MobileSmith, Inc. - Annual Report: 2006 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
[
X
] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
OF 1934
For
the fiscal year ended December 31, 2006
or
[
]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
OF 1934
For
the transition period from __________ to __________
Commission
file number 333-119385
SMART
ONLINE, INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
(State
or other jurisdiction of incorporation)
|
95-4439334
(I.R.S.
Employer Identification No.)
|
|
|
2530
Meridian Parkway, 2nd
Floor
Durham,
North Carolina
(Address
of principal executive offices)
|
27713
(Zip
Code)
|
(919)
765-5000
(Registrant's
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act: None
Securities
registered pursuant to Section 12(g) of the Act:
Common
Stock, $0.001 par value
(Title
of Class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes [ ] No [ X ]
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes [ X ] No [ ]
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 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 [ ]
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this
Form 10-K. [ ]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
|
Large
accelerated filer [ ]
|
Accelerated
filer [ ]
|
Non-accelerated
filer [ X ]
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes [ ] No [ X ]
The
aggregate market value of common stock held by non-affiliates of the registrant
as of March 15, 2007 was approximately $24,010,000 (based on the closing sale
price of $2.80 per share).
The
number of shares of the registrant’s Common Stock, $0.001 par value per share,
outstanding as of March 15, 2007 was 17,766,971.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held June 21, 2007 are
incorporated by reference into Part III.
1
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2
PART
I
Special
Note Regarding Forward-Looking Statements
This
Annual Report on Form 10-K contains forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933, or the Securities Act,
and
Section 12E of the Securities Exchange Act of 1934, or the Exchange Act,
regarding our plans, objectives, expectations, intentions, future financial
performance, future financial condition, and other statements that are not
historical facts. You can identify these statements by our use of the future
tense, or by forward-looking words such as “may,” “will,” “expect,”
“anticipate,” “believe,” “intend,” “estimate,” “continue,” and other similar
words and phrases. Examples of sections containing forward-looking statements
include “Part I - ITEM 1. BUSINESS” and “Part II - ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.” These
forward-looking statements are subject to risks, uncertainties, and assumptions
that are difficult to predict. Therefore, actual results may differ materially
and adversely from those expressed in any forward-looking statements. Readers
are directed to risks and uncertainties identified in “Part I - ITEM
1A.RISK
FACTORS”
and
elsewhere in this report for factors that may cause actual results to be
different than those expressed in these forward-looking statements. Except
as
required by law, we undertake no obligation to revise or update publicly any
forward-looking statements for any reason.
OVERVIEW
Smart
Online, Inc. develops and markets products and services targeted to small
businesses (less than 50 employees) that are delivered via a
Software-as-a-Service, or SaaS, model. Our goal is to be the leading provider
of
on-demand SaaS applications for small businesses. We sell our products and
services primarily through private
label syndication and original equipment manufacturer, or OEM, distribution
channels, although small businesses may purchase products and services directly
through our main portal located at www.smartonline.com.
Our
primary source of revenue currently comes from sales of our SaaS applications
for business management, web marketing, and e-commerce, which represented 63%,
77%, and 55% of our revenue from continuing operations for the fiscal years
ended December 31, 2006, 2005, and 2004, respectively. We derive revenue from
sales of services that are designed to complement our product offerings and
allow us to create custom business solutions that fit our end-users’ and our
channel partners’ needs, which represented 35%, 19%, and 0% of our revenue from
continuing operations for the fiscal years ended December 31, 2006, 2005, and
2004, respectively.
We
offer
two technology
platforms that communicate via web service and serve as the foundation for
delivery of our business solutions: OneBizSM
and
iDirect
ArchitectureTM,
or iDA.
Each is described more fully below. Both
platforms
allow integrated applications to share data with the
other
products and/or services running on our platforms. Our
products and services are primarily offered on a subscription basis using the
on-demand SaaS model.
HISTORY
We
were
incorporated in Delaware in 1993 and initially offered our software applications
using traditional distribution methods of diskettes and later CD-ROMs. In 2000,
we moved away from the traditional distribution model and began primarily
offering on-demand SaaS applications over the Internet. Unlike the traditional
distribution method that requires a customer to install, configure, and maintain
hardware, software, and network services internally to support the software
applications, our proprietary SaaS applications allow small businesses to
subscribe to a wide variety of applications that have been developed
specifically for delivery over the Internet on an on-demand basis with very
little or no installation or maintenance required.
During
October 2005, we acquired substantially all of the assets of Computility, Inc.,
or Computility, a privately held developer and distributor of sales force
automation and customer relationship management, or SFA/CRM, software
applications based in Des Moines, Iowa. We operated this business under the
name
Smart CRM, Inc. (d/b/a Computility), or Smart CRM. Also during October 2005,
we
acquired all the stock of iMart Incorporated, or iMart, a privately held
developer and distributor of multi-channel e-commerce systems based in Grand
Rapids, Michigan. We operate this subsidiary as Smart Commerce.
Upon
our
integration of Smart CRM’s SFA/CRM application into our OneBizSM
platform, management determined that the remaining operations of Smart CRM,
specifically consulting and network management, were not integral to our ongoing
operations and business model. On September 29, 2006, we sold these non-integral
Smart CRM assets to Alliance Technologies, Inc., or Alliance, and reclassified
Smart CRM as a discontinued operation. For further information about this
business closure, see Note 17, “Acquisitions & Dispositions” in our
consolidated financial statements included in this report.
3
The
Smart
CRM assets sold to Alliance included the traditional SFA/CRM software
application developed and sold by Smart CRM and its predecessor in interest,
Computility. We retained all rights relating to the derivative SFA/CRM SaaS
application developed by us with Smart CRM and incorporated into our
OneBizSM
platform.
Consistent
with SFAS No. 131, Disclosures
About Segments of an Enterprise and Related Information,
or SFAS
No. 131, we have defined two reportable segments based on factors such as
geography, products, customers, how operations are managed, and how our chief
executive officer, the chief operating decision-maker, views results. Those
segments are our core operations, or the Smart Online segment, and the
operations of our wholly-owned subsidiary, or the Smart Commerce
segment.
The
Smart
Commerce segment's revenues are derived primarily from the development and
distribution of multi-channel e-commerce systems including domain name
registration and e-mail solutions, e-commerce solutions, website design and
website hosting. In 2006, our Smart Commerce segment generated 86% of our total
consolidated revenue and 96% and 100% of our subscription and professional
services revenue, respectively.
The
Smart
Online segment generates revenues from the development and distribution of
internet-delivered SaaS small business applications through a variety of
subscription, integration and syndication channels. In 2006, our Smart Online
segment generated 14% of our total consolidated revenue and 100% of our
integration and syndication revenue, and 4% of our subscription
revenue.
We
include costs such as corporate general and administrative expenses and
share-based compensation expenses that are not allocated to specific segments
in
the Smart Online segment, which includes the parent or corporate
segment.
During
the period from 2000 to 2006, we were functioning primarily in a research and
development mode as we adapted our products for the SaaS model. We began
shifting our focus to the marketing of our most current products in the fourth
quarter of 2006. During fiscal 2006, the operations we acquired following the
iMart acquisition, which we operate as Smart Commerce, were revenue-generating
operations. Accordingly, the majority of current revenues is generated by our
Smart Commerce segment.
PRINCIPAL
PRODUCTS AND SERVICES
Our
principal products and services include:
| · |
SaaS
applications for business management, web marketing, and
e-commerce;
|
| · |
software
business tools that assist customers in developing written content;
and
|
| · |
services
that are designed to complement our product offerings and allow us
to
create custom business solutions that fit our end-users’ and our channel
partners’ needs.
|
Business
Management SaaS Applications
Our
business management SaaS applications are designed to allow users to access
and
work on information securely from anywhere with an Internet browser. These
applications include:
Business
Dashboard:
Our
Business Dashboard application provides a snapshot of real-time business
information in a single view, allowing users to monitor key business information
about their company and employees. The dashboard automatically aggregates data
from multiple sources and summarizes the information for the user quickly and
efficiently. Examples of business information that users may view on the
dashboard include: a list of key documents for the user, daily events scheduled,
FedEx packages shipped by a user, or a list of new employees. The dashboard
is
entirely role-based, and displays different information to each user based
upon
their role and access levels within the company.
Accounting:
Our
Accounting application is targeted for users that want to create and maintain
their accounting books online in a secure fashion but do not have the time
or
resources to learn and understand the intricacies of traditional accounting
applications designed for larger businesses. The Accounting application
functions allow a user to create invoices, record payments, print checks,
produce real-time financial statements and reports, as well as manage accounts
receivable and payable.
SFA/CRM:
Our
SFA/CRM application is designed to allow users to create standardized processes
to define their sales approach, create SFA marketing plans, and monitor and
guide sales activities. Companies can utilize the customer service management
feature to create, monitor, and track service requests and execute issue
escalation and notification. Users can display and present their business data
with built-in report templates designed to provide information on sales
activity, pipeline funnels, revenue and other relevant business
data.
4
Human
Resource Center:
Our
Human Resource, or HR, Center application is designed to allow companies to
manage their daily human resources needs, including employee information, HR
documents, performance reviews and compensation. The HR Center application
also
allows employers to manage the attendance records of each employee by creating
and assigning vacation, sick leave, civil leave, and other different policies
to
each individual employee. The application can monitor and approve or decline
as
needed time-off requests and automatically track how much time each employee
has
available on a per policy basis.
Calendar:
Our
Calendar application is a full function, easy-to-use online calendar. The
Calendar application features daily, weekly, and monthly views, together with
a
mini-calendar that allows the user to quickly browse to any other date. Users
can set up automated email reminders at their convenience, indicating how early
they would like to be notified of an upcoming event. In addition, users have
the
option to collaborate with their colleagues by sharing their calendar and
events. This application also includes a to-do list, allowing users to setup
tasks, assign priorities and due dates, and mark tasks as complete as they
work
through them.
Contacts:
Our
Contacts application is designed to provide users with an online business
contact management system. Contacts can be sorted by group or alphabetically.
Users also have the option to add, edit, and remove contact groups at their
own
convenience, or they can use the default set of groups that is already provided
for them when they sign up. Furthermore, users have the option to share their
contacts between colleagues. Using the intuitive sharing system built into
the
application, users select whether they would like a contact to remain private
or
shared.
e-Commerce:
Our
e-commerce applications, OneDomainTM
and
OneDomainXTM,
are
designed to give customers the ability to conduct their business online and
include website design and launch, inventory query, shopping cart, financial
transactions, shipping, domain name registration and business to business
communication for small businesses. Our e-commerce applications also include
our
Direct Marketing Architecture, or iDMA, which is a technology platform that
is
designed to help direct marketers increase sales, better leverage corporate
resources, and deliver superior customer service, and our Direct Selling
Architecture, or iDSA, which is a system available for direct selling and
network marketing companies.
Business
Tools
We
offer
a variety of business tools through our website to aid small businesses. Most
of
these tools are also available through the private-label sites of our partners.
Our business tools include Business Plan Writer, Business Letters, Business
and
Legal Forms, Marketing Plan Writer, Job Description Writer, Employee Policy
Manual Writer, Government Forms, and Business Guides.
Additional
Services
These
services are designed to complement our product offerings and allow us to create
custom business solutions that fit our end-users’ and our channel partners’
needs. The services offered to our partners include business consulting,
graphics design, website content syndication, specialized compensation
calculation, inventory management, domain name registration, and personalized
email creation, FedEx tracking, loan center, press release writing, business
plan writing & evaluation, e-commerce tax services, e-mail marketing, web
analytics, warehouse order fulfillment, and business and personal
calculators.
MODE
OF
OPERATIONS
“Software-as-a-Service”
Model
We
follow
the SaaS model for delivering our products and services to our customers. The
Internet allows for delivery of software in new ways. For example, a company
can
download a software application instead of buying it from the local retail
store. However, software purchased in this fashion still needs to be installed,
updated, and the data backed-up, all by the end-user. The on-demand SaaS model
eliminates these additional tasks. Instead, end users visit a website and use
the SaaS applications, all via a web browser, with no installation, no special
information technology knowledge, and no maintenance. The SaaS application
is
transformed into a service that can be used anytime, anywhere by the end-user.
Multi-tenant SaaS applications have the additional benefit of allowing
functionality to be added to our applications in one place to the benefit of
all
users. This allows us to have easier maintenance, universal upgrading, and
quick
deployment of new features.
Revenue
Stream
We
charge
small businesses who use our SaaS applications a subscriber fee on a monthly
subscription basis, rather than the large upfront cost typically charged for
traditional software applications.
5
Platforms
We
have
designed two technology
platforms to serve as the foundation for delivery of our business solutions:
OneBizSM
and
iDA.
OneBizSM
is our
business management platform offered though our main portal and through the
sites of our private-label partners. This allows us to offer our proprietary
products, as well as certain integration partner products, to our partners’
small business customers in the “look” and “feel” of the partner’s website. iDA
is our web marketing and web selling platform offered through Smart Commerce.
Both
platforms
communicate with each other via web services and have the ability to allow
integrated applications to share data with the
rest
of the products and/or services running on our platforms. The platforms
also
allow
users to seamlessly login to multiple SaaS applications/services without having
to re-enter a user ID and password or navigate to another site. Both
platforms use
a
modular methodology, which allows various components to be assembled for rapid
new application development and enhancement. Our OneBizSM
platform
has a distinct profile feature that is created for every company when users
sign
up and register. This profile is continually updated based on operations
performed and information requested by each company as its users operate on
the
platform.
Integration
and Sharing
Our
platforms allow end-users to share information (with selectivity and control
options) with other members of their organization. Each user that subscribes
to
our platform can have multiple members or employees who share information with
one another. Information entered by one user can be shared and modified by
one
or more other users, promoting collaboration within a company.
Several
of the applications within our platforms are integrated with one another.
Integration means that certain applications communicate and share information
with other applications.
TARGET
MARKET AND SALES CHANNELS
Our
consistent focus from the beginning has been to design software products and
services to help start and run small businesses. The small business market
is
diverse, fragmented, yet very large and, we believe, underserved. We define
small businesses as those having less than 50 employees. Even within this
definition, there exists a large variety of businesses. Therefore, we have
focused on offering a wide range of software products that combine simplicity
and affordability. We realize that many new small businesses will fail
relatively quickly, which forces us to continuously seek out new end-users
to
replace existing end-user attrition. Another characteristic of small businesses
is that they are typically late adopters of technology. Internet adoption is
well past critical mass, and we believe the growth rate of small businesses
using web-based applications will exceed the growth rate of large enterprises.
These businesses may even leapfrog traditional software and go straight from
paper-based management to a SaaS solution.
Although
our ultimate end-users are small businesses and entrepreneurs who access our
software products and services via the web, we use channel partners such as
financial institutions, telecommunication companies, direct selling
organizations, retailers, technology companies, and small business consultants
as channels to reach small business customers. These partnerships can be
constructed in a variety of formats - from resellers to co-branded offerings
to
private label or OEM solutions. We
typically seek partnerships with organizations that already have a relationship
with small businesses. We have successfully targeted our applications to direct
selling organizations, financial companies as
well
as business media companies.
Our
plan
for 2007 is to increase our revenue through a combination of four sales and
marketing initiatives:
| · |
soliciting
additional syndication partners,
|
| · |
actively
managing relationships with our partners to increase sales,
|
| · |
bundling
our software in packages targeted to different types of
industries within
the small business market, and
|
| · |
introducing
new applications and products of greater value to small businesses.
|
We
have
not yet implemented all of these marketing strategies, and others have not
been
implemented until recently. At this time, we cannot determine how successful
these strategies will be.
We
also
plan to continue to update, enhance, and add to the functionality of our
platforms, and add sales and marketing personnel to implement our syndication
partner strategy.
6
PRINCIPAL
CUSTOMERS
Currently,
two customers are considered major customers the loss of whom could have a
material adverse effect on our business. Both of these customers currently
subscribe to the applications offered by, and purchase professional services
from, our Smart Commerce segment.
Britt
Worldwide, or BWW, is an entity that indirectly controls a significant number
of
independent business owners, or IBOs, who currently subscribe to our services.
The aggregate of the subscriptions from these IBOs represented approximately
45%
of our consolidated revenue for the fiscal year ended December 31, 2006. BWW
was
not a customer of ours in 2004, and was a customer of ours only after we
acquired iMart in October 2005. Accordingly, BWW represented 0% and 15% of
our
revenues in 2004 and 2005, respectively. Although our revenue is derived from
the IBO, because BWW can influence the actions of the IBOs, this revenue has
been aggregated for purposes of this annual report on Form 10-K.
Vera
Bradley Designs, Inc., or Vera Bradley, a manufacturer of high quality handbags,
luggage and other accessories, is also a major customer. Vera Bradley accounted
for approximately 28% of our consolidated revenues for fiscal year ended
December 31, 2006. Vera Bradley was not a customer of ours in either 2004 or
2005, and therefore represented 0% of our revenue in those years.
RESEARCH
& DEVELOPMENT
Between
1999 and 2000, we made a strategic decision to shift our focus from traditional
software delivery to the SaaS model. From that point until the present, we
have
devoted substantially all of our development personnel’s time and efforts toward
the research and development of our OneBizSM
platform
and the associated applications. In the fourth quarter of 2006, we began to
shift our focus from research and development to the marketing of our latest
products.
In
2004,
we spent approximately $563,000 on research and development. In 2005, our
research and development costs increased to approximately $1.6 million as we
increased our efforts to develop our OneBizSM
applications for new partners. In 2006, our research and development costs
were
approximately $2.0 million with the increase over 2005 primarily related to
development efforts in Smart Commerce.
We
have
not engaged in any customer sponsored research and development.
COMPETITION
The
market for small business software applications is highly competitive and
subject to rapid change. The direct competition we face depends on the software
application within our platforms and the delivery model capabilities of our
competitors.
We
have
two primary categories of competitors: large companies that offer a wide range
of products for small to medium size businesses and other companies that offer
only one or two software products that compete with our broad range of software
products.
Our
principal direct competition comes from several large vendors of SaaS
applications for small businesses that sell many products similar to ours.
Most
of these competitors also sell other products and services not specifically
targeted to small businesses, although some of their products have been modified
for small business use or are marketed as small business products. These
competitors include, but are not limited to, Microsoft, Oracle, NetSuite,
Intuit, SAP, Sage and Yahoo!.
We
also
expect to face competition from new entrants that will market SaaS applications
similar to ours to small businesses. As we introduce more software products,
we
expect to encounter more competitors. Companies that offer only one or two
products that compete with our suite of SaaS applications include:
| · |
Accounting
software applications: Netsuite, Intuit, SAP, Sage, Microsoft and
others.
|
| · |
Human
resource software applications: Employease, Oracle, Sage and
others.
|
| · |
e-Commerce
solutions: Register.com, GoDaddy.com, 1and1 Internet, Yahoo!, eBay's
Storefront, Yahoo! Store, Microsoft, NetSuite, Homestead and
others.
|
| · |
SFA/CRM
applications: Microsoft, Oracle, Sage, Salesforce.com, Netsuite,
and
others.
|
Although
we believe we offer highly competitive services and software, many of our
competitors have greater resources, and a larger number of total customers
for
their products and services. In addition, a number of our competitors sell
many
products to our current and potential customers, as well as to systems
integrators and other vendors and service providers. These competitors may
be
able to respond more quickly to new or emerging technologies and changes in
customer requirements, or to devote greater resources to the development,
promotion, and sale of their products, than we can. It is also possible that
new
competitors or alliances among competitors or other third parties may emerge
and
rapidly acquire market share. Increased competition may result in price
reductions, reduced gross margins, and change in market share, any of which
could harm our business.
7
On
each
competitive front, we seek to compete against these larger and better financed
companies primarily by offering a suite of SaaS applications that are useful
to
small businesses. We believe we offer more SaaS applications and features
specifically targeted to small businesses than most of our competitors. We
believe one distinctive value our applications offer is the integration of
the
applications. By integrating data sharing across applications through our
platform, small businesses can enter or change data once. However, our
individual applications must also be competitive with the applications offered
by industry leaders in those specific segments which will require additional
development work by us. If we are unable to develop new and enhances
applications that are competitive, our business may be harmed.
We
also
plan to leverage our private label syndication partners to sell our SaaS
applications to their small business customers. We offer these partners and
potential partners the ability for large corporations to private-label our
products to offer their small business customers value added products and
services. While we may lack the marketing budget or resources to compete with
industry giants, we believe our corporate syndication partners will allow us
to
compete effectively if we are able to motivate our partners to devote resources
to selling subscriptions. This strategy will require us to hire additional
personnel to develop and manage these relationships and to sign additional
partners to private label our SaaS applications.
We
also
believe that our focus on delivering our products and service via the SaaS
business model enables us to compete with these companies. This model requires
very little initial investment by small businesses and we believe it is cost
competitive with the products of many competitors over the long-term. SaaS
applications provide our customers with access to their important business
data
from any location via the Internet and can be updated automatically and without
a charge to the customer. This functionality enables us to continually improve
the ease of use and performance of our SaaS applications as we receive feedback
from our customers. However, this functionality may also make the SaaS model
more attractive to competitors that currently offer their products through
traditional methods of software delivery. As a result, we expect the number
of
competitors offering software via the SaaS model to increase in the
future.
WORKING
CAPITAL PRACTICES
Due
to
the nature of the model we have adopted for the delivery of our products, our
working capital needs are primarily cash and equivalents and accounts
receivable, which are necessary to support and sustain our operations. We do
not
carry any significant inventory nor do we maintain substantial reserves for
returns or credit terms.
INTELLECTUAL
PROPERTY RIGHTS
Our
success depends, in part, upon our proprietary technology, processes, trade
secrets, and other proprietary information, and our ability to protect this
information from unauthorized disclosure and use. We rely on a combination
of
copyright, trade secret, and trademark laws, confidentiality procedures,
contractual provisions, and other similar measures to protect our proprietary
information. We do not own any issued patents or have any patent applications
pending.
Despite
our efforts to protect our proprietary rights, unauthorized parties may attempt
to copy aspects of our products or to obtain and use information that we regard
as proprietary, and third parties may attempt to develop similar technology
independently. Policing unauthorized use of our products is difficult,
particularly because the global nature of the Internet makes it difficult to
control the ultimate destination or security of software or other data
transmitted. While we are unable to determine the extent to which piracy of
our
software products exists, software piracy can be expected to be a persistent
problem. In addition, the laws of some foreign countries do not protect our
proprietary rights to as great an extent as do the laws of the United States,
and we expect that it will become more difficult to monitor use of our products
if we increase our international presence.
We
have
registered copyrights, trademarks and registered service marks on more than
a
dozen products and data services. These marks include, but are not limited
to:
Smart Online, OneBiz, Smart Attorney, Smart Business Plan, iMart, and
OneDomain.
As
part
of our efforts to protect our proprietary information, we enter into license
agreements with our customers and nondisclosure agreements with certain of
our
employees, consultants and corporate partners. These agreements generally
contain restrictions on disclosure, use, and transfer of our proprietary
information. We also employ various physical security measures to protect our
software source codes, technology, and other proprietary
information.
8
EMPLOYEES
As
of
March 15, 2007, we had 56 full-time employees. No employees are known by us
to
be represented by a collective bargaining agreement, and we have never
experienced a strike or similar work stoppage.
AVAILABLE
INFORMATION
Our
corporate information is accessible through our main web portal at
www.smartonline.com. We are not including the information contained on our
website as a part of, or incorporating it by reference into this annual report
on Form 10-K. Although we endeavor to keep our Internet website current and
accurate, there can be no guarantees that the information on the Internet
website is up to date or correct. We make available free of charge through
our
website our annual reports on Form 10-K, quarterly reports on Form 10-Q, and
current reports on Form 8-K, amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act, and beneficial ownership
reports filed by officers, directors, and principal security holders under
Section 16(a) of the Exchange Act as soon as reasonably practicable after we
electronically file such material with, or furnish such material to, the SEC.
These reports may be accessed by following the link under “Investors--SEC
Filings” on our website.
An
investment in Smart Online involves significant risks. You should read the
risks
described below very carefully before deciding whether to invest in Smart
Online. The following is a description of what we consider our key challenges
and risks.
We
operate in a dynamic and rapidly changing business environment that involves
substantial risk and uncertainty and these risks may change over time. The
following discussion addresses some of the risks and uncertainties that could
cause, or contribute to causing, actual results to differ materially from
expectations. In evaluating our business, you should pay particular attention
to
the descriptions of risks and uncertainties described below and in other
sections of this document and our other filings. These risks and uncertainties
are not the only ones we face. Additional risks and uncertainties not presently
known to us, that we currently deem immaterial, or that are similar to those
faced by other companies in our industry or business in general may also affect
our business. If any of the risks described below actually occurs, our business,
financial condition, or results of operations could be materially and adversely
affected.
We
have
organized these factors into the following categories below:
| · |
Our
Financial Condition
|
| · |
Our
Products and Operations
|
| · |
Our
Market, Customers and Partners
|
| · |
Our
Officers, Directors, Employees and
Stockholders
|
| · |
Regulatory
Matters that Affect Our Business
|
| · |
Matters
Related to the Market For Our
Securities
|
Risks
Associated with Our Financial Condition
(1)
We have had recurring losses from operations since inception, and have
deficiencies in working capital and equity capital. If we do not rectify these
deficiencies through additional financing or growth, we may have to cease
operations and liquidate our business. Because we have only nominal tangible
assets, you may lose your entire investment.
Through
December 31, 2006, we have lost an aggregate of approximately $57 million since
inception on August 10, 1993. During the years ended December 31, 2006 and
2005,
we incurred a net loss of approximately $5.0 million and $15.6 million,
respectively. Losses do not include the pre-acquisition losses, or profit,
of
the two companies we acquired during the fourth quarter of 2005. At December
31,
2006, we had a $3.8 million working capital deficit. Our working capital,
including our line of credit and recent financing transaction for $6 million,
is
not sufficient to fund our operations beyond July 2008, unless we substantially
increase our revenue, limit expenses or raise substantial additional financing.
Factors such as the suspension of trading of shares of our common stock by
the
SEC, and the resulting drop in share price, trading volume and liquidity; the
commercial success of our existing services and products; the timing and success
of any new services and products; the progress of our research and development
efforts; our results of operations; the status of competitive services and
products; and the timing and success of potential strategic alliances or
potential opportunities to acquire technologies or assets may require us to
seek
additional funding sooner than we expect. If we fail to raise sufficient
financing, we will not be able to implement our business plan, we may have
to
liquidate our business and you may lose your investment.
9
(2)
Any issuance of shares of our common stock in the future could have a dilutive
effect on your investment.
We
may
issue shares of our common stock in the future for a variety of reasons. For
example, under the terms of the stock purchase warrant and agreement we recently
entered into with Atlas Capital, S.A., or Atlas, Atlas may elect to purchase
up
to 444,444 shares of our common stock at $2.70 per share upon termination of,
or
if we are in breach under the terms of our line of credit with Wachovia Bank,
NA, or Wachovia. In connection with our recent private financing, we issued
warrants to the investors to purchase an additional 1,176,471 shares of our
common stock at $3.00 per share, and warrants to our placement agent in that
transaction to purchase 35,000 shares of our common stock at $2.55 per share.
In
addition, we may raise funds in the future by issuing additional shares of
common stock or other securities.
If
we
raise additional funds through the issuance of equity securities or debt
convertible into equity securities, the percentage of stock ownership by our
existing stockholders would be reduced. In addition, such securities could
have
rights, preferences, and privileges senior to those of our current stockholders,
which could substantially decrease the value of our securities owned by them.
For example, from March through August 2006, we sold an aggregate of 1,000,000
shares of common stock to investors for a price of $2.50 per share for total
aggregate proceeds of $2.5 million. Similarly, in February 2007, we sold an
aggregate of 2,352,941 shares of common stock to investors for a price of $2.55
per share, and issued the investors warrants for the purchase of an aggregate
of
1,176,471 shares of common stock at an exercise price of $3.00 per share, for
total aggregate proceeds of $6 million. Because
of the share price, we had to sell a significant number of shares to raise
the
necessary amount of capital. You
may
experience dilution in the value of your shares as a result.
(3)
In the future, we may enter into certain debt financing transactions with third
parties that could adversely affect our financial health.
We
currently have a secured loan arrangement from Fifth Third Bank. Under the
terms
of this agreement, Smart Commerce borrowed $1.8 million to be repaid in
twenty-four (24) monthly installments of $75,000 plus interest beginning in
December 2006. The interest rate is prime plus 1.5% as periodically determined
by Fifth Third. The loan is secured by all of the assets of Smart Commerce
and
all of Smart Commerce’s intellectual property. The loan is guaranteed by us and
such guaranty is secured by all the common stock of Smart Commerce.
We
also
have a revolving line of credit from Wachovia. The line of credit advanced
by
Wachovia is $2.5 million, and as
of
March 14, 2007, we have drawn down approximately $2.1 million.
Any
advances made on the line of credit must be repaid no later than August 1,
2008,
with monthly payments of accrued interest only commencing on December 1, 2006
on
any outstanding balance. The interest shall accrue on the unpaid principal
balance at the LIBOR Market Index Rate plus 0.9%. The line of credit is secured
by Smart Online's deposit account at Wachovia and an irrevocable standby letter
of credit in the amount of $2.5 million issued by HSBC Private Bank (Suisse)
S.A. with Atlas Capital, S.A. as account party.
We
are
evaluating various equity and debt financing options and in the future may
incur
indebtedness that could adversely affect our financial health. For example,
indebtedness could:
| • |
increase
our vulnerability to general adverse economic and industry
conditions;
|
| • |
require
us to dedicate a substantial portion of our cash flow from operations
to
payments on our debt, thereby reducing the availability of our cash
flow
to fund working capital, capital expenditures and other general corporate
purposes;
|
| • |
limit
our flexibility in planning for, or reacting to, changes in our business
and the industry in which we
operate;
|
| • |
result
in the loss of a significant amount of our assets or the assets of
our
subsidiary if we are unable to meet the obligations of these
arrangements;
|
| • |
place
us at a competitive disadvantage compared to our competitors that
have
less indebtedness or better access to capital by, for example, limiting
our ability to enter into new markets;
and
|
| • |
limit
our ability to borrow additional funds in the
future.
|
Risks
Associated with Our Products and Operations
(4)
Our business is dependent upon the development and market acceptance of our
applications, including the acceptance of using some of our applications to
conduct business. Our business models and operating plans have changed as a
result of forces beyond our control. Consequently, we have not yet demonstrated
that we have a successful business model or operating
plan.
10
We
continually revise our business models and operating plans as a result of
changes in our market, the expectations of customers and the behavior of
competitors. Today, we anticipate that our future financial performance and
revenue growth will depend, in large part, upon our Internet-based SaaS business
model and the results of our sales efforts to reach agreements with syndication
partners with small business customer bases, but these business models may
become ineffective due to forces beyond our control that we do not currently
anticipate. We recently entered into agreements with two new syndication
partners, but we have not yet derived any revenue under these agreements.
Consequently, we have not yet demonstrated that we have a successful business
model or operating plan. Our evolving business model makes our business
operations and prospects difficult to evaluate. There can be no assurance that
our revised business model will allow us to capture significant future market
potential. Investors in our securities should consider all the risks and
uncertainties that are commonly encountered by companies in this stage of
operations under our current business model, particularly companies, such as
ours, that are in emerging and rapidly evolving markets.
Our
future financial performance and revenue growth will depend, in part, upon
the
successful development, integration, introduction, and customer acceptance
of
our software applications. Thereafter, other new products either developed
or
acquired and enhanced versions of our existing applications will be critically
important to our business. Our business could be harmed if we fail to deliver
timely enhancements to our current and future solutions that our customers
desire. We also must continually modify and enhance our services and products
to
keep pace with market demands regarding hardware and software platforms,
database technology, information security, and electronic commerce technical
standards. There can be no assurance that we will be able to successfully
develop new services or products, or to introduce in a timely manner and gain
acceptance of our new services or products in the marketplace.
Our
business could be harmed if we fail to achieve the improved performance that
customers want with respect to our current and future offerings. We cannot
assure you that our products will achieve widespread market penetration or
that
we will derive significant revenues from the sale of our
applications.
Certain
of our services involve the storage and transmission of customers’ proprietary
information (such as credit card, employee, purchasing, supplier, and other
financial and accounting data). If customers determine that our services do
not
provide adequate security for the dissemination of information over the Internet
or corporate extranets, or are otherwise inadequate for Internet or extranet
use, or if, for any other reason, customers fail to accept our products for
use,
our business will be harmed. Our failure to prevent security breaches, or
well-publicized security breaches affecting the Internet in general, could
significantly harm our business, operating results, and financial
condition.
(5)
We may consider strategic divestiture, acquisition or investment opportunities
in the future. We face risks associated with any such
opportunity.
From
time
to time we evaluate strategic opportunities available to us for product,
technology or business acquisitions, investments and divestitures. In the
future, we may divest ourselves of products or technologies that are not within
our continually evolving business strategy or acquire other products or
technologies. We may not realize the anticipated benefits of any such current
or
future opportunity to the extent that we anticipate, or at all. We may have
to
issue debt or equity securities to pay for future acquisitions or investments,
the issuance of which could be dilutive to our existing stockholders. If any
opportunity is not perceived as improving our earnings per share, our stock
price may decline. In addition, we may incur non-cash amortization charges
from
acquisitions, which could harm our operating results. Any completed acquisitions
or divestitures would also require significant integration or separation
efforts, diverting our attention from our business operations and strategy.
Our
limited acquisition experience is from 2005, and therefore our ability as an
organization to integrate any acquired companies into our business is unproven.
