expenses 23,976 86,798
Deferred financing costs -- 322,192
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Total current assets 6,260,558 831,529
---------- ----------
Property and equipment, net 29,668 --
Other assets
Goodwill and intangible assets 1,802,389 --
Security deposits 18,237 5,156
---------- ----------
Total Assets $8,110,852 $ 836,685
========== ==========
See accompanying notes.
2
SmartServ Online, Inc.
Consolidated Balance Sheets
March 31, December 31,
2004 2003
------------- -------------
(Unaudited)
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities
Accounts payable $ 1,520,334 $ 1,702,768
Accrued liabilities 956,001 928,393
Accrued salaries 31,129 78,133
Accrued interest payable -- 218,848
------------- -------------
Total current liabilities 2,507,464 2,928,142
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Deferred revenues 33,333 37,500
Notes payable -- 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 as of March 31, 2004, 738,480 --
aggregate liquidation preference of $10,175,360 and $0 as
of March 31, 2004 and December 31, 2003, respectively
Common stock - $.01 par value
Authorized - 40,000,000 shares
Issued - 2,913,187; outstanding - 2,878,840 shares as 29,132 22,613
of March 31, 2004 and 2,261,300 shares as
of December 31, 2003
Additional paid-in capital 101,823,219 85,160,306
Notes receivable from former officers (187,525) (255,525)
Unearned compensation (1,767,859) --
Treasury stock, 34,347 shares at cost (68,000) --
Accumulated deficit (94,997,392) (90,396,781)
------------- -------------
Total stockholders' equity (deficiency) 5,570,055 (5,469,387)
------------- -------------
Total Liabilities and Stockholders' Equity (Deficiency) $ 8,110,852 $ 836,685
============= =============
See accompanying notes.
3
SmartServ Online, Inc.
Consolidated Statements of Operations
(Unaudited)
Three Months
Ended March 31,
--------------------------
2004 2003
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Revenues $ 73,711 $ 230,987
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Costs and expenses
Costs of services (316,866) (1,216,831)
Sales and marketing expenses (43,706) (276,534)
General and administrative expenses (650,949) (999,180)
Stock-based compensation (1,532,141) (28,194)
----------- -----------
Total costs and expenses (2,543,662) (2,520,739)
----------- -----------
Loss from operations (2,469,951) (2,289,752)
Other income (expense)
Interest income 3,221 4,532
Interest expense and other financing costs (1,937,081) (375,886)
Legal settlement (196,800) --
Gain from extinguishment of debt -- 305,822
Foreign exchange gain -- 93
----------- -----------
(2,130,660) (65,439)
----------- -----------
Net loss $ (4,600,611) $(2,355,191)
=========== ===========
Preferred stock dividend accrued (913,840) --
Net loss applicable to common shareholders $(5,514,451) $(2,355,191)
=========== ===========
Basic and diluted loss per common share $ (2.25) $ (1.20)
=========== ===========
Weighted average shares outstanding - basic and diluted 2,447,453 1,956,468
=========== ===========
See accompanying notes.
4
SmartServ Online, Inc.
Consolidated Statement of Changes in Stockholders' Equity (Deficiency)
Three Months Ended March 31, 2004
(Unaudited)
Common Stock Preferred Stock
Series A Notes Receivable Additional
Preferred from Former Paid-in
Shares Par Value Shares Stock Officers Capital
------------- ------------- ------------- --------- ------------- -------------
Balances at December 31, 2,261,300 $ 22,613 -- $ -- $ (255,525) $ 85,160,306
2003
Issuance of common stock 500,002 5,000 -- -- -- 1,635,007
to acquire nReach, Inc.
Issuance of common stock 91,885 919 -- -- -- 639,499
related to financing
Issuance of common stock 60,000 600 -- -- -- 196,200
to vendor to satisfy
debt
Issuance of warrants as -- -- -- -- -- 91,641
compensation for
services
Issuance of warrants -- -- -- -- -- 1,777,569
related to financing
Issuance of warrants to -- -- -- -- -- 22,569
vendor to satisfy debt
Employee stock -- -- -- -- -- 3,300,000
compensation
Amortization of unearned -- -- -- -- -- --
compensation
Treasury stock shares -- -- -- -- 68,000 --
returned in settlement
of note receivable
from former officer
Beneficial conversion -- -- -- -- -- 9,914,268
option on convertible
Preferred Stock
Series A Preferred Stock -- -- 876,491 738,480 -- --
Accretion of dividends -- -- -- -- -- (738,480)
on Series A Preferred
Stock
Dividends accrued on -- -- -- -- -- (175,360)
Preferred Stock
Net loss for the period -- -- -- -- -- --
------------- ------------- ------------- --------- ------------- -------------
Balances at March 31, 2,913,187 $ 29,132 876,491 $ 738,480 $ (187,525) $ 101,823,219
2004
============= ============= ============= ========= ============= =============
See accompanying notes.
Treasury Unearned Accumulated
Stock Compensation Deficit
------------- ------------- -------------
Balances at December 31, $ -- $ -- $ (90,396,781)
2003
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
Employee stock -- (1,885,717) --
compensation
Amortization of unearned -- 117,858 --
compensation
Treasury stock shares (68,000) -- --
returned in settlement
of note receivable
from 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 -- -- (4,600,611)
------------- ------------- -------------
Balances at March 31, $ (68,000) $ (1,767,859) $ (94,997,392)
2004
============= ============= =============
See accompanying notes.