Acquisitions and investments involve numerous risks, including:
| • |
difficulties
in integrating operations, technologies, services and
personnel;
|
| • |
diversion
of financial and managerial resources from existing
operations;
|
| • |
reduction
of available cash;
|
| • |
risk
of entering new markets;
|
| • |
potential
write-offs of acquired assets;
|
| • |
potential
loss of key employees;
|
11
| • |
inability
to generate sufficient revenue to offset acquisition or investment
costs;
and
|
| • |
delays
in customer purchases due to
uncertainty.
|
If
we
fail to properly evaluate and execute acquisitions, divestitures or investments,
our business and prospects may be seriously harmed.
(6)
We entered into a debt financing transaction in order to make certain
installment payments under our agreement in the iMart acquisition. Failure
to
comply with the provisions of this loan agreement could have a material adverse
effect on us.
When
we
purchased iMart in October 2005, we committed to make installment payments
of
approximately $3,462,000 and non-competition payments to two key employees
of
$780,000. Prior to the loan agreement described below, the cash flow we received
from the business we purchased from iMart has been insufficient to cover any
of
the installment payments we have been required to make, and we have had to
fund
the difference. We
recently amended the lock box agreement, terminating the iMart shareholders’
security interest in the amounts in the lock box account, and agreed to pay
the
installment payments and noncompetition payments in three non-equal installments
by February 2007, which have been paid in full.
In
order
to make these payments, we entered into a loan agreement with Fifth Third Bank
in order to finance a portion of the payments to the iMart shareholders. Under
the terms of this agreement, Smart Commerce borrowed $1.8 million to be repaid
in twenty-four (24) monthly installments of $75,000 plus interest. The interest
rate is prime plus 1.5% as periodically determined by Fifth Third Bank.
Currently and at closing, the prime rate was 8.25%. The loan is secured by
all
of the assets of Smart Commerce, including a security account of $250,000 and
all of Smart Commerce’s intellectual property. The loan is guaranteed by us and
such guaranty is secured by all the common stock of Smart Commerce. If an event
of default occurs and remains uncured, then the lender could foreclose on the
assets securing the loan. If that were to occur, it would have a substantial
adverse effect on our business. Making the payments on the loan used to finance
part of these payments may drain our financial resources or cause other material
harm to our business if the lender forecloses on the secured assets.
(7)
We rely on third-party software that may be difficult to repair should errors
or
failures occur. Such an error or failure, or the process undertaken by us to
correct such an error or failure, could disrupt our services and harm our
business.
We
rely
on software licensed from third parties in order to offer our services. We
use
key systems software from commercial vendors. The software we use may not
continue to be available on commercially reasonable terms, or at all, or
upgrades may not be available when we need them. We currently do not have
support contracts or upgrade subscriptions with some of our key vendors. We
are
not currently aware of any immediate issues, but any loss of the right to use
any of this software could result in delays in providing our services until
equivalent technology is either developed by us, or, if available, is
identified, obtained and integrated, which could harm our business. Any errors
or defects in, or unavailability of, third-party software could result in errors
or a failure of our services, which could harm our business.
We
also
use key systems software from leading open source communities that are free
and
available in the public domain. Our products will use additional public domain
software, if needed for successful implementation and deployment. We currently
do not have support contracts for the open source software that we use. We
rely
on our own research and development personnel and the open source community
to
discover and fix any errors and bugs that may exist in the software we use.
As a
result, if there are errors in such software of which we are unaware or are
unable to repair in a timely manner, there could be a disruption in our services
if certain critical defects are discovered in the software at a future date.
Risks
Associated with Our Markets, Customers and Partners
(8)
The structure of our subscription model makes it difficult to predict the rate
of customer subscription renewals or the impact non-renewals will have on our
revenue or operating results.
Our
small
business customers do not sign long-term contracts. Our customers have no
obligation to renew their subscriptions for our services after the expiration
of
their initial subscription period and in fact, customers have often elected
not
to do so. In addition, our customers may renew for a lower-priced edition of
our
services or for fewer users. Many of our customers utilize our services without
charge. These factors make it difficult to accurately predict customer renewal
rates. Our customers’ renewal rates may decline or fluctuate as a result of a
number of factors, including when we begin charging for our services, their
dissatisfaction with our services and their capability to continue their
operations and spending levels. The number of current subscribers is less than
the number of subscribers in mid-January 2006, but has been relatively constant
since September 2006. If
our
customers do not renew their subscriptions for our services, or we are not
able
to increase the number of subscribers, our revenue may decline and our business
will suffer.
12
(9)
We depend on corporate partners to market our products through their web sites
under relatively short-term agreements in order to increase subscription fees
and grow revenue. Failure of our partners’ marketing efforts or termination of
these agreements could harm our business.
Subscription
fees represented approximately 52%, 22% and 0% of total revenues for 2006,
2005
and 2004, respectively. With the launch of our new applications and the
acquisition of iMart, subscription fees represent a significant percentage
of
our total revenues and our future financial performance and revenue growth
depends, in large part, upon the growth in customer demand for our outsourced
services delivery models. We depend on our syndication partners and referral
relationships to offer our core products and services to a larger customer
base
than we can reach through direct sales or other marketing efforts. Although
we
recently entered into agreements with two new syndication partners and a
marketing referral agreement, we have not yet derived any revenue under these
agreements. Our success depends in part on the ultimate success of our
syndication partners and referral partners and their ability to market our
products and services successfully. Our partners are not obligated to provide
potential customers to us. In addition, some of these third parties have
entered, and may continue to enter into, strategic relationships with our
competitors. Further, many of our strategic partners have multiple strategic
relationships, and they may not regard us as significant for their businesses.
Our strategic partners may terminate their respective relationships with us,
pursue other partnerships or relationships, or attempt to develop or acquire
products or services that compete with our products or services. Our strategic
partners also may interfere with our ability to enter into other desirable
strategic relationships. If we are unable to maintain our existing strategic
relationships or enter into additional strategic relationships, we will have
to
devote substantially more resources to the distribution, sales, and marketing
of
our products and services.
(10)
Our future growth is substantially dependent on customer demand for our
subscription services delivery models. Failure to increase this revenue could
harm our business.
We
have
invested significantly in infrastructure, operations, and strategic
relationships to support our SaaS delivery model, which represents a significant
departure from the delivery strategies that other software vendors and we have
traditionally employed. To maintain positive margins for our small business
services, our revenues will need to continue to grow more rapidly than the
cost
of such revenues. There can be no assurance that we will be able to maintain
positive gross margins in our subscription services delivery models in future
periods. If our subscription services business does not grow sufficiently,
we
could fail to meet expectations for our results of operations, which could
harm
our business.
Any
delays in implementation may prevent us from recognizing subscription revenue
for periods of time, even when we have already incurred costs relating to the
implementation of our subscription services. Additionally, subscribers can
cancel their subscriptions to our services at any time and, as a result, we
may
recognize substantially less revenue than we expect. If large numbers of
customers cancel or otherwise seek to terminate subscription agreements more
quickly than we expect, our operating results could be substantially harmed.
To
become successful, we must cause subscribers who do not pay fees to begin paying
fees and increase the length of time subscribers pay subscription
fees.
(11)
There are risks associated with international operations, which may become
a
bigger part of our business in the future.
We
currently do not generate revenue from international operations. Although we
have recently signed an agreement with a company to market our products and
services in a foreign country, this agreement has not yet generated any revenue
for us. We
are
currently evaluating whether and how to expand into additional international
markets. If we continue to develop our international operations, these
operations will be subject to risks associated with operating abroad. These
international operations are subject to a number of difficulties and special
costs, including:
| • |
costs
of customization and localization of products for foreign
countries;
|
| • |
laws
and business practices favoring local
competitors;
|
| • |
uncertain
regulation of electronic commerce;
|
| • |
compliance
with multiple, conflicting, and changing governmental laws and
regulations;
|
| • |
longer
sales cycles; greater difficulty in collecting accounts
receivable;
|
| • |
import
and export restrictions and
tariffs;
|
|
•
|
potentially
weaker protection for our intellectual property than in the United
States,
and practical difficulties in enforcing such rights
abroad;
|
13
| • |
difficulties
staffing and managing foreign
operations;
|
| • |
multiple
conflicting tax laws and regulations;
and
|
| • |
political
and economic instability.
|
Our
international operations may also face foreign currency-related risks. To date,
all of our revenues have been denominated in United States Dollars, but an
increasing portion of our revenues may be denominated in foreign currencies.
We
do not engage in foreign exchange hedging activities, and therefore our
international revenues and expenses may be subject to the risks of foreign
currency fluctuations.
We
must
also customize our services and products for international markets. This process
is much more complex than merely translating languages. For example, our ability
to expand into international markets will depend on our ability to develop
and
support services and products that incorporate the tax laws, accounting
practices, and currencies of particular countries. Since a large part of our
value proposition to customers is tied to developing products with the peculiar
needs of small businesses in mind, any variation in business practice from
one
country to another may substantially decrease the value of our products in
that
country unless we identify the important differences and customize our product
to address the differences.
Our
international operations may also increase our exposure to international laws
and regulations. If we cannot comply with domestic or foreign laws and
regulations, which are often complex and subject to variation and unexpected
changes, we could incur unexpected costs and potential litigation. For example,
the governments of foreign countries might attempt to regulate our services
and
products or levy sales or other taxes relating to our activities. In addition,
foreign countries may impose tariffs, duties, price controls or other
restrictions on foreign currencies or trade barriers, any of which could make
it
more difficult for us to conduct our business in international
markets.
Risks
Associated with Our Officers, Directors, Employees and
Stockholders
(12)
Our executive management team is critical to the execution of our business
plan
and the loss of their services could severely impact negatively on our
business.
Our
success depends significantly on the continued services of our executive
management personnel. Losing any of our officers could seriously harm our
business. Competition for executives is intense. If we had to replace any of
our
officers, we would not be able to replace the significant amount of knowledge
that they have about our operations. All of our executive team work at the
same
location, which could make us vulnerable to loss of our entire management team
in the event of a natural or other disaster. We do not maintain key man
insurance policies on any of our employees.
(13)
Officers, directors and principal stockholders control us. This might lead
them
to make decisions that do not benefit the interests of minority
stockholders.
Our
officers, directors and principal stockholders beneficially own or control
approximately 51% of our outstanding common stock. As a result, these persons,
acting together, will have the ability to control substantially all matters
submitted to our stockholders for approval (including the election and removal
of directors and any merger, consolidation or sale of all or substantially
all
of our assets) and to control our management and affairs. Accordingly, this
concentration of ownership may have the effect of delaying, deferring or
preventing a change in control of us, impeding a merger, consolidation, takeover
or other business combination involving us or discouraging a potential acquiror
from making a tender offer or otherwise attempting to obtain control of us,
which in turn could materially and adversely affect the market price of our
common stock.
Regulatory
Risks
(14)
Compliance with new regulations governing public company corporate governance
and reporting is uncertain and expensive.
As
a
public company, we have incurred and will incur significant legal, accounting
and other expenses that we did not incur as a private company. We will incur
costs associated with our public company reporting requirements. We also
anticipate that we will incur costs associated with recently adopted corporate
governance requirements, including requirements under the Sarbanes-Oxley Act
of
2002, or Sarbanes-Oxley, the changes in our internal controls and procedures,
as
well as new rules implemented by the SEC and the NASD. We expect these rules
and
regulations to increase our legal and financial compliance costs and to make
some activities more time consuming and costly. Any unanticipated difficulties
in preparing for and implementing these reforms could result in material delays
in complying with these new laws and regulations or significantly increase
our
costs. Our ability to fully comply with
14
these
new
laws and regulations is also uncertain. Our failure to prepare timely for and
implement the reforms required by these new laws and regulations could
significantly harm our business, operating results, and financial condition.
We
also expect that these new rules and regulations may make it more difficult
and
more expensive for us to obtain director and officer liability insurance and
we
may be required to accept reduced policy limits and coverage or incur
substantially higher costs to obtain the same or similar coverage. We have
also
incurred substantial additional professional fees and expenses associated with
the SEC’s suspension of trading of our securities in January 2006, and with the
internal investigation authorized by our Board of Directors in March 2006.
Although our insurance carrier has paid a portion of these fees, not all such
fees and expenses will be covered by our insurance.
By
the
end of fiscal 2007, we are required to comply with Sarbanes-Oxley requirements
involving management’s assessment of our internal control over financial
reporting and our independent accountants’ audit of that assessment is required
for fiscal 2008. In March 2006, we retained a new Chief Financial Officer.
His
review of our internal control over financial reporting to date and the final
findings of our Audit Committee investigation have identified several
deficiencies in our internal control over financial reporting. While we have
made some progress on this remediation effort, we continue to work on addressing
all the issues raised in these findings. Although we believe our on-going review
and testing of our internal control over financial reporting will enable us
to
be compliant with these requirements, we have identified some deficiencies
and
may identify others that we may not be able to remediate and test by the end
of
fiscal 2007. If we cannot assess our internal controls over financial reporting
as effective, it may affect our management’s assessment of our internal control
environment as it will be disclosed in our Annual Report on Form 10-K for fiscal
year 2007 and our stock price could decline.
(15)
The SEC suspension of trading of our securities has damaged our business, and
it
could damage our business in the future.
The
suspension of trading by the SEC has harmed our business in many ways, and
may
cause further harm in the future. Prior to our re-entry onto the Over the
Counter Bulletin Board, or the OTC-BB, for quotation, our ability to raise
financing on favorable terms to us and our existing stockholders suffered due
to
the lack of liquidity of our stock, the questions raised by the SEC’s action,
and the resulting drop in the price of our common stock. As a result, we did
not
raise sufficient financing to make the sales and marketing investments we felt
were needed in 2006 to substantially increase revenue. Legal and other fees
related to the SEC’s action also reduced our cash flow which jeopardized our
ability to make the installment payments required by the agreements to acquire
iMart. We recently completed a private placement financing for $6 million,
however we make no assurance that we will not continue to experience additional
harm as a result of the SEC matter. The time spent by our management team and
directors dealing with issues related to the SEC action also detracted from
the
time they spent on our operations, including strategy development and
implementation. Finally, an important part of our business plan is to enter
into
private label syndication agreements with large companies. The SEC’s action and
related matters have caused us to be a less attractive partner for large
companies and to lose important opportunities. The SEC’s action and related
matters may cause other problems in our operations.
Risks
Associated with the Market for Our Securities
(16)
If securities analysts do not publish research or reports about our business
or
if they downgrade our stock, the price of our stock could
decline.
The
trading market for our common stock relies in part on the research and reports
that industry or financial analysts publish about us or our business. Because
our stock is currently quoted on the OTC-BB rather than traded on a national
exchange, analysts may not be interested in conducting research or publishing
reports on us. If we do not succeed in attracting analysts to report about
our
company, most investors will not know about us even if we are successful in
implementing our business plan. We do not control these analysts. There are
many
large, well established publicly traded companies active in our industry and
market, which may mean it will be less likely that we receive widespread analyst
coverage. Furthermore, if one or more of the analysts who do cover us downgrade
our stock, our stock price would likely decline rapidly. If one or more of
these
analysts cease coverage of our company, we could lose visibility in the market,
which in turn could cause our stock price to decline. Lower trading volume
may
also mean that you could not resell your shares.
(17)
Our revenues and operating results may fluctuate in future periods and we may
fail to meet expectations of investors and public market analysts, which could
cause the price of our common stock to decline.
Our
revenues and operating results may fluctuate significantly from quarter to
quarter. If quarterly revenues or operating results fall below the expectations
of investors or public market analysts, the price of our common stock could
decline substantially. Factors that might cause quarterly fluctuations in our
operating results include:
| · |
the
evolving demand for our services and
software;
|
| · |
spending
decisions by our customers and prospective
customers;
|
15
| · |
our
ability to manage expenses;
|
| · |
the
timing of product releases;
|
| · |
changes
in our pricing policies or those of our
competitors;
|
| · |
the
timing of execution of contracts;
|
| · |
changes
in the mix of our services and software
offerings;
|
| · |
the
mix of sales channels through which our services and software are
sold;
|
| · |
costs
of developing product enhancements;
|
| · |
global
economic and political conditions;
|
| · |
our
ability to retain and increase sales to existing customers, attract
new
customers and satisfy our customers’
requirements;
|
| · |
the
renewal rates for our service;
|
| · |
the
rate of expansion and effectiveness of our sales force;
|
| · |
the
length of the sales cycle for our
service;
|
| · |
new
product and service introductions by our
competitors;
|
| · |
technical
difficulties or interruptions in our
service;
|
| · |
regulatory
compliance costs;
|
| · |
integration
of acquisitions; and
|
| · |
extraordinary
expenses such as litigation or other dispute-related settlement
payments.
|
In
addition, due to a slowdown in the general economy and general uncertainty
of
the current geopolitical environment, an existing or potential
customer may reassess or reduce its planned technology and Internet-related
investments and defer purchasing decisions. Further delays or reductions in
business spending for technology could have a material adverse effect on our
revenues and operating results.
(18)
Our stock price is likely to be highly volatile and may
decline.
The
trading prices of the securities of technology companies have been highly
volatile. Accordingly, the trading price of our common stock has been and is
likely to continue to be subject to wide fluctuations. Further, our common
stock
has a limited trading history. Factors affecting the trading price of our common
stock include:
| · |
variations
in our actual and anticipated operating
results;
|
| · |
the
volatility inherent in stock prices within the emerging sector in
which we
conduct business;
|
| · |
announcements
of technological innovations, new services or service enhancements,
strategic alliances or significant agreements by us or by our
competitors;
|
| · |
recruitment
or departure of key personnel;
|
| · |
changes
in the estimates of our operating results or changes in recommendations
by
any securities analysts that elect to follow our common
stock;
|
| · |
market
conditions in our industry, the industries of our customers and the
economy as a whole; and
|
| · |
the
volume of trading in our common stock, including sales of substantial
amounts of common stock issued upon the exercise of outstanding options
and warrants.
|
16
In
addition, the stock market from time to time has experienced extreme price
and
volume fluctuations that have affected the trading prices of many emerging
growth companies. Such fluctuations have often been unrelated or
disproportionate to the operating performance of these companies. These broad
trading fluctuations could adversely affect the trading price of our common
stock.
Further,
securities class action litigation has often been brought against companies
that
experience periods of volatility in the market prices of their securities.
Securities class action litigation could result in substantial costs and a
diversion of our management’s attention and resources. If such a suit is brought
against us, we may determine, like many defendants in such lawsuits, that it
is
in our best interests to settle such a lawsuit, even if we believe that the
plaintiffs’ claims have no merit, to avoid the cost and distraction of continued
litigation. Any liability we incur in connection with any potential lawsuit
could materially harm our business and financial position and, even if we defend
ourselves successfully, there is a risk that management’s distraction in dealing
with this type of lawsuit could harm our results.
(19)
Shares eligible for public sale could adversely affect our stock price. Certain
holders of shares of our common stock signed agreements that prohibit resales
of
our common stock. If substantial numbers of shares are resold as lock-up periods
expire, the market price of our common stock is likely to decrease
substantially.
At
March
15, 2007, 17,766,971
shares
of our common stock were issued and outstanding and 3,996,015 shares may be
issued pursuant to the exercise of warrants and options. During May 2005, we
registered on Form S-8 5,000,000 shares of our common stock for issuance to
our
officers, directors and consultants under our 2004 Equity Compensation Plan,
of
which at March 15, 2007, 51,500 shares were outstanding and 2,340,100 shares
are
subject to outstanding stock options of the 5,000,000 shares reserved for
issuance under such plan. The remaining outstanding shares of our common stock
are restricted and may be sold in the public market only if they qualify for
an
exemption from registration under Rules 144 or
701
promulgated under the Securities Act.
We
entered into agreements that limit the number of shares that may be sold during
specific time periods, or Dribble Out Agreements, with all of the investors
who
purchased shares of our stock from us in private placements during 2005 and
2006, a total of approximately 2,497,000 shares. Under these Dribble Out
Agreements, sales of shares are limited to 25% during a rolling 30-day period.
Such limitations terminate six months after the effective date of the
registration statement registering these shares.
Our
stock
is very thinly traded. The average daily trading volume for our common
stock between October 2006 and January 2007 was approximately 18,000 shares
per day. The number of shares that could be sold during this period was
restrained by Dribble Out Agreements and other contractual limitations imposed
on some of our shares, while there was no similar contractual restraint on
the
number of buyers of our common stock. This means that market supply may increase
more than market demand for our shares when lock-up and dribble-out periods
expire. Many companies experience a decrease in the market price of their shares
when such events occur.
We
cannot
predict if future sales of our common stock, or the availability of our common
stock held for sale, will materially and adversely affect the market price
for
our common stock or our ability to raise capital by offering equity securities.
Our stock price may decline if the resale of shares under Rule 144, in addition
to the resale of registered shares, at any time in the future exceeds the market
demand for our stock.
Market
conditions and market makers may cause your investment in our common stock
to
significantly diminish and become very illiquid.
We
can
offer no assurance that the volume of trading of our shares in the public
markets will be sufficient to allow all sellers to sell at the times or prices
sellers desire. Future sales of substantial amounts of our shares in the public
market could adversely affect market prices prevailing from time to time and
could impair our ability to raise capital through the sale of our equity
securities.
(20)
Our securities may be subject to “penny stock” rules, which could adversely
affect our stock price and make it more difficult for you to resell our
stock.
The
SEC
has adopted rules that regulate broker-dealer practices in connection with
transactions in penny stocks. Penny stocks are generally equity securities
with
a price of less than $4.00 per share(other than securities registered on certain
national securities exchanges or quotation systems, provided that reports with
respect to transactions in such securities are provided by the exchange or
quotation system pursuant to an effective transaction reporting plan approved
by
the SEC).
The
penny
stock rules require a broker-dealer, prior to a transaction in a penny stock
not
otherwise exempt from those rules, to deliver a standardized risk disclosure
document prescribed by the SEC, which:
17
| · |
contains
a description of the nature and level of risk in the market for penny
stocks in both public offerings and secondary
trading;
|
| · |
contains
a description of the broker’s or dealer’s duties to the customer and of
the rights and remedies available to the customer with respect to
a
violation of such duties or other
requirements;
|
| · |
contains
a brief, clear, narrative description of a dealer market, including
“bid”
and “ask” prices for penny stocks and the significance of the spread
between the bid and ask price;
|
| · |
contains
a toll-free telephone number for inquiries on disciplinary
actions;
|
| · |
defines
significant terms in the disclosure document or in the conduct of
trading
penny stocks; and
|
| · |
contains
such other information and is in such form (including language, type,
size, and format) as the SEC
requires.
|
The
broker-dealer also must provide the customer, prior to effecting any transaction
in a penny stock, with:
| · |
bid
and ask quotations for the penny
stock;
|
| · |
the
compensation of the broker-dealer and its salesperson in the
transaction;
|
| · |
the
number of shares to which such bid and ask prices apply, or other
comparable information relating to the depth and liquidity of the
market
for such stock; and
|
| · |
monthly
account statements showing the market value of each penny stock held in
the customer’s account.
|
In
addition, the penny stock rules require that, prior to a transaction in a penny
stock not otherwise exempt from those rules, the broker-dealer must make a
special written determination that the penny stock is a suitable investment
for
the purchaser and receive the purchaser’s written acknowledgment of the receipt
of a risk disclosure statement, a written agreement related to
transactions involving penny stocks, and a signed and dated copy of a written
suitability statement. These disclosure requirements could have
the
effect of reducing the trading activity in the secondary market for our stock
because it will be subject to these penny stock rules. Therefore, stockholders
may have difficulty selling those securities.
Our
principal administrative and research and development facility is located in
Durham, North Carolina near Research Triangle Park and consists of approximately
5,800 square feet of office space held under a lease that expires on October
31,
2007. We also lease approximately 1,500 square feet of office space in Clive,
Iowa under a lease that expires on October 31, 2008, and approximately 6,800
square feet of office space in Grand Rapids, Michigan. The Michigan facility
is
currently leased on a month-to-month basis.
Smart
Online, Inc. v. Genuity, Inc.
- We
instituted this action against Genuity, Inc., or Genuity, on May 22, 2001,
in
the Superior Court of Wake County, North Carolina, Civil Action No.
01-CVS-06277. We brought claims against Genuity for breach of contract, breach
of express warranty, breach of implied warranty of merchantability, breach
of
warranty of fitness for a particular purpose, conversion, unfair and deceptive
trade practices, negligent misrepresentation and fraud arising from Genuity’s
failure to perform properly under contracts with us, from Genuity’s failure to
return certain property belonging to us, and from certain representations made
by Genuity with regard to the services we needed under the contracts. In our
complaint, we sought treble and punitive damages, costs, a return of the
property and other appropriate relief. On or about July 23, 2001, Genuity filed
its answer to the complaint along with counterclaims against us. In its
counterclaims, Genuity brought claims for breach of contract alleging that
we
failed to pay for the services rendered by Genuity, and sought damages, costs
and other appropriate relief. On October 22, 2002, the court denied Genuity’s
request to dismiss our breach of contract claim, allowed us to amend our
complaint to restate our claim for breach of contract, and dismissed our claims
for breach of implied warranties. The parties were completing discovery and
preparing for trial when the case was automatically stayed as a result of
Genuity’s filing for bankruptcy. This case is still subject to the automatic
stay.
Suit
Against Michael Nouri Regarding Smart Online, S.A.
On or
about March 7, 2002, we petitioned (as is required under French law) a court
in
France to allow us to liquidate our French subsidiary, Smart Online S.A. As
a
result, we paid $113,056.83 to Smart Online S.A. in settlement of all claims
against us. Michael Nouri, our President and CEO and the former President and
CEO of Smart Online S.A., was subsequently sued personally as the legal
representative of Smart Online S.A. The Liquidateur for Smart Online, S.A.
has
agreed to a proposal for settlement offered by Mr. Nouri in the amount of
€15,000 (approximately US $18,500 based on an exchange rate of approximately
US
$1.23 per €1.00 on March 7, 2006). On October 19, 2006, the court officially
recorded the withdrawal of the claims asserted by the Liquidateur. Our Board
of
Directors has authorized us to indemnify Mr. Nouri for the amount of any
settlement and all legal costs and fees and other expenses associated with
the
defense of Mr. Nouri in relation to this matter, because Mr. Nouri was acting
on
our behalf in the liquidation of our French subsidiary.
18
Order
of Securities and Exchange Commission Suspending the Trading of Smart Online
Securities.
On
January 17, 2006, the SEC temporarily suspended the trading of our securities.
In its “Order of Suspension of Trading,” the SEC stated that the reason for the
suspension was a lack of current and accurate information concerning our
securities because of possible manipulative conduct occurring in the market
for
our stock. By its terms, that suspension ended on January 30, 2006 at 11:59
p.m.
EST. As a result of the SEC’s suspension, NASDAQ
withdrew its acceptance of our application to have our common stock traded
on
the NASDAQ Capital Market, and our securities did not automatically return
to
quotation on the OTC-BB.
After
the filing of the required paperwork by a market maker, our common stock
returned to quotation on the OTC-BB on September 11, 2006. Simultaneously with
the suspension, the SEC advised us that it was conducting
a non-public investigation. While we continue to cooperate with the SEC,
we
are
unable to predict at this time whether the SEC will take any adverse action
against us.
ITEM
4.
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our
Annual Meeting of Stockholders was held on December 11, 2006. The following
matters were submitted to a vote of the stockholders with the results shown
below:
(a) Election
of six directors, each elected to serve until the later of the next Annual
Meeting of Stockholders or until such time as his successor has been duly
elected and qualified.
|
|
|
|
|
|
|
Name
|
|
Votes
For
|
|
Votes
Withheld
|
|
Dennis
Michael Nouri
|
|
10,143,539
|
|
300
|
|
Thomas
P. Furr
|
|
10,143,539
|
|
300
|
|
Jeffrey
W. LeRose
|
|
10,143,739
|
|
100
|
|
Shlomo
Elia
|
|
10,143,539
|
|
300
|
|
Philippe
Pouponnot
|
|
10,143,539
|
|
300
|
|
C.
James Meese, Jr.
|
|
10,143,639
|
|
200
|
(b) Ratification
of the appointment of Sherb & Co., LLP as independent auditors for the
fiscal year ended December 31, 2006.
|
|
|
|
|
|
|
Votes
For
|
|
Votes
Against
|
|
Abstained
|
|
10,143,739
|
|
100
|
|
0
|
The
matters listed above are described in detail in our definitive proxy statement
dated November 29, 2006 for the Annual Meeting of Stockholders held on December
11, 2006.
PART
II
ITEM
5.
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES
OF EQUITY SECURITIES
Our
common stock was approved for quotation on the OTC-BB under the symbol “SOLN” on
March 15, 2005, but trading did not begin until mid-April 2005. The following
table sets forth the high and low bid prices for our common stock for the
quarterly periods since trading began until December 31, 2006. The prices set
forth below reflect inter-dealer quotations, without retail mark-up, mark-down,
or commission and may not necessarily represent actual
transactions.
|
For
the Quarter Ending
|
|
High
|
|
Low
|
||
|
June
30, 2005
|
$
|
8.05
|
$
|
1.05
|
||
|
September
30, 2005
|
$
|
11.50
|
$
|
8.05
|
||
|
December
31, 2005
|
$
|
11.25
|
$
|
6.30
|
||
|
March
31, 2006
|
$
|
10.00
|
$
|
8.05
|
||
|
June
30, 2006
|
$
|
n/a
|
$
|
n/a
|
||
|
September
30, 2006
|
$
|
2.80
|
$
|
1.75
|
||
|
December
31, 2006
|
$
|
2.75
|
$
|
0.90
|
19
Due
to
the suspension in trading of our securities, from January 17, 2006 until
September 11, 2006, our common stock was not listed on any exchange or included
in any interdealer quotation system. Our common stock resumed trading on the
OTC-BB on September 11, 2006. For the quarter ended March 31, 2006, the high
and
low bid prices in the table above reflect bids made on the OTC-BB during the
period from January 1, 2006 through and including January 13, 2006. For the
quarter ended June 30, 2006, there are no high and low bid prices for our common
stock on the OTC-BB. The high and low bid prices for this period were $4.25
and
$1.05, respectively. For the quarter ended September 30, 2006, the high and
low
bid prices in the table above reflect bids made on the OTC-BB during the period
from September 11, 2006 through and including September 30, 2006.
We
have
not repurchased any shares of our stock since December 31, 2004.
At
March
15, 2007, there were approximately 280 record
holders of our common stock. Record holders do not include owners whose
shares are held in street name by a broker or other nominee.
We
have
never declared or paid any cash dividends on our common stock and do not intend
to declare or pay dividends for the foreseeable future.
During
2006, we sold equity securities that were not registered under the Securities
Act, as described in our quarterly reports on Form 10-Q and current reports
on
Form 8-K filed in connection with such transactions.
ITEM
6.
SELECTED FINANCIAL DATA
The
following table sets forth selected consolidated financial data that has been
derived from our audited financial statements for the years ended December
31,
2006, 2005, 2004, 2003, and 2002. The following selected financial data should
be read in conjunction with our financial statements and related notes thereto,
and with “Item 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.”
Income
Statement Data
|
INCOME
STATEMENT DATA
|
Fiscal
Year Ended
December
31,
|
||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||
|
Revenues
|
$
|
3,644,890
|
|
$
|
2,155,425
|
|
$
|
1,002,970
|
|
$
|
1,261,223
|
|
$
|
1,391,645
|
|
|
Loss
from Continuing Operations
|
$
|
(2,498,144
|
)
|
$
|
(15,554,874
|
)
|
$
|
(2,671,929
|
)
|
$
|
(1,558,773
|
)
|
$
|
(805,406
|
)
|
|
Loss
per Share from Continuing Operations
|
$
|
(0.17
|
)
|
$
|
(1.20
|
)
|
$
|
(0.26
|
)
|
$
|
(0.61
|
)
|
$
|
(0.25
|
)
|
|
Net
Loss Attributable to Common
Stockholders
|
$
|
(5,023,707
|
)
|
$
|
(15,590,609
|
)
|
$
|
(8,319,049
|
)
|
$
|
(4,375,836
|
)
|
$
|
(1,766,606
|
)
|
|
Net
Loss per Share - Basic and Diluted
|
$
|
(0.33
|
)
|
$
|
(1.20
|
)
|
$
|
(0.82
|
)
|
$
|
(0.61
|
)
|
$
|
(0.25
|
)
|
|
Number
of Shares Used in Per Share
Calculation
|
15,011,830
|
12,960,006
|
10,197,334
|
7,145,047
|
7,181,759
|
|
|||||||||
|
BALANCE
SHEET DATA
|
As
of December 31,
|
||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||
|
Total
Assets
|
$
|
7,433,009
|
$
|
14,558,079
|
$
|
773,701
|
$
|
306,072
|
$
|
252,579
|
|||||
|
Long-term
Obligations
|
$
|
836,252
|
$
|
2,963,289
|
$
|
1,091,814
|
$
|
1,193,211
|
$
|
958,925
|
|||||
|
Redeemable
Preferred Stock
|
$
|
-
|
$
|
-
|
$
|
-
|
$
|
17,509,214
|
$
|
14,692,150
|
|||||
|
Stockholders’
Equity (Deficit)
|
$
|
1,825,998
|
|
$
|
6,672,631
|
$
|
(1,911,090
|
)
|
$
|
(22,014,156
|
)
|
$
|
(19,268,323
|
)
|
|
During
October 2005, we acquired substantially all of the assets of Computility, a
privately held developer and distributor of SFA/CRM software applications,
based
in Des Moines, Iowa. We operated this SFA/CRM business under the name Smart
CRM.
In September 2006, we sold substantially all of the assets of Smart CRM to
Alliance Technologies, Inc. We retained rights to the SFA/CRM application that
we developed and added to our OneBizSM
platform.
20
Also
during October 2005, we acquired all the stock of iMart Incorporated, a
privately held developer and distributor of multi-channel e-commerce systems
based in the Great Lakes region of the United States. We operate this e-commerce
business under the name Smart Commerce, Inc.
ITEM
7.
MANAGEMENT’S DISCUSSION AND
ANALYSIS
OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We
develop and market Internet-delivered SaaS applications and data resources
for
small businesses. We reach small businesses through syndication arrangements
with large corporations that private-label our software applications through
their corporate websites and through our own website, www.smartonline.com.
We
believe our syndication relationships provide a cost and time efficient way
to
market to the extremely diverse and large, yet fragmented small business
sector.
Consistent
with SFAS No. 131, we have defined two reportable segments based on factors
such
as geography, products, customers, how operations are managed, and how the
chief
operating decision-maker views results. Those segments are our core operations,
or the Smart Online segment, and the operations of our wholly-owned subsidiary,
or the Smart Commerce segment. Substantially all of our revenues are generated
by the Smart Commerce segment as the resources of our Smart Online segment
were
focused primarily on research and development efforts from 2000 to late 2006,
and in 2006, on the SEC suspension and resulting investigations.
The
Smart
Commerce segment's revenues are derived primarily from the development and
distribution of multi-channel e-commerce systems including domain name
registration and e-mail solutions, e-commerce solutions, website design and
website hosting. In 2006, our Smart Commerce segment generated 86% of our total
consolidated revenue and 96% and 100% of our subscription and professional
services revenue, respectively.
The
Smart
Online segment generates revenues from the development and distribution of
internet-delivered SaaS small business applications through a variety of
subscription, integration and syndication channels. In 2006, our Smart Online
segment generated 14% of our total consolidated revenue and 100% of our
integration and syndication revenue, and 4% of our subscription
revenue.
The
Company includes costs such as corporate general and administrative expenses
and
share-based compensation expenses that are not allocated to specific segments
in
the Smart Online segment, which includes the parent or corporate
segment.
Except
as
noted below, all financial information for periods prior to our acquisition
of
Computility and iMart contained in this annual report on Form 10-K refers to
the
financial performance of Smart Online only, and does not include the financial
performance of either Computility or iMart before the acquisitions occurred
in
October of 2005. All financial information for periods after these acquisitions
contained in this annual report on Form 10-K includes the financial performance
of the businesses we acquired, unless otherwise noted. Due to the sale of
substantially all of the assets of Smart CRM on September
29, 2006
, Smart
CRM is classified throughout this annual report on Form 10-K as discontinued
operations and the assets and liabilities related to Smart CRM are classified
as
available for sale.
During
2006, we made significant improvements to our applications and
platforms, including enhancements to the OneBizSM
dashboard, the iDA marketing features and adding additional software
applications to OneBizSM
such as
our SFA/CRM and Accounting applications. We recently redesigned our website
to
provide greater ease-of-use. We began offering our primary products as part
of
the second version of our new applications in November 2005. As of
December 31, 2006, certain bundles of our applications are offered on our
website and the websites of three private label partners. In May of 2006, we
integrated a simplified version of the SFA/CRM software applications that we
acquired in October of 2005 into our OneBizSM
application suite, and we will integrate applications from one platform into
the
other as requested by our customers. We have not yet received any request to
do
so.
We
derive
subscription revenue primarily from our stand alone e-commerce application,
which is offered through our subsidiary, Smart Commerce. We generate a small
amount of revenue from subscriptions through our Smart Online segment. In the
first half of 2006, the number of subscribers to our software products had
declined. We are not certain what caused this decline. Some customers had
indicated they had difficulty accessing our software applications on our
website. Consequently, we redesigned our website and product bundling to address
this problem. As of March 2007, the decline in the number of subscribers has
ceased, but the level of subscribers is still significantly lower than the
number from January 2006. It is critical that we grow our subscriber base,
which
we expect will be done primarily through our private-label partners. Failure
to
do so will negatively affect our business.
On
January 17, 2006, the SEC temporarily suspended the trading of our securities.
By its terms, that suspension ended on January 30, 2006. Simultaneously with
the
suspension, the SEC advised us that it would be conducting a non-public
investigation. In March 2006, our Board of Directors authorized its Audit
Committee to conduct an internal investigation of matters relating to the SEC
suspension and investigation. The Audit Committee did not conclude that any
of
our officers or directors have engaged in fraudulent
21
or
criminal activity. However, it did conclude that we lacked an adequate control
environment, and has taken action to address certain conduct of management
that
was revealed as a result of the investigation. As a result of the SEC matter
and
the Audit Committee investigation, our management was distracted from our daily
operations and obtaining
adequate sources of financing to sustain our operations,
and the
uncertainty surrounding the situation caused us to be a less attractive partner
for businesses with whom we were looking to affiliate. As of March 26, 2007,
the
SEC has not provided us with any communication indicating that its investigation
has concluded or that we or any of our officers or directors have engaged in
any
criminal or fraudulent conduct with respect to Smart Online. As described in
ITEM 9A - Controls and Procedures of this annual report on Form 10-K, we
continue to improve our controls and procedures in line with the recommendations
of the Audit Committee.
During
October 2005, we acquired substantially all of the assets of Computility. We
operated this SFA/CRM business under the name Smart CRM. During 2006, we
integrated a simplified version of the SFA/CRM product we acquired from
Computility into our OneBizSM
platform. Following this successful integration, in September 2006 we sold
to a
strategic buyer the remaining assets of Computility, which primarily related
to
computer networking and software businesses. These businesses were not strategic
to our long-term business model. Also during October 2005, we acquired all
the
stock of iMart. We operate this e-commerce business under the name Smart
Commerce.
The
initial effect of these acquisitions on our working capital has been negative
with approximately $200,000 negative cash flow through December 31, 2005 and
approximately $1,100,000 cumulative, net negative cash flow through December
31,
2006. Approximately $800,000 of the negative cash flow has been principal
payments of purchase price towards the iMart acquisition. As of February 2007,
the previous owners of iMart have been paid all installment payments required
under the purchase agreement, including non-compete payments. We were able
to
make these payments by conducting
a refinancing
of the payments with a loan of approximately $1.8 million from Fifth Third
Bank,
as well as through a drawdown of approximately $1.0 million from our revolving
line of credit with Wachovia, described below. The loan
from
Fifth Third Bank is to be paid back in 24 monthly installments. The loan is
secured by all of the assets of Smart Commerce and all of Smart Commerce’s
intellectual property and is guaranteed by us and such guaranty is secured
by
all the common stock of Smart Commerce.
In
November 2006, we established a$1.3 million revolving line of credit with
Wachovia, which we subsequently increased to $2.5 million. Any advances made
on
the line of credit are to be paid off no later than August 1, 2008, with monthly
payments of accrued interest on any outstanding balance commencing on December
1, 2006. The line of credit is secured by the Company’s deposit account at
Wachovia and an irrevocable standby letter of credit in the amount of $2.5
million issued by HSBC Private Bank (Suisse) S.A. with Atlas, a current
stockholder, as account party. As
of
March 14, 2007, we have drawn down $2.1 million of the $2.5 million Wachovia
line of credit.
In
connection with the increase in the letter of credit to obtain the increase
of
the Wachovia line of credit, we entered into a warrant purchase agreement with
Atlas. Under the terms of this agreement, we issued a warrant to Atlas to
purchase up to 444,444 shares of common stock at a price of $2.70
per
share at the termination of the line of credit or if we are in default under
the
terms of the line of credit.
In
January 2007, several of our executive officers entered into new compensation
arrangements with us. Under the terms of these new agreements, these executive
officers agreed to a reduction in their base salaries to $100,000 per year.
In
exchange for this reduction, these executive officers will be paid an equal
amount from a bonus pool of 10% of our "Free Cash Flow," defined as our total
revenue, less operating expenses (with non-cash items added back), less
principal debt payments.
In
February 2007, we completed a private placement with two new investors. We
sold
an aggregate of 2,352,941 shares of common stock for $2.55 per share, issued
warrants to purchase 1,176,471 shares of common stock with an exercise price
of
$3.00 per share, and received $6 million in gross proceeds from the sale. In
connection with this transaction, we paid our placement agent 7% of the gross
proceeds and issued the agent warrants to purchase 35,000 shares of our common
stock at an exercise price of $2.55.
Fiscal
Year
Our
fiscal year ends on December 31. References to fiscal 2006, for example, refer
to the calendar year ended December 31, 2006.
Sources
of Revenue
We
derive
revenues from the following sources:
|
·
|
Subscription
fees - monthly fees charged to customers for access to our SaaS
applications.
|
|
·
|
Integration
fees - fees charged to partners to integrate their products into
our
syndication platform.
|
|
·
|
Syndication
fees - fees consisting of:
|
22
|
·
|
fees
charged to syndication partners to create a customized private-label
site.
|
|
|
·
|
barter
revenue derived from syndication agreements with media
companies.
|
|
|
·
|
Professional
service fees - fees related to consulting services which complement
our
other products and applications.
|
|
|
·
|
Other
revenues - revenues generated from non-core activities such as sales
of
shrink-wrapped products, OEM contracts and miscellaneous other
revenues.
|
|
Our
current primary focus is to target those established companies that have both
a
substantial base of small business customers as well as a recognizable and
trusted brand name. Our goal is to enter into partnerships with these
established companies whereby they private label our products and offer them
to
their base of small business customers. We believe the combination of the
magnitude of their customer bases and their trusted brand names and recognition
will help drive our subscription volume.
Subscription
revenues consist of sales of subscriptions directly to end-users, or to others
for distribution to end-users, hosting and maintenance fees, and e-commerce
website design fees. Subscription sales are made either on a subscription or
on
a “for fee” basis. Subscriptions, which include access to most of our offerings
are payable in advance on a monthly basis and are typically paid via credit
card
of the individual end-user or their aggregating entity. During past years,
most
of our OneBizSM
users
have been given free use of our products for extended time periods. During
the
fourth quarter of 2005, we changed that policy to a limited 30-day free use
period, after which we terminate access for users who fail to become paid
subscribers. We have delayed the termination of access for those subscribers
as
we were not yet able to offer the complete suite of applications which we deemed
as necessary in order to convince free customers to convert to paying customers.
However, we do not expect to convert a significant number of these free users
into paying subscribers as we have shifted our focus to forging strategic
partnerships with other companies that have small business customer bases.
We
expect lower net fees from subscribers at the private label syndication websites
of our partners than from our main portal since our agreements call for us
to
share revenue generated on each respective site. In 2006, 96% of our
subscription revenue was generated by our Smart Commerce segment, and the
remaining 4% by our Smart Online segment.
When
appropriate, we charge our partners a fee for private-labeling our website
in
their own customized interface (i.e., in the “look and feel” of our partners’
sites). This fee is based on the extent of the modifications required as well
as
the revenue sharing ratio that has been negotiated between us and our partner.
If a fee is charged for the production of the website and the modifications,
it
is recorded as Syndication Revenue.
In
certain instances, we have integrated products offered by other companies into
our products or websites. This is a means for the partner to generate additional
traffic to their own website or revenue for their own product. Such revenue
is
recorded as integration revenue. Our integration contracts also provide for
us
to receive a percentage of revenue generated by our partner. Such revenues
to
date have been immaterial.
Both
syndication and integration fees are recognized on a monthly basis over the
life
of the contract, although a significant portion of integration fees is received
upfront. Our contracts and support contracts are non-cancelable, though
customers typically have the right to terminate their contracts for cause if
we
fail to perform. We generally invoice our paying syndication or integration
customers in annual or monthly installments and typical payment terms provide
that our customers pay us within 30 days of invoice. Amounts that have been
invoiced are recorded as accounts receivable and in deferred revenue or
revenue depending on whether the revenue recognition criteria have been met.
In
general, we collect our billings in advance of the service period. As we have
shifted our focus toward driving subscription revenue, which we deem to have
the
greatest potential for future revenue growth, we have seen a decrease in
syndication and integration revenue through 2006 and we expect to this decrease
to continue through 2007. In 2006, 100% of our syndication and integration
revenue was generated by our Smart Online segment.
Professional
service fees are fees generated from consulting services often directly
associated with other projects which will generate subscription revenue. For
example, a partner may request that we re-design its website to better
accommodate our products or to improve its own website traffic. Such fees are
typically billed on a time and material basis and are recognized as revenue
when
these services are performed and the customer is invoiced. In 2006, 100% of
our
professional services revenue was generated by our Smart Commerce
segment
Other
revenues consist primarily of non-core revenue sources such as traditional
shrink-wrap software sales and miscellaneous web services. It also includes
OEM
revenue generated through sales of our applications bundled with products
offered by manufacturers such as Dell, Gateway and CompUSA. Revenues from OEM
arrangements are reported and paid to us on a quarterly basis and are
subject to certain contractual minimum volumes.
23
Revenue
From Related Parties
In
the
past, we entered into a number of business transactions with related parties
(as
described below). Although we have little intention of entering into new related
party transactions, we might do so if the transaction was for the benefit of
our
stockholders.
Approximately
0%, 0%, and 32.9% of total revenues for the years ended December 31, 2006,
2005,
and 2004, respectively, were from a single customer, Smart IL Ltd., or SIL,
formerly known as Smart Revenue Europe Ltd., an Israel based software company
that specialized in secured instant messaging products. During March 2004,
SIL
ceased further development of its technology and laid-off all employees after
SIL delivered to us a version of its instant messenger product. SIL is currently
seeking to license or sell its technology. If our private label partners require
that this instant messenger to be bundled with our platform, then certain
revenue must be shared with SIL. SIL is owned by Doron Roethler, one of our
stockholders.
We
paid
$221,517 to the Small Business Lending Institute, Inc. , or SBLI, during the
first three months of 2004, because SBLI paid our employees during the first
quarter of 2004 while we were dealing with a tax matter with the Internal
Revenue Service. The temporary transfer of our employees to SBLI allowed us
to
obtain a clean cut off to determine the extent of our tax liability. Tamir
Sagie, an officer of Smart Online at the time, was an officer of SBLI. Michael
Nouri, our Chief Executive Officer, is a shareholder in SBLI.
The
following is a summary of related party revenues for years ended December 31,
2006, 2005 and 2004.
|
|
Year
Ended
December
31,
2006
|
Year
Ended
December
31,
2005
|
Year
Ended
December
31,
2004
|
|||||||
|
SIL
Integration fees
|
$
|
-
|
$
|
-
|
$
|
330,050
|
||||
|
SBLI
Consulting Services
|
-
|
-
|
-
|
|||||||
|
Total
Related Party Revenues
|
$
|
-
|
$
|
-
|
$
|
330,050
|
||||
Cost
of Revenues
Cost
of
revenues consists primarily of salaries and related employee expenses associated
with employees who provide maintenance and support services. Additionally,
during 2005, a portion of cost of revenues included third-party
fees.
During
2005, we acquired rights to an accounting software engine from a software
development company and co-developed our accounting software with that
developer. We have exclusive rights to the accounting application and
non-exclusive rights to the software engine included in the application. During
the third quarter of 2005, we capitalized $105,000 of costs associated with
this
acquired software.
During
the fourth quarter
of
2005,
management changed its estimate as to the realizability of the value of this
asset and determined that the full value of the asset capitalized to date should
be written off and all future costs incurred related to this same software
should be expensed in the period incurred until the criteria of SFAS No.
86,
Accounting
for the Costs of Software to be Sold, Leased, or Otherwise
Marketed,
or SFAS
No. 86,
for
capitalizing software costs are met. No amounts were capitalized in
2006.
Operating
Expenses
During
2006, 2005, and 2004 our efforts were primarily focused on product development
and integration. We employed approximately 18 full-time development employees
during 2004. During 2005, we completed two acquisitions and hired additional
development and sales staff bringing the total to 72 full-time employees at
December 31, 2005. As of March 15, 2007, we had 56 employees. Most employees
perform multiple functions.
Research
and Development.
Historically, we have not capitalized any costs associated with the development
of our products and platform. SFAS No. 86 requires capitalization of certain
software development costs subsequent to the establishment of technological
feasibility. Because any such costs that would be capitalized following the
establishment of technological feasibility would immediately be written off
due
to uncertain realizability, all such costs have been recorded as research and
development costs and expensed as incurred. Because of our proprietary, scalable
and secure multi-user architecture, we are able to provide all customers with
a
service based on a single version of our application. As a result, we do not
have to maintain multiple versions, which enables us to have relatively low
research and development expenses as compared to traditional enterprise software
business models. We expect that in the future, research and development expenses
will increase substantially in absolute dollars but decrease as a percentage
of
total revenue as we upgrade and extend our service offerings, develop new
technologies and transition from development stage to revenue generation.
24
Marketing
and Sales.
During
2006, 2005, and 2004, we spent limited funds on marketing, advertising, and
public relations. Our business model of partnering with established companies
with extensive small business customer bases allows us to leverage the marketing
dollars spent by our partners rather than requiring us to incur such costs.
We
do not conduct any significant direct marketing or advertising programs. Our
sales and marketing costs are expected to increase significantly in 2007 due
to
the addition of several sales persons, including a Vice President of Sales
and
Marketing. As we begin to grow the number of subscribers to our products, sales
and marketing expense will increase due to the various percentages of revenue
we
may be required to pay to partners.
General
and Administrative.
General
and administrative expenses consist of salaries and related expenses for
executive, finance and accounting, legal, human resources, and information
technology personnel, professional fees, and other corporate expenses, including
facilities costs. General and administrative expenses have increased and will
continue to increase as we add personnel and incur additional professional
fees
and insurance costs related to the growth of our business and to our operations
as a public company. Non-recurring general and administrative expenses increased
in 2006 as a result of the SEC’s suspension of trading of our securities, the
continuing SEC action, and the internal investigation of matters relating to
that suspension. Our expenses related to these matters have continued to
decrease to an immaterial amount in the fourth quarter of 2006. We expect to
incur additional material costs in 2007 as we take the necessary steps to comply
with Section 404 of the Sarbanes-Oxley Act.
Stock-Based
Expenses.
Our
operating expenses include stock-based expenses related to options and warrants
issued to employees and non-employees. These charges have been significant
and
are reflected in our historical financial results. Effective January 1, 2006,
we
adopted SFAS No. 123 (revised
2004), Share-Based
Payment,
or SFAS
No. 123R,
which
has resulted and will continue to result in material costs on a prospective
basis. See Note 11, “Stockholders’ Deficit,” of the Consolidated Financial
Statements in this report. In addition, in connection with the issuance of
1,273,000 shares of our common stock issued pursuant to investor relations
services contracts, including 1,250,000 of which were issued in the fourth
quarter of 2005, we have incurred non-cash expenses equal to the market value
of
the shares of approximately $9.9 million. In 2006, the 1,250,000 shares
issued in the fourth quarter of 2005 were redeemed by Smart Online, resulting
in
other income of $3,125,000. This was done in connection with the settlement
agreements between the parties issued these shares and us. Under these
agreements, these parties retained the cash fee paid to them, totaling $500,000,
for their services.
Critical
Accounting Policies and Estimates
Our
discussion and analysis of financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared
in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates
and
judgments that affect the reported amounts of assets, liabilities, revenues
and
expenses, and related disclosures of contingent assets and liabilities.
“Critical accounting policies and estimates” are defined as those most important
to the financial statement presentation and that require the most difficult,
subjective, or complex judgments. We base our estimates on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying value of assets and liabilities that are not readily apparent
from
other sources. Under different assumptions and/or conditions, actual results
of
operations may materially differ. We periodically re-evaluate our critical
accounting policies and estimates, including those related to revenue
recognition, provision for doubtful accounts, expected lives of customer
relationships, useful lives of intangible assets and property and equipment,
provision for income taxes, valuation of deferred tax assets and liabilities,
and contingencies and litigation reserves. We presently believe the following
critical accounting policies involve the most significant judgments and
estimates used in the preparation of our consolidated financial
statements.
Revenue
Recognition-
We
recognize revenue in accordance with accounting standards for software and
service companies including the SEC’s Staff Accounting Bulletin 104,
Revenue
Recognition,
or SAB
104,, Emerging Issues Task Force Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables,
or EITF
00-21,
Emerging
Issues Task Force Issue No. 99-19, Reporting
Revenue Gross as a Principal or Net as an Agent,
or EITF
99-19,and
related interpretations including American Institute of Certified Public
Accountants, or AICPA, Technical Practice Aids. We also utilize interpretative
guidance from regulatory and accounting bodies, which include, but are not
limited to, the SEC, the AICPA, the Financial Accounting Standards Board, or
FASB, and various professional organizations.
We
recognize revenue when all of the following conditions are satisfied: (1) there
is persuasive evidence of an arrangement; (2) the service has been provided
to
the customer; (3) the collection of our fees is probable; and (4) the amount
of
fees to be paid by the customer is fixed or determinable. EITF 00-21 states
that
revenue arrangements with multiple deliverables should be divided into separate
units of accounting if the deliverables in the arrangement meet the following
criteria: (1) the delivered item has value to the customer on a stand-alone
basis; (2) there is objective and reliable evidence of the fair value of the
undelivered item; and (3) if the arrangement includes a general right of return
relative to the delivered item, delivery or performance of the undelivered
item
is considered probable and substantially in control of the vendor. Our
syndication and integration agreements typically include multiple deliverables
including the grant of a non-exclusive license to distribute, use and access
to
our platform, fees for the integration of
25
content
into our platform, maintenance and hosting fees, documentation and training,
and
technical support and customer support fees. We cannot establish fair value
of
the individual revenue deliverables based on objective and reliable evidence
because we do not have a long, consistent history of standard syndication and
integration contractual arrangements, there have only been a few contracts
that
have continued past the initial contractual term, we do not have any contracts
in which these elements have been sold as stand-alone items, and there is no
third-party evidence of fair value for products or services that are
interchangeable and comparable to our products and services. As such, we cannot
allocate revenue to the individual deliverables and must record all revenues
received as a single unit of accounting as further described below.
Additionally, we have evaluated the timing and substantive nature of the
performance obligations associated with the multiple deliverables noted above,
including the determination that the remaining obligations are essential to
the
ongoing usability and functionality of the delivered products, and determined
that revenue should be recognized over the life of the contracts, commencing
on
the date the site goes on-line.
Syndication
fees consist primarily of fees charged to syndication partners to create and
maintain a customized private-label site and ongoing support, maintenance and
customer service. Syndication agreements typically include an advance fee and
monthly hosting fees. Integration fees consist primarily of fees charged to
integration partners to integrate their products into our syndication platform.
Amounts that have been invoiced are recorded as accounts receivable and in
deferred revenue and the revenue is recognized ratably over the specified lives
of the contracts, commencing on the date the site goes on-line. Syndication,
integration and support contracts typically provide for early termination only
upon a material breach by either party that is not cured in a timely manner.
If
a contract terminates earlier than its term, the remaining deferred revenue
is
recognized upon termination. It is possible that the estimates of expected
duration of customer contract lives may change and the period over which such
syndication revenues are amortized could be adjusted. Any such change in
specified contract lives could affect future results of operations.
Both
syndication and integration fees are recognized on a monthly basis over the
life
of the contract, although a significant portion of the fee from integration
agreements is received upfront. Customers are generally invoiced in annual
or
monthly installments and typical payment terms provide that customers pay within
30 days of invoice. In general, billings are collected in advance of the service
period.
Other
revenues, which include traditional shrink-wrap sales and OEM arrangements,
are
recorded based on the greater of actual sales or contractual minimum guaranteed
royalty payments. For OEM contracts, we record the minimum guaranteed royalties
monthly and receive payment of the royalties on a quarterly basis, thirty (30)
days in arrears. To the extent actual royalties exceed the minimum guaranteed
royalties, the excess is recorded in the quarter we receive notification of
such
additional royalties.
Subscription
revenues consist of subscription sales directly to end-users, or to others
for
distribution to end-users, hosting and maintenance fees, e-commerce website
design fees and online loan origination fees. Subscription sales are made either
on a monthly subscription or a one-time for fee basis. Subscriptions, which
include access to most of our offerings, are payable in advance on a monthly
basis. Currently, most of our syndication agreements call for us to receive
a
percentage of revenue generated. Depending on the criteria of each individual
contract and in accordance with EITF 99-19, a determination is made as to
whether we should recognize the gross revenue with a corresponding expense
for
the portion paid to or retained by the partner or recognize only our net portion
as revenue. At this time, we are still selling certain products and services
on
a “for fee” basis. We also recently began to offer to our potential syndication
partners volume discounts for pre-paid subscriptions, which they can either
resell or contribute to their small business customers, but no volume sales
have
occurred. E-Commerce website design fees, which are charged for building and
maintaining corporate websites or to add the capability for e-commerce
transactions, are recognized over the life of the project. Domain name
registration fees are recognized over the term of the registration period.
Online loan origination fees are charged to provide users online financing
options. We receive payments for loans or credit provided.
Professional
service fees are recognized over the term of the consulting engagement as
services are performed, which is typically one to three months. Advance payments
for consulting services, if billed and paid prior to completion of the project,
are recorded as deferred revenue when received. If the fees are not fixed or
determinable, revenue is recognized as work is performed and billed. In
determining whether the professional service fees can be accounted for
separately from subscription and support revenues, we consider the following
factors for each consulting agreement: availability of the consulting services
from other vendors, whether objective and reliable evidence for fair value
exists of the undelivered elements, the nature of the consulting services,
the
timing of when the consulting contract was signed in comparison to the
subscription service start date, and the contractual dependence of the
subscription service on the customer’s satisfaction with the consulting
work.
Barter
Transactions -
Barter
revenue relates to syndication and integration services provided by us to
business customers in exchange for advertising in the customers’ trade magazines
and on their websites. Barter expenses reflect the expense offset to barter
revenue. The amount of barter revenue and expense is recorded at the estimated
fair value of the services received or the services provided, whichever is
more
objectively determinable, in the month the services and advertising are
exchanged. We apply APB 29, Accounting
for Non-Monetary Transactions,
the
provisions of EITF 93-11, Accounting
for Barter Transactions Involving Barter Credits
and EITF
99-17, Accounting
for Advertising and Barter Transactions
and,
accordingly, recognize barter revenues only to the extent that we
have
26
similar
cash transactions within a period not to exceed six months prior to the date
of
the barter transaction. To date the amount of barter revenue to be recognized
has been more objectively determinable based on integration and syndication
services provided. For revenue from integration and syndication services
provided for cash to be considered similar to the integration and syndication
services provided in barter transactions, the services rendered must have been
in the same media and similar term as the barter transaction. Once the value
of
the barter revenue has been determined, we follow the same revenue recognition
principles as we apply to cash transactions with unearned revenues being
deferred as described more fully under the caption “Revenue Recognition” above.
Barter revenues totaled approximately $103,000, $424,000 and $113,000, for
the
years ended December 31, 2006, 2005 and 2004, respectively.
Impairment
of Long Lived Assets -
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets
to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured
by
the amount by which the carrying amount of the assets exceeds the fair value
of
the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
Income
Taxes. We
are
required to estimate our income taxes in each of the jurisdictions in which
we
operate. This involves estimating our current tax liabilities in each
jurisdiction, including the impact, if any, of additional taxes resulting from
tax examinations as well as making judgments regarding our ability to realize
our deferred tax assets. Such judgments can involve complex issues and may
require an extended period to resolve. In the event we determine that we will
not be able to realize all or part of our net deferred tax assets, an adjustment
would be made in the period such determination is made. We recorded no income
tax expense in any of the periods presented, as we have experienced significant
operating losses to date. If utilized, the benefit of our total net operating
loss carryforwards may be applied to reduce future tax expense. Since our
utilization of these deferred tax assets is dependent on future profits, which
are not assured, we have recorded a valuation allowance equal to the net
deferred tax assets. These carryforwards would also be subject to limitations,
as prescribed by applicable tax laws. As a result of prior equity financings
and
the equity issued in conjunction with certain acquisitions, we have incurred
ownership changes, as defined by applicable tax laws. Accordingly, our use
of
the acquired net operating loss carryforwards may be limited. Further, to the
extent that any single year loss is not utilized to the full amount of the
limitation, such unused loss is carried over to subsequent years until the
earlier of its utilization or the expiration of the relevant carryforward
period.
Results
of Operations
The
following tables set forth selected consolidated statements of operations data
for each of the periods indicated.
|
|
|
Year
Ended
December
31,
2006
|
|
Year
Ended
December
31,
2005
|
|
Year
Ended
December
31,
2004
|
|
|||
|
REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
Integration
Fees
|
|
$
|
182,660
|
|
$
|
798,178
|
|
$
|
374,055
|
|
|
Syndication
Fees
|
|
|
218,386
|
|
|
402,847
|
|
|
176,471
|
|
|
Subscription
Fees
|
|
|
1,904,192
|
|
|
468,621
|
|
|
-
|
|
|
Professional
Services Fees
|
|
|
1,269,300
|
|
|
401,677
|
|
|
-
|
|
|
Other
Revenue
|
|
|
70,352
|
|
|
84,102
|
|
|
122,394
|
|
|
Related
Party Revenues
|
|
|
-
|
|
|
-
|
|
|
330,050
|
|
|
Total
Revenues
|
|
|
3,644,890
|
|
|
2,155,425
|
|
|
1,002,970
|
|
|
|
|
|
|
|
|
|
|
|||
|
COST
OF REVENUES
|
|
|
329,511
|
|
|
154,892
|
|
|
211,616
|
|
|
|
|
|
|
|
|
|
|
|||
|
GROSS
PROFIT
|
|
|
3,315,379
|
|
|
2,000,533
|
|
|
791,354
|
|
|
|
|
|
|
|
|
|
|
|||
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|||
|
General
and Administrative
|
|
|
5,648,377
|
|
|
15,038,563
|
|
|
2,432,928
|
|
|
Sales
and Marketing
|
|
|
1,016,107
|
|
|
1,386,019
|
|
|
596,989
|
|
|
Research
and Development
|
|
|
2,016,507
|
|
|
1,649,956
|
|
|
563,372
|
|
27
|
|
|
|
|
|
|
|
|
|||
|
Total
Operating Expenses
|
|
|
8,680,991
|
|
|
18,074,538
|
|
|
3,593,289
|
|
|
|
|
|
|
|
|
|
|
|||
|
LOSS
FROM CONTINUING OPERATIONS
|
|
|
(5,365,612
|
)
|
|
(16,074,005
|
)
|
|
(2,801,935
|
)
|
|
|
|
|
|
|
|
|
|
|||
|
OTHER
INCOME (EXPENSE):
|
|
|
|
|
|
|
|
|||
|
Interest
Expense, Net
|
|
|
(254,381
|
)
|
|
(37,502
|
)
|
|
(119,389
|
)
|
|
Gain
on Debt Forgiveness
|
|
|
144,351
|
|
|
556,215
|
|
|
249,395
|
|
|
Redemption
of Investor Relations Shares
|
3,125,000
|
-
|
-
|
|||||||
|
Writeoff
of Investment
|
(25,000
|
)
|
-
|
-
|
||||||
|
Other
Income (Expense)
|
(122,502
|
)
|
418
|
-
|
||||||
|
|
|
|
|
|
|
|
|
|||
|
Total
Other Income
|
|
|
2,867,468
|
|
|
519,131
|
|
|
130,006
|
|
|
NET
LOSS FROM CONTINUING OPERATIONS
|
|
|
(2,498,144
|
)
|
|
(15,554,874
|
)
|
|
(2,671,929
|
)
|
|
DISCONTINUED
OPERATIONS
|
||||||||||
|
Loss
of Operations of Smart CRM (2006 includes gain on sale of assets
of
$563,835, write-off of goodwill of $2,793,321 and loss on operations
of
$296,077), net of tax ($0)
|
(2,525,563
|
)
|
-
|
|||||||
|
Loss
on Discontinued Operations
|
(2,525,563
|
)
|
(35,735
|
)
|
||||||
|
Preferred
stock dividends and accretion of discount on preferred
stock
|
|
|
-
|
|
-
|
|
(2,215,625
|
)
|
||
|
Accretive
dividend issued in connection with registration rights
agreement
|
-
|
-
|
(206,085
|
)
|
||||||
|
Converted
preferred stock inducement cost
|
|
|
-
|
|
|
-
|
|
(3,225,410
|
)
|
|
|
NET
LOSS
|
||||||||||
|
Net
loss attributed to common stockholders
|
|
$
|
(5,023,707
|
)
|
$
|
(15,590,609
|
)
|
$
|
(8,319,049
|
)
|
The
following tables set forth selected consolidated statements of operations data
for each of the periods indicated as a percentage of total
revenues.
|
Year
Ended December 31,
|
|||||||||
|
REVENUES:
|
2006
|
2005
|
2004
|
||||||
|
Integration
Fees
|
5%
|
37%
|
37%
|
||||||
|
Syndication
Fees
|
6%
|
19%
|
18%
|
||||||
|
Subscription
Fees
|
52%
|
22%
|
-
|
||||||
|
Professional
Services Fees
|
35%
|
19%
|
-
|
||||||
|
Other
Revenue
|
2%
|
3%
|
12%
|
||||||
|
Related
Party Revenues
|
-
|
-
|
33%
|
||||||
|
Total
Revenues
|
100%
|
100%
|
100%
|
||||||
28
|
COST
OF REVENUES
|
9%
|
7%
|
21%
|
||||||
|
GROSS
PROFIT
|
91%
|
93%
|
79%
|
||||||
|
OPERATING
EXPENSES:
|
|||||||||
|
G&A
|
155%
|
698%
|
243%
|
||||||
|
Sales
& Marketing
|
28%
|
64%
|
60%
|
||||||
|
Development
|
55%
|
77%
|
56%
|
||||||
|
Total
Operating Expenses
|
238%
|
839%
|
359%
|
||||||
|
Net
Income (Loss) from Operations
|
-147%
|
-746%
|
-279%
|
||||||
|
OTHER
INCOME (EXPENSES):
|
|||||||||
|
Interest
Income (Expense), net
|
-7%
|
-2%
|
-12%
|
||||||
|
Gain
/ Loss on Legal Settlements
|
4%
|
26%
|
25%
|
||||||
|
Other
Income
|
82%
|
-
|
-
|
||||||
|
Writeoff
of Investment
|
-1%
|
-
|
-
|
||||||
|
Gain
on Sale of Assets
|
-
|
-
|
-
|
||||||
|
DISCONTINUED
OPERATIONS
|
|||||||||
|
Gain
from Operations of Smart CRM
|
|||||||||
|
(including
Loss on Sale of $2,140,054)
|
-69%
|
-2%
|
-
|
||||||
|
Income
Tax
|
-
|
-
|
-
|
||||||
|
Income
from Discontinued Operations
|
-69%
|
-2%
|
-
|
||||||
|
NET
INCOME (LOSS)
|
-138%
|
-723%
|
-266%
|
||||||
|
Preferred
Stock Dividends and Accretion
|
|||||||||
|
of
Discount on Preferred Stock
|
-
|
-
|
-221%
|
||||||
|
Accretive
dividend issued in connection
|
|||||||||
|
with
Reg Rights Statement
|
-
|
-
|
-21%
|
||||||
|
Converted
Preferred Stock Inducement Cost
|
-
|
-
|
-322%
|
||||||
|
Net
Loss Attributed to Common Stockholders
|
-138%
|
-723%
|
-830%
|
||||||
Overview
of Results of Operations for the Fiscal Year Ended December 31,
2006
Total
revenues for the year ended December 31, 2006 were $3.6 million, an increase
of
$1.4 million or 69% over 2005. Subscription revenue for 2006 was $1.9 million,
an increase of $1.4 million or 305% over 2005. For 2006, we reported in two
segments for the first time and derived $513,000 and $3.1 million of our
consolidated revenue from our Smart Online segment and Smart Commerce segment,
respectively.