5
SmartServ Online, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
Three Months
Ended March 31,
--------------------------
2004 2003
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Operating Activities
Net loss $(4,600,611) $(2,355,191)
Adjustments to reconcile net loss to net cash
used for operating activities
Gain from extinguishment of debt -- (305,822)
Depreciation and amortization -- 464,587
Noncash compensation costs 640,418 28,194
Noncash consulting services 91,641 --
Noncash payments to vendors 219,369 --
Amortization of deferred compensation 1,532,141 --
Amortization of deferred financing costs 1,231,772 338,964
Amortization of deferred revenues -- (168,694)
Changes in operating assets and liabilities
Accounts receivable 3,481 (84,554)
Accrued interest receivable 43,783 9,707
Prepaid expenses 65,765 100,756
Prepaid compensation 88,749 --
Accounts payable and accrued liabilities (434,557) 631,790
Deferred revenues (4,167) 138,000
Security deposit (11,212) 28,716
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Net cash used for operating activities (1,133,428) (1,173,547)
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Investing Activities
Purchase of equipment (18,099) --
Purchase of nReach, Inc. (87,500) --
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Net cash used for investing activities (105,599) --
----------- -----------
Financing Activities
Proceeds from the issuance of series A convertible preferred stock
and warrants - net 8,569,525 --
Proceeds from the issuance of notes and warrants - net -- 1,000,000
Proceeds from the issuance of common stock -- 335,537
Repayment of notes payable and accrued interest (1,391,504) (295,000)
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Net cash provided by financing activities 7,178,021 1,040,537
----------- -----------
Increase (decrease) in cash and cash equivalents 5,938,994 (133,010)
Cash - beginning of period 139,178 154,759
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Cash - end of period $ 6,078,172 $ 21,749
=========== ===========
See accompanying notes.
6
SmartServ Online, Inc.
Notes to Unaudited Consolidated Financial Statements
March 31, 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.
During February 2004, the Company acquired the issued and outstanding common
stock of an early stage company, nReach, Inc., to increase the Company's focused
offerings of products and services to the cell phone industry. 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.
nReach may provide the Company with access to a large number of consumers
through its existing marketing arrangements with large retailers. nReach has an
arrangement with Merit Industries, a manufacturer of touch-screen entertainment
devices, to introduce self-serve mobile content vending machines capable of
delivering nReach's ringtones, images and games. Prior to the Company's
acquisition, nReach had minimal revenues and incurred a significant loss in
2003.
The Company has since its inception earned limited revenues and incurred
substantial recurring operating losses, including net losses of $4,600,611 for
the three month period ended March 31, 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 $94,997,392 and
$90,396,781 at March 31, 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 20 as of March 15, 2004 (including nReach employees). These
efforts have reduced the Company's average monthly operating expenses from
approximately $1,090,000 in July 2002 to approximately $370,000 as of March 2004
(including operating expenses of nReach), excluding noncash stock compensation,
depreciation and amortization. The Company anticipates that its monthly
operating expenses will increase during 2004 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 and
expects to use the net proceeds of approximately $8,600,000 from this offering
for repayment of outstanding obligations, completion of strategic acquisitions
and general working capital. In particular, the Company anticipates using a
significant portion of its working capital
7
to settle its accounts payable, which accounts payable were approximately
$1,520,000 and $1,700,000 as of March 31, 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 12 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.
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
- ---------------------------
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. Significant intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Revenue Recognition
- -------------------
The Company recognizes revenue from the use of its products and services in
accordance with American Institute of Certified Public Accountants' ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition", SOP 98-9,
"Modification of SOP 97-2, Software Recognition, With Respect to 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
- --------------------
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
8
any, from professional services contracts are recognized at the time such losses
are identified. Maintenance and support fees paid in advance are nonrefundable
and are recognized ratably over the term of the agreement, generally 12 months.
Hosting Services
- ----------------
Hosting service arrangements are based on a flat monthly fee or on the number of
users and may include a one-time setup fee. The one-time setup fee is recognized
over the term of the hosting arrangement, and the hosting services revenue is
recognized monthly as earned on a fixed fee or variable rate basis.
Deferred Revenues
- -----------------
Deferred revenues, resulting from customer prepayments, are recognized as
services are provided throughout the term of the agreement with the respective
customer.
Deferred Financing Costs
- ------------------------
Deferred financing costs represent those costs incurred in connection with the
issuance of the Company's convertible notes. These costs are recorded at the
fair value of the consideration (cash or securities) paid to the finders in such
transactions and are amortized to operations as other financing costs over the
terms of the respective notes.
Earnings Per Share
- ------------------
Basic earnings per share is computed on the weighted average number of common
shares outstanding; however, it does not include the unvested portion of
restricted shares in accordance with Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings Per Share". Diluted earnings per share reflects the
increase in the weighted average common shares outstanding that would result
from the assumed exercise of outstanding stock options calculated using the
treasury stock method when dilutive.
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 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.
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 quarters
ended March 31, 2004 and 2003 were $1,516,504 and $70,000, respectively.
Concentration of Credit Risk
- ----------------------------
Financial instruments that potentially subject SmartServ to concentrations of
credit risk consist solely of accounts receivable. At March 31, 2004 and
December 31, 2003, accounts receivable consist principally
9
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 March 31, 2004 and 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 $-0- and $3,561 for the
quarters ended March 31, 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.
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 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
10
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 Ended
March 31,
--------------------------
2004 2003
----------- -----------
Net loss as reported $(4,600,611) $(2,355,191)
Employee stock-based compensation included in
net loss 1,532,141 1,323
Employee stock-based compensation pursuant to
SFAS 123/SFAS 148 (164,785) (917,494)
----------- -----------
Proforma net loss $(3,233,255) $(3,271,362)
=========== ===========
Basic and diluted loss per share $ (2.25) $ (1.20)
----------- -----------
Proforma basic and diluted loss per share $ (1.32) $ (1.68)
=========== ===========
Foreign Currency Translation
- ----------------------------
The financial statements of the Company's foreign subsidiaries, whose functional
currencies are other than the U.S. dollar, have been translated into U.S.
dollars in accordance with SFAS No. 52, Foreign Currency Translation. All
balance sheet accounts have been translated using the exchange rates in effect
at the balance sheet date. Income statement amounts have been translated using
the average rate for the year. Gains and losses resulting from the changes in
exchange rates from year to year have been reported in accumulated other
comprehensive income.
3. Property and Equipment
Property and equipment consist of the following:
March 31, December 31,
2004 2003
----------- -----------
Data processing equipment $ 4,594,526 $ 4,594,526
Office furniture and equipment 427,142 397,474
Display equipment 71,335 71,335
Leasehold improvements 69,852 69,852
----------- -----------
5,162,855 5,133,187
Impairment of capital assets (843,768) (843,768)
Accumulated depreciation (4,289,419) (4,289,419)
----------- -----------
$ 29,668 $ --
=========== ===========
11
4. Note Receivable From Officer
In December 2000, the Company's Board of Directors authorized the issuance of a
line of credit to Sebastian Cassetta, SmartServ's former Chief Executive
Officer, for an amount not to exceed $500,000. Such amount bears 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 has been accrued and is
payable at maturity. Commencing July 1, 2002 until maturity, interest shall be
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.