Our
net
loss for 2006 was $5.0 million, a decrease of $10.6 million from a net loss
of
$15.6 million in 2005. Net loss for 2006 included a loss from discontinued
operations of $2.5 million, and $3,125,000 of other income from the redemption
of investor relations shares. For 2005, the loss from discontinued operations
was approximately $36,000. Net loss for 2006 also included non-cash charges
of
$782,000 related to amortization and depreciation and $780,000 related to
compensation costs for stock options as accounted for under SFAS No. 123R.
During 2005, we incurred depreciation and amortization expense of $217,000
and
no stock option expense as SFAS No. 123R was not yet adopted. 2005 included
a
non-cash charge of $9.7 million related to investor relations contracts that
we
cancelled during 2006.
29
During
2006, substantial costs were incurred related to the SEC’s suspension of the
trading of our common stock and the resulting SEC and internal investigation.
Legal expense related to the SEC and internal investigations was approximately
$1.0 million for 2006.
In
the
first quarter of 2006, we learned that one of our major customers for the Smart
Commerce segment underwent a restructuring. During 2006, this restructuring
resulted in a loss of approximately 45% of the revenue generated by this
customer. Revenue from this customer decreased in the months following the
restructuring, then leveled off for the last three months of 2006.
As
of
January 1, 2006, we offered our OneBizSM
and iDA
platforms to small businesses through four total syndication partners. During
2006, one of these partners, Union Bank of California, N.A., renewed its
contract for a one year term. As of December 31, 2006, our OneBizSM
and iDA
platforms were available through four syndication partners and our main portal.
In
September 2006, we sold substantially all of the assets of Smart CRM to
Alliance. This sale resulted in $600,000 cash proceeds and the elimination
of
approximately $1.7 million in liabilities. We recorded an impairment of goodwill
of approximately $2.8 million resulting in a net loss on sale of approximately
$2.1 million. As a result, we reported results of operations for Smart CRM
prior
to the sale of assets as discontinued operations.
During
the first half of 2006, the number of subscribers to our products and services
through our main portal and the web sites of our partners declined. Over the
second half of 2006 and into 2007, the number of subscribers has been relatively
constant. We are not aware of all the factors that led to the decrease in the
number of subscribers, but we are aware that some complained about the ease
of
use of our website. We subsequently redesigned our main portal to address these
concerns. Also, in the fourth quarter of 2006, we began focusing on increasing
these subscription numbers by contracting with new partners to market our
applications to their small business customers.
At
December 31, 2006, we had $577,000 in cash of which $250,000 was restricted
as
compared to cash of $1.7 million at December 31, 2005, of which $230,000 was
restricted. Accounts receivable at December 31, 2006 was $248,000 as compared
to
$505,000 at December 31, 2005. Deferred revenue at December 31, 2006 was
$325,000 as compared to $766,000 at December 31, 2005.
Comparison
of the Results of Operations for the Years Ended December 31, 2006 and
2005
Revenues
- Total
revenues were $3.6 million in 2006 as compared to $2.2 million in 2005, an
increase of $1.4 million or 69%. Subscription revenue for 2006 was $1.9 million,
an increase of $1.4 million or 305% over 2005. This increase was primarily
attributable to the subscription revenue of Smart Commerce, which was
operational as our subsidiary for the full twelve months of 2006 as compared
to
only two and one half months during 2005 (October 18, 2005 to December 31,
2005). In the first quarter of 2006, we learned that one customer of Smart
Commerce, constituting approximately 40% of iMart’s 2005 revenue, underwent a
restructuring that resulted in a decrease of approximately 45% in its business
with Smart Commerce between April 2006 and December 2006. Although this customer
restructuring has had a negative effect on Smart Commerce, we are targeting
to
offset this loss by securing new customers in 2007. As of March 15, 2007, we
have secured one new customer for Smart Commerce. Integration revenue decreased
$615,000, or 77%, to $183,000 in 2006. Syndication revenue decreased $185,000,
or 46%, to $218,000 in 2006 compared to 2005. This decrease was primarily
attributable to our shift away from integration and syndication revenue as
we
began focusing on building subscription revenue. Accordingly, we have let the
majority of our integration and syndication contracts expire in 2006. We expect
our integration and syndication revenue to continue to decline as we work to
increase our subscription revenue. Professional services fees increased $867,000
or 216% to $1,269,000 in 2006 compared to 2005. This increase was primarily
attributable to the professional service fees of Smart Commerce, which was
operational as our subsidiary for the full twelve months of 2006 as compared
to
only two and one half months during 2005 (October 18, 2005 to December 31,
2005), and revenue for a perpetual license of approximately $500,000. We
did not derive any material revenue from related parties during
2005.
Cost
of Revenues - Cost
of
revenues were $330,000 in 2006 as compared to $155,000 in 2005, an increase
of
$175,000 or 113%. The Smart Commerce segment contributed $271,000 to cost of
revenues in 2006 as compared to $56,000 in 2005, an increase of $215,000. This
increase was offset by a decrease in cost of revenues of $43,000 in the Smart
Online segment over 2005, which was the result of headcount reductions in
personnel directly responsible for integration and syndication contract
maintenance.
General
and Administrative - General
and administrative expenses were $5.6 million in 2006 as compared to $15 million
in 2005, a decrease of $9.4 million or 62%. This decrease was primarily due
to
decreases in investor relations, management consultant, travel, meal and
entertainment and bonus expenses, which was offset by increases in total
compensation expense, legal and professional fees and expenses related to Smart
Commerce.
Our
investor relations expenses decreased by $10,285,000, from $10,318,000 in 2005
to $33,000 in 2006. The expenses for 2005 were extraordinarily high as a result
of shares that we issued to
investor relations firms. Pursuant to settlement agreements with these investor
relations firms in 2006, we redeemed these shares in 2006, resulting in a $3.125
million increase in our other income. Our management consulting expenses
decreased by $1,295,000, from $1,320,000 in 2005 to $25,000 in 2006. This
decrease resulted from
30
our
termination or non-renewal of contracts with a substantial number of management
consulting firms. Travel expenses decreased by $146,000, from $220,000 in 2005
to $74,000 in 2006. This decrease was the combined result of higher than normal
expense in 2005 when our executives were traveling frequently related to
financing and investing activity, specifically with Atlas and the Blueline
Fund,
combined with lower than normal expense in 2006 when travel was greatly
curtailed as management focused on the SEC and internal investigation. For
those
same reasons, our meals and entertainment expenses decreased by $44,000, from
$60,000 in 2005 to $16,000 in 2006. Our bonus expenses also decreased by
$51,000, from $52,000 in 2005 to $1,000 in 2006 as we curtailed our cash
incentive programs due to, in part, the following factors (1) the suspension
in
the trading of our securities by the SEC and the related investigation, (2)
the
repeated need to enter into various financing transactions in order to continue
operations, (3) we had immaterial revenues other than those generated by Smart
Commerce and Smart CRM, and (4) we have only experienced net losses to
date.
The
decreases in our general and administrative expenses were offset by a $1,022,000
increase in total compensation expense, from $645,000 in 2005 to $1,667,000
in
2006. Of this increase, $794,000 is attributable to the non-cash stock option
expense now required by our adoption of SFAS No. 123R and the remaining $228,000
of the increase is attributable to salaries paid to our CFO, COO and Corporate
Counsel. As a result of hiring a full-time CFO, third party accounting and
bookkeeping fees decreased by $405,000, from $669,000 in 2005 to $264,000 in
2006.
The
decreases in our general and administrative expenses also were offset by a
$827,000 increase in legal and professional fees, from $421,000 in 2005 to
$1,248,000 in 2006. This increase was primarily attributable to the legal costs
related to the SEC and internal investigations. Management anticipates an
increase in legal and professional fees in 2007 for non-recurring expenses
related to the costs of compliance with the Sarbanes-Oxley Act and other public
company-related expenses. The increased expenses associated with the SEC’s
suspension of trading of our securities, the continuing SEC action, and the
internal investigation of matters relating thereto are all non-recurring
expenses, but may continue to be significant expenses in 2007. To date, our
insurers have only agreed to cover a portion of the fees and expenses related
to
the SEC action and the internal investigation.
Finally,
our Smart Commerce segment contributed an additional $237,000 of general and
administrative expense in 2006 as compared to 2005, because Smart Commerce
was
operational as our subsidiary for the full twelve months of 2006 as compared
to
only two and one half months during 2005 (October 18, 2005 to December 31,
2005).
Sales
and Marketing - Sales
and
marketing expense decreased by $370,000, from $1,386,000 in 2005 to $1,016,000
in 2006. This decrease was primarily attributable to decreases in our
advertising, sales and marketing wages, management consulting, commission,
marketing and public relations expenses, which were offset by increased expenses
related to our Smart Commerce segment.
Advertising
expense decreased by $289,000, from $290,000 in 2005 to $1,000 in 2006 primarily
due to reduced barter advertising expense. Sales and marketing wages decreased
by $263,000, from $402,000 in 2005 to $139,000 in 2005, primarily due to the
promotion to Chief Operating Officer of an individual whose salary has now
been
re-allocated to general and administrative expenses as well as the elimination
of several sales positions. Management
consulting expense decreased by $73,000, from $79,000 in 2005 to $6,000 in
2006,
as we relied less on outside consultants. Commission expense decreased by
$46,000, from $52,000 in 2005 to $6,000 in 2006, as we reduced our sales staff
due to workforce reductions. We expect commission expense to increase in 2007
as
we anticipate hiring additional sales staff as we renew our focus on revenue
generation. Marketing expense decreased by $90,000, from $96,000 in 2005 to
$6,000 in 2006, as we reduced our direct marketing efforts in 2006 and shifted
to leveraging the marketing power of our partners. Public relations expense
decreased by $90,000, from $103,000 in 2005 to $12,000 in 2006, as we greatly
reduced our utilization of third party public relations firms and focused our
expenditures on our core operations.
These
decreases in our sales and marketing expenses in 2006 were offset by the
contribution of an additional $492,000 by our Smart Commerce segment to sales
and marketing expense in 2006 as compared to 2005, because Smart Commerce was
operational as our subsidiary for the full twelve months of 2006 as compared
to
only two and one half months during 2005 (October 18, 2005 to December 31,
2005).
Development
Expense
-
Development expense increased by $367,000, from $1,650,000 in 2005 to $2,017,000
in 2006. This increase was primarily attributable to an additional $706,000
in
development expense from our Smart Commerce segment in 2006 as compared to
$116,000 in 2005, because Smart Commerce was operational as our subsidiary
for
the full twelve months of 2006 as compared to only two and one half months
during 2005 (October 18, 2005 to December 31, 2005). This increase was offset
by
a $185,000 decrease in accounting application development expense, from $293,000
in 2005 to $108,000 in 2006. This decrease was the result of a reevaluation
of
our efforts regarding the accounting application in 2006. During the second
half
of 2006 when our needs pertaining to the accounting application were being
re-evaluated and re-designed, no significant development expense related to
the
accounting application was incurred as no significant designing or programming
was taking place.
Development
bonus expense decreased by $150,000 from $150,000 in 2005 as bonuses were
suspended in 2006.
31
Other
Income (Expense)
- In
2005, we paid an aggregate $500,000 in cash and issued an aggregate of 1,250,000
shares of our common stock to two investor relations consultants pursuant to
consulting agreements with each. At the time of issuance, the aggregate value
of
the shares of common stock was approximately $9,738,000. In 2006, we entered
into settlement agreements with each of these investors relations consultants.
Under the terms of the settlement agreements, the consultants retained all
of
the cash fees paid to them, but released any interest in the shares that were
issued. These shares were redeemed by us in 2006, resulting in other income
of
$3,125,000.
We
incurred net interest expense of $254,000, net of interest income of $11,000,
in
2006 as compared to net interest expense of $38,000, net of $33,000 of interest
income in 2005. This increase in net interest expense of $174,000, or 218%,
is
primarily attributable to the carrying cost for a full year of the debt
associated with the iMart and Computility acquisitions. The decrease in interest
income is primarily the result of reduced cash balances in interest-earning
accounts.
Due
to
our financing activities related to the iMart purchase price as well as the
establishment and use of our Wachovia line of credit, we anticipate that
interest expense will be significantly higher in 2007.
Comparison
of the Results of Operations for the Years Ended December 31, 2005 and
2004
Revenues
- Total
revenues were $2.2 million in 2005 as compared to $1.0 million in 2004, an
increase of $1.2 million, or 115%. Our subscription revenue increased from
zero
in 2004 to $469,000 in 2005. Revenues from professional services increased
from
zero in 2004 to $402,000 in 2005. These increases were primarily attributable
to
our acquisition of all of the stock of iMart, which became our subsidiary,
Smart
Commerce, in October 2005.
Integration
revenues in 2005 totaled $798,000 as compared to $374,000 in 2004, representing
an increase of $424,000, or 113%. This increase was primarily due to two new
integration contracts that accounted for approximately 43% of the 2005
integration revenues. Syndication revenues in 2005 totaled $403,000, as compared
to $176,000 in 2004, representing an increase of $227,000, or 128%, due
primarily to our entering into new syndication agreements. All of the 2005
syndication revenues were from three agreements. The 2005 and 2004 integration
and syndication revenues also included $424,000 and $113,000,
respectively, of revenue derived from barter transactions.
We
did
not derive any material revenue from related parties during 2005. In 2004,
revenues from related parties accounted for $330,050, or 33%, of total revenue.
Management does not expect related party revenues to be a significant source
of
income going forward.
Cost
of Revenues - Cost
of
revenues was $155,000 in 2005 as compared to $212,000 in 2004, a decrease of
$57,000, or 27%. This decrease was primarily a result of a decrease in the
costs
of wages associated with maintaining and supporting integration and syndication
partners due to a reduction in the number of active contracts. These wages
decreased by $96,000, from $129,000 in 2004 to $33,000 in 2005. In addition,
stock-based consulting expense decreased by $22,000, from $22,000 in 2004 to
zero in 2005 because we no longer used these consultants. However, these
decreases were offset due to the acquisition of iMart, which increased the
cost
of revenues by $56,000 for 2005 primarily due to third-party domain registration
fees and personnel costs associated with supporting subscription services.
This
increase in costs of revenues for the Smart Commerce segment represented 7%
of
Smart Commerce’s revenue for 2005.
General
and Administrative -
General
and administrative expenses increased by approximately $12.6 million, from
$2.4
million in 2004 to $15 million in 2005. Approximately $10.2 million of this
increase is attributable to two investor relations contracts of which $9.7
million was paid in stock and $500,000 was paid in cash. As described above,
we
subsequently entered into settlement agreement with these parties and redeemed
the shares. Additionally, in 2005 we paid a total of $499,000 in cash and issued
23,000 shares of common stock valued at a total of $216,000 to other investor
relations consultants. Approximately $159,000 of the increase in general and
administration expense is attributable to amortization expense related to
intangible assets acquired from iMart. 2004 included $350,000 of general and
administrative expense associated with the conversion of certain warrants to
common stock and $66,000 of stock-based compensation expense. Finally, general
and administrative expense increased due to a $319, 000 increase in legal and
professional fees, from $770,000 in 2004 to $1,089,000 in 2005, which was
primarily due to costs associated with conducting financial statements audits
for 2002 and 2003 and one-time expenses associated with preparing to become
a
public company.
Sales
and Marketing -
Sales
and marketing increased by $789,000, from $597,000 in 2004 to $1,386,000 in
2005, as we increased our sales and marketing staff and activities. 2004
included approximately $206,000 of barter advertising expense as compared to
$274,000 for 2005.
32
Development
-
Development expense increased by $1,087,000, from $563,000 in 2004 to $1,650,000
in 2005. This increase is primarily the result of our adding additional
programming, database management, quality assurance, and project management
resources to support the on-going development of the applications.
Other
Income (Expense) - We
incurred net interest expense of $38,000, net of $33,000 of interest income,
in
2005 and $119,000 of interest expense in 2004. The 2005 interest expense of
approximately $71,000 was primarily the result of interest expense on the
non-compete and purchase price notes related to our acquisitions of iMart and
Computility. We earned approximately $33,000 of interest income related to
bank
deposits during 2005, compared to zero in 2004. 2004 interest expense included
$75,000 of interest related to the issuance of 150,000 shares of common stock
to
a relative of one of our officers in consideration for extending the term of
a
loan and loaning additional funds to us as described in Note 8, Loans, to the
accompanying audited financial statements. The remainder of the 2004 interest
expense was primarily attributable to interest due on deferred compensation
owed
to certain of our officers and interest related to unpaid payroll tax
obligations. There was no interest income in 2004. Both the deferred
compensation and income tax obligations were relieved during the first quarter
of 2005.
During
2005 and 2004, we realized gains totaling $556,000 and $249,000, respectively,
from negotiated and contractual releases of outstanding liabilities. The gains
from debt forgiveness resulted from unrelated third parties, primarily trade
creditors who had performed services for us, agreeing to accept as payment
in
full a lesser amount than the stated liability in consideration for timely
payment of the negotiated settlement.
Provision
for Income Taxes
We
did
recorded a provision for income tax expense in 2006, 2005 or 2004 because we
have been generating net losses. Furthermore, we have not recorded an income
tax
benefit for 2006, 2005, and 2004, primarily due to continued substantial
uncertainty regarding our ability to realize our deferred tax assets. Based
upon
available objective evidence, there has been sufficient uncertainty regarding
the ability to realize our deferred tax assets, which warrants a full valuation
allowance in our financial statements. As of December 31, 2006, we had
approximately $42 million in net operating loss carryforwards, which may
utilized to offset future taxable income.
Utilization
of our net operating loss carryforwards may be subject to substantial annual
limitation due to the ownership change limitations provided by the Internal
Revenue Code and similar state provisions. Such an annual limitation could
result in the expiration of the net operating loss carryforwards before
utilization.
Liquidity
and Capital Resources
As
of
December 31, 2006, our principal sources of liquidity were cash and cash
equivalents totaling $577,000 and accounts receivable of $248,000. As of March
15, 2007, our principal sources of liquidity were cash and cash equivalents
totaling approximately $5,114,000 and accounts receivable of approximately
$209,000. This increase in cash and cash equivalents from December 31, 2006
to
March 15, 2007 is primarily due to total aggregate proceeds of $6,000,000 from
our sale of 2,352,941
shares of common stock to investors for a price of $2.55 per share, which
included warrants for the purchase of an aggregate of 1,176,471 shares of common
stock at an exercise price of $3.00 per share.
Of this,
$250,000 of our cash is restricted in accordance with our promissory note with
Fifth Third Bank, or Fifth Third, described below. As of March 15, 2007, we
have
drawn approximately $2.1 million of our $2.5 million line of credit, leaving
approximately $400,000 available for our operations.
Cash
Flow from Operations.
Cash
flows used in operations in 2006 totaled $3.25 million, down from $6.35 million
in 2005 and $3.69 million in 2004. This decrease was primarily attributable
to
cash flows from the two companies we acquired in October 2005.
Cash
Flow from Financing Activity.
In
2006, we generated a total of $1.72 million net cash from our financing
activities. This net cash was generated through both equity and debt financing,
as described below.
Equity
Financing.
Our
primary source of cash during 2006, 2005 and 2004, as well as prior years,
was
from the sale of our securities. Between March 2006 and August 2006, we sold
an
aggregate of 1 million shares of our common stock to four investors, three
of
whom were current stockholders, for a price of $2.50 per share resulting in
gross proceeds of $2,500,000. We incurred immaterial issuance costs related
to
these stock sales. During 2005, we generated net cash from financing activities,
including the sales of shares of our common stock, of approximately $7.7
million. During the first half of 2004, we sold shares of common stock to new
and existing shareholders resulting in net proceeds of $3.33 million. During
the
second half of 2004, we sold shares of common stock to new and existing
investors in a private placement resulting in net proceeds of $1.4
million.
33
Debt
Financing.
In
2006, we entered into two debt financing transactions. On November 9, 2006,
Smart Commerce entered into a loan agreement with Fifth Third Bank. Under the
terms of this agreement, Smart Commerce borrowed $1.8 million to be repaid
in 24
monthly installments of $75,000 plus interest beginning in December 2006. The
interest rate is prime plus 1.5% as periodically determined by Fifth Third.
Currently and at closing, the prime rate was 8.25%. The loan is secured by
all
of the assets of Smart Commerce, including a security account of $250,000 with
Fifth Third, and all of Smart Commerce’s intellectual property. The loan is
guaranteed by us and such guaranty is secured by all the common stock of Smart
Commerce. Under the terms of the loan agreement, Smart Commerce has established
a lock box account with Fifth Third, but has the right to use the amounts
deposited therein for any purpose not inconsistent with the loan agreement
and
related documents so long as no event of default exists and is continuing.
Further, the $250,000 in the security account will be released in 3 installments
of approximately $83,000 if on June 30, 2007, December 31, 2007, and June 30,
2008 Smart Commerce meets certain debt
covenants regarding operating metrics for Smart Commerce.
On
November 14, 2006, we entered into a revolving credit arrangement with Wachovia.
The line of credit advanced by Wachovia was $1.3 million, and can be used for
general working capital. This was increased to $2.5 million in January 2007.
Any
advances made on the line of credit must be paid off no later than August 1,
2008, with monthly payments of accrued interest commencing on December 1, 2006
on any outstanding balance. The interest shall accrue on the unpaid principal
balance at the LIBOR Market Index Rate plus 0.9%. The line of credit is secured
by our deposit account at Wachovia and an irrevocable standby letter of credit
in the amount of $2.5 million issued by HSBC Private Bank (Suisse) S.A. with
Atlas as account party. We have separately agreed with Atlas that in the event
of a default by us in the repayment of the line of credit that results in the
letter of credit being drawn, we shall reimburse Atlas any sums that Atlas
is
required to pay under such letter of credit. At our sole discretion, these
payments may be made in cash or by issuing shares of our common stock at a
set
per share price of $2.50.
Deferred
Revenue. At
December 31, 2006, we had deferred revenue totaling $325,000, net of offsetting
amounts receivable. Deferred revenue represents amounts collected in advance
of
the revenue being recognized. Based upon current conditions, we expect that
approximately 96% of this amount will be recognized during 2007.
We
have
not yet achieved positive cash flows from operations, and our main sources
of
funds for our operations have been the sale of securities in private placements
and the Wachovia line of credit. We must continue to rely on these sources
until
we are able to generate sufficient revenue to fund our operations. We
believe that anticipated cash flows from operations, funds available from our
existing line of credit, together with cash on hand, will provide sufficient
funds to finance our operations at least for the next 12 months. Changes in
our
operating plans, lower than anticipated sales, increased expenses, or other
events may cause us to need to seek additional equity or debt financing in
future periods. There can be no guarantee that financing will be available
on
acceptable terms or at all. Additional equity financing could be dilutive to
the
holders of our common stock, and additional debt financing, if available, could
impose greater cash payment obligations and more covenants and operating
restrictions. We have no current plans to seek any such additional
financing.
Recent
Developments
New
Contracts.
During
the first quarter of 2007, we entered into the following new
contracts:
| · |
Two
syndication agreements, one through our Smart Online segment which
will
offer a private label suite of branded food safety compliance applications
for industry associations. The partnership will incorporate our partner’s
food industry traceability and compliance functionality into our
business
application suite. The other through our Smart Commerce segment with
a
leading direct selling
organization.
|
| · |
Marketing
referral agreement through our Smart Online segment with a firm that
provides IT services to financial service companies in Caribbean
countries. We entered into this partnership to offer a Spanish version
of
our applications to financial service companies, which will be offered
as
a private labeled site to the partner’s small business
customers.
|
Sales
of Securities.
On
February 21, 2007, we sold an aggregate of 2,352,941 shares of our common stock
at $2.55 per share to two new investors for aggregate gross proceeds of
$6,000,000. Under the purchase agreement, we issued the investors warrants
for
the purchase of an aggregate of 1,176,471 shares of common stock at an exercise
price of $3.00 per share. We also entered into registration rights agreements
with the investors that obligate us to register the shares sold for resale
by
the investors by a certain date. If a registration statement is not timely
made,
we are obligated to pay a cash penalty up to 10% of the aggregate purchase
price. Under the terms of the registration rights agreement, we cannot offer
for
sale or sell any securities until May 22, 2007, subject to certain limited
exceptions, unless, in the opinion of our outside counsel, such offer or sale
would not jeopardize the availability of exemptions from the registration and
qualification requirements under applicable securities laws with respect to
this
placement. We incurred issuance costs of approximately $500,000 related to
this
private placement, excluding warrants issued to our private placement agent.
As
part
of the issuance costs of this transaction, we issued our placement agent a
warrant to purchase 35,000 shares of our common stock at an exercise price
of
$2.55 per share. We also entered into a registration rights agreement with
the
agent. Under this agreement, the shares issuable upon exercise of the warrant
must be included on the same registration statement we are obligated to file
as
described above, but with no provisions for the payment of any penalties for
late registration or effectiveness.
34
On
January 15, 2007, we entered into a "Stock Purchase Warrant and Agreement"
with
Atlas as incentive to modify an irrevocable standby letter of credit underlying
our revolving line of credit arrangement with Wachovia. Under the terms of
this
agreement, Atlas receives a warrant to purchase up to 444,444 shares of our
common stock at $2.70 per share at the termination of the Wachovia line of
credit or if we are in default under the terms of the Wachovia line of credit.
If the warrant is exercised in full, it will result in gross proceeds to the
Company of approximately $1,200,000.
On
March
29, 2007, we issued 55,666 shares of our common stock to certain investors
as
registration penalties for our failure to timely file a registration statement
covering shares owned by those investors as required pursuant to registration
rights agreements between such investors and us.
Wachovia
Revolving Line of Credit.
As of
March 14, 2007, we have drawn down $2.1 million of the $2.5 million Wachovia
line of credit.
Outlook
for 2007
With
the
release of our new applications and the expenses associated with becoming a
public company, we believe our capital requirements in 2007 and beyond will
be
greater than in past years. Although we do not anticipate these needs to be
substantial, the non-recurring costs associated with the SEC’s suspension of
trading of our securities and related investigation, and the internal
investigation of matters relating thereto, may increase our capital requirements
in 2007. As
such,
our historical cash flows may not be indicative of future cash flows. The
following is a discussion of factors that we consider important to our future
capital requirements and which will affect the amount of additional capital
we
need to raise. Our future capital requirements will depend on many factors,
including our rate of revenue growth, the expansion of our marketing and sales
activities, the timing and extent of spending to support product development
efforts and expansion into new territories, the timing of introductions of
new
services and enhancements to existing services, and the market acceptance of
our
services.
Primary
drivers for future operating cash flows include the commercial success of our
existing services and products and the timing and success of any new services
and products and our ability to maintain and grow the revenues from the
companies we acquired. We will continue to seek additional integration and
syndication customers who typically pay an upfront fee and to increase revenues
generated from small business end users, and increase our effort in regard
to
direct sales and cross selling of pre-paid subscriptions.
Generally,
we expect we will need to increase marketing and sales expenses before we can
substantially increase our revenue from sales of subscriptions. We have
increased our sales and marketing department as of December 2006 and added
personnel in January 2007. We also expect increased expenses from the revenue
share component of our recently executed contracts.
As
a
public company, we will incur significant legal, accounting and other expenses
that we did not incur as a private company. We will incur costs associated
with
our public company reporting requirements. We incurred costs in excess of $1
million associated with the SEC suspension of trading described above; recently
adopted corporate governance requirements, including requirements under the
Sarbanes-Oxley Act of 2002; as well as new rules implemented by the SEC, the
NASD, and national securities exchanges. We expect these rules and regulations
to increase our legal and financial compliance costs and to make some activities
more time-consuming and costly. Any unanticipated difficulties in preparing
for
and implementing these reforms could result in material delays in complying
with
these new laws and regulations or significantly increase our costs.
Historically, we have failed to file our SEC periodic reports on time and our
ability to fully comply with these new laws and regulations is also uncertain.
Our failure to timely prepare for and implement the reforms required by these
new laws and regulations could significantly harm our business, operating
results, and financial condition. We are currently evaluating and monitoring
developments with respect to these new rules, and we cannot predict or estimate
the amount of additional costs we may incur or the timing of such
costs.
In
accordance with the provisions of SFAS No. 131, as we continue to integrate
the
operations and management of our subsidiaries, we may periodically re-assess
the
manner in which we report our segment data. Changes in our internal organization
or the manner in which we monitor and manage our business and the business
of
our subsidiaries may result in the identification of different segments that
provide more meaningful data than our current segment presentation.
Contractual
Obligations.
The
following table lists certain of our contractual obligations as of December
31,
2006:
|
Payments
Due By Period
|
|||||
|
Total
|
Less
than 1 year
|
1
-
3 years
|
3
-
5 years
|
More
than 5 years
|
|
|
Long-Term
Debt Obligations
|
$3,062,631
|
$2,237,631
|
$825,000
|
-
|
-
|
|
Capital
Lease Obligations
|
-
|
-
|
-
|
-
|
-
|
|
Operating
Lease Obligations
|
33,000
|
18,000
|
15,000
|
-
|
-
|
|
Purchase
Obligations
|
250,000
|
250,000
|
-
|
-
|
-
|
|
Other
Long-Term Liabilities
|
-
|
-
|
-
|
-
|
-
|
|
TOTAL
|
$3,345,631
|
$2,505,631
|
$840,000
|
-
|
-
|
35
ITEM
7A.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest
rate sensitivity
We
had
unrestricted cash and cash equivalents totaling $327,000, $1,435,000, and
$173,000 at December 31, 2006, 2005, and 2004, respectively. These amounts
were
invested primarily in demand deposit accounts and money market funds. The cash
and cash equivalents are held for working capital purposes. We do not enter
into
investments for trading or speculative purposes. Due to the short-term nature
of
these investments, we believe that we do not have any material exposure to
changes in the fair value of our investment portfolio as a result of changes
in
interest rates. Declines in interest rates, however, will reduce future
investment income.
Two
debt
instruments have variable interest rates; one is prime + 1.5% and the other
is
LIBOR + .9% (See Note 9 - “Notes Payable,” to the Consolidated Financial
Statements). At December 31, 2006, the outstanding principal balance on these
loans was $1,725,000 and $602,000, respectively. Due to the relatively short
term of these debt instruments combined with the relative stability of interest
rates, we do not expect interest rate or market volatility will have a material
effect on our cash flows.
36
ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
INDEX
TO
FINANCIAL STATEMENTS
|
Page
number
|
|
|
REPORT
OF INDEPENDENT REGISTERED
|
|
|
PUBLIC
ACCOUNTING FIRM
|
F-2
|
|
|
|
|
CONSOLIDATED
BALANCE SHEETS
|
F-3
|
|
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
F-4
|
|
CONSOLIDATED
STATEMENTS OF
|
|
|
STOCKHOLDERS’
(DEFICIT) EQUITY
|
F-5
|
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
F-7
|
|
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
|
F-9
|
F-1
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders
and Directors
Smart
Online, Inc.
Durham,
North Carolina
We
have
audited the accompanying consolidated balance sheets of Smart Online, Inc.
as of
December 31, 2006 and 2005, and the related consolidated statement of
operations, stockholders’ (deficit) equity, cash flows for each of the years
then ended December 31, 2006, 2005 and 2004. These financial statements are
the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of Smart Online, Inc. as
of
December 31, 2006 and 2005, and the results of its operations and its cash
flows
for each of the years then ended December 31, 2006, 2005 and 2004, in conformity
with accounting principles generally accepted in the United States.
|
/s/
Sherb & Co., LLP
Certified
Public Accountants
|
New
York,
New York
March
28,
2007
F-2
SMART
ONLINE, INC.
CONSOLIDATED
BALANCE SHEETS
|
Assets
|
|
December
31,
2006
|
|
December
31,
2005
|
|
||
|
CURRENT
ASSETS:
|
|
|
|
|
|
|
|
|
Cash
and Cash Equivalents
|
|
$
|
326,905
|
|
$
|
1,434,966
|
|
|
Restricted
Cash
|
|
|
250,000
|
|
|
230,244
|
|
|
Accounts
Receivable, Net
|
|
|
247,618
|
|
|
504,979
|
|
|
Prepaid
Expenses
|
|
|
100,967
|
|
|
370,225
|
|
|
Assets
Available for Sale
|
|
|
-
|
|
|
74,876
|
|
|
Total
current assets
|
|
|
925,490
|
|
|
2,615,290
|
|
|
PROPERTY
AND EQUIPMENT, Net
|
|
|
180,360
|
|
|
216,969
|
|
|
INTANGIBLE
ASSETS, Net
|
|
|
3,617,477
|
|
|
4,298,358
|
|
|
GOODWILL
|
2,696,642
|
5,489,963
|
|||||
|
OTHER
ASSETS
|
|
|
13,040
|
|
|
40,400
|
|
|
ASSETS
AVAILABLE FOR SALE
|
-
|
1,897,099
|
|||||
|
TOTAL
ASSETS
|
|
$
|
7,433,009
|
|
$
|
14,558,079
|
|
|
Liabilities
and Stockholders' Equity
|
|
|
|
|
|
|
|
|
CURRENT
LIABILITIES:
|
|
|
|
|
|
|
|
|
Accounts
Payable
|
|
$
|
850,730
|
|
$
|
855,904
|
|
|
Accrued
Registration Rights Penalty
|
|
|
465,358
|
|
|
129,945
|
|
|
Current
Portion of Notes Payable
|
|
|
2,839,631
|
|
|
2,127,486
|
|
|
Deferred
Revenue
|
|
|
313,774
|
|
|
687,222
|
|
|
Accrued
Liabilities
|
|
|
301,266
|
|
|
91,233
|
|
|
Liabilities
Held for Sale
|
-
|
1,030,369
|
|||||
|
Total
Current Liabilities
|
|
|
4,770,759
|
|
|
4,922,159
|
|
|
|
|
|
|
|
|
|
|
|
LONG-TERM
LIABILITIES:
|
|
|
|
|
|
|
|
|
Long-Term
Portion of Notes Payable
|
|
|
825,000
|
|
|
2,243,652
|
|
|
Deferred
Revenue
|
|
|
11,252
|
|
|
78,771
|
|
|
Liabilities
Held for Sale
|
-
|
640,866
|
|||||
|
Total
Long-Term Liabilities
|
|
|
836,252
|
|
|
2,963,289
|
|
|
Total
Liabilities
|
|
|
5,607,011
|
|
|
7,885,448
|
|
|
COMMITMENTS
AND CONTINGENCIES
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY:
|
|
|
|
|
|
|
|
|
Common
stock, $.001 Par Value, 45,000,000 Shares Authorized, Shares Issued
and
Outstanding:
December
31, 2006 - 15,379,030, December 31, 2005 --15,607,230
|
|
|
15,379
|
|
|
15,607
|
|
|
Additional
Paid-in Capital
|
|
|
59,159,919
|
|
|
58,982,617
|
|
|
Accumulated
Deficit
|
|
|
(57,349,300
|
)
|
|
(52,325,593
|
)
|
|
Total
Stockholders' Equity
|
|
|
1,825,998
|
|
|
6,672,631
|
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
7,433,009
|
|
$
|
14,558,079
|
|
See
notes
to financial statements.
F-3
SMART
ONLINE, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
|
Year
Ended
December
31,
2006
|
|
Year
Ended
December
31,
2005
|
|
Year
Ended
December
31,
2004
|
|
|||
|
REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
Integration
Fees
|
|
$
|
182,660
|
|
$
|
798,178
|
|
$
|
374,055
|
|
|
Syndication
Fees
|
|
|
218,386
|
|
|
402,847
|
|
|
176,471
|
|
|
Subscription
Fees
|
|
|
1,904,192
|
|
|
468,621
|
|
|
-
|
|
|
Professional
Services Fees
|
|
|
1,269,300
|
|
|
401,677
|
|
|
-
|
|
|
Other
Revenue
|
|
|
70,352
|
|
|
84,102
|
|
|
122,394
|
|
|
Related
Party Revenues
|
|
|
-
|
|
|
-
|
|
|
330,050
|
|
|
Total
Revenues
|
|
|
3,644,890
|
|
|
2,155,425
|
|
|
1,002,970
|
|
|
|
|
|
|
|
|
|
|
|||
|
COST
OF REVENUES
|
|
|
329,511
|
|
|
154,892
|
|
|
211,616
|
|
|
|
|
|
|
|
|
|
|
|||
|
GROSS
PROFIT
|
|
|
3,315,379
|
|
|
2,000,533
|
|
|
791,354
|
|
|
|
|
|
|
|
|
|
|
|||
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|||
|
General
and Administrative
|
|
|
5,648,377
|
|
|
15,038,563
|
|
|
2,432,928
|
|
|
Sales
and Marketing
|
|
|
1,016,107
|
|
|
1,386,019
|
|
|
596,989
|
|
|
Research
and Development
|
|
|
2,016,507
|
|
|
1,649,956
|
|
|
563,372
|
|
|
|
|
|
|
|
|
|
|
|||
|
Total
Operating Expenses
|
|
|
8,680,991
|
|
|
18,074,538
|
|
|
3,593,289
|
|
|
|
|
|
|
|
|
|
|
|||
|
LOSS
FROM CONTINUING OPERATIONS
|
|
|
(5,365,612
|
)
|
|
(16,074,005
|
)
|
|
(2,801,935
|
)
|
|
|
|
|
|
|
|
|
|
|||
|
OTHER
INCOME (EXPENSE):
|
|
|
|
|
|
|
|
|||
|
Interest
Expense, Net
|
|
|
(254,381
|
)
|
|
(37,502
|
)
|
|
(119,389
|
)
|
|
Gain
on Debt Forgiveness
|
|
|
144,351
|
|
|
556,215
|
|
|
249,395
|
|
|
Redemption
of Investor Relations Shares
|
3,125,000
|
-
|
-
|
|||||||
|
Writeoff
of Investment
|
(25,000
|
)
|
-
|
-
|
||||||
|
Other
Income (Expense)
|
(122,502
|
)
|
418
|
-
|
||||||
|
|
|
|
|
|
|
|
|
|||
|
Total
Other Income
|
|
|
2,867,468
|
|
|
519,131
|
|
|
130,006
|
|
|
NET
LOSS FROM CONTINUING OPERATIONS
|
|
|
(2,498,144
|
)
|
|
(15,554,874
|
)
|
|
(2,671,929
|
)
|
|
DISCONTINUED
OPERATIONS
|
||||||||||
|
Loss
of Operations of Smart CRM (2006 includes gain on sale of assets
of
$563,835, write-off of goodwill of $2,793,321 and loss on operations
of
$296,077), net of tax ($0)
|
(2,525,563
|
)
|
-
|
|||||||
|
Loss
on Discontinued Operations
|
(2,525,563
|
)
|
(35,735
|
)
|
||||||
|
Preferred
stock dividends and accretion of discount on preferred
stock
|
|
|
-
|
|
-
|
|
(2,215,625
|
)
|
||
|
Accretive
dividend issued in connection with registration rights
agreement
|
-
|
-
|
(206,085
|
)
|
||||||
|
Converted
preferred stock inducement cost
|
|
|
-
|
|
|
-
|
|
(3,225,410
|
)
|
|
|
NET
LOSS
|
||||||||||
|
Net
loss attributed to common stockholders
|
|
$
|
(5,023,707
|
)
|
$
|
(15,590,609
|
)
|
$
|
(8,319,049
|
)
|
|
NET
LOSS PER SHARE:
|
|
|
|
|
|
|
|
|||
|
Continuing
Operations
Basic
and Diluted
|
|
$
|
(0.17
|
)
|
$
|
(1.20
|
)
|
$
|
(0.26
|
)
|
|
Discontinued
Operations
Basic
and Diluted
|
(0.17
|
)
|
0.00
|
0.00
|
||||||
|
Net
Loss Attributed to common stockholders
Basis
and Diluted
|
(0.33
|
)
|
(1.20
|
)
|
(0.82
|
)
|
||||
|
SHARES
USED IN COMPUTING NET LOSS PER SHARE:
|
|
|
|
|
|
|
|
|||
|
Basic
and Diluted
|
|
|
15,011,830
|
|
|
12,960,006
|
|
|
10,197,334
|
|
See
notes
to financial statement.
F-4
SMART
ONLINE, INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ DEFICIT
FOR
THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
|
Common
Stock
|
Additional
Paid-
|
Accumulated
|
||||||||||||||
|
Shares
|
$.001
Par
|
In
Capital
|
Deficit
|
Total
|
||||||||||||
|
BALANCE,
DECEMBER 31, 2003
|
7,261,965
|
7,262
|
8,607,712
|
(30,629,130
|
)
|
(22,014,156
|
)
|
|||||||||
|
Conversion
of Preferred Stock into common stock
|
2,948,608
|
2,949
|
19,721,890
|
-
|
19,724,839
|
|||||||||||
|
Conversion
of Preferred Stock Inducement Cost
|
-
|
-
|
3,225,410
|
(3,225,410
|
)
|
-
|
||||||||||
|
Interest
Expense Associated with Notes Payable
|
-
|
-
|
75,000
|
-
|
75,000
|
|||||||||||
|
Accretion
of Redeemable preferred
|
-
|
-
|
(2,215,625
|
)
|
-
|
(2,215,625
|
)
|
|||||||||
|
Issuance
of common stock, Net of Issuance Costs of $183,350
|
1,288,744
|
1,289
|
4,762,355
|
-
|
4,763,644
|
|||||||||||
|
Issuance
of common stock Rescinded
|
(28,572
|
)
|
(29
|
)
|
(99,973
|
)
|
-
|
(100,002
|
)
|
|||||||
|
Issuance
of Stock Options to Officers
|
-
|
-
|
161,000
|
-
|
161,000
|
|||||||||||
|
Issuance
of Stock Options to Members of Advisory Board
|
-
|
-
|
6,034
|
-
|
6,034
|
|||||||||||
|
Issuance
of common stock to Former Holders of Preferred Stock Pursuant to
Registration Rights Agreement
|
58,230
|
58
|
206,027
|
(206,085
|
)
|
-
|
||||||||||
|
Conversion
of Bank One Warrant into common stock
|
100,000
|
100
|
349,900
|
-
|
350,000
|
|||||||||||
|
Issuance
of Stock Option to Consultant
|
-
|
1,495
|
-
|
1,495
|
||||||||||||
|
Exercise
of Warrants
|
2,857
|
3
|
8,607
|
-
|
8,610
|
|||||||||||
|
Net
Loss
|
|
|
(2,671,929
|
)
|
(2,671,929
|
)
|
||||||||||
|
BALANCE,
DECEMBER 31, 2004
|
11,631,832
|
11,632
|
34,809,832
|
(36,732,554
|
)
|
(1,911,090
|
)
|
|||||||||
|
Issuance
of common stock, Net of Issuance Costs of $630,525
|
1,391,642
|
1,392
|
6,719,614
|
-
|
6,721,006
|
|||||||||||
|
Exercise
of Warrants
|
579,717
|
580
|
1,305,518
|
-
|
1,306,098
|
|||||||||||
|
Issuance
of Warrants
|
-
|
-
|
19,231
|
-
|
19,231
|
|||||||||||
|
Issuance
of common stock for Services
|
39,886
|
40
|
343,408
|
-
|
343,448
|
|||||||||||
|
Issuance
of common stock to Employees as Bonus
|
4,200
|
4
|
40,106
|
-
|
40,110
|
|||||||||||
|
Exercise
of Stock Options
|
16,500
|
16
|
57,734
|
-
|
57,750
|
|||||||||||
|
Issuance
of IR Shares-GIC
|
625,000
|
625
|
5,174,375
|
-
|
5,175,000
|
|||||||||||
|
Issuance
of IR Shares-Berkley
|
625,000
|
625
|
4,561,875
|
-
|
4,562,500
|
|||||||||||
|
iMart
Acquisition
|
205,767
|
205
|
1,815,688
|
-
|
1,815,893
|
|||||||||||
|
Computility
Acquisition
|
484,213
|
484
|
3,534,271
|
-
|
3,534,755
|
|||||||||||
|
Issuance
of Shares to Spectrum Technologies
|
3,473
|
4
|
299,996
|
-
|
30,000
|
|||||||||||
|
Elimination
of iMart (Bayberry) Equity Not Acquired
|
-
|
-
|
-
|
(2,430
|
)
|
(2,430
|
)
|
|||||||||
|
Issuance
of Options to Consultants
|
-
|
-
|
570,014
|
-
|
570,014
|
|||||||||||
|
Gift
of Shares to Charitable Organization
|
-
|
-
|
955
|
-
|
955
|
|||||||||||
|
Net
Loss
|
|
|
(15,590,609
|
)
|
(15,590,609
|
)
|
|
BALANCE
DECEMBER 31, 2005
|
15,607,230
|
15,607
|
58,982,617
|
(52,325,593
|
)
|
6,672,631
|
||||||||||
|
Cashless
Exercise of Options
|
4,800
|
5
|
(5
|
)
|
-
|
0.00
|
||||||||||
|
Issuance
of Warrants
|
17,000
|
17
|
22,083
|
-
|
22,100
|
|||||||||||
|
Cancellation
of GIC Shares
|
(625,000
|
)
|
(625
|
)
|
(1,561,875
|
)
|
-
|
(1,562,500
|
)
|
|||||||
|
Issuance
of common stock
|
1,000,000
|
1,000
|
2,499,000
|
-
|
2,500,000
|
|||||||||||
|
Cancellation
of Berkley Shares
|
(625,000
|
)
|
(625
|
)
|
(1,561,875
|
)
|
-
|
(1,562,500
|
)
|
|||||||
|
SFAS
123 Expense
|
779,974
|
779,974
|
||||||||||||||
|
Net
Loss
|
(5,023,707
|
)
|
(5,023,707
|
)
|
||||||||||||
|
BALANCE
DECEMBER 31 2006
|
15,379,030
|
$
|
15,379
|
$
|
59,159,919
|
$
|
(57,349,300
|
)
|
$
|
1,825,998
|
||||||
See
notes
to financial statements.
F-5
SMART
ONLINE, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
Year
Ended
December
31,
2006
|
|
Year
Ended
December
31,
2005
|
|
Year
Ended
December
31,
2004
|
|
|||
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss from continuing operations
|
|
$
|
(2,498,144
|
)
|
$
|
(15,554,874
|
)
|
$
|
(2,671,929
|
)
|
|
Adjustments
to reconcile net loss to net
|
|
|
|
|
|
|
|
|
|
|
|
cash
provided by (used in) operating
|
|
|
|
|
|
|
|
|
|
|
|
activities:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
& amortization
|
|
|
727,922
|
|
|
260,852
|
|
|
51,531
|
|
|
Shares
issued for services in lieu of cash payments
|
|
|
-
|
|
|
9,767,500
|
|
|
-
|
|
|
Write-off
of investment
|
25,000
|
-
|
-
|
|||||||
|
Bad
Debt Expense
|
63,317
|
-
|
-
|
|||||||
|
Redemption
of investor relations shares
|
(3,125,000
|
)
|
-
|
-
|
||||||
|
Stock
option expense
|
779,974
|
-
|
-
|
|||||||
|
Registration
rights penalty expense
|
|
|
335,413
|
|
|
129,947
|
|
|
-
|
|
|
Loss
on disposal of property and equipment
|
|
|
-
|
|
|
-
|
|
|
8,855
|
|
|
Common
shares, warrants, or options issued in lieu of
Compensation
|
|
|
-
|
|
|
826,739
|
|
|
168,530
|
|
|
Common
shares issued for extension of loan
|
|
|
|
|
|
|
|
|
75,000
|
|
|
Common
shares issued in exchange for warrants
|
|
|
-
|
|
|
-
|
|
|
350,000
|
|
|
Issuance
of warrants
|
|
|
-
|
|
|
19,231
|
|
|
-
|
|
|
Gain
on debt forgiveness
|
|
|
(144,351
|
)
|
|
(556,634
|
)
|
|
-
|
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
183,386
|
|
(101,541
|
)
|
|
51,672
|
|
|
|
Related
party receivable
|
|
|
-
|
|
|
-
|
|
|
38,682
|
|
|
Other
accounts receivable
|
|
|
-
|
|
|
4,687
|
|
|
(43,455
|
)
|
|
Prepaid
expenses
|
|
|
264,333
|
|
(194,519
|
)
|
|
(24,850
|
)
|
|
|
Other
assets
|
|
|
8,308
|
|
|
45,187
|
|
|
(500
|
)
|
|
Legal
settlement obligation
|
|
|
-
|
|
|
-
|
|
|
(181,563
|
)
|
|
Deferred
revenue
|
|
|
(440,964
|
)
|
|
(592,010
|
)
|
|
(225,951
|
)
|
|
Accounts
payable
|
|
|
121,699
|
|
|
482,261
|
|
|
(321,274
|
)
|
|
Accrued
payroll
|
|
|
-
|
|
(110,079
|
)
|
|
46,946
|
|
|
|
Accrued
payroll taxes payable
|
|
|
-
|
|
(30,741
|
)
|
|
(961,196
|
)
|
|
|
Accrued
interest payable
|
|
|
-
|
|
|
-
|
|
|
(126,871
|
)
|
|
Accrued
expenses
|
|
|
234,601
|
|
|
44,572
|
|
|
-
|
|
|
Deferred
compensation payable
|
-
|
(1,091,814
|
)
|
80,166
|
||||||
|
Cash
flow from operations of discontinued
operations
|
|
|
212,201
|
|
300,744
|
|
-
|
|
||
|
Net
cash (used in) provided by operating
|
|
|
|
|
|
|
|
|
|
|
|
Activities
|
|
|
(3,252,305
|
)
|
|
(6,350,492
|
)
|
|
(3,686,207
|
)
|
See notes to financial statements
F-6
SMART
ONLINE, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(continued)
|
Year
Ended
December
31,
2006
|
Year
Ended
December
31,
2005
|
Year
Ended
December
31,
2004
|
||||||||
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
Purchase
of property and equipment
|
|
|
(8,457
|
)
|
|
(224,757
|
)
|
|
(82,710
|
)
|
|
Smart
CRM Non-Compete Agreement
|
|
|
-
|
|
(90,000
|
)
|
|
-
|
|
|
|
Cash
acquired from iMart at acquisition
|
|
|
-
|
|
32,028
|
|
|
-
|
|
|
|
Redemption
(Purchase) of marketable securities
|
-
|
395,000
|
(395,000
|
)
|
||||||
|
Cash
flow from investing activities of discontinued operations
|
|
|
432,545
|
|
|
(154,105
|
)
|
|
||
|
Net
cash used in investing activities
|
|
|
424,088
|
|
(41,834
|
)
|
|
(477,710
|
)
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
Borrowings
on notes payable
|
|
|
2,402,000
|
|
|
-
|
|
|
-
|
|
|
Repayments
on notes payable
|
|
|
(3,102,918
|
)
|
|
(65,000
|
)
|
|
(350,000
|
)
|
|
Restricted
cash
|
|
|
(21,211
|
)
|
|
(230,244
|
)
|
|
-
|
|
|
Advances
from (to) Smart CRM
|
|
|
570,923
|
|
(123,829
|
)
|
|
-
|
|
|
|
Cash
flow from financing activities of discontinued
operations
|
(650,738
|
)
|
(139,615
|
)
|
||||||
|
(Repayments)
borrowings from stockholder
|
|
|
-
|
|
|
-
|
|
|
(86,480
|
)
|
|
Issuance
of Common Stock
|
|
|
2,522,100
|
|
|
8,212,641
|
|
|
4,672,250
|
|
|
Net
cash provided by financing activities
|
|
|
1,720,156
|
|
|
7,653,953
|
|
|
4,235,770
|
|
|
NET
INCREASE IN CASH
AND
CASH EQUIVALENTS
|
|
|
(1,108,061
|
)
|
|
1,261,627
|
|
|
71,853
|
|
|
CASH
AND CASH EQUIVALENTS,
BEGINNING
OF PERIOD
|
|
|
1,434,966
|
|
|
173,339
|
|
|
101,486
|
|
|
CASH
AND CASH EQUIVALENTS,
END
OF PERIOD
|
|
$
|
326,905
|
|
$
|
1,434,966
|
|
$
|
173,339
|
|
|
Supplemental
disclosures:
|
|
|
|
|
|
|
|
|
|
|
|
Cash
payment during the year for interest:
|
|
$
|
292,807
|
|
$
|
158,232
|
|
$
|
47,447
|
|
|
Cash
payment during the year for income taxes:
|
|
$
|
-
|
|
$
|
-
|
|
|
-
|
|
|
Non-cash
financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
Debt
Assumed by Purchaser of Assets of Smart CRM
|
$
|
1,733,190
|
$
|
-
|
$
|
-
|
||||
|
Notes
Payables issued related to Acquisitions
|
|
$
|
-
|
|
$
|
3,659,301
|
|
|
-
|
|
|
Notes
Payable for iMart Non-Compete Agreements
|
|
$
|
-
|
|
$
|
715,998
|
|
|
-
|
|
|
Assets
and Liabilities of Computility acquired for stock:
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
Receivable, net
|
|
$
|
-
|
|
$
|
6,894
|
|
|
-
|
|
|
Other
Current Assets
|
|
$
|
-
|
|
$
|
10,742
|
|
|
-
|
|
|
Property,
Plant and Equipment, net
|
|
$
|
-
|
|
$
|
388,128
|
|
|
-
|
|
|
Other
Assets
|
|
$
|
-
|
|
$
|
246,228
|
|
|
-
|
|
|
Accounts
Payable
|
|
$
|
-
|
|
$
|
109,897
|
|
|
-
|
|
|
Subscription
and Notes Payable
|
|
$
|
-
|
|
$
|
1,807,327
|
|
|
-
|
|
|
Other
Liabilities
|
|
$
|
-
|
|
$
|
29,549
|
|
|
-
|
|
|
Non-cash
accretion of preferred
|
|
|
|
|
|
|
|
-
|
|
|
|
stock
redemption value
|
|
$
|
-
|
|
$
|
-
|
|
$
|
2,215,625
|
|
|
Conversion
of preferred stock
|
|
|
|
|
|
|
|
|
|
|
|
into
Common Stock
|
|
$
|
-
|
|
$
|
-
|
|
$
|
19,724,839
|
|
|
Conversion
of preferred stock
|
|
|
|
|
|
|
|
|
|
|
|
inducement
cost
|
|
$
|
-
|
|
$
|
-
|
|
$
|
3,225,410
|
|
See
notes
to financial statements
F-7
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FOR
THE YEARS ENDED DECEMBER 31, 2006, 2005 and 2004.
1. NATURE
OF BUSINESS
Smart
Online, Inc. (the “Company”) develops and markets products and services targeted
towards small businesses (less than 50 employees) that are delivered via a
Software-as-a-Service (“SaaS”) model. The Company sells its products and
services primarily through private
label syndication and OEM distribution channels, although small businesses
may
purchase products and services directly through its main portal located at
www.smartonline.com.
The
Company’s primary source of revenue currently comes from sales of SaaS
applications for business management, web marketing, and e-commerce, which
represented 63%, 77%, and 55% of its revenue from continuing operations for
the
fiscal years ended December 31, 2006, 2005, and 2004, respectively. The Company
derives revenue from sales of professional services which represented 35%,
19%,
and 0% of revenue from continuing operations for the fiscal years ended December
31, 2006, 2005, and 2004, respectively.
In
previous years, the Company’s auditors expressed doubt about our ability to
continue as a going concern. The Company has been able to address these concerns
such that no similar doubt exists at this time. Actions taken by the Company
that effect this determination include (1) raising substantial additional
capital in February 2007 (See Note 18 - Subsequent Events); (2) selling
substantially all the assets of its wholly owned subsidiary, Smart CRM, Inc.,
and (3) controlling expenses and anticipated loses.
The
Company continues to incur development expenses to enhance and expand its
products by focusing on establishing its Internet-delivered SaaS applications
and data resources. All allocable expenses to establish the technical
feasibility of the software have been recorded as research expense. The ability
of the Company to successfully develop and market its products is dependent
upon
certain factors, including the timing and success of any new services and
products, the progress of research and development efforts, results of
operations, the status of competitive services and products, and the timing
and
success of potential strategic alliances or potential opportunities to acquire
technologies or assets, any of which may require the Company to seek additional
funding sooner than expected.
2. SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Principles
of Consolidation -
The
accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries, Smart CRM, Inc., and Smart Commerce,
Inc. All significant intercompany accounts and transactions have been
eliminated. Subsidiary accounts are included only from the date of acquisition
forward. See Note 17, Acquisitions & Dispositions.
Revenue
Recognition-
The
Company recognizes revenue in accordance with accounting standards for software
and service companies including the Securities and Exchange Commission’s (the
“SEC”) Staff Accounting Bulletin 104 Revenue
Recognition
(“SAB
104”), Emerging Issues Task Force Issue No. 00-21 Revenue
Arrangements with Multiple Deliverables
(“EITF
00-21”),
Emerging
Issues Task Force Issue No. 99-19 Reporting
Revenue Gross as a Principal or Net as an Agent
(“EITF
99-19”),and
related interpretations including American Institute of Certified Public
Accountants (“AICPA”) Technical Practice Aids. The Company utilizes
interpretative guidance from regulatory and accounting bodies, which include,
but are not limited to, the SEC, the AICPA, the Financial Accounting Standards
Board (“FASB”), and various professional organizations.
Revenue
is recognized when all of the following conditions are satisfied: (1) there
is
persuasive evidence of an arrangement; (2) the service has been provided to
the
customer; (3) the collection of fees is probable; and (4) the amount of fees
to
be paid by the customer is fixed or determinable. EITF 00-21 states that revenue
arrangements with multiple deliverables should be divided into separate units
of
accounting if the
F-8
deliverables
in the arrangement meet the following criteria: (1) the delivered item has
value
to the customer on a stand-alone basis; (2) there is objective and reliable
evidence of the fair value of the undelivered item; and (3) if the arrangement
includes a general right of return relative to the delivered item, delivery
or
performance of the undelivered item is considered probable and substantially
in
control of the vendor. Syndication and integration agreements typically include
multiple deliverables including the grant of a non-exclusive license to
distribute, use and access the Company’s platform, fees for the integration of
content into the platform, maintenance and hosting fees, documentation and
training, and technical support and customer support fees. The Company cannot
establish fair value of the individual deliverables based on objective and
reliable evidence due to the lack of a consistent history of standard
syndication and integration contractual arrangements, there have only been
a few
contracts that have continued past the initial contractual term, there have
not
been any contracts in which these elements have been sold as stand-alone items,
and there is no third-party evidence of fair value for products or services
that
are interchangeable and comparable to the Company’s products and services. As
such, revenue is not allocated to the individual deliverables and must be
recorded as a single unit of accounting as further described below.
Additionally, the Company has evaluated the timing and substantive nature of
the
performance obligations associated with the multiple deliverables noted above,
including the determination that the remaining obligations are essential to
the
ongoing usability and functionality of the delivered products, and determined
that revenue should be recognized over the life of the contracts, commencing
on
the date the site goes online.
Subscription
revenues consist primarily of subscription sales directly to end-users, or
to
others for distribution to end-users, hosting and maintenance fees, and
e-commerce website design. Subscription sales are made either on a monthly
subscription or a one-time for fee basis. Subscriptions are payable in advance
on a monthly basis. Currently, most syndication agreements call for the Company
to receive a percentage of revenue generated. Depending on the criteria of
each
individual contract and in accordance with EITF 99-19, a determination is made
as to whether revenue should be recognized gross with a corresponding expense
for the portion paid to or retained by the partner, or if only the net portion
should be recognized as revenue. At this time, the Company is still selling
certain products and services on a “for fee” basis. The Company also recently
stopped offering to its potential syndication partners volume discounts for
pre-paid subscriptions, which they can either market or contribute to their
small business customers, because no volume sales occurred. E-Commerce website
design fees, which are charged for building and maintaining corporate websites
or to add the capability for e-commerce transactions, are recognized over the
life of the project. Domain name registration fees are recognized over the
term
of the registration period. Online loan origination fees are charged to provide
users online financing options. The Company receives payments for loans or
credit provided.
Professional
service fees are recognized over the term of the consulting engagement as
services are performed, which is typically one to three months. Advance payments
for consulting services, if billed and paid prior to completion of the project,
are recorded as deferred revenue when received. If the fees are not fixed or
determinable, revenue is recognized as work is performed and billed. In
determining whether the professional service fees can be accounted for
separately from subscription and support revenues, the following factors are
considered for each consulting agreement: availability of the consulting
services from other vendors, whether objective and reliable evidence for fair
value exists of the undelivered elements, the nature of the consulting services,
the timing of when the consulting contract was signed in comparison to the
subscription service start date, and the contractual dependence of the
subscription service on the customer’s satisfaction with the consulting
work.
Syndication
fees consist primarily of fees charged to syndication partners to create and
maintain a customized private-label site and ongoing support, maintenance and
customer service. Syndication agreements typically include an advance fee and
monthly hosting fees. Integration fees consist primarily of fees charged to
integration partners to integrate their products into the Company’s platform.
Amounts that have been invoiced are recorded as accounts receivable and in
deferred revenue and the revenue is recognized ratably over the specified lives
of the contracts, commencing on the date the site goes online. Syndication,
integration and support contracts typically provide for early termination only
upon a material breach by either party that is not cured in a timely manner.
If
a contract terminates earlier than its term, the remaining deferred revenue
is
recognized upon termination. It is possible that the estimates of expected
duration of customer contract lives may change and the period over which such
revenues are amortized could be adjusted. Any such change in specified contract
lives could affect future results of operations.
F-9
Both
syndication and integration fees are recognized on a monthly basis over the
life
of the contract, although a significant portion of the fee from integration
agreements is received upfront. Customers are generally invoiced in annual
or
monthly installments and typical payment terms provide that customers pay within
30 days of invoice. In general, billings are collected in advance of the service
period.
OEM
revenues are recorded based on the greater of actual sales or contractual
minimum guaranteed royalty payments. The Company records the minimum guaranteed
royalties monthly and receives payment of the royalties on a quarterly basis,
thirty days in arrears. To the extent actual royalties exceed the minimum
guaranteed royalties, the excess is recorded in the quarter the Company receives
notification of such additional royalties.
Barter
Transactions -
Barter
revenue relates to syndication and integration services provided to business
customers in exchange for advertising in the customers' trade magazines and
on
their Web sites. Barter expenses reflect the expense offset to barter revenue.
The amount of barter revenue and expense is recorded at the estimated fair
value
of the services received or the services provided, whichever is more objectively
determinable, in the month the services and advertising are exchanged. The
Company applies APB 29,
Accounting for Non-Monetary Transactions,
the
provisions of EITF 93-11,
Accounting for Barter Transactions Involving Barter Credits,
and EITF
99-17, Accounting
for Advertising Barter Transactions
and,
accordingly, recognizes barter revenues only to the extent that there have
been
similar cash transactions within a period not to exceed six months prior to
the
date of the barter transaction. To date the amount of barter revenue to be
recognized has been more objectively determinable based on integration and
syndication services provided. For revenue from integration and syndication
services provided for cash to be considered similar to the integration and
syndication services provided in barter transactions, the services rendered
must
have been in the same media and similar term as the barter transaction. Further,
the quantity or volume of integration or syndication revenue received in a
qualifying past cash transaction can only evidence the fair value of an
equivalent quantity or volume of integration or syndication revenue received
in
subsequent barter transactions. In other words, a past cash transaction can
only
support the recognition of revenue on integration and syndication contracts
transactions up to the dollar amount of the cash transactions. When the cash
transaction has been used to support an equivalent quantity and dollar amount
of
barter revenue, that transaction cannot serve as evidence of fair value for
any
other barter transaction. Once the value of the barter revenue has been
determined, the same revenue recognition principles are followed that apply
to
cash transactions with unearned revenues being deferred as described more fully
above. At the time the barter revenue is recorded, an offsetting pre-paid barter
advertising asset is recorded. This pre-paid barter advertising asset is
amortized to expense as advertising services are received such as when an
advertisement runs in a magazine. Barter revenues totaled approximately
$103,000, $424,000, and $113,000 in 2006, 2005, and 2004, respectively.
Cash
and Cash Equivalents -
All
highly liquid investments with an original maturity of three months or less
are
considered to be cash equivalents.
Restricted
Cash
- Under
the terms of a promissory note between Smart Commerce and Fifth Third Bank,
$250,000 on deposit at Fifth Third Bank serves as loan collateral and is
restricted. Such restricted cash is scheduled to be released from the
restrictions in three equal installments of approximately $83,000, on June
30,
2007, December 31, 2007 and June 30, 2008, if the Company meets certain debt
covenants regarding operating metrics for Smart Commerce.
Allowance
for Doubtful Accounts - The
need
for an allowance for doubtful accounts is evaluated based on specifically
identified amounts that management believes to be uncollectible. Management
also
records an additional allowance based on an assessment of the general financial
conditions affecting its customer base. If actual collections experience
changes, revisions to the allowance may be required. Based upon the
aforementioned criteria, management has recorded an allowance of approximately
$65,000, zero, and zero as of December 31, 2006, 2005 and 2004,
respectively.