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.
5. Notes Payable
In May 2000, the Company entered into a Business Alliance Agreement with
Hewlett-Packard Company ("HP") whereby the companies agreed to jointly market
their respective products and services, and to work on the build-out of
SmartServ's domestic and international infrastructure. In furtherance of these
objectives, HP provided the Company with a line of credit of up to $20,000,000
for the acquisition of approved hardware, software and services. On September
10, 2002, the Company and HP amended the terms of the promissory note to provide
for the (i) reduction of SmartServ's aggregate outstanding principal and accrued
interest amount of $7,045,000 to $1,000,000, (ii) return of certain unused
hardware by SmartServ, (iii) issuance by SmartServ of a warrant for the purchase
of 8,333 shares of common stock with an exercise price of $6.996 per share and
(iv) repayment of $500,000 of the amended obligation on September 10, 2002. The
remaining $500,000 obligation was evidenced by a note, bearing an interest rate
of 11%, secured by the Company's assets exclusive of its internally developed
software products, and was satisfied through a partial repayment in February
2003. The Company recorded a gain of $305,822 resulting from the Company's
partial repayment of the note in February 2003.
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 warrants have been valued in accordance with the Black-Scholes pricing
methodology and recorded in the financial statements as deferred interest costs
and netted against the outstanding obligation. Deferred interest costs are
amortized into operations in accordance with the interest method. Alpine Capital
Partners, Inc. ("Alpine") received a finder's fee of $70,000; representing 7% of
the aggregate purchase price of the convertible note and a warrant to purchase
15,167 shares of common stock exercisable at $9.66 per share, expiring on
February 14, 2005, in connection with this transaction. These warrants have been
valued in accordance with the Black-Scholes pricing methodology and recorded in
the financial statements as deferred compensation costs. This amount is being
amortized
12
into operations on a straight-line basis over the 12 month 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. Alpine is to receive a finder's
fee of $17,500 in connection with the April amendment. The warrants issued to
Global and Alpine contain certain antidilution provisions and expire on February
14, 2006. During February 2004, SmartServ paid in full the principal and accrued
interest due Global, 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
of Series A Convertible Preferred Stock, $.01 par value ("Series A"), and
warrants for $10 million in aggregate gross proceeds. 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 March 31, 2004 the amount of the Company's debt obligations were paid in
full or converted to Series A as described above.
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 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 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
13
$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 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.
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 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.
Pursuant to a Restricted Stock Agreement dated December 28, 1998, the Company
received a promissory note in the original principal amount of $457,496.86 from
Sebastian E. Cassetta, its former Chairman and Chief Executive Officer, for his
purchase of restricted shares of common stock. As of March 31, 2004, the balance
due of such loan is $187,525, after recording of a valuation allowance in
connection with the potential uncollectibility of such loan from Mr. Cassetta
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. Additionally, the Company issued 91,885
shares of common stock primarily as finders fees related to the Company's recent
financings.
The Company's failure to timely file its Form 10-KSB for its fiscal year ending
December 31, 2002 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 failed to do so by May 14, 2003, so it is required
to pay a fee of $8,250 for the first month of the deficiency and a fee of
$16,500 for each month thereafter until the shares underlying the warrant are
registered.
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
covering these securities is no longer effective.
14
Obligation to File a Registration Statement:
- --------------------------------------------
Global Capital Funding Group, L.P. holds warrants to purchase up to 257,333
shares of common stock, and a convertible note convertible into 189,394 shares
of common stock (which was paid off in February, 2004). The Company was required
to file a Registration Statement covering all such shares on April 14, 2003 and
by agreement with Global is required to include such shares in a Registration
Statement. 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, but it has not yet been declared effective by the Securities and
Exchange Commission (the "SEC").
7. Stock-based Compensation
In connection with the grant of certain stock options, warrants and other
compensation arrangements, the Company has recorded charges to earnings that are
noncash in nature. Certain of these stock option grants are subject to the
variable plan requirements of APB No. 25 that require the Company to record
compensation expense for changes in the fair value of its common stock.
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).
Stock-based compensation for the three months ended March 31, 2004 was for the
impact of options granted at less than fair market value on the measurement date
and for the three months ended March 31, 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:
15
Three Months
Ended March 31,
--------------------------
2004 2003
----------- -----------
Costs of services $ (536,251) $ 396
General and administrative expenses (995,890) (28,590)
----------- -----------
$(1,532,141) $ (28,194)
=========== ===========
8. Earnings Per Share
The following table sets forth the computation of basic and diluted loss per
share:
Three Months
Ended March 31,
---------------------------
2004 2003
------------ -----------
Numerator:
Net loss applicable to common shareholders $ (5,514,451) $(2,355,191)
============ ===========
Denominator:
Weighted average shares - basic and diluted 2,447,453 1,956,468
============ ===========
Basic and diluted loss per common share $ (2.25) $ (1.20)
============ ===========
Outstanding employee stock options and other warrants to purchase an aggregate
of 18,769,788 and 1,049,333 shares of common stock at March 31, 2004 and 2003,
respectively, were not included in the computations of diluted earnings per
share and neither was convertible preferred stock, convertible into 8,764,910
shares of common stock at March 31, 2004, because the Company reported losses
for the periods and therefore their inclusion would be antidilutive.
9. Commitments and Contingencies.
On or about June 4, 1999, Michael Fishman, SmartServ's former Vice President of
Sales, commenced an action against the Company and certain directors and
officers, in the Connecticut Superior Court for the Judicial District of
Stamford/Norwalk at Stamford (Michael Fishman v. SmartServ Online, Inc., et
al.). On February 11, 2003, the Company received a favorable trial decision in
this matter. This decision, entered after a trial in the Superior Court of
Connecticut, found no liability by SmartServ or the individual defendants on any
of Mr. Fishman's claims. Mr. Fishman's time to appeal has expired.
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, SmartServ's
former legal counsel, filed a complaint against SmartServ 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.
16
While the Company intends to vigorously defend such lawsuit, an unfavorable
outcome could have a material adverse effect on the Company's financial
condition, results of operation and cash flows.