F-10
Concentration
of Credit Risk
-
Financial instruments which potentially subject the Company to concentrations
of
credit risk consist principally of cash and accounts receivable. At times,
cash
balances may exceed the FDIC insurable limits of $100,000. See Note 13 - “Major
Customers and Concentration of Credit Risk” for further discussion of risk
within accounts receivable.
Prepaid
Expenses
-
Prepaid expenses primarily represent advance payments to registries for domain
name registrations as well as other advance payments for various other expenses.
Prepaid expenses are amortized to expense on a straight-line basis over the
period covered by the expenses. In the case of prepaid registry fees, the
amortization period is consistent with the revenue recognition of the related
domain name registration.
Software
Development Costs -
SFAS No.
86,
Accounting for the Costs of Software to be Sold, Leased or Otherwise
Marketed,
requires capitalization of certain software development costs subsequent to
the
establishment of technological feasibility. Based on the Company’s product
development process, technological feasibility is established upon completion
of
a working model. Costs related to software development incurred between
completion of the working model and the point at which the product is ready
for
general release have been insignificant. During 2005, the Company acquired
certain rights to an accounting software application that has been integrated
with its OneBiz
SM
platform, but is still under development. All amounts related to the development
and modification of this engine have been expensed as research and development
costs. The remaining portion of the software assignment and development fees
is
expected to be earned and payable during 2007.
SFAS
No.
2, Accounting
for Research and Development Costs,
establishes accounting and reporting standards for research and development.
In
accordance with SFAS No. 2, costs to enhance existing products or costs incurred
after the general release of the service using the product are expensed in
the
period they are incurred.
Impairment
of Long Lived Assets -
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets
to
be held and used is measured by a comparison of the carrying amount of an asset
to future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured
by
the amount by which the carrying amount of the assets exceeds the fair value
of
the assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell.
Property
and Equipment -
Property and equipment are stated at cost and are depreciated over their
estimated useful lives, using the straight-line method as follows:
|
Office
equipment
|
5
years
|
|
Computer
software
|
3
years
|
|
Computer
hardware
|
5
years
|
|
Furniture
and fixtures
|
7
years
|
|
Automobiles
|
5
years
|
Intangible
Assets -
Intangible assets consists primarily of assets obtained through the acquisitions
of Computility, Inc. (“Computility”) and iMart Incorporated (iMart”). Those
acquired assets include customer bases, technology, non-compete agreements,
work
forces in place and goodwill. The Company also has several patents, copyrights
and trademarks related to products, names and logos used throughout the product
lines. All assets are amortized over their estimated useful lives with the
exception of work forces in place and goodwill which are deemed to have
indefinite lives and are not amortized.
Fair
Values -
The fair
values of cash equivalents, accounts receivable, accounts payable, accrued
liabilities, and notes payable approximate the carrying values due to the short
period of time to maturity.
F-11
Advertising
Costs -
All
advertising costs are expensed as incurred. Advertising expense during 2006,
2005, and 2004 was $49,000, $403,669 and $170,774, respectively. The 2006 period
includes $38,000 of barter advertising expense. The 2005 period included
$273,751 of barter advertising expenses. The 2004 period included $205,833
of
barter advertising expenses and a credit of $58,400 related to prior advertising
activities. .
Net
Loss per Share -
Basic
loss per share is computed using the weighted-average number of common shares
outstanding during the periods. Diluted loss per share is computed using the
weighted-average number of common and dilutive common equivalent shares
outstanding during the periods. Common equivalent shares consist of redeemable
preferred stock, stock options and warrants that are computed using the treasury
stock method. Shares issuable upon the exercise of redeemable preferred stock,
stock options and warrants, totaling 2,360,100, 2,791,500, and 2,405,078 shares
on December 31, 2006, 2005 and 2004, respectively, are excluded from the
calculation of common equivalent shares as the impact was
anti-dilutive.
Stock-Based
Compensation -
Prior to
January 1, 2006, the Company accounted for its stock-based compensation plans
in
accordance with the intrinsic value provisions of Accounting Principles Board
Opinion (“APB”) No. 25,
Accounting for Stock Issued to Employees.
Stock
options are generally granted at prices equal to the fair value of the Company’s
common stock on the grant dates. Accordingly, no compensation expense was
recorded in 2005 and 2004. Had compensation expense been recognized consistent
with the fair value provisions of SFAS No. 123,
Accounting for Stock-Based Compensation,
net
loss attributed to common stockholders and net loss attributed to common
stockholders per share for the years ended December 31, 2005 and 2004 would
have
been changed to the pro forma amounts indicated below:
|
|
|
Year
Ended
December
31,
2005
|
|
Year
Ended
December
31,
2004
|
|
||
|
Net
loss attributed to
|
|
|
|
|
|
|
|
|
common
stockholders:
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
(15,590,609
|
)
|
$
|
(8,319,049
|
)
|
|
Add:
Compensation cost
|
|
|
|
|
|
|
|
|
recorded
at intrinsic
|
|
|
|
|
|
|
|
|
Value
|
|
|
-
|
|
|
161,000
|
|
|
Less:
Compensation cost using
|
|
|
|
|
|
|
|
|
the
fair value method
|
|
|
(581,494
|
)
|
|
(455,301
|
)
|
|
Pro
forma
|
|
$
|
(16,172,103
|
)
|
$
|
(8,613,350
|
)
|
|
|
|
Year
Ended
December
31,
2005
|
|
Year
Ended
December
31,
2004
|
|
||
|
Reported
net loss attributed to
|
|
|
|
|
|
|
|
|
common
stockholders:
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
(1.20
|
)
|
$
|
(0.82
|
)
|
|
|
|
|
|
|
|
|
|
|
Pro
forma net loss per share:
|
|
|
|
|
|
|
|
|
Basic
and diluted
|
|
$
|
(1.25
|
)
|
$
|
(0.84
|
)
|
Effective
January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
Share-Based
Payment
(“SFAS
No. 123R”) using the Modified Prospective Approach. Under the Modified
Prospective Approach, the amount of compensation cost recognized includes:
(i) compensation cost for all share-based payments granted prior to, but
not yet vested as of January 1, 2006, based on the grant date fair value
estimated in
F-12
accordance
with the provisions of SFAS No. 123 and (ii) compensation cost for all
share-based payments that are granted subsequent to January 1, 2006, based
on the grant date fair value estimated in accordance with the provisions of
SFAS
No. 123R. Upon adoption, the Company recognized the stock-based
compensation of previously granted share-based options and new share based
options under the straight-line method over the requisite service period. Total
stock-based compensation expense recognized under SFAS No. 123R, was
approximately $780,000 for the year ended December 31, 2006.
No stock-based compensation was capitalized in the consolidated financial
statements.
The
fair
value of option grants under the Company’s equity compensation plan and other
stock option issuances during the years ended December 31, 2006, 2005 and 2004
were estimated using the Black-Scholes option-pricing model with the following
weighted-average assumptions:
|
Year
Ended
December
31,
2006
|
Year
Ended
December
31,
2005
|
Year
Ended
December
31,
2004
|
|||||
|
Dividend
yield
|
0.00%
|
0.00%
|
0.00%
|
||||
|
Expected
volatility
|
150%
|
60.20%
|
0.00%
|
||||
|
Risk
free interest rate
|
4.56%
|
4.25%
|
4.23%
|
||||
|
Expected
lives (years)
|
4.7
|
9.5
|
8.9
|
Management
Estimates -
The
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America. In preparing the financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities as of the date of the balance
sheet and income and expense for the period then ended. Certain estimates made
pertain to allowance for doubtful accounts, returns, and litigation reserves.
Actual results could differ from those estimates.
Reclassifications -
Certain
2005 balances have been reclassified to conform with their 2006 presentation.
These reclassifications did not result in a change to total assets, total
liabilities, equity or net loss as previously reported.
3.
INDUSTRY SEGMENT INFORMATION
SFAS
No.
131,
Disclosures About Segments of an Enterprise and Related
Information,
establishes standards for the way in which public companies disclose certain
information about operating segments in their financial reports. Consistent
with
SFAS No. 131, the Company has defined two reportable segments, described below,
based on factors such as geography, how it manages its operations and how the
chief operating decision-maker views results.
The
Smart
Commerce segment's revenues are derived primarily from the development and
distribution of multi-channel e-commerce systems including domain name
registration and e-mail solutions, e-commerce solutions, website design and
website hosting.
The
Smart
Online segment generates revenues from the development and distribution of
internet-delivered SaaS small business applications through a variety of
subscription, integration and syndication channels.
The
Company includes costs such as corporate general and administrative expenses
and
share-based compensation expenses that are not allocated to specific segments
in
the Smart Online segment, which includes the parent or corporate
segment.
The
following table shows the Company's financial results by reportable segment
for
the year ended December 31, 2006:
F-13
|
|
Smart
Online
|
Smart
Commerce
|
Consolidated
|
|||||||
|
|
|
|||||||||
|
REVENUES:
|
||||||||||
|
Integration
fees
|
|
$
|
182,660
|
$
|
-
|
$
|
182,660
|
|||
|
Syndication
fees
|
218,386
|
-
|
218,386
|
|||||||
|
Subscription
fees
|
73,978
|
1,830,214
|
1,904,192
|
|||||||
|
Professional
services fees
|
-
|
1,269,300
|
1,269,300
|
|||||||
|
Other
Revenues
|
38,114
|
32,238
|
70,352
|
|||||||
|
Total
Revenues
|
513,138
|
3,131,752
|
3,644,890
|
|||||||
|
COST
OF REVENUES
|
58,560
|
270,951
|
329,511
|
|||||||
|
|
||||||||||
|
OPERATING
EXPENSES
|
6,864,287
|
1,816,704
|
8,680,991
|
|||||||
|
|
||||||||||
|
OPERATING
INCOME (LOSS)
|
(6,409,709
|
)
|
1,044,097
|
(5,365,612
|
)
|
|||||
|
|
||||||||||
|
OTHER
INCOME (LOSS)
|
2,899,310
|
(31,842
|
)
|
2,867,468
|
||||||
|
DISCONTINUED
OPERATIONS
|
(2,525,563
|
)
|
-
|
(2,525,563
|
)
|
|||||
|
NET
INCOME/(LOSS) BEFORE INCOME TAXES
|
|
$
|
(6,035,962
|
)
|
$
|
1,012,255
|
$
|
(5,023,707
|
)
|
|
|
|
|
|
|
|
|
|
|
|||
|
TOTAL
ASSETS
|
|
$
|
6,554,944
|
$
|
878,065
|
$
|
7,433,009
|
|||
4. MARKETABLE
SECURITIES
As
of
December 31, 2004, marketable securities consisted of the
following:
|
Amortized
Cost
|
Fair
Value
|
||||||
|
Municipal
bonds - redeemed February 2005
|
$
|
395,000
|
$
|
395,000
|
|||
The
Company did not hold any marketable securities as of December 31,
2006.
5. PROPERTY
AND EQUIPMENT
Property
and equipment consists of the following at:
|
December
31,
2006
|
December
31,
2005
|
|||||
|
Office
equipment
|
$
|
88,715
|
|
$
|
144,290
|
|
|
Furniture
and fixtures
|
7,125
|
7,125
|
||||
|
Computer
software
|
552,585
|
550,775
|
||||
|
Computer
hardware and equipment
|
803,225
|
746,499
|
||||
|
Automobiles
|
29,504
|
29,504
|
||||
|
|
1,481,154
|
1,478,193
|
||||
|
Less
accumulated depreciation
|
(1,300,794
|
)
|
(1,261,224
|
)
|
||
|
Property
and equipment, net
|
$
|
180,360
|
$
|
216,969
|
F-14
Depreciation
expense for the years ended December 31, 2006, 2005 and 2004 was $79,313,
$150,204 and $47,167, respectively.
6. INTANGIBLE
ASSETS
Intangible
assets consist primarily of intangibles acquired during the Computility and
iMart acquisitions in October 2005 (See Note 17 - “Acquisitions &
Dispositions” for details on intangible assets sold during 2006). In addition to
these assets acquired, the Company has copyrights and trademarks related to
products, names and logos used throughout the product lines. The assets acquired
through the acquisitions include customer bases, technology, non-compete
agreements, trade names, workforces in place and goodwill. Trade names, work
forces in place and goodwill are not subject to amortization and for the purpose
of presentation, work forces in place are combined with goodwill.
|
Asset
Category
|
Value
Assigned
|
Residual
Value
|
Weighted
Avg
Useful
Life
|
Accumulated
Amortization
|
Carrying
Value
|
|
Customer
Base
|
$
1,944,347
|
$0
|
5.9
|
$
405,525
|
$
1,538,822
|
|
Technology
|
$
501,264
|
$0
|
3
|
$
201,898
|
$
299,366
|
|
Non-Compete
|
$
891,785
|
$0
|
3.9
|
$
279,706
|
$
612,079
|
|
Copyright
& Trademark
|
$
50,339
|
$0
|
10
|
$
38,629
|
$
11,710
|
|
Trade
Name *
|
$
1,155,500
|
n/a
|
n/a
|
n/a
|
$
1,155,500
|
|
Work
Force &
Goodwill
*
|
$
2,696,642
|
n/a
|
n/a
|
n/a
|
$ 2,696,642
|
|
TOTALS
|
$
7,239,877
|
$
925,758
|
$
6,314,119
|
*
Trade
Name and Work Force & Goodwill are not subject to amortization and are
deemed to have an indefinite life in accordance with SFAS No. 142 -
Goodwill and Other Intangible Assets.
Intangible
assets acquired, excluding goodwill, were valued based on the results of an
independent valuation performed by a certified appraiser. Goodwill was
calculated as the difference between the purchase price of the acquisition
(which was negotiated in an arms-length transaction) and the value of the
identifiable tangible and intangible assets acquired. Trademarks and copyrights
were capitalized using the costs of all legal and application fees
incurred.
For
the
years ended December 31, 2006, 2005 and 2004, the aggregate amortization expense
on the above intangibles was approximately $702,886, $260,788 and $4,365,
respectively. The estimated aggregate amortization expense for the years ended
December 31, 2007 through 2011 will be approximately $737,457, $695,147,
$469,253, $200,639 and $200,639 for each respective year. All intangible assets
are amortized using the straight-line method over their estimated useful
lives.
7.. DEFERRED
COMPENSATION
Certain
officers of the Company deferred a portion of their compensation, including
commissions and interest charges on previously earned but unpaid compensation,
from the second quarter of 2001 until September, 2003. In October 2003, these
salary deferrals plus interest were converted to promissory notes (the “2003
Notes”) in the aggregate amount of $1,049,765. These notes were payable on or
before May 31, 2004 and bore interest at a rate of 15% per annum. During the
fourth quarter of 2003 and the first quarter of 2004, these officers deferred
an
additional $141,771. Additionally, during this period $50,135 of the original
notes payable were repaid. In April 2004, the holders of the 2003 Notes agreed
to exchange the existing notes for new promissory notes payable on or before
December 31, 2005 ("2004 Notes"). The principal amount of the 2004 Notes,
$1,141,401, included the unpaid principal from the original notes plus the
subsequent deferrals. Subsequently during 2004, $191,624 was repaid against
the 2004 Notes and an additional $2,302 of compensation was deferred. The
2004 Notes bore interest at a rate of 15% per annum through June 1, 2004 at
which time the holders voluntarily reduced the rate to 8% per annum. On April
30, 2004,
the
2004 Notes were extended until May 31, 2005, but later during 2004 the officers
entered into standstill agreements not to demand payment until June 30, 2006.
The standstill agreement was again amended on December 22, 2004, to provide
that
demand for payment could be made upon the earlier of June 30, 2006 or the
closing after January 1, 2005 of a financing with gross proceeds to the Company
of $2,000,000 or more. After the Company raised $2,500,000 from a sale of
securities to a foreign investor in February 2005, it paid in full the $949,777
of deferred compensation, plus all accrued interest of $154,288, and cancelled
the related promissory notes to these officers.
F-15
8. LOANS
During
2000, the Company borrowed $125,000 from a stockholder, David Williams. The
loan
accrued interest at a rate of 8.0% per annum and was repaid in March 2004
including accrued interest of $33,534.
During
2002, William Furr, a relative of one of the Company’s officers, loaned the
Company $270,000. In consideration for this loan, the Company issued 20,000
shares of restricted stock to this individual without additional consideration
by Mr. Furr. The value of these shares was not significant. Subsequently during
2002, the Company repaid $225,000 of this indebtedness. In 2003, it borrowed
an
additional $190,000 from this individual and repaid $10,000. In consideration
for extending the term of the 2002 borrowings and for loaning the additional
$190,000, the Company issued this individual an additional 150,000 shares of
common stock. It recorded interest expense of $75,000 in 2003 and 2004 related
to this issuance. In addition, this note accrued interest at a rate of 15%
per
annum. In March 2004, the Company repaid this indebtedness in full plus accrued
interest of $10,264.
9. NOTES
PAYABLE
On
November 9, 2006, Smart Commerce entered into a loan agreement with Fifth Third
Bank. Under the terms of this agreement, Smart Commerce borrowed $1.8 million
to
be repaid in 24 monthly installments of $75,000 plus interest beginning in
December 2006. The interest rate is prime plus 1.5% as periodically determined
by Fifth Third Bank. The loan is secured by all of the assets of Smart Commerce,
including a cash security account of $250,000 and all of Smart Commerce’s
intellectual property. The loan is guaranteed by the Company and such guaranty
is secured by all the common stock of Smart Commerce. Under the terms of the
loan agreement, Smart Commerce established a lock box account with Fifth Third
Bank, but has the right to use the amounts deposited in the account for any
purpose not inconsistent with the loan agreement and related documents so long
as no event of default exists and is continuing. Such restricted cash is
scheduled to be released from the restrictions in three equal installments
of
approximately $83,000, on June 30, 2007, December 31, 2007 and June 30, 2008,
if
the Company meets certain debt covenants regarding operating metrics for Smart
Commerce.
On
November 14, 2006, the Company entered into a revolving credit arrangement
with
Wachovia Bank, NA ("Wachovia") for $1.3 million which can be used for general
working capital. Any advances made on the line of credit are to be paid off
no
later than August 1, 2007, with monthly payments of accrued interest on any
outstanding balance commencing on December 1, 2006. The interest shall accrue
on
the unpaid principal balance at the LIBOR Market Index Rate plus 0.9%. The
line
of credit is secured by the Company’s deposit account at Wachovia and an
irrevocable standby letter of credit in the amount of $1,300,000 issued by
HSBC
Private Bank (Suisse) S.A. with Atlas Capital, S.A. (“Atlas”), a current
stockholder, as account party. Atlas and the Company have separately agreed
that
in the event of a default by the Company in the repayment of the line of credit
that results in the letter of credit being drawn, it shall reimburse Atlas
any
sums that Atlas is required to pay under such letter of credit. At the sole
discretion of the Company, these payments to Atlas may be made in cash or by
issuing shares of the Company’s common stock at a set per share price of $2.50.
As of December 31, 2007, the unused line of credit with Wachovia was
$698,000.
As
of
December 31, 2006, the Company had Notes Payable totaling $3,664,631. The detail
of these notes is as follows:
F-16
|
Note
Description
|
S/T
Portion
|
L/T
Portion
|
Total
|
Maturity
|
Rate
|
|
iMart
Purchase Price Note
|
$
601,435
|
$
-
|
$
601,435
|
Jan
2007
|
8.0%
|
|
iMart
Non-Compete Note
|
378,526
|
-
|
378,526
|
Oct
2007
|
8.0%
|
|
Acquisition
Fee - iMart
|
209,177
|
-
|
209,177
|
Oct
2007
|
8.0%
|
|
Acquisition
Fee - Computility
|
148,493
|
-
|
148,493
|
Mar
2007
|
8.0%
|
|
Fifth
Third Note
|
900,000
|
825,000
|
1,725,000
|
Nov
2008
|
Prime
+ 1.5%
|
|
Wachovia
Credit Line
|
602,000
|
-
|
602,000
|
Aug
2007
|
Libor
+ 0.9%
|
|
TOTALS
|
$2,839,631
|
$825,000
|
$3,664,631
|
As
of
December 31, 2006, the prime rate was 8.25% and LIBOR was 5.32%.
The
five-year schedule of note maturity is as follows:
|
2007:
|
$
|
2,839,631
|
|
|
|
2008:
|
825,000
|
|
||
|
TOTAL:
|
$
|
3,664,631
|
|
Prior
to
the purchase of Computility and for the period following the acquisition, new
customer contracts were typically factored to provide working capital.
Subscription financing payable represents the amount of customer contracts
that
had been factored. Contracts were typically factored with 30 to 36 months
remaining. In February 2005, Computility entered into a Floor Plan Agreement
with a finance company that provided additional debt financing of $150,000
for
working capital. The debt was secured by subscription revenues and was required
to be repaid in 12 equal monthly installments beginning in March 2006. Interest
was at the corporate prime rate plus 4%. The Company assumed this debt as part
of the October 2005 acquisition (asset purchase) of Computility. As part of
the
sale of substantially all of the assets of Smart CRM in September 2006, both
of
these liabilities were assumed by the purchaser.
10. LEASES
Operating
Leases -
The
Company leases two facilities, one in Iowa and one in North Carolina, under
renewable operating lease agreements which current terms expire in October
2008
and October 2007, respectively. As of December 31, 2006, future annual minimum
operating lease payments are as follows:
|
2007
|
|
$
|
128,000
|
|
|
2008
|
$
|
15,000
|
||
|
Total
|
|
$
|
143,000
|
|
Rent
expense for the years ended December 31, 2006, 2005, and 2004 was $258,623,
$251,800 and $99,606, respectively.
11. STOCKHOLDERS'
DEFICIT
Corporate
Reorganization
During
the first quarter of 2004, the Company completed a corporate reorganization
of
its capital stock, which eliminated its Series A Preferred Stock. All holders
of
Series A Preferred Stock who participated in the reorganization received 2.218
shares of common stock for each share of Series A Preferred Stock they held
prior to the reorganization, and also received the right to receive cash
payments from the Company equal to a percentage of the net proceeds the Company
raised in excess of $5 million of net proceeds from sales of equity securities
and convertible debt securities during calendar year 2004. The Company received
net proceeds of $4,763,644 from the sale of equity and convertible debt
securities during calendar year 2004, and therefore had no liability to the
former holders of Series A Preferred Stock.
F-17
Participating
holders of Series A Preferred Stock who signed the Reorganization Agreements
also agreed to transfer restrictions on a portion of the common stock they
received in the reorganization that include, among other restrictions, a
“lock-up” agreement preventing the sale or transfer of the shares (other than
transfers to certain related parties). Pursuant to the lock-up agreement
commencing October 1, 2005 through September 30, 2006 each holder could transfer
up to 8.5% of such holder's shares that are subject to the restrictions during
each calendar month. The Reorganization Agreements also contained mutual
releases by the Company and participating holders of Series A Preferred
Stock.
Common
Stock
The
Company is authorized to issue 45,000,000 shares of common stock, $0.001 par
value per share. As of December 31, 2006, it had 15,379,030 shares of
common stock outstanding. Holders of common stock are entitled to one vote
for
each share held.
During
the first half of 2004, following the conversion of its Series A Preferred
Stock
as described above, the Company sold 999,141 shares of common stock to new
and
existing stockholders at a purchase price of $3.50 per share, resulting in
gross
proceeds of $3,496,994. It incurred issuance costs of $163,350 related to these
sales, including $31,000 paid to an officer of the Company. As an inducement
to
one of the investors that participated in this round of financing, an officer
of
the Company and a stockholder entered into a Put Agreement, dated March 10,
2004, with the investor. The Company was not a party to this agreement, but
this
agreement was entered into at the time of the investment into the Company to
provide comfort to the investor that the Company would fulfill its obligation
to
cause its common stock to be publicly traded. The Put Agreement gave the
investor the right to require the grantors to purchase for $2.2 million the
628,571 shares of common stock and warrants to purchase 188,571 shares of common
stock held by the investor. The Put Agreement could have been exercised at
the
sole discretion of the investor during the month of March 2005 or during the
month of March 2006. The Put Agreement terminated and the put option cannot
be
exercised after (i) the common stock of the Company is listed or quoted for
public trading, or (ii) the Company’s stockholders vote to approve any action
reasonably necessary to cause the Company’s common stock to be publicly traded,
but the aforementioned investor votes against the action, or (iii) the
aforementioned investor transfers any of its common stock or warrants to a
third
party. The Put Agreement cannot be assigned and terminates if the investor
transfers the securities covered by the Put Agreement. As a result the
registration of the Company’s common stock, this Put Agreement was cancelled in
March 2005.
On
August
6, 2004, the Company made a rescission offer to stockholders who purchased
999,141 shares of common stock and warrants to acquire an additional 288,638
shares of common stock for $3.50 per share in a private placement conducted
during March through June of 2004. The rescission offer was made because in
connection with the audit of its financial statements and due diligence review
of information in connection with the registration of shares sold in the private
placement described above, the Company identified certain inaccuracies and
omissions in the information it provided to investors in the private placement.
These inaccuracies and omissions included changes to how the Company recognized
revenue, establishing reserves for contingent liabilities, inventory, accounts
receivable, and equipment write downs and other accounting adjustments, failing
to disclose the effects of anti-dilution provisions after dilutive issuances
and
failure to disclose information about customers, discounting, promotions and
other product price information. In the rescission offer, the Company offered
to
repurchase all the shares and warrants sold in the private placement for the
original purchase price, plus interest, and afforded stockholders a thirty-day
period in which to accept the rescission offer. One stockholder accepted the
rescission offer and the Company paid that stockholder $102,610 as payment
in
full of the purchase price, including interest thereon of $2,608 in exchange
for
28,572 shares of common stock and warrants to purchase 7,500 shares of common
stock. No other stockholders accepted the rescission offer and all stockholders
to whom the offer was made executed and delivered releases for any potential
liabilities arising out of disclosures made by the Company in the private
placement.
In
connection with the private placement conducted during March through June of
2004, the Company and the investors executed registration rights agreements.
This registration rights agreement required the Company to pay investors 2%
of
their investment for each thirty-day period after July 1, 2004 in which the
Company failed to file a registration statement registering shares sold in
the
private placement, which amount is prorated for partial 30-day periods. The
registration rights agreements provided that the Company could choose to pay
this by issuing shares of its common stock in lieu of cash, which it chose
to
do. On September 29, 2004, the Company issued 58,226 shares of its common stock
to satisfy amounts that accrued through September 29, 2004 at the rate of one
share for each $3.50 of accrued penalty liability. The Company recorded the
issuance of these shares, at the fair value of $206,085, as a dividend to the
respective stockholders.
F-18
During
August and September 2004, the Company sold 290,000 shares of its common stock
to new and existing investors in a private placement for a price of $5.00 per
share resulting in gross proceeds of $1,450,000. The Company incurred issuance
costs of $20,000 related to these sales and also incurred $31,000 in consulting
expense that was paid to an officer of the Company related to this financing.
As
an inducement to one of the investors that participated in this round of
financing, an officer of the Company and a stockholder entered into a Put
Agreement dated August 13, 2004 with the investor. The Company was not a party
to this agreement, but this agreement was entered into at the time of the
investment in the Company to provide comfort to the investor that the Company
would fulfill its obligation to cause its common stock to be publicly traded.
The Put Agreement gave the investor the right to require the grantors to
purchase 100,000 shares of common stock held by the investor for $500,000.
The
Put Agreement could have been exercised at the sole discretion of the investor
during the month of March 2005 or during the month of March 2006. The Put
Agreement terminates and the put option cannot be exercised after (i) the common
stock of the Company became listed or quoted for public trading, or (ii) the
stockholders of the Company vote to approve any action reasonably necessary
to
cause the Company's stock to be publicly traded, but the aforementioned investor
votes against the action, or (iii) the aforementioned investor transfers any
of
its common stock or warrants to a third party. The Put Agreement cannot be
assigned and terminates if the investor transfers the securities covered by
the
Put Agreement. As a result of the Company registering its common stock, this
put
agreement was cancelled in March 2005.
During
February and March 2005, the Company sold 500,000 and 80,000 shares of common
stock, respectively, to foreign investors in sales exempt under Regulation
S.
The February and March 2005 stock sales resulted in gross proceeds of $2,500,000
and $400,000, respectively. A portion of those funds was used to repay deferred
compensation, including interest thereon, as more fully discussed in Note 7.
In
connection with this financing, the Company incurred stock issuance costs
of $290,000 to an entity that is an existing stockholder. Concurrent with
the sale of common stock, the Company issued warrants to purchase 50,000 shares
of common stock to this investor in consideration for the investor agreeing
to
certain restrictions on their ability to sell the shares. These warrants have
an
exercise price of $5.00 per share and terminate on January 1, 2007. During
February 2005, the Company raised an additional $125,000 in gross proceeds
from
the sale of 25,000 shares of common stock at $5.00 per share in a private
placement.
During
the third quarter of 2005, the Company sold 786,642 shares of its common stock
to new and existing investors for a price of $5.50 per share resulting in gross
proceeds of $4,326,531. In connection with this financing, the Company incurred
stock issuance costs of $340,525 to an entity introduced to it by an existing
stockholder, Doron Roethler. Additionally, in connection with these offerings,
the Company entered into Registration Rights Agreements with these stockholders
under which the Company is required to file a registration statement with the
SEC to register the shares sold in the offering no later than September 30,
2005. As of December 31, 2006, the Company had accrued $465,347 of registration
rights penalties which the Company expects to pay in stock. The accrual of
this
penalty has been treated as a period cost as part of general and administrative
expenses.
During
2005, the Company paid a bonus of 4,200 shares of its common stock to
non-officer employees. The Company recorded approximately $40,000 of
compensation expense related to this bonus payment. The expense associated
with the stock bonus was calculated based upon the fair market value of the
common stock on the date the bonus was awarded.
On
March
30, 2006, the Company sold 400,000 shares of its common stock to Atlas, an
existing stockholder, for a price of $2.50 per share resulting in gross proceeds
of $1,000,000. The Company incurred immaterial issuance costs related to this
stock sale. As part of this sale, Atlas received contractual rights to purchase
shares at a lower price should the Company enter into a private placement
agreement in the future in which the Company sells shares of common stock for
less than $2.50 per share.
F-19
On
May
31, 2006, the Company entered into a Settlement Agreement with General
Investments Capital, Ltd. (“GIC”) with respect to a Consulting Agreement, dated
October 26, 2005. Under the Consulting Agreement, GIC was to receive 625,000
shares of the Company's common stock (the “GIC Shares”) and a cash payment of
$250,000 (the “GIC Cash Fee”) for investor relations consulting services. The
Company paid the entire GIC Cash Fee, and the GIC Shares were, but never
delivered. Under the Settlement Agreement, GIC agreed, in part, to release
its
claim to the GIC Shares, but retained the GIC Cash Fee as consideration for
services performed under the Consulting Agreement and for entering into the
Settlement Agreement. The parties also mutually released each other from any
additional payment or services under the Consulting Agreement. The Company
recorded a gain of $1,562,500 related to this settlement.
On
June
29, 2006, the Company sold 400,000 shares of its common stock to Atlas for
a
price of $2.50 per share resulting in gross proceeds of $1,000,000. The Company
incurred immaterial issuance costs related to this stock sale.
On
July
6, 2006, the Company sold 100,000 shares of common stock to the Blueline Fund
(“Blueline”), an existing investor for a price of $2.50 per share resulting in
gross proceeds of $250,000. The Company incurred immaterial issuance costs
related to this stock sale.
In
August
2006, the Company sold an aggregate of 100,000 shares of its common stock to
Blueline and Phillippe Pouponnot, for a price of $2.50 per share, resulting
in
gross proceeds of $250,000. The Company incurred immaterial issuance costs
related to these stock sales.
On
August
30, 2006, the Company entered into a Settlement Agreement with Berkley Financial
Services, Ltd. (“Berkley”) with respect to a Consulting Agreement, dated October
26, 2005. Under the Consulting Agreement, Berkley was to receive 625,000 shares
of the Company's common stock (the “Berkley Shares”) and a cash payment of
$250,000 (the “Berkley Cash Fee”) for investor relations consulting services.
The Company paid the entire Berkley Cash Fee, and the Berkley Shares were
issued, but never delivered. Under the Settlement Agreement, Berkley agreed,
in
part, to release its claim to the Berkley Shares, but retained the Berkley
Cash
Fee as consideration for services performed under the Consulting Agreement
and
for entering into the Settlement Agreement. The parties also mutually released
each other from any additional payment or services under the Consulting
Agreement. The Company recorded a gain of $1,562,500 related to this
settlement.
Preferred
Stock
The
Board
of Directors is authorized, without further stockholder approval, to issue
up to
5,000,000 shares of $0.001 par value preferred stock in one or more series
and
to fix the rights, preferences, privileges and restrictions applicable to such
shares, including dividend rights, conversion rights, terms of redemption and
liquidation preferences, and to fix the number of shares constituting any series
and the designations of such series.
In
March
2004, the outstanding shares of the Company's Series A Preferred Stock were
converted to common stock pursuant to a plan of reorganization approved by
the
Company's Board of Directors and stockholders. The carrying value of $19,724,839
for the Series A Preferred Stock at date of conversion was re-classed to common
stock and additional paid-in capital. The Series A Preferred Stock was
convertible into common stock at an initial rate of one share of common stock
for each share of Series A Preferred Stock but the conversion rate increased
to
approximately 1.22 shares of common stock for each share of Series A Preferred
Stock at the time of conversion pursuant to weighted average antidilution
provisions. Additionally, the Series A Preferred Stock had a non-cumulative
dividend rate of $0.35 per quarter, a liquidation preference of $15.12 per
share, plus declared unpaid dividends, was entitled to cast one vote for each
share of common stock into which it was convertible voting as a single class
with the common stock, had class voting rights with respect to certain major
corporate events and was redeemable at the option of its holders after August
31, 2004 for a price equal to $14 per share, plus 7% compounded annually. There
were no shares of Preferred Stock outstanding at December 31,
2006.
F-20
In
connection with the 2004 conversion of the Series A Preferred Stock, the Company
offered an inducement of one share of common stock in exchange for contractual
commitments in addition to the contractual conversion noted in the preceding
paragraph. In accordance with SFAS No. 84,
Induced Conversions of Convertible Debt,
the
Company recorded the $3.2 million premium as a charge to arrive at net loss
available to common stockholders.
Warrants
On
September 3, 2004, Bank One exchanged a warrant for 100,000 shares of common
stock of the Company, which were issued to J P Morgan Chase & Co., an
affiliate of Bank One. The fair value of the shares issued was $350,000 which
was recorded as an expense in the 2004 statement of operations.
During
2004, the Company issued warrants to purchase an aggregate of 288,638 shares
of
common stock (7,500 of which were cancelled as part of the rescission offer
previously described) to stockholders in connection with the 2004 common stock
issuance previously described. These warrants have an exercise price of $3.50
per share. During November 2004, warrants to purchase 2,460 shares of common
stock at $3.50 per share were exercised resulting in proceeds of
$8,610.
During
February 2005, a consulting firm that was issued warrants to purchase 350,000
shares of common stock in November 2003 acquired 50,000 shares of the Company's
common stock as a result of the cashless exercise of warrants. Warrants to
purchase 67,568 shares of common stock were cancelled in this cashless exercise.
The fair market value of the Company's common stock at the time of exercise
was
$5.00. During May 2005, this same consulting firm acquired 48,617 shares of
the
Company's common stock as a result of the cashless exercise of warrants.
Warrants to purchase 62,432 shares of common stock were cancelled in this
cashless exercise. The fair market value of the Company's common stock at the
time of exercise was $5.875.
During
2005, holders of warrants to purchase 355,428 shares of common stock exercised
their warrants resulting in gross proceeds to the Company of $1,175,998. The
warrants had exercise prices that ranged from $1.30 to $5.00 per
share.
During
2006, holders of warrants to purchase 17,000 shares of common stock exercised
their warrants resulting in gross proceeds to the Company of $22,100. The
warrants had an exercise price of $1.30 per share.
All
the
foregoing warrants contain cashless exercise provisions, and as of December
31,
2006, all had either been exercised or expired.
Stock
Option Plans
2004
Equity Compensation Plan
The
Company adopted its 2004 Equity Compensation Plan (the “2004 Plan”) as of March
31, 2004. The 2004 Plan provides for the grant of incentive stock options,
nonstatutory stock options, restricted stock, and other direct stock awards
to
employees (including officers) and directors of the Company as well as to
certain consultants and advisors. The total number of shares of common stock
reserved for issuance under the 2004 plan is 5,000,000 shares, subject to
adjustment in the event of stock split, stock dividend, recapitalization or
similar capital change.
During
the second quarter of 2004, the Company granted options to purchase 394,000
shares of common stock to its employees and officers at an exercise price of
$3.50 per share. Additionally, during May 2004, the Company issued options
to
purchase 50,000 shares of common stock to a consultant at an exercise price
of
$3.50 per share. The fair value of the options at the grant date was not
significant.
F-21
On
July
1, 2004, the Company granted options to purchase 75,000 shares of common stock
to an officer of the Company. This option had an exercise price of $3.50 per
share and a term of ten years. The fair value of the option, issued to the
consultant, at the grant date was not significant.
During
the third quarter of 2004, the Company granted options to purchase 80,000 shares
of common stock under the 2004 Plan to members of the Company's advisory
committee. These options had an exercise price of $3.50 per share, a term of
five years, and vest 12.5% per meeting each committee member attends. The
Company recorded consulting expense of $6,034 during 2004 related to these
options.
During
November 2004, the Company granted options to purchase 6,000 shares of common
stock under the 2004 Plan to a consultant. These options had an exercise price
of $5.00 per share, a term of ten years, and vested and became exercisable
on
December 1, 2004. The Company recorded consulting expense of $1,495 during
the
fourth quarter of 2004 related to these options.
During
April 2005, the Company granted options to purchase 180,000 shares of common
stock to a consultant, 34,000 shares of common stock to new Board members,
25,000 shares to an officer, and 2,500 shares to an employee. All options were
granted at an exercise price of $5.00 per share.
During
July 2005, the Company granted options to purchase 721,250 shares of common
stock to employees and officers and an additional 20,000 options to members
of
the Board of Directors. These options contain an exercise price of $8.61 per
share. Also during July 2005, options to purchase 150,000 shares at a weighted
average exercise price of $5.00 per share expired unexercised.
At
December 31, 2006, options to purchase 1,494,200 shares of common stock were
outstanding under the 2004 Plan with a weighted-average exercise price of $6.14
per share.
2001
Equity Compensation Plan
The
Company adopted the 2001 Equity Compensation Plan (the “2001 Plan”) as of May
31, 2001. The 2001 Plan provides for the grant of incentive stock options,
nonstatutory stock options, restricted stock, and other direct stock awards
to
employees (including officers) and directors of the Company as well as to
certain consultants and advisors. The total number of shares of common stock
reserved for issuance under the 2001 Plan is 870,000 shares, subject to
adjustment in the event of stock split, stock dividend, recapitalization or
similar change.
During
February 2004, the Company granted options to purchase 150,000 shares of common
stock to two officers of the Company at an exercise price of $1.30 per share.
The Company recorded $161,000 of compensation expense during 2004 related to
the
grant of these options.
At
December 31, 2006, options to purchase 670,000 shares of common stock were
outstanding under the 2001 Plan. As of April 15, 2004, the Company cannot make
any further grants under the 2001 Plan.
1998
Stock Option Plan
The
Company adopted the 1998 Equity Compensation Plan (the “1998 Plan”) as of
November 12, 1998. The 1998 Plan provides for the grant of options intended
to
qualify as “incentive stock options,” and options that are not intended to so
qualify or “nonstatutory stock options.” As of December 31, 2006, the total
number of shares of common stock reserved for issuance under the 1998 Plan
is
288,900 shares, subject to adjustment in the event of stock split, stock
dividend, recapitalization or similar change. Options to purchase 21,200 shares
were outstanding under the 1998 Plan at December 31, 2006. As of April 15,
2004,
the Company may not make any further grants under the 1998 plan.
Additional
Options Granted
Additionally,
at December 31, 2006, options to purchase 250,000 shares of common stock issued
in the third quarter of 2005 were outstanding outside any of the aforementioned
stock option plans.
F-22
The
exercise price for incentive stock options granted under the above plans is
required to be no less than the fair market value of the common stock on the
date the option is granted, except for options granted to 10% stockholders,
which are required to have an exercise price of not less than 110% of the fair
market value of the common stock on the date the option is granted. Incentive
stock options typically have a maximum term of 10 years, except for option
grants to 10% stockholders, which are subject to a maximum term of 5 years.
Nonstatutory stock options have a term determined by either the Board of
Directors or the Compensation Committee. Options granted under the plans are
not
transferable, except by will and the laws of descent and
distribution.
A
summary
of the status of the plan and other stock option issuances as of December 31,
2004, 2005 and 2006, and changes during the periods ended on these dates is
as
follows:
|
|
|
Shares
|
|
Weighted
Average
Exercise
Price
|
|
||
|
|
|
|
|
|
|
||
|
BALANCE,
January 1, 2004
|
|
|
1,358,900
|
|
$
|
3.16
|
|
|
Granted
|
|
|
755,000
|
|
$
|
3.07
|
|
|
Forfeited
|
|
|
(345,000
|
)
|
$
|
4.12
|
|
|
BALANCE,
December 31, 2004
|
|
|
1,768,900
|
|
$
|
2.78
|
|
|
Granted
|
|
|
1,535,950
|
|
$
|
7.98
|
|
|
Exercised
|
(16,500
|
)
|
3.50
|
||||
|
Forfeited
|
|
|
(560,400
|
)
|
$
|
3.61
|
|
|
BALANCE,
December 31, 2005
|
|
|
2,727,950
|
|
$
|
5.34
|
|
|
Granted
|
|
|
256,500
|
|
$
|
7.61
|
|
|
Forfeited
|
|
|
(624,350
|
)
|
$
|
7.13
|
|
|
BALANCE,
December 31, 2006
|
|
|
2,360,100
|
|
$
|
5.33
|
|
The
following table summarizes information about stock options outstanding at
December 31, 2006:
|
|
|
|
|
Currently
Exercisable
|
|
|
Exercise
Price
|
Number
of
Shares
Outstanding
|
Average
Remaining
Contractual
Life
(Years)
|
Weighted
Average
Exercise
Price
|
Number
of
Shares
|
Weighted
Average
Exercise
Price
|
|
|
|
|
|
|
|
|
$
1.30 - $ 1.43
|
595,000
|
3.0
|
$
1.41
|
595,000
|
$
1.41
|
|
$
2.50 - $ 3.50
|
512,500
|
8.2
|
$
3.39
|
322,540
|
$
3.49
|
|
$
5.00
|
252,400
|
8.8
|
$
5.00
|
170,400
|
$
5.00
|
|
$
7.00
|
153,000
|
9.7
|
$
7.00
|
53,000
|
$
7.00
|
|
$
8.61 - $ 9.00
|
586,000
|
9.5
|
$
8.70
|
88,900
|
$
8.61
|
|
$
9.60 to $ 9.82
|
261,200
|
2.5
|
$
9.82
|
110,240
|
$
9.82
|
At
December 31, 2006, there remains $2,529,044 of unvested expense yet to be
recorded related to all options outstanding. Information, based on the date
of
issuance, regarding options for the year ended December 31, 2006:
|
Shares
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Fair
Value
|
|||
|
Year
Ended December 31, 2006
|
|||||
|
Exercise
price exceeds market price
|
-
|
-
|
-
|
||
|
Exercise
price equals market price
|
256,500
|
$
|
7.61
|
$
|
6.97
|
|
Exercise
price is less than market price
|
-
|
-
|
-
|
F-23
The
number of options exercisable at December 31, 2006, 2005 and 2004 were
1,340,080, 1,057,698 and 1,367,560, respectively. The weighted average exercise
price was $5.33 at December 31, 2006
Dividends
- The
Company has not paid any cash dividends through December 31, 2006.
12. INCOME
TAXES
The
Company accounts for income taxes under the asset and liability method in
accordance with the requirements of SFAS No. 109, Accounting
for Income Taxes (“SFAS
No. 109”). Under the asset and liability method, deferred income taxes are
recognized for the tax consequences of “temporary differences” by applying
enacted statutory tax rates applicable to future years to differences between
the financial statement carrying amounts and the tax bases of existing assets
and liabilities.
The
balances of deferred tax assets and liabilities are as follows:
|
|
|
December
31,
2006
|
|
December
31,
2005
|
|
December
31,
2004
|
|
|||
|
Net
current deferred income tax
assets
relate to:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
$
|
159,000
|
|
$
|
6,000
|
|
$
|
3,000
|
|
|
Stock
Based Expenses
|
|
|
226,000
|
|
|
226,000
|
|
|
226,000
|
|
|
Net
operating loss carryforwards
|
|
|
14,275,000
|
|
|
13,111,000
|
|
|
11,015,000
|
|
|
Total
|
|
|
14,660,000
|
|
|
13,343,000
|
|
|
11,244,000
|
|
|
Less
valuation allowance
|
|
|
14,660,000
|
|
|
13,343,000
|
|
|
11,244,000
|
|
|
Net
current deferred income tax
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
Under
SFAS No. 109, a valuation allowance is provided when it is more likely than
not
that the deferred tax asset will not be realized.
Total
income tax expense differs from expected income tax expense (computed by
applying the U.S. federal corporate income tax rate of 34% to profit (loss)
before taxes) as follows:
|
|
|
Year
Ended
December
31,
2006
|
|
Year
Ended
December
31,
2005
|
|
Year
Ended
December
31,
2004
|
|
|||
|
Statutory
federal tax rate
|
|
|
34
|
%
|
|
34
|
%
|
|
34
|
%
|
|
Tax
benefit computed at statutory rate
|
|
$
|
(1,708,000
|
)
|
$
|
(5,257,000
|
)
|
$
|
(908,000
|
)
|
|
State
income tax benefit, net of federal effect
|
|
|
(229,000
|
)
|
|
(704,000
|
)
|
|
(121,000
|
)
|
|
Change
in valuation allowance
|
|
|
1,317,000
|
|
|
2,140,000
|
|
|
927,000
|
|
|
SFAS
No. 123R permanent difference
|
265,000
|
-
|
-
|
|||||||
|
Investor
relations shares permanent difference
|
|
|
(1,205,000
|
)
|
|
3,808,000
|
|
|
|
|
|
Book
loss in excess of tax on disposal of assets
|
1,425,000
|
-
|
-
|
|||||||
|
Other
adjustments
|
|
|
-
|
|
|
-
|
|
|
77,000
|
|
|
Other
permanent differences
|
|
|
135,000
|
|
|
13,000
|
|
|
25,000
|
|
|
Total
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
F-24
As
of
December 31, 2006, the Company had U.S. federal net operating loss (“NOL”)
carryforward of approximately $38 million, which expires between 2009 and 2020.
For state tax purposes, the NOL expires between 2009 and 2020. In accordance
with Section 382 of the Internal Revenue Code of 1986, as amended, a change
in
equity ownership of greater than 50% of the Company within a three-year period
can result in an annual limitation on the Company's ability to utilize its
NOL
carryforwards that were created during tax periods prior to the change in
ownership.
13. MAJOR
CUSTOMERS AND CONCENTRATION OF CREDIT RISK
Financial
instruments that potentially subject the Company to credit risk consist
principally of trade receivables. The Company believes the concentration of
credit risk in its trade receivables is substantially mitigated by ongoing
credit evaluation processes, relatively short collection terms and the nature
of
the Company's syndication partner client base, primarily mid and large size
public corporations with significant financial histories. Collateral is not
generally required from customers. The need for an allowance for doubtful
accounts is determined based upon factors surrounding the credit risk of
specific customers, historical trends and other information.
A
significant portion of revenues is derived from certain customer relationships.
The following is a summary of customers that represent greater than ten percent
of total revenues:
|
|
|
|
|
Year
Ended December 31, 2006
|
|
|||||
|
|
|
|
|
Revenues
|
|
%
of Total
Revenues
|
|
|||
|
Customer
A
|
|
|
Professional
Services
|
|
$
|
1,011,181
|
|
|
27.7
|
%
|
|
Customer
B
|
Subscription
|
1,649,703
|
45.3
|
%
|
||||||
|
Others
|
|
|
Various
|
|
|
984,006
|
|
|
27.0
|
%
|
|
Total
|
|
|
|
|
$
|
3,644,890
|
|
|
100.0
|
%
|
|
|
|
|
|
Year
Ended December 30, 2005
|
|
|||||
|
|
|
|
|
Revenues
|
|
%
of Total
Revenues
|
|
|||
|
Customer
B
|
|
|
Subscription
|
|
$
|
319,874
|
|
|
14.8
|
%
|
|
Others
|
|
|
Various
|
|
|
1,835,551
|
|
|
85.2
|
%
|
|
Total
|
|
|
|
|
$
|
2,155,425
|
|
|
100.0
|
%
|
|
|
|
|
|
Year Ended
December 30, 2004
|
|
|||||
|
|
|
|
|
Revenues
|
|
%
of Total
Revenues
|
|
|||
|
Customer
C
|
|
|
Integration
|
|
$
|
330,050
|
|
|
32.9
|
%
|
|
Others
|
|
|
Various
|
|
|
672,920
|
|
|
67.1
|
%
|
|
Total
|
|
|
|
|
$
|
1,002,970
|
|
|
100.0
|
%
|
One
customer accounted for substantially all of the accounts receivable at December
31, 2004. As of December 31, 2005, three customers accounted for 25%, 22%,
and
10% of accounts receivable, respectively. As of December 31, 2006, three
customers accounted for 47%,26%, and 21% of accounts receivable,
respectively.
14. RELATED
PARTY TRANSACTIONS
American
Investment Holding Group, Inc., which is wholly owned by two officers of the
Company, owned approximately 18.5% of the outstanding common stock of the
Company as of December 31, 2006. The same officers also own a controlling
interest in other companies.
F-25
In
February 2005, the Company entered into an investment banking agreement with
Berkley whereby Berkley served as nonexclusive agent in connection with the
negotiations and closing of one or more transactions with investors outside
the
United States. Pursuant to this agreement, Berkley was paid approximately
$290,000 in cash in 2005. The Company sent a notice of termination of this
agreement to Berkley on March 22, 2006. In addition, in October 2005, the
Company entered into an investor relations agreement with Berkley, under which
Berkley was paid $250,000 and issued 625,000 shares of stock. On August 30,
2006, the Company entered into a Settlement Agreement with Berkley with respect
to the investor relations agreement. Under the Settlement Agreement, Berkley
agreed, in part, to release its claim to the Berkley Shares, but retained the
Berkley Cash Fee as consideration for services performed under the Consulting
Agreement and for entering into the Settlement Agreement. The parties also
mutually released each other from any additional payment or services under
the
Consulting Agreement. The Company believes there is a business relationship
between Doron Roethler (a stockholder who beneficially owns more than 10% of
our
stock) and Berkley.
During
2005, the following loans were made by certain investors, consultants and/or
stockholders of the Company to the Company’s Chief Executive Officer: (i)
$809,736.49 was borrowed from Leon Sokolic, one of our stockholders, (ii)
$77,971.20 was borrowed from Atlas, one of our stockholders, (iii) $80,000
was
borrowed from Pete Coker, the principal of Tryon Capital, which provided
financial consulting services to us and received a warrant and cash fees, and
(iv) $296,589 was borrowed from Berkley, which was paid substantial amounts
of
cash and stock (such stock subsequently being redeemed) from us, including
during the period in which Berkley was making loans to our Chief Executive
Officer.
In
March
2005, the Company entered into a consulting agreement with Hadar, LLC (“Hadar”).
David E.Y. Sarna, a member of Hadar, was appointed as a member of the Board
of
Directors on April 18, 2005, elected Chairman of the Audit Committee of the
Board September 13, 2005, and resigned from the Board and all Committees of
the
Board on June 23, 2006. The Company’s understanding is that Mr. Sarna and Isaac
Nussen were and remain partners of Hadar. Under the terms of the consulting
agreement, Hadar was to act as a financial advisor to the Company regarding
the
introduction and evaluation of potential investors. Payment for these services
was to be 8% of proceeds for investors who invest $5 million or less, and 6%
of
proceeds for investors who invest over $5 million. Upon Mr. Sarna's election
to
the Board of Directors, no further business was conducted between Hadar and
the
Company. No monies were ever paid to Hadar by the Company, and no monies are
payable to the Company. The Company does not believe that Hadar provided
services to us under the consulting agreement.
An
officer of the Company and a trust established by this officer for the benefit
of his children have from time to time provided loans to the Company. During
2003, the Company borrowed $796,568 and repaid $759,165 to these same parties
leaving an outstanding liability to the officer and the trust of $47,798 at
December 31, 2003. During the first six months of 2004, the Company borrowed
an
additional $186,335. During 2004, the Company repaid the entire outstanding
balance of $234,133. Until October 2003, the Company did not pay any interest
on
these loans; thereafter the loans accrued interest at a rate of
15.0%.
During
2003 and 2004, the Company contracted with a consulting firm owned by one of
its
officers to provide strategic international sales and marketing services.
Consulting fees of $70,000 and $27,083 were paid during 2004 and 2003,
respectively, related to these services. Additionally, the Company paid the
same
consulting firm $31,000 related to the sale of certain shares of common stock
during the first half of 2004. In addition, during the third quarter of 2004,
the Company paid this same consultant an additional $31,000 in consulting fees
for assisting the Company with obtaining additional equity financing during
the
quarter.
In
March
2004, Smart IL, Ltd. (“SIL”) ceased further development of its technology and
laid off its employees. SIL is currently seeking opportunities to license or
sell its technology. The Company continues to support this technology on behalf
of SIL with the current integration agreement running into October 2006. The
revenues derived from this agreement with SIL were recognized as income on
a
straight-line basis over the life of the agreement. The Company recognized
zero,
zero and $330,051 of revenue related to the integration, co-development and
reseller agreements with SIL during 2006, 2005 and 2004,
respectively.
F-26
The
Company paid $158,384 in 2004 to the Small Business Lending Institute, Inc.
(“SBLI”) because SBLI paid the Company’s employees during the first quarter of
2004 while the Company was dealing with a tax matter with the Internal Revenue
Service. Tamir Sagie, a former officer of the Company, was also an officer
of
SBLI, and the Company’s Chief Executive Officer is a minority shareholder of
SBLI.
During
2004, the Company borrowed $4,793 from an officer and repaid $91,273 to this
officer which included the amount borrowed plus all amounts owed under previous
loans. The loans accrued interest at a rate of 15%. During 2004, the Company
lent a trust established by an officer $142,860, and the trust repaid the entire
balance owed, totaling $181,542. As of December 31, 2005, all borrowings from
and loans to the officer and the trust were repaid in full. The Company recorded
interest expense of zero and $4,649 during 2005 and 2004, respectively,
related to these loans.
The
following is a summary of related party revenues for the years ended December
31, 2006, 2005 and 2004:
|
|
Year
Ended
December
31,
2006
|
Year
Ended
December
31,
2005
|
Year
Ended
December
31,
2004
|
|||||||
|
Smart
II, Ltd. ("SIL"), formerly
known
as Smart Revenue Europe
Ltd.
- Integration fees
|
$
|
-
|
|
$
|
-
|
|
$
|
330,050
|
|
|
|
Total
Related Party Revenues
|
|
$
|
-
|
|
$
|
-
|
|
$
|
330,050
|
|
The
following is a summary of related party expenses for the years ended December
31, 2006, 2005 and 2004:
|
Year
Ended
December
31,
2006
|
Year
Ended
December
31,
2005
|
Year
Ended
December
31,
2004
|
||||||||
|
Nen,
Inc. - consulting fees included in sales and marketing expense related
to
strategic international sales and marketing ervices
|
$
|
-
|
$
|
17,500
|
$
|
70,000
|
||||
|
Nen,
Inc. - consulting fees included in general and administrative expense
related to assisting the Company with obtaining additional equity
financing
|
-
|
-
|
62,000
|
|||||||
|
SBLI
- consulting fees included in general and administrative
expense
|
-
|
-
|
30,000
|
|||||||
|
SIL
- moving expenses, reseller payment, and technical co-development
work
|
-
|
-
|
75,000
|
|
||||||
|
Interest
expense incurred on loans from officer
|
-
|
-
|
4,649
|
|
||||||
|
Total
Related Party Expenses
|
$
|
-
|
$
|
17,500
|
$
|
241,649
|
|
|||
F-27
15. EMPLOYEE
BENEFIT PLANS
All
full-time employees who meet certain age and length of service requirements
are
eligible to participate in the Company’s 401(k) Plan. The plan provides for
contributions by the Company in such amounts as the Board of Directors may
annually determine, as well as a 401(k) option under which eligible participants
may defer a portion of their salary. The Company did not make any contributions
to the plan during 2006, 2005 or 2004.
16. COMMITMENTS
& CONTINGENCIES
The
Company is subject to claims and suits that arise from time to time in the
ordinary course of business.
The
Company did not pay its payroll taxes for the period of the fourth quarter
of
2000 through the fourth quarter of 2003. In March 2004, the Company notified
the
Internal Revenue Service of its delinquent payroll tax filings and voluntarily
paid the outstanding balance of its payroll taxes in the amount of $1,003,830
plus accrued interest of $122,655 to the Internal Revenue Service. The Internal
Revenue Service notified the Company that it owed penalties plus accrued
interest related to the above matter. At December 31, 2004, the Company had
recorded a liability for accrued penalties and interest of $573,022. On February
18, 2005, the Internal Revenue Service agreed to accept the Company's offer
in
compromise (Form 656) in settlement of all of the Company's outstanding federal
tax liabilities. Pursuant to the terms of the agreement, the Company agreed
to
pay $26,100, surrender all credits and refunds for 2005 or earlier tax periods,
and remain in compliance with all federal tax obligations for a term of five
years. The Company paid $26,100 to the Internal Revenue Service on February
25,
2005, as required under the settlement terms. As a result of the settlement,
the
Company recorded a gain on legal settlement of approximately $547,000 during
2005.
In
August
2005, the Company entered into a software assignment and development agreement
with the developer of a customized accounting software application. In
connection with this agreement, the developer would be paid up to $512,500
and
issued up to 32,395 shares of the Company common stock based upon the developer
attaining certain milestones. As of December 31, 2006, the Company had
paid $262,500 and issued 3,473 shares of common stock related to this
obligation.
On
January 17, 2006, the SEC temporarily suspended the trading of the Company’s
securities. In its “Order of Suspension of Trading,” the SEC stated that the
reason for the suspension was a lack of current and accurate information
concerning the Company’s securities because of possible manipulative conduct
occurring in the market for its stock. By its terms, that suspension ended
on
January 30, 2006 at 11:59 p.m. EST. Simultaneously with the suspension, the
SEC
advised the Company that the SEC was conducting
a non-public investigation. As of March 26, 2007, the SEC has not provided
the
Company with any communication indicating that its investigation has concluded
or that the Company or any of its officers or directors have engaged in any
criminal or fraudulent conduct with respect to Smart Online.
17. ACQUISITIONS
& DISPOSITIONS
Computility
Acquisition & Disposition
On
October 4, 2005, the Company purchased substantially all of the assets of
Computility, Inc. (“Computility”). In consideration for the purchased assets,
the seller was issued 484,213 shares of common stock and the Company assumed
certain liabilities totaling approximately $1.9 million. The shares were
valued at $7.30 per share which was the median trading price on the acquisition
date. The total purchase price, including liabilities assumed, was approximately
$5.8 million including approximately $228k of acquisition fees. Of the total
shares issued, 84,213 were delivered to Computility at the closing of the
acquisition and 400,000 were held in escrow to cover certain indemnification
provisions of Computility. The initial escrow period expired on September 24,
2006 as to 250,000 shares, while the remaining 150,000 shares are subject to
a
second escrow scheduled to expire on March 24, 2007.
F-28
In
addition, two key employees of Computility entered into employment agreements
with Smart CRM, Inc., a wholly-owned subsidiary of the Company, pursuant to
which each earned $91,800 over and above their base compensation during the
fifteen months ending December 31, 2006, for meeting certain performance goals.
Also as part of these employment agreements, the Company paid these two key
employees $45,000 each in October of 2005 in exchange for their covenants not
to
compete. These two employees were each granted an option to purchase 75,000
shares of the Company's common stock at $7.00 per share. Each of the options
vest and become exercisable in six equal, quarterly increments of 12,500 shares
upon the achievement of certain quarterly performance milestones. As of December
31, 2006, options to purchase an aggregate of 50,000 shares of common stock
had
vested under these agreements.
A
condensed balance sheet of Computility on October 4, 2005 is presented
below:
|
Assets:
|
|
|
|
|
|
Accounts
Receivable, net
|
|
$
|
6,894
|
|
|
Other
Current Assets
|
|
|
10,742
|
|
|
P,P
& E, net
|
|
|
388,128
|
|
|
Other
Assets
|
|
|
246,228
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
651,992
|
|
|
|
|
|
|
|
|
Liabilities
& Equity
|
|
|
|
|
|
Accounts
Payable
|
|
$
|
109,897
|
|
|
Subscriptions
Payable
|
|
|
1,657,327
|
|
|
Note
Payable
|
|
|
150,000
|
|
|
Other
Liabilities
|
|
|
29,549
|
|
|
TOTAL
LIABILITIES
|
|
|
1,946,773
|
|
|
|
|
|
|
|
|
Equity
|
|
|
(1,294,781
|
)
|
|
TOTAL
LIABILITIES AND EQUITY
|
|
$
|
651,992
|
|
The
book
values shown above were determined to be the appropriate fair market values,
so
no adjustment was required to mark-to-market. Goodwill acquired as part of
this
acquisition was determined to be approximately $3.7 million based on an
independent valuation performed in accordance with SFAS No. 141,
Business Combinations
(“SFAS
No. 141”). Goodwill was determined as follows:
|
Consideration
Paid (including acquisition costs and liabilities assumed)
|
|
$
|
5,800,640
|
|
|
Tangible
Assets Acquired
|
|
|
(651,992
|
)
|
|
Identifiable
Intangible Assets Acquired
|
|
|
(1,424,220
|
)
|
|
Goodwill
|
|
$
|
3,724,428
|
|
Historically,
Computility derived substantially all of its revenue from software and hardware
subscription agreements which typically have three year terms with substantial
penalties for early termination. Until the date of the acquisition, Computility
factored substantially all of its subscription agreements and received
approximately 65% of the expected cash flow from the subscription period upfront
and used the cash to fund ongoing operations. As a result of the factor
arrangements, the Company was required to provide services to the customers,
but
only received approximately 35% of the corresponding customer payments to fund
ongoing operations. The remaining 65% of the monthly customer payments was
used
to offset approximately $1.7 million of the factor liabilities of Computility
assumed by the Company. In addition, the shares issued as part of the purchase
price held in escrow secure the customer payments used to offset this liability.
Upon
our
successful integration of the SFA/CRM application into the
Company's OneBizSM
platform, management deemed the remaining operations of Smart CRM, specifically
consulting and network management, to be non-strategic to ongoing operations.
On
September 29, 2006, the Company, Smart CRM and Alliance Technologies, Inc.
("Alliance") executed and delivered an Asset Purchase Agreement pursuant to
which Alliance acquired substantially all of the assets of Smart CRM. In
accordance with SFAS No. 144,
Accounting for the Impairment and Disposal of Long-Lived Assets
, the
Company has reported the operating results for Smart CRM as discontinued
operations and the assets and liabilities ultimately sold or disposed as
available for sale.
F-29
The
Smart
CRM assets sold to Alliance included the traditional SFA/CRM application
developed and sold by Smart CRM and its predecessor in interest, Computility.
The Company retained all rights relating to the derivative SaaS application
developed by the Company with Smart CRM and incorporated into its
OneBizSM
platform. The other assets sold included substantially all of the fixed assets
and computer hardware and software of Smart CRM, and certain identifiable
intangible assets, including technology, customer bases, and common law
trademarks relating to Computility. Further, Alliance agreed to hire
substantially all of the employees of Smart CRM following the asset sale, with
the exception of two key employees who remained with the Company.
In
consideration for the transfer of these assets, Alliance paid the Company
$600,000 in cash and assumed approximately $1.7 million in total liabilities
related to Smart CRM, including all liabilities associated with the factoring
activity of Smart CRM, for total compensation of approximately $2.3 million.
In
exchange, Alliance received assets valued at approximately $1.7 million,
resulting in a gain on sale of $653,267. The goodwill associated with the
disposed assets has been written down to zero resulting in an additional
non-cash charge to “Other Income/Expense” in the amount of $2,793,321. The
combined effect is a net loss on the sale of substantially all of the assets
of
Smart CRM totaling $2,140,054.
The
major
classes and carrying amounts of the assets and liabilities disposed of are
as
follows:
|
|
|
|
|
Carrying
Value
at
9/29/06
|
|
|
|
|
|
|
|
|
||
|
ASSETS
|
|
|
|
|
||
|
Accounts
Receivable, net
|
|
$
|
82,290
|
|
||
|
Fixed
Assets, net
|
|
|
400,624
|
|
||
|
Identifiable
Intangibles, net
|
|
|
972,566
|
|
||
|
Deferred
Financing Costs
|
|
|
224,443
|
|
||
|
TOTAL
ASSETS SOLD
|
|
$
|
1,679,923
|
|
||
|
LIABILITIES
|
|
|
|
|
||
|
Notes
& Factor Debt Payable
|
|
$
|
1,610,478
|
|
||
|
Customer
Prepaid Services
|
|
|
122,712
|
|
||
|
TOTAL
LIABILITIES ASSUMED BY BUYER
|
|
$
|
1,733,190
|
|
||
|
CASH
PAID BY BUYER
|
|
$
|
600,000
|
|
||
|
TOTAL
CONSIDERATION
|
|
$
|
2,333,190
|
|
||
|
|
|
|
|
|
||
|
Gain
on sale of Assets and Liabilities before Goodwill
Write-down
|
|
|
653,267
|
|
||
|
Write-down
of Goodwill related to Assets Sold
|
|
|
(2,793,321
|
)
|
||
|
|
|
|
|
|
||
|
Net
Loss on Sale of Assets
|
|
$
|
2,140,054
|
|
||
In
addition, two key employees of Smart CRM entered into consulting and non-compete
agreements with Alliance. Under these agreements, each key employee will provide
certain consulting services to Alliance to assist with the transition of the
purchased assets. Both key employees are prohibited from competing with Alliance
with regard to the business associated with the assets purchased, but each
is
specifically allowed to continue his employment with the Company. In exchange,
each key employee will receive a payment from Alliance of
$50,000.
F-30
The
Company and an entity controlled by the same key employees also entered into
an
agreement whereby this entity was paid $55,000 immediately
following the closing of the asset sale described herein for assistance
with identifying Alliance as an acquirer of the assets.
There
is
no relationship between the Company, Smart CRM and their affiliates, and
Alliance and its affiliates.
iMart
Incorporated Acquisition
On
October 18, 2005, the Company completed its purchase of all of the capital
stock
of iMart Incorporated (“iMart”), a Michigan-based company providing
multi-channel electronic commerce systems, pursuant to a Stock Purchase
Agreement, dated as of October 17, 2005, by and among the Company, iMart and
the
stockholders of iMart. The Company currently operates this business as its
wholly-owned subsidiary, Smart Commerce.
iMart's
stockholders were issued 205,767 shares of common stock and the Company agreed
to pay iMart's stockholders approximately $3,462,000 in cash installments.