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.
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 $4,600,611 for the three
month period ended March 31, 2004, $17,537,775 and $8,037,173 for the years
ended December 31, 2003 and 2002, respectively. Additionally, we had an
accumulated deficit of $94,997,392 and $90,396,781 at March 31, 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 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 believe we have sufficient working capital for the next
twelve months. It is likely we may require additional funds in the long term
depending upon the growth of our revenues, our business strategy, the costs of
any acquisitions and other factors.
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, provided, if the value of such 500,002 shares
immediately prior to June 1, 2004 is less than $900,000, we will issue up to
299,167 additional shares of our common stock with respect to such difference in
value. We also agreed
17
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, 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. This company may provide us with access
to a large number of consumers through its existing marketing arrangements with
large retailers.
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.
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 expect to perform certain development projects during 2004
to enhance our product offerings, including development of mobile lifestyle BREW
and J2ME applications.
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.
18
Results of Operations
Quarter Ended March 31, 2004 versus Quarter Ended March 31, 2003
During the quarter ended March 31, 2004, we recorded revenues of $73,711
substantially all of which were earned through our licensing agreement with
QUALCOMM. During the quarter ended March 31, 2003, we recorded revenues of
$230,987. Of such revenues, $208,100 were earned through our licensing agreement
with Salomon Smith Barney. During the quarter ended March 31, 2003, we
recognized $168,700 from the amortization of deferred revenues associated with
this agreement. We do not anticipate receiving revenues from Salomon Smith
Barney in 2004.
During the quarter ended March 31, 2004, we incurred costs of services of
$316,866, a decrease of 74% over the quarter ended March 31, 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 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, 2003, we incurred costs of services of
$1,216,831, which consist primarily of information and communication costs
($148,900), personnel costs ($576,500), computer hardware leases, depreciation
and maintenance costs ($323,100), facilities ($62,000) and amortization expenses
relating to capitalized software.
During the quarter ended March 31, 2004, we incurred sales and marketing
expenses of $43,706, a decrease of 84% over the quarter ended March 31, 2003.
Such costs decreased primarily due to US personnel reductions, reductions in
travel, reductions in advertising and trade shows and reductions in professional
fees. Components of the sales and marketing category consist primarily of
personnel costs ($25,433), consulting costs ($9,763) and trade show costs
($8,510). During the quarter ended March 31, 2003, we incurred sales and
marketing expenses of $276,534, which consist primarily of personnel costs
($205,100), professional fees ($17,800), and travel and lodging ($32,700).
During the quarter ended March 31, 2004, we incurred general and administrative
expenses of $650,949, a decrease of 35% over the quarter ended March 31, 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 ($84,740), consulting fees ($247,325), professional
fees ($234,554), facilities ($41,880) and insurance ($29,688). During the
quarter ended March 31, 2003, we incurred general and administrative expenses of
$999,180, which consist primarily of personnel costs ($319,200), professional
fees ($331,100), facilities ($121,400), insurance ($96,000) and computer
hardware leases, depreciation and maintenance costs ($40,300).
During the quarter ended March 31, 2004, the net noncash charge for stock-based
compensation amounted to $1,532,141, compared to a net noncash charge of $28,194
during the quarter ended March 31, 2003. Such noncash costs increased 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. Noncash charges for consulting
services for the quarters ended March 31, 2004 and 2003 were $91,641 and $0,
respectively, resulting primarily from the issuance of warrants to the Company's
former legal counsel as part of his separation agreement and from the
amortization of deferred costs associated with the prior issuance of warrants to
purchase common stock to financial, legal, marketing and technical consultants.
19
Interest income for the quarters ended March 31, 2004 and 2003 amounted to
$3,221 and $4,532, respectively. Such amounts were earned primarily from our
investments in money fund accounts. During the quarters ended March 31, 2004 and
2003, interest and other financing costs were $1,937,081 and $375,886,
respectively. During the quarters ended March 31, 2004 and 2003, interest and
other financing costs were incurred in connection with the completion, in
February 2004, of a $10 million private offering of investment Units in the 2004
Private Placement and, in February 2003, the $20 million line of credit facility
with HP and the convertible note issued to Global Capital Funding Group, LP
("Global").
During the quarter ended March 31, 2003, we recorded a gain of $305,822
resulting from the partial repayment, in full settlement of the amended
promissory note issued to Hewlett-Packard Company.
Basic and diluted loss per share was $2.25 for the quarter ended March 31, 2004
compared to $1.20 per share for the quarter ended March 31, 2003. The loss per
share for the quarter ended March 31, 2004 includes an accrued preferred stock
dividend of $913,840. The weighted average shares outstanding increased to
2,447,453 at March 31, 2004 from 1,956,468 at March 31, 2003.
Capital Resources and Liquidity
At March 31, 2004 and December 31, 2003, the Company had cash of $6,078,172 and
$139,178, respectively. Net cash used in operations was $1,133,428 for the
quarter ended March 31, 2004 compared to $1,173,547 during the quarter ended
March 31, 2003.
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 Ventures, Inc. ("Spencer Trask") received compensation as the placement
agent for the 2004 Private Placement as described below under the heading
"Changes in Securities and Use of Proceeds." 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), completion of strategic acquisitions and general working capital. We
also anticipated using a significant portion of our working capital to settle
our accounts payable, which accounts payable were approximately $1,520,000 and
$1,700,000 as of March 31, 2004 and December 31, 2003, respectively.
In February 2004, the convertible notes issued in the May, June, September and
November 2003 bridge financings (as described below) 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.
20
During the period January 1, 2003 through December 31, 2003, we issued 73,731
shares of common stock to investors upon the exercise of warrants to purchase
such shares. Proceeds from the exercise of these warrants were $376,000.
While the warrants to purchase common stock issued during the year ended
December 31, 2003 and thereafter represent an additional source of capital, they
expire between May 2006 and November 2008 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.
On November 11, 2003, we issued 18 Units in a financing transaction comprised of
a $50,000 convertible note ("November Notes") and a warrant ("November Warrant")
to purchase 16,667 shares of our common stock. The Units were sold to 20
investors for an aggregate of $900,000. Holders of the November Notes had the
right to convert the November Notes into shares of common stock at a price equal
to $2.10 per share. The November Notes bore interest at 8% per annum, and the
maturity date was the earlier of December 19, 2003 or the completion of an
equity placement of at least $3 million, at which time the November Notes would
automatically convert into the equity placement. Holders of the November
Warrants have the right to exercise the November Warrants into shares of common
stock at a price equal to $1.50 per share. Finders' compensation to Spencer
Trask and Richard Berland consisted of (i) a cash fee of $90,000, or 10% of the
aggregate purchase price of all of the Units; (ii) warrants to purchase 136,000
shares of common stock, or 20% of the shares of common stock underlying the
securities in the Units sold, and (iii) 2,778 shares of unregistered common
stock per Unit sold. In addition, Spencer Trask received a non-accountable
expense allowance of $27,000, or 3% of the aggregate proceeds of all Units sold
in the November transaction. All of the November Notes and the November Warrants
have full ratchet anti-dilution protection. In December 2003, as an inducement
to extend the maturity date of the November Notes to February 19, 2004, we
offered the noteholders a warrant to purchase additional shares of common stock
in an amount equal to 25% of the number of shares into which the notes purchased
in the Unit are convertible.
On September 16, 2003, we issued 7.4 Units in a financing transaction consisting
of an offering of up to 12 Units comprised of a $50,000 convertible note and a
warrant to purchase 16,667 shares of our common stock. On September 19, 2003, we
issued the remaining 4.6 Units of the financing transaction (collectively the
"September Transaction"). The Units were sold to accredited investors for an
aggregate of $600,000. Holders of the notes had the right to convert the notes
into shares of common stock at a price equal to $1.896 per share for the notes
issued on September 16, 2003 and $1.920 per share for the notes issued on
September 19, 2003. The convertible notes bore interest at 8% per annum, and the
maturity date of the notes was the earlier of November 19, 2003 or the
completion of an equity placement of at least $3 million, at which time the
notes would automatically convert into the equity placement. Holders of the
warrants have the right to exercise the warrants into shares of common stock at
a price equal to $1.50 per share. Finders' compensation to Spencer Trask and
Richard Berland for the September Transaction consisted of (i) a cash fee of
$60,000, or 10% of the aggregate purchase price of all of the Units; (ii)
warrants to purchase 102,988 shares of common stock, or 20% of the shares of
common stock underlying the securities in the Units sold, and (iii) 2,778 shares
of unregistered common stock per Unit sold. In addition, Spencer Trask received
a non-accountable expense allowance of $18,000, or 3% of the aggregate proceeds
of all Units sold in the September Transaction. All of the notes and the
warrants have full ratchet anti-dilution protection. In November 2003, as an
inducement to extend the maturity date of the notes to February 19, 2004, we
offered the noteholders a warrant to purchase additional shares of common stock
in an amount equal to 25% of the number of shares into which the notes purchased
in the Unit are convertible.
The September Transaction required the consent of Global, the holder of $1.25
million of our convertible notes issued in February and April 2003 (as described
below), and of 51% or more of the holders of our $1.5 million convertible notes
issued in connection with the bridge financings in May and June 2003 (as
described below). As an inducement to obtain their consent, such holders
received (a) a change in the
21
conversion price of their convertible notes equal to the lowest conversion price
of the notes issued in the September financings ($1.896 per share) and (b) an
increase in the number of shares purchasable pursuant to the warrant to reflect
a full ratchet dilution formula with a decrease in the exercise price of the
warrants to the exercise price of the warrants issued in the September financing
($1.50). Such amendment, as it pertains to the holders of convertible notes
issued in the May and June 2003 bridge financings, was effective on November 25,
2003, coincident with the effective date of a one-for-six reverse stock split.
We recorded a charge in the amount of $4,828,000 as "Other Financing Costs" for
the fair value of the consideration granted to these note holders for such
consent.
During the quarter ended June 30, 2003, we recorded a valuation allowance of
$129,000 in connection with the potential uncollectibility of a loan made to Mr.
Mario Rossi, our then Executive Vice President and Chief Technology Officer, for
the purchase of our restricted stock. During the quarter ended September 30,
2003, we recorded a partial recovery amounting to $44,500 in connection with
such obligation. Mr. Rossi's ability to repay this loan and interest thereon is
highly contingent on the market value of his investment in us. While this loan
had an original maturity date of December 2003, in his separation agreement in
October 2003, the maturity date was extended until April 15, 2004. In January
2004, Mr. Rossi assigned and transferred all of the 34,347 restricted shares of
stock to us and we cancelled the non-recourse debt.
In May 2003, in consideration of $358,000, we issued 3.58 Units consisting of
convertible notes and warrants to purchase common stock ("May Units") to 8
investors. Each May Unit consisted of a $100,000 convertible note and a warrant
to purchase 33,333 shares our common stock. The convertible notes bore interest
at 8% per annum, were convertible into our common stock at $4.464 (the average
of the closing bid prices of our common stock for the 5 days prior to the
closing of the transaction) per share and were to mature on the earlier of
November 19, 2003 or the closing of an equity placement of not less than $3
million. The warrants are exercisable at $4.464 per share and expire on May 19,
2006. In June 2003, in consideration of $1,142,000, we issued 11.42 Units ("June
Units") to 20 investors. Each June Unit also consisted of a $100,000 convertible
note and a warrant to purchase 33,333 shares of our common stock. The
convertible notes bore interest at 8% per annum, were convertible into our
common stock at $4.764 (the average of the closing bid prices of the our common
stock for the 5 days prior to the closing of the transaction) per share and were
to mature on the earlier of November 19, 2003 or the closing of an equity
placement of not less than $3 million. The warrants are exercisable at $4.764
per share and expire on June 13, 2006. Spencer Trask, Steven B. Rosner and
Richard Berland acted as finders for the May and June 2003 transactions. As
consideration therefor, the finders received their proportionate share of a (i)
cash fee of $150,000, or 10% of the aggregate purchase price of the Units sold,
(ii) warrants to purchase 510,158 shares of our common stock at $1.50 per share,
and (iii) 5,555 shares of unregistered common stock per Unit sold. In addition,
Spencer Trask received a non-accountable expense allowance of $45,000, or 3% of
the aggregate proceeds of all Units sold in the May and June 2003 transactions.