This
amount was payable in four equal payments of $432,866 on the first business
day
of each of January 2006, April 2006, July 2006 and October 2006. The remaining
$1,731,465 was payable in January 2007. The shares were valued at $8.825 per
share which was the median trading price on the acquisition date. The total
purchase price for 100% of the outstanding iMart shares was approximately $5.3
million including approximately $339,000 of acquisition fees.
A
condensed balance sheet for iMart on October 18, 2005 is presented
below:
|
Assets
|
||||
|
Cash
|
$
|
32,035
|
||
|
Accounts
Receivable
|
356,781
|
|||
|
Prepaid
Registration
|
77,038
|
|||
|
Other
Current Assets
|
8,882
|
|||
|
Total
Current Assets
|
474,736
|
|||
|
P,P&E,
net
|
64,099
|
|||
|
Other
Assets
|
25,000
|
|||
|
|
|
|
||
|
TOTAL
ASSETS
|
$
|
563,835
|
||
|
|
|
|
|
|
|
Liabilities
|
||||
|
Accounts
Payable
|
$
|
36,759
|
||
|
Deferred
Revenue
|
533,447
|
|||
|
Other
Current Liabilities
|
1,641
|
|||
|
Total
Current Liabilities
|
571,847
|
|||
|
Loan
Payable
|
65,000
|
|||
|
|
||||
|
TOTAL
LIABILITIES
|
$
|
636,847
|
|
|
|
|
||||
|
Equity
|
(73,012
|
)
|
||
|
TOTAL
LIABILITIES & EQUITY
|
$
|
563,835
|
|
The
book
values shown above were determined to be the appropriate fair market values,
so
no adjustment was required to mark-to-market. Goodwill acquired as part of
this
acquisition was determined to be approximately $1.8 million based on an
independent valuation performed in accordance with SFAS No. 141. Goodwill was
determined as follows:
F-31
|
Consideration
Paid (including acquisition costs and liabilities assumed)
|
$
|
6,732,265
|
|
|
|
Tangible
Assets Acquired
|
(563,835
|
)
|
||
|
Identifiable
Intangible Assets Acquired
|
(4,402,895
|
)
|
||
|
Goodwill
|
$
|
1,765,535
|
|
In
addition, the Company was required to pay $780,000 for non-competition
agreements to key personnel of the acquired company in eight equal quarterly
installments during the period beginning in January 2006 and ending October
2007. The purchase price installment payments were secured by the net proceeds
of customer contracts of Smart Commerce. On November 9, 2006, Smart Commerce
entered into a loan agreement with Fifth Third Bank. Under the terms of the
loan
agreement, Smart Commerce established a lock box and a cash security account
of
$250,000. This limited the Company’s ability to use cash derived from this
revenue until all payments and indebtedness was paid in full. See Note 9, “Notes
Payable,” for additional information about this transaction. The former CEO of
iMart had contractual rights to operate Smart Commerce, Inc. within agreed
financial parameters.
The
results of operations of iMart are included in the Company's consolidated
statements of operations for the period October 18, 2005 through December 31,
2005.
Pro
Forma Results of Operations (Unaudited)
The
following pro forma results of operations show the results of operations had
the
acquisition of iMart and disposition of Smart CRM been completed at the
beginning of each of the periods presented below:
For
the
Year Ended December 31, 2004:
|
|
Smart
Commerce
|
Smart
Online
|
Pro
forma
Unaudited
|
|
Revenue
|
$
3,380,609
|
$
1,002,970
|
$4,383,579
|
|
Net
Income / (Loss)
|
1,423,691
|
(2,671,929)
|
(1,248,238)
|
|
Net
Income / (Loss) Attributable
to
common stockholders
|
1,423,691
|
(8,319,049)
|
(6,895,358)
|
|
|
|
|
|
|
EPS
|
|
|
$
(.63)
|
For
the
Year Ended December 31, 2005:
|
|
Smart
Commerce
|
Smart
Online
|
Pro
forma
Unaudited
|
|
Revenue
|
$
3,706,738
|
$
1,353,107
|
$ 5,059,845
|
|
Net
Income / (Loss)
|
1,487,279
|
(15,919,694)
|
(14,460,441)
|
|
Net
Income / (Loss) Attributable
to
common stockholders
|
1,487,279
|
(15,919,694)
|
(14,432,415)
|
|
|
|
|
|
|
EPS
|
|
|
$
(1.07)
|
F-32
For
the
Year Ended December 31, 2006:
|
|
Smart
Commerce
|
Smart
Online
|
Pro
forma
Unaudited
|
|
Revenue
|
$
3,131,752
|
$
513,138
|
$
3,644,556
|
|
Net
Income / (Loss)
|
1,012,255
|
(3,510,399)
|
(2,498,144)
|
|
Net
Income / (Loss) Attributable
to
common stockholders
|
1,012,255
|
(3,510,399)
|
(2,498,144)
|
|
|
|
|
|
|
EPS
|
|
|
$
(0.17)
|
The
2005
and 2006 pro formas exclude the losses from discontinued operations related
to
Smart CRM. For 2005 and 2006, those losses were $35,735 and $2,525,563,
respectively.
18. SUBSEQUENT
EVENTS
In
a
transaction that closed on February 21, 2007, the Company sold an aggregate
of
2,352,941 shares of its common stock to two new investors (the "Investors").
The
private placement shares were sold at $2.55 per share pursuant to a Securities
Purchase Agreement (the "SPA") between the Company and each of the Investors.
The aggregate gross process were $6 million and the Company incurred issuance
costs of approximately $585,000. Under the SPA, the Investors were issued
warrants for the purchase of an aggregate of 1,176,471 shares of common stock
at
an exercise price of $3.00 per share. These warrants contain a provision for
cashless exercise and must be exercised by February 21, 2010.
The
Company and each of the Investors also entered into a Registration Rights
Agreement (the "Investor RRA") whereby the Company has an obligation to register
the shares for resale by the Investors by filing a registration statement within
thirty (30) days of the closing of the private placement, and to have the
registration statement declared effective sixty (60) days after actual filing,
or ninety (90) days after actual filing if the SEC reviews the registration
statement. If a registration statement is not timely filed or declared effective
by the date set forth in the Investor RRA, the Company is obligated to pay
a
cash penalty of 1% of the purchase price on the day after the filing or
declaration of effectiveness is due, and 0.5% of the purchase price per every
thirty (30) day period thereafter, to be prorated for partial periods, until
the
Company fulfills these obligations. Under no circumstances can the aggregate
penalty for late registration or effectiveness exceed 10% of the aggregate
purchase price. Under the terms of the Investor RRA, the Company cannot offer
for sale or sell any securities until May 22, 2007, subject to certain limited
exceptions, unless, in the opinion of the Company’s counsel, such offer or sale
does not jeopardize the availability of exemptions from the registration and
qualification requirements under applicable securities laws with respect to
this
placement. On
March
28, 2007, the Company entered into an amendment to the Investor RRA with each
Investor to extend the registration filing obligation date by an additional
eleven calendar days.
As
part
of the commission paid to Canaccord Adams, Inc. ("CA"), the Company's placement
agent in the transaction described above, CA was issued a warrant to purchase
35,000 shares of the Company's common stock at an exercise price of $2.55 per
share. This warrant contains a provision for cashless exercise and must be
exercised by February 21, 2012. CA and the Company also entered into a
Registration Rights Agreement (the "CA RRA"). Under the CA RRA, the shares
issuable upon exercise of the warrant must be included on the same registration
statement the Company is obligated to file under the Investor RRA described
above, but CA is not entitled to any penalties for late registration or
effectiveness.
On
January 24, 2007, the Company entered into an amendment to its line of credit
with Wachovia described in Note 9, Notes Payable. The amendment resulted in
an
increase in the line of credit from $1.3 million to $2.5 million. The pay-off
date for the line of credit was also extended from August 1, 2007 to August
1,
2008. The line of credit is secured by the Company's deposit account at Wachovia
and an irrevocable standby letter of credit (the "Letter of Credit") in the
amount of $2,500,000 issued by HSBC Private Bank (Suisse) S.A. with Atlas as
account party. As of
March
15, 2007, the Company has drawn down approximately $2.1 million on the line
of
credit.
F-33
As
incentive to
modify
the letter of credit, the
Company entered into a "Stock Purchase Warrant and Agreement" (the "Warrant
Agreement") with Atlas on January 15, 2007. Under the terms of the Warrant
Agreement, Atlas received a warrant to purchase up to 444,444 shares of the
Company’s common stock at $2.70 per share at the termination of the line of
credit or if the Company is in default under the terms of the line of credit
with Wachovia. If the warrant is exercised in full, it will result in gross
proceeds to the Company of approximately $1,200,000.
On
January 12, 2007, the Compensation Committee of the Company's Board of Directors
approved five executive level managers modifying their compensation, each
reducing their salary for the remainder of 2007 to $100,000. In
consideration for these modifications, the employees have agreed to a
performance based aggregate quarterly bonus. The aggregate bonus will be ten
percent (10%) of any "Free Cash Flow" which will be divided equally among these
five officers (i.e., 2% of Free Cash Flow each). For these purposes, "Free
Cash
Flow" is defined as the Company’s total revenue, less operating expenses (with
non-cash items added back), less principal debt payments. These
bonuses relate only to "Free Cash Flow" during 2007 as this bonus
arrangement expires on December 31, 2007. On January 1, 2008, compensation
for these officers is scheduled to return to pre-reduction levels.
The
aggregate savings from these modifications, including payroll tax effects and
without taking any potential bonus into account, will be approximately $260,000
annually.
In
January 2007, the Company entered into employment agreements with its new Vice
President - Sales and Vice President - Business Development. These two
individuals were the co-founders of Computility and operated Smart CRM after
the
Company’s purchase of the assets of Computility, described in Note 17 -
Acquisitions & Dispositions.
Under
the
terms of these agreements, the Company agreed to pay an annual salary of
$150,000 to each of these individuals. They also have the ability to earn a
net
commission of zero to 10% each and a bonus of zero to $200,000 each, based
on
revenue ranging from less than $2 million to over $10 million in 2007. Any
commission paid to these individuals will be net of any commission paid by
the
Company to any and all other individuals. For purposes of these agreements,
“revenue” is defined as net cash received by the Company, excluding any revenue
received by any present or future subsidiary of the Company.
On
March
29, 2007, the Company issued 55,666 shares of its common stock to certain
investors as registration penalties for its failure to timely file a
registration statement covering shares owned by those investors as required
pursuant to registration rights agreements between such investors and the
Company.
19. Summary
of Operations by Quarters (Unaudited)
|
2006
|
2005
|
|||||||||||||||||||||||
|
1st
Qtr.
|
2nd
Qtr.
|
3rd
Qtr.
|
4th
Qtr.
|
1st
Qtr.
|
2nd
Qtr.
|
3rd
Qtr.
|
4th
Qtr.
|
|||||||||||||||||
|
Revenues
|
$
|
1,357,959
|
|
$
|
840,820
|
|
$
|
749,206
|
|
$
|
696,905
|
|
$
|
253,238
|
|
$
|
406,116
|
|
$
|
344,692
|
|
$
|
1,151,379
|
|
|
Gross
Profit
|
$
|
1,255,856
|
|
$
|
761,720
|
|
$
|
717,895
|
|
$
|
579,908
|
|
$
|
221,511
|
|
$
|
384,205
|
|
$
|
318,892
|
|
$
|
1,075,925
|
|
|
Loss
from Operations
|
$
|
(1,457,401
|
)
|
$
|
(1,509,185
|
)
|
$
|
(1,081,173
|
)
|
$
|
(1,317,853
|
)
|
$
|
(847,484
|
)
|
$
|
(874,306
|
)
|
$
|
(2,188,462
|
)
|
$
|
(12,163,753
|
)
|
|
Net
Income (Loss ) From Continuing Operations Attributable to common
stockholders
|
$
|
(1,556,862
|
)
|
$
|
133,023
|
$
|
429,581
|
$
|
(1,503,886
|
)
|
$
|
(294,145
|
)
|
$
|
(860,819
|
)
|
$
|
(2,180,856
|
)
|
$
|
(12,254,789
|
)
|
||
|
Discontinued
Operations
|
(39,563
|
)
|
(156,571
|
)
|
(2,329,429
|
)
|
||||||||||||||||||
|
Net
Loss
|
(1,596,425
|
)
|
(23,548
|
)
|
(1,899,848
|
)
|
(1,503,886
|
)
|
(294,145
|
)
|
(860,819
|
)
|
(2,180,856
|
)
|
(12,254,789
|
)
|
||||||||
F-34
|
Net
Loss Per Share-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Continuing
Operations
|
||||||||||||||||||||||||
|
Basic
|
|
(0.11
|
)
|
|
(0.00
|
)
|
|
0.03
|
|
(0.10
|
)
|
|
(0.02
|
)
|
|
(0.07
|
)
|
|
(0.17
|
)
|
|
(0.84
|
)
|
|
|
Fully
Diluted
|
(0.11
|
)
|
(0.00
|
)
|
0.03
|
(0.10
|
)
|
(0.02
|
)
|
(0.07
|
)
|
(0.17
|
)
|
(0.84
|
)
|
|||||||||
|
Discontinued
Operations
|
||||||||||||||||||||||||
|
Basic
|
(0.01
|
)
|
(0.15
|
)
|
||||||||||||||||||||
|
Fully
Diluted
|
(0.01
|
)
|
(0.15
|
)
|
||||||||||||||||||||
|
Net
Loss Attributed to common stockholders
|
||||||||||||||||||||||||
|
Basic
|
(0.11
|
)
|
(0.00
|
)
|
(0.13
|
)
|
(0.10
|
)
|
(0.02
|
)
|
(0.07
|
)
|
(0.17
|
)
|
(0.84
|
)
|
||||||||
|
Fully
Diluted
|
(0.11
|
)
|
(0.00
|
)
|
(0.12
|
)
|
(0.10
|
)
|
(0.02
|
)
|
(0.07
|
)
|
(0.17
|
)
|
(0.84
|
)
|
||||||||
|
Number
of Shares Used in Per Share Calculation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||
|
Basic
|
14,984,228
|
15,117,967
|
15,127,510
|
14,914,233
|
11,829,610
|
12,387,333
|
12,832,365
|
14,667,137
|
||||||||||||||||
|
Fully
Diluted
|
14,984,228
|
15,117,967
|
15,387,110
|
14,914,233
|
11,829,610
|
12,387,333
|
12,832,365
|
14,667,137
|
F-35
ITEM
9.
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
ITEM
9A.
CONTROLS
AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
We
maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
and
15d-15(e) under the Exchange Act) that are designed to provide reasonable
assurances that information required to be disclosed by us in the reports that
we file or submit under the Exchange Act is recorded, processed, summarized
and
reported, within the time periods specified in the SEC’s rules and forms, and
that such information is accumulated and communicated to management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. In designing and
evaluating the disclosure controls and procedures, management recognized that
disclosure controls and procedures, no matter how well designed and operated,
can provide only reasonable assurances of achieving the desired control
objectives, as ours are designed to do, and management necessarily was required
to apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures
Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of our disclosure controls
and procedures as of the end of the period covered by this Form 10-K. Based
on
such evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this Form 10-K, our
disclosure controls and procedures were not effective because of the significant
deficiencies described below under “Changes in Internal Control Over Financial
Reporting,” which we are in the process of remediating.
Changes
in Internal Controls Over Financial Reporting
As
described in our Annual Report on Form 10-K for the fiscal year ending December
31, 2005, filed with the SEC on July 11, 2006, or the 2005 Annual Report, we
have begun to implement controls in response to the final findings of our Audit
Committee’s investigation related to the SEC’s suspension of trading of our
common stock in January 2006.
As
a
result of the findings of the Audit Committee investigation, we have made the
following changes to our internal controls:
| · |
Mr.
Jeffrey LeRose was appointed to the position of non-executive Chairman
of
the Board of Directors to separate the leadership of the Board of
Directors from the management of the Company, replacing Mr. Michael
Nouri,
who remained as President, Chief Executive Officer, and a member
of the
Board.
|
| · |
Mr.
Nouri has repaid all amounts outstanding to several noteholders,
including
Berkley Financial Services through sales of shares of our common
stock
from Mr. Nouri’s personal holdings.
|
| · |
Our
Chief Financial Officer has been involved in communications with
investment professionals, including analysts, brokers and potential
institutional investors.
|
| · |
Our
Chief Financial Officer has been given direct reporting responsibility
to
the Audit Committee with respect to any such
communications.
|
| · |
Three
additional, non-management directors have been appointed to our Board
of
Directors, two of whom qualify as “independent” under Item 407(a) of
Regulation S-K. One of these “independent” directors also qualifies as an
“audit committee financial expert” under Item 407(d)(5)(ii) of Regulation
S-K and is serving as the Chairman of the Audit
Committee.
|
| · |
Our
outside counsel has provided periodic educational training for management
and directors by outside legal counsel and other appropriate professional
advisors.
|
| · |
We
have adopted a revised Securities Trading
Policy.
|
37
| · |
Controls
have been implemented regarding the review and approval of material
contracts by our Chief Financial Officer, Corporate Counsel, and
where
appropriate, our outside counsel and Board of Directors, including
the
creation of a contract checklist to be completed by our Chief Financial
Officer and Corporate Counsel for each material
agreement.
|
| · |
We
have instituted a program requiring written confirmation of compliance
with our Code of Ethics and Conflicts of Interest Policy on a quarterly
basis from all members of management and the Board of
Directors.
|
| · |
We
entered into a contract with Ethical Advocates, Inc. for confidential
and
anonymous incident reporting.
|
| · |
Multiple
control systems have been put in place to review checks paid to officers
and directors in excess of $2,500.
|
| · |
We
now have three members of our Board who are members of the National
Association of Corporate Directors
(“NACD”).
|
Two
other
measures identified in the 2005 Annual Report were our evaluation of whether
we
would add two positions to our company in order to help with our internal
controls and procedures. At this time, we have decided not to hire a new General
Counsel. We concluded that the controls described above and the retention of
new
outside legal counsel augmenting the work of our current Corporate Counsel
provides sufficient controls. We have also completed our evaluation of whether
the responsibilities and duties of a Chief Compliance Officer can be fulfilled
by a current member of management or whether it is necessary to seek a qualified
outside candidate. We have determined that this function can be filled by a
current member of our management team, and have assigned the primary
responsibility to administer and set compliance policy, monitor and assess
control deficiency identification and remediation and report to the Audit
Committee on matters concerning legal, corporate governance and ethical
compliance to our Corporate Counsel.
We
have
not yet implemented or effectively tested all of the measures described above
and expect that their full implementation and testing will take significant
time
and effort. We expect to make additional changes to our controls as we continue
to integrate our acquired businesses and respond to the final findings of the
Audit Committee investigation. We recognize that “tone at the top” is a key
element to an organization’s control environment and are focused and committed
to providing the correct tone and structure within the company. We cannot assure
you that we will not in the future identify further deficiencies in our
controls. However, we plan to continue to review and make any necessary changes
to the overall design of our control environment in order to enhance our
corporate governance and reporting practices.
Other
than those described above, there have been no significant changes in our
internal control over financial reporting that occurred during the last fiscal
quarter of the fiscal year ended December 31, 2006 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
ITEM
9B.
OTHER
INFORMATION
There
is
no information required to be disclosed on a current report on Form
8-K during the fourth quarter of 2006 that was not disclosed on a current
report on Form 8-K.
On
March
28, 2007, we entered into amendments to the registration rights agreements
dated
February 21, 2007 with the investors to which we sold shares of our common
stock
for aggregate proceeds of $6,000,000. The original registration rights
agreements obligated us to register the shares sold for resale by the investors
by March 23, 2007. The investors agreed to extend the registration obligation
date to April 3, 2007.
38
PART
III
Information
called for in Items 10, 11, 12, 13, and 14 is incorporated by reference from
our
definitive proxy statement relating to our Annual Meeting of Stockholders,
which
will be filed with the SEC within 120 days after the end of fiscal
2006.
ITEM
10.
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM
11.
EXECUTIVE
COMPENSATION
ITEM
12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM
13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE
PART
IV
(a)(1)
and (2). The financial statements and reports of our independent registered
public accounting firm are filed as part of this report (see “Index to Financial
Statements,” at Part II, Item 8). The financial statement schedules are not
included in this Item as they are either not applicable or are included as
part
of the consolidated financial statements.
(a)(3)
The following exhibits have been or are being filed herewith and are numbered
in
accordance with Item 601 of Regulation S-K:
|
Exhibit
No.
|
Description
|
|
2.1
|
Asset
Purchase Agreement, dated September 30, 2006, by and between Alliance
Technologies, Inc., Smart CRM, Inc., and Smart Online, Inc. (incorporated
herein by reference to Exhibit 2.1 to our Quarterly Report on Form
10-Q,
as filed with the SEC on November 14, 2006)
|
|
3.1
|
Articles
of Incorporation, as restated (incorporated herein by reference to
Exhibit
3.1 to our Registration Statement on Form SB-2, as filed with the
SEC on
September 30, 2004))
|
|
3.2
|
Bylaws,
as amended
|
|
4.1
|
Specimen
Common Stock Certificate (incorporated herein by reference to Exhibit
4.1
to our Registration Statement on Form SB-2, as filed with the SEC
on
September 30, 2004)
|
|
10.1*
|
2004
Equity Compensation Plan (incorporated herein by reference to Exhibit
10.1
to our Registration Statement on Form SB-2, as filed with the SEC
on
September 30, 2004)
|
|
10.2*
|
Form
of Incentive Stock Option Agreement under 2004 Equity Compensation
Plan
(incorporated herein by reference to Exhibit 10.2 to our Annual Report
on
Form 10-K, as filed with the SEC on July 11, 2006)
|
|
10.3*
|
Form
of Non-Qualified Stock Option Agreement under 2004 Equity Compensation
Plan (incorporated herein by reference to Exhibit 10.3 to our Annual
Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.4*
|
2001
Equity Compensation Plan (terminated as to future grants April 15,
2004)
(incorporated herein by reference to Exhibit 10.2 to our Registration
Statement on Form SB-2, as filed with the SEC on September 30,
2004)
|
39
|
10.5*
|
1998
Equity Compensation Plan (terminated as to future grants effective
April
15, 2004) (incorporated herein by reference to Exhibit 10.3 to our
Registration Statement on Form SB-2, as filed with the SEC on September
30, 2004)
|
|
10.6
|
Form
of Reorganization, Lock-Up Proxy and Release Agreement, dated January
1,
2004, between Smart Online, Inc. and certain stockholders (incorporated
herein by reference to Exhibit 10.4 to our Registration Statement
on Form
SB-2, as filed with the SEC on September 30, 2004)
|
|
10.7
|
Form
of Lock-up Agreement dated January 1, 2004 between Smart Online,
Inc. and
certain stockholders (incorporated herein by reference to Exhibit
10.5 to
our Registration Statement on Form SB-2, as filed with the SEC on
September 30, 2004)
|
|
10.8
|
Form
of Subscription Agreement with lock-up provisions between Smart Online,
Inc. and certain investors (incorporated herein by reference to Exhibit
10.6 to our Registration Statement on Form SB-2, as filed with the
SEC on
September 30, 2004)
|
|
10.9
|
Form
of Registration Rights Agreement dated as of February 1, 2004 between
Smart Online, Inc. and certain investors (incorporated herein by
reference
to Exhibit 10.7 to our Registration Statement on Form SB-2, as filed
with
the SEC on September 30, 2004)
|
|
10.10*
|
Employment
Agreement dated April 1, 2004 with Michael Nouri (incorporated herein
by
reference to Exhibit 10.8 to our Registration Statement on Form SB-2,
as
filed with the SEC on September 30, 2004)
|
|
10.11*
|
Employment
Agreement dated April 1, 2004 with Henry Nouri (incorporated herein
by
reference to Exhibit 10.9 to our Registration Statement on Form SB-2,
as
filed with the SEC on September 30, 2004)
|
|
10.12*
|
Employment
Agreement dated April 1, 2004 with Ronna Loprete (incorporated herein
by
reference to Exhibit 10.10 to our Registration Statement on Form
SB-2, as
filed with the SEC on September 29, 2004)
|
|
10.13*
|
Employment
Agreement dated April 1, 2004 with Scott Whitaker
|
|
10.14*
|
Employment
Agreement dated April 1, 2004 with Thomas Furr
|
|
10.15*
|
Amendment
to the Employment Agreement dated November 9, 2005 with Thomas
Furr
|
|
10.16*
|
Employment
Agreement dated March 21, 2006 with Nicholas A. Sinigaglia (incorporated
herein by reference to Exhibit 10.1 to our Current Report on Form
8-K, as
filed with the SEC on March 27, 2006)
|
|
10.17*
|
Description
of Salary Reduction Agreements
|
|
10.18
|
Asset
Purchase Agreement dated as of October 4, 2005 by and among Smart
Online,
Inc., Smart CRM, Computility, Inc. and certain shareholders of
Computility, Inc. (incorporated herein by reference to Exhibit 2.1
to our
Current Report on Form 8-K, as filed with the SEC on October 7,
2005)
|
|
10.19
|
Stock
Purchase Agreement dated as of October 17, 2005 by and among Smart
Online,
Inc., iMart Incorporated and the shareholders of iMart Incorporated
(incorporated herein by reference to Exhibit 2.1 to our Current Report
on
Form 8-K, as filed with the SEC on October 24, 2005)
|
|
10.20*
|
Employment
Agreement dated as of October 17, 2005 by and among Smart Online,
Inc.,
iMart Incorporated and Gary Mahieu (incorporated herein by reference
to
Exhibit 2.2 to our Current Report on Form 8-K, as filed with the
SEC on
October 24, 2005)
|
|
10.21
|
Letter
Agreement dated February 23, 2005 by and between Smart Online, Inc.
and
Berkley Financial Services (BFS) Ltd. for financial advisory services
(incorporated herein by reference to Exhibit 10.32 to our Annual
Report on
Form 10-K, as filed with the SEC on July 11, 2006)
|
|
10.22
|
Consulting
Agreement, dated October 4, 2005, by and between Smart Online, Inc.
and
Berkley Financial Services Ltd. (incorporated herein by reference
to
Exhibit 99.1 to our Current Report on Form 8-K, as filed with the
SEC on
November 10, 2005)
|
|
10.23
|
Consulting
Agreement, dated October 26, 2005, by and between Smart Online, Inc.
and
General Investments Capital (GIC) Ltd. (incorporated herein by reference
to Exhibit 99.2 to our Current Report on Form 8-K, as filed with
the SEC
on November 10, 2005)
|
40
|
10.24
|
Settlement
Agreement, effective May 31, 2006, by and between Smart Online, Inc.
and
General Investments Capital (GIC) Ltd. (incorporated herein by reference
to Exhibit 99.1 to our Current Report on Form 8-K, as filed with
the SEC
on June 6, 2006)
|
|
10.25
|
Form
of Subscription Agreement, Subscriber Rights Agreement, and Dribble
Out
Agreement, dated August 17 and 21, 2006, by and between Smart Online,
Inc.
and certain investors (incorporated herein by reference to Exhibit
10.2 to
our Quarterly Report on Form 10-Q, as filed with the SEC on November
14,
2006)
|
|
10.26
|
Form
of Subscription Agreement, Subscriber Rights Agreement, and Dribble
Out
Agreement, dated June 29 and July 6, 2006, by and between Smart Online,
Inc. and certain investors (incorporated herein by reference to Exhibit
10.36 to our Annual Report on Form 10-K, as filed with the SEC on
July 11,
2006)
|
|
10.27
|
Form
of Subscription Agreement, Subscriber Rights Agreement, and Dribble
Out
Agreement, dated March 30, 2006, by and between Smart Online, Inc.
and
Atlas Capital, SA (incorporated herein by reference to Exhibit 10.37
to
our Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.28
|
Settlement
Agreement, dated August 25, 2006, by and between Smart Online, Inc.
and
Berkley Financial Services, Ltd. (incorporated herein by reference
to
Exhibit 99.1 to our Current Report on Form 8-K, as filed with the
SEC on
August 28, 2006)
|
|
10.29
|
Form
of Subscription Agreement, Registration Rights Agreement, and Dribble
Out
Agreement, dated July 19, September 7 and September 13, 2005, by
and
between Smart Online, Inc. and Atlas Capital, SA (incorporated herein
by
reference to Exhibit 10.38 to our Annual Report on Form 10-K, as
filed
with the SEC on July 11, 2006)
|
|
10.30
|
Form
of Subscription Agreement, Registration Rights Agreement, and Dribble
Out
Agreement, dated September 7, 2005, by and between Smart Online,
Inc. and
Credit Suisse Zurich (incorporated herein by reference to Exhibit
10.39 to
our Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.31
|
Form
of Subscription Agreement, Registration Rights Agreement, and Dribble
Out
Agreement, and Exhibits thereto, dated February 25, 2005, by and
between
Smart Online, Inc. and The Blueline Fund (incorporated herein by
reference
to Exhibit 10.40 to our Annual Report on Form 10-K, as filed with
the SEC
on July 11, 2006)
|
|
10.32*
|
Indemnification
Agreement, dated April ,14 2006, by and between Smart Online, Inc.
and
David E.Y. Sarna (incorporated herein by reference to Exhibit 10.42
to our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.33*
|
Indemnification
Agreement, dated April ,14 2006, by and between Smart Online, Inc.
and
Joan Keston (incorporated herein by reference to Exhibit 10.43 to
our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.34*
|
Indemnification
Agreement, dated January 26, 2006, by and between Smart Online, Inc.
and
Tom Furr (incorporated herein by reference to Exhibit 10.44 to our
Annual
Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.35*
|
Indemnification
Agreement, dated January 26, 2006, by and between Smart Online, Inc.
and
Henry Nouri (incorporated herein by reference to Exhibit 10.45 to
our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.36*
|
Indemnification
Agreement, dated April 14, 2006, by and between Smart Online, Inc.
and
Scott Whitaker (incorporated herein by reference to Exhibit 10.46
to our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.37*
|
Indemnification
Agreement, dated January 26, 2006, by and between Smart Online, Inc.
and
Michael Nouri (incorporated herein by reference to Exhibit 10.47
to our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.38*
|
Smart
Online, Inc. Revised Board Compensation Policy, effective August
1, 2006
(incorporated herein by reference to Exhibit 10.3 to our Quarterly
Report
on Form 10-Q, as filed with the SEC on November 14,
2006)
|
|
10.39*
|
Smart
Online, Inc. Revised Board Compensation Policy, effective November
17,
2006
|
|
10.40
|
Form
of Amendments to Registration Rights Agreements and Amendments to
Subscriber Rights Agreements, dated from October 2, 2006 through
January
26, 2007, by and between Smart Online, Inc. and certain
investors
|
41
|
10.41*
|
Amendment
to Lock Box Agreement, dated November 8, 2006, by and between Smart
Online, Inc., Smart Commerce, Inc. and certain former shareholders
of
iMart Incorporated
|
|
10.42
|
Business
Loan Agreement, Promissory Note, Guaranty, Security Agreements and
Collateral Assignments dated October 17, 2006 by and between Smart
Online,
Inc., Smart Commerce and Fifth Third Bank
|
|
10.43
|
Promissory
Note, Loan Agrement, Agreement and Security Agreement dated November
14,
2006, by and between Smart Online, Inc. and Wachovia Bank,
NA
|
|
21.1
|
Subsidiaries
of Smart Online, Inc.
|
|
23.1
|
Consent
of Independent Registered Public Accounting Firm
|
|
31.1
|
Certification
of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
|
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
|
|
32.1
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. [This
exhibit
is being furnished pursuant to Section 905 of the Sarbanes-Oxley
Act of
2002 and shall not, except to the extent required by that Act, be
deemed
to be incorporated by reference into any document or filed herewith
for
the purposes of liability under the Securities Exchange Act of 1934,
as
amended, or the Securities Act of 1933, as amended, as the case may
be.]
|
|
32.2
|
Certification
of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350,
as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
[This
exhibit is being furnished pursuant to Section 905 of the Sarbanes-Oxley
Act of 2002 and shall not, except to the extent required by that
Act, be
deemed to be incorporated by reference into any document or filed
herewith
for the purposes of liability under the Securities Exchange Act of
1934,
as amended, or the Securities Act of 1933, as amended, as the case
may
be.]
|
*
Management contract or compensatory plan.
42
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) 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.
|
SMART
ONLINE, INC.
Registrant
|
||
|
By:
|
/s/
Michael Nouri
|
|
|
Michael
Nouri, Principal Executive Officer
March
30, 2007
|
||
|
|
|
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
/s/
Nicholas A. Sinigaglia
Nicholas
A. Sinigaglia, Principal Financial Officer and
Principal
Accounting Officer
March
30,
2007
/s/
Michael Nouri
Michael
Nouri
Principal
Executive Officer and Director
March
30,
2007
/s/
Jeffrey W. LeRose
Jeffrey
W. LeRose
Director
March
30,
2007
/s/
Tom
Furr
Tom
Furr
Director
March
30,
2007
43
/s/
C.
James Meese, Jr.
C.
James
Meese, Jr.
Director
March
30,
2007
/s/
Shlomo Elia
Shlomo
Elia
Director
March
30,
2007
/s/
Philippe Pouponnot
Philippe
Pouponnot
Director
March
30,
2007
44
EXHIBIT
INDEX
|
Exhibit
No.
|
Description
|
|
2.1
|
Asset
Purchase Agreement, dated September 30, 2006, by and between Alliance
Technologies, Inc., Smart CRM, Inc., and Smart Online