Proceeds from the sale of the Units were used for working capital purposes. In
November 2003, we, as an inducement to extend the maturity date of the notes to
February 19, 2004, offered the note holders a warrant to purchase additional
shares of common stock in an amount equal to 25% of the number of shares into
which the notes purchased in the Unit are convertible.
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. Mr. Cassetta's ability to repay these
loans and interest thereon is highly contingent on the market value of his
investment in our common 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.
22
At December 31, 2002, 287,500 public warrants (SSOLW) and 50,000 warrants with
terms identical to the public warrants were outstanding. These warrants were
convertible into our common stock at the ratio of 15 warrants per share of
common stock at an exercise price of $63.00 per share. These warrants were
redeemable by us on not less than 30 days written notice at the redemption price
of $0.60 per warrant, provided the average closing bid quotation of the common
stock as reported on the Nasdaq Stock Market has been at least 187.5% of the
current exercise price of the warrants for a period of 20 consecutive trading
days ending on the third day prior to the date on which we give notice of
redemption. These warrants expired on March 20, 2003.
In February 2003, we issued a convertible note to Global in consideration for
the receipt of $1 million. The note bore interest at the rate of 10% per annum,
was secured by our assets, exclusive of its internally developed software
products. As additional consideration, we issued Global a warrant for the
purchase of 33,333 shares of our common stock at an exercise price of $9.68 per
share. Alpine Capital Partners, Inc. ("Alpine") received a finder's fee of
$70,000, representing 7% of the aggregate purchase price of the convertible
note, and a warrant to purchase 15,167 shares of common stock exercisable at
$9.66 per share, expiring on February 14, 2005, in connection with this
transaction. In April 2003, we borrowed an additional $250,000 from Global and
amended the convertible note to include such amount. As additional
consideration, we issued Global a warrant for the purchase of 3,333 shares of
our common stock at an exercise price of $7.20 per share. Alpine is to receive a
finder's fee of $17,500 in connection with the April amendment. The warrants
issued to Global and Alpine contain certain antidilution provisions and expire
on February 14, 2006. Proceeds from the notes were used for working capital
purposes. In November 2003, in connection with the sale of Units in the November
2003 bridge financing and the sale of Units in the 2004 Private Placement, we
required the consent of Global. As an inducement to obtain its consent, we
issued Global a warrant to purchase 16,667 shares of common stock at an exercise
price of $2.40 per share. During February 2004, the note, as amended, matured
and was paid off in full including accrued interest.
In February 2003, we issued 20,590 shares of common stock to 5 vendors in
settlement of our obligations, aggregating $164,000, to such vendors.
In January 2003, the Company borrowed $70,000 from Steven B. Rosner that was
used for working capital. The debt was evidenced by an unsecured note bearing an
interest rate of 12% per annum and was repaid in February 2003.
In September 2002, we issued Units consisting of 647,368 shares of our common
stock and warrants to purchase 323,685 shares of common stock, exercisable at
$5.10 through September 8, 2007, to 22 accredited investors at a purchase price
of $5.4750 per Unit. Gross proceeds from this transaction amounted to
$3,544,346. We agreed to pay fees consisting of $249,050, an expense allowance
of $25,000, and warrants to purchase 73,008 shares of common stock at an
exercise price of $5.10 per share, expiring on September 8, 2007, as
compensation to certain individuals and entities that acted as finders.
Additionally, we incurred costs and other fees of $28,000 in connection with
this transaction. The warrants expire in September 2007 and are not callable by
us. Therefore, they cannot be relied upon by the Company as a definite source of
capital. The warrant holders may choose to exercise their warrants if the market
price of the Company's common stock exceeds the exercise price of the warrant.
Between January 1, 2003 through April 2003, warrants issued in September 2002
for the purchase of 73,731 shares of common stock were exercised. Proceeds from
such exercises were $376,000.
In June 2002, First Albany Corporation, acting as placement agent for us,
completed a private placement of Units at a price of $8.40 per unit consisting
of 130,952 shares of common stock and warrants to purchase common stock. The net
proceeds of $823,500 from the issuance of these Units were used for general
working capital requirements. The investors received warrants, callable under
certain conditions, for the purchase of an aggregate of 238,095 shares of common
stock at an exercise price of $8.40 per share through the expiration date on
June 5, 2007, as well as non-callable warrants for the purchase of an aggregate
of 32,738 shares of common stock, subject to antidilution adjustments, upon the
occurrence of
23
certain events, at an exercise price of $8.82 per share through June 5, 2007. In
August 2002, pursuant to the terms of the callable warrants, we provided the
investors with a notice calling such warrants; however, the investors rejected
our call as permitted by the warrant. In September 2002, the callable warrants
expired unexercised. Between July 2002 and December 2002, non-callable warrants
for the purchase of 34,142 shares of common stock were exercised. Proceeds from
such exercises were $176,500.
In May 2000, we entered into a Business Alliance Agreement with HP whereby the
companies agreed to jointly market their respective products and services and to
work on the build-out of our domestic and international infrastructure. In
furtherance of these objectives HP provided us with a line of credit of up to
$20,000,000 for the acquisition of approved hardware, software and services. As
of September 28, 2001, the expiration date of the facility, HP had advanced us
$6,723,156 thereunder. In September 2002, we reached agreement with HP to amend
the terms of the promissory note to provide for the (i) reduction of our
aggregate outstanding principal and accrued interest amount of $7,045,000 to
$1,000,000, (ii) return of certain unused hardware by us, (iii) issuance by us
of a warrant for the purchase of 8,333 shares of common stock and (iv) repayment
of $500,000 of the amended obligation on September 10, 2002. The remaining
obligation was evidenced by a note, bearing an interest rate of 11%, to be
repaid as follows: $200,000 on December 31, 2002, $200,000 on January 28, 2003
and $100,000 on February 27, 2003. The warrant expires on September 9, 2005 and
has an exercise price of $10.494 per share. In connection therewith, we recorded
a charge to earnings of $38,000 representing the fair value of the warrant as
determined in accordance with the Black-Scholes model. Additionally, we
recognized a net gain of $5,679,261 in 2002 resulting from the extinguishment of
this obligation. In February 2003, we reached agreement with HP to amend the
terms of the amended promissory note to provide for the settlement of our
outstanding obligation of $530,800, inclusive of accrued interest of $30,800, in
consideration of the payment by us of $225,000. As a result, during the quarter
ended March 31, 2003, we recognized an additional gain of $305,822, resulting
from the extinguishment of this obligation.
Our failure to timely file or keep registration statements effective has
affected the registration rights held by certain of our stockholders and warrant
holders. At March 31, 2004, we recorded an aggregate of $177,375 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, but it has not yet been declared
effective by the Securities and Exchange Commission ("SEC").
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 20 as of March 15, 2004 (including
the nReach acquisition completed in March 2004). These efforts have reduced our
average monthly operating expenses from approximately $1,090,000 in July 2002 to
approximately $370,000 as of March 2004 (including operating expenses of
nReach), excluding non-cash stock compensation, depreciation and amortization.
The Company anticipates that its monthly operating expenses will increase during
2004 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.
24
We believe we have sufficient working capital for the next twelve months. It is
likely we may require additional funds in the long term depending upon the
growth of our revenues, our business strategy, the costs of any acquisitions and
other factors. Should the Company be unable to raise additional debt or equity
financing, it may be forced to seek a merger or cease operations.
Certain Factors That May Affect Future Results
- ----------------------------------------------
Forward-looking statements in this document and those made from time-to-time by
our employees are made under the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. 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;
We have significant accounts payable obligations; 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 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 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 first 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.
PART 2. OTHER INFORMATION
Item 1. Legal Proceedings
In August of 2003, we entered into a Stipulation of Arbitration with Brauning
Inc., Mike Silva and Todd Peterson, former consultants to us (collectively, the
"Claimants"), pursuant to which we and the Claimants agreed to resolve, in a
binding arbitration proceeding, the Claimants' demand for damages resulting from
an alleged breach of contract and a failure by us to timely register the shares
of common
25
stock underlying certain consulting warrants issued by us to the Claimants.
Although we believe that the shares underlying the warrants were timely
registered, and that the Claimants demand is without merit, we reached an
agreement to settle this matter in order to avoid the uncertainties of
litigation. Under the terms of the settlement agreement, dated February 27,
2004, we issued 60,000 shares of our common stock in satisfaction of the claim,
and we have paid Claimants $45,000 for certain wireless industry consulting
reports. We also granted registration rights to the recipients of such 60,000
shares.
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 seeks payment of unpaid invoices for
legal services in the amount of $599,244. While we intend to vigorously defend
such lawsuit, an unfavorable outcome could have a material adverse effect on our
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, all quarterly and periodic
reports filed subsequent to such Form 10-KSB and the Company's most recent proxy
materials.
In connection with settling a debt owed to our former landlord One Station Place
Limited Partnership, in January 2004 we granted them an immediately exercisable
warrant to purchase 22,000 shares of common stock at $1.34 per share. The
warrant expires in January 2007. This warrant was issued in reliance upon the
exemption from registration provided by Section 4(2) of the Securities Act of
1933, as amended ("Securities Act").
In connection with leaving our employ and his execution of an Employee
Separation Agreement with us, dated February 2, 2003, we granted to Richard
Kerschner in February 2004 a warrant to purchase 50,000 shares of our common
stock. The warrant has a term of five years, is immediately exercisable, and has
an exercise price of $1.65 per share. This warrant was issued in reliance upon
the exemption from registration provided by Section 4(2) of the Securities Act.
In connection with settling a lawsuit brought by Brauning Inc., Mike Silva and
Todd Peterson, former consultants to us (collectively, the "Claimants"), we
entered into a settlement agreement, dated February 27, 2004, under which we
issued 60,000 shares of our common stock as partial consideration for settling
the claim. These shares were issued in reliance upon the exemption from
registration provided by Section 4(2) of the Securities Act.
In February 2004, we completed the closing of a $10 million private offering of
investment Units to approximately 190 accredited investors at the price of $15
per Unit ("2004 Private Placement"). 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 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, are immediately exercisable 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.
These Units, shares of preferred stock and warrants were all issued in reliance
upon the exemption from registration provided under the SEC's Rule 506 adopted
under the Securities Act.
The rights of the holders of common stock have been limited or qualified by the
issuance of the Series A convertible preferred stock. In general, the Series A
preferred stock ranks senior to our common stock and
26
senior to any class or series of our capital stock hereafter created, in each
case as to payment of dividends, distributions of assets upon liquidation, and
our dissolution or winding up, whether voluntary or involuntary. For instance,
each outstanding share of Series A preferred stock receives a liquidation
preference equal to the aggregate purchase price at which the shares, along with
accompanying warrants, were first issued and sold by us in the 2004 Private
Placement, plus all accrued and unpaid dividends. Each holder of Series A
preferred stock is further entitled to share pro rata in the distribution of any
remaining assets with the common stockholders, such distribution to be based on
the number of shares of our common stock that would be held if the Series A
preferred stock were converted into shares of common stock. Each holder of the
Series A preferred stock is also entitled to receive preferential cumulative
dividends at the rate of 8% per year on the initial purchase price of the Series
A preferred stock, payable quarterly. The holders of our Series A preferred
stock are also entitled to notice of any stockholders' meeting and to vote with
the common stockholders on all matters submitted to a vote of our stockholders.
The Series A preferred stockholders are entitled to the number of votes equal to
the number of shares of common stock into which the Series A preferred stock are
then convertible. This resulted in an immediate dilution in voting rights of
common stockholders. Additionally, the Series A preferred stock is entitled to
vote separately on certain matters affecting the Series A preferred stock and as
required by law. The Series A preferred stockholders have preemptive rights in
general, subject to certain limited exceptions.
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.
In addition, the convertible notes issued in the 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, 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 of $2.82 per share. These warrants are immediately
exercisable and expire in February 2007. These Units, shares of preferred stock
and warrants to the investors were issued in reliance upon the exemption from
registration provided under the SEC's Rule 506 adopted under the Securities Act.
In March 2004, we entered into a consulting agreement with Brockington
Securities, Inc., whereby Brockington agreed to render consulting services to
us. As partial compensation for such services, we issued a warrant to purchase
100,000 shares of common stock to Brockington, which warrant is convertible at
the price of $1.50 per share. This warrant was issued in reliance upon the
exemption from registration provided by Section 4(2) of the Securities Act.
As partial consideration for our acquisition of nReach in March 2004, we issued
500,002 shares of our common stock to the 10 shareholders of nReach, each of
whom was either sophisticated or an accredited investor, and may issue more
shares if certain contingencies are met. Spenser Trask is owed a fee for this
transaction based on the aggregate consideration paid, but these shares have not
yet been issued. These shares of common stock were issued in reliance upon the
exemption from registration provided by Section 4(2) of the Securities Act.
27
In March 2004, we amended and restated the December 2002 consulting agreement
between Steven B. Rosner and us by extending the term by one year until March
2005. In consideration for this new agreement, we granted Mr. Rosner a warrant
to purchase 300,000 shares of common stock at an exercise price of $1.50 per
share and Mr. Rosner waived $60,000 in consulting fees that we owed him under
the December 2002 consulting agreement. This warrant was issued in reliance upon
the exemption from registration provided by Section 4(2) of the Securities Act.
The following chart describes our repurchases of our common stock during the
first quarter ended March 31, 2004.
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
- ------------------------- --------------------- --------------------- ----------------------- ------------------------
(d) Maximum Number (or
(c) Total Number of Approximate Dollar
Shares Purchased as Value) of Shares that
Part of Publicly May Yet Be Purchased
(a) Total Number of (b) Average Price Announced Plans or Under the Plans or
Period Shares Purchased Paid per Share Programs Programs
- ------------------------- --------------------- --------------------- ----------------------- ------------------------
1/1/04 - 1/31/04 34,347 /1/ $1.98 /1/ 0 0
- ------------------------- --------------------- --------------------- ----------------------- ------------------------
2/1/04 - 2/29/04 0 0 0 0
- ------------------------- --------------------- --------------------- ----------------------- ------------------------
3/1/04 - 3/31/04 0 0 0 0
- ------------------------- --------------------- --------------------- ----------------------- ------------------------
Total 34,347 -- 0 0
- ------------------------- --------------------- --------------------- ----------------------- ------------------------
- --------
1 These shares were acquired from Mario Rossi, our former Executive Vice
President, Chief Technology Officer and Director, in connection with his
retirement and a Separation Agreement between Mr. Rossi and us effective as of
October 21, 2003. The shares were issued to Mr. Rossi pursuant to a Restricted
Stock Agreement and in exchange for a note in the original principal amount of
$152,500 (the "Rossi Note"). The outstanding amount of principal on the Rossi
Note ($68,000) was cancelled upon delivery by Mr. Rossi to SmartServ of the
34,347 shares of restricted stock that secured the Rossi Note.
28
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
2.1 Reorganization and Stock Purchase Agreement dated as of January 29,
2004 by and among nReach, Inc., SmartServ and the shareholders of
nReach set forth on Schedule A thereto /1/
3.1 Amended and Restated Certificate of Incorporation, as amended /2/
4.1 Form of Warrant for the Investors in the 2004 Private Placement /2/
4.2 Form of Registration Rights Agreement, dated February 13, 2004,
between SmartServ and the Investors in the 2004 Private Placement /2/
4.3 Specimen Certificate of SmartServ's Series A Convertible Preferred
Stock /2/
4.4 Form of Warrant for Spencer Trask issued pursuant to the 2004 Private
Placement /2/
10.1 Employee Separation Agreement, dated February 2, 2004, between
SmartServ and Richard Kerschner /3/
10.2 Placement Agency Agreement, dated January 29, 2004, between SmartServ
and Spencer Trask in connection with the 2004 Private Placement /2/
10.3 Employment Agreement dated as of March 12, 2004 between SmartServ and
Robert Pons /3/
10.4 Employment Agreement dated as of March 12, 2004 between SmartServ and
Timothy G. Wenhold /3/
10.5 Option Agreement dated as of March 12, 2004 between SmartServ and
Robert Pons /3/
10.6 Option Agreement dated as of March 12, 2004 between SmartServ and
Timothy G. Wenhold /3/
10.7 Settlement Agreement dated as of February 27, 2004 by and among
SmartServ and Michael Silva, Todd Peterson and Brauning Inc. /3/
10.8 Amended and Restated Consulting Agreement dated as of March 31, 2004
between SmartServ and Steven B. Rosner, as amended /3/
10.9 Consulting Agreement dated as of March 31, 2004 between SmartServ and
Brockington Securities, Inc., as amended /3/
10.10 Employment Agreement dated as of February 28, 2004 between SmartServ
and Michael Stemple /3/
10.11 Warrant for Richard Kerschner dated as of February 2, 2004 /3/
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 +
29
+ Filed herewith.
1 Filed as an Exhibit to our Form 8-K, dated March 4, 2004.
2 Filed as an Exhibit to our Annual Report on Form 10-KSB for the fiscal
year ended December 31, 2003 on April 13, 2004.
3 Filed as an Exhibit to our Registration Statement on Form SB-2
(Registration No. 333-115462) on May 13, 2004.
(b) Reports on Form 8-K
On January 30, 2004, the Company filed a Form 8-K under Item 5 of such
Form. The information related to the Company's press release issued on
January 30, 2004 regarding the private placement of certain of its
securities.
On January 30, 2004, the Company filed a Form 8-K under Item 5 of such
Form. The information related to the Company's (i) press release issued on
January 30, 2004 announcing certain changes in management, and (ii) press
release issued January 30, 2004 announcing the signing of stock purchase
agreements with nReach, Inc. and Mobile Airwaves, Inc. The Form 8-K also
provided a copy of updated risk factors applicable to investments in the
Company's securities.
On March 1, 2004, the Company filed a Form 8-K under Item 5 of such Form.
The information related to the Company's press releases issued February 17,
2004 and March 1, 2004 regarding the private placement of certain of its
securities.
On March 4, 2004, the Company filed a Form 8-K under Item 2 of such Form.
The information related to the Company's acquisition of all of the stock of
nReach, Inc. and the assumption of certain obligations in connection
therewith.
30
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 19, 2004 /s/ Robert M. Pons
------------ ----------------------------------------
Robert M. Pons
Chief Executive Officer
Date: May 19, 2004 /s/ Len von Vital
------------ ----------------------------------------
Len von Vital
Chief Financial Officer
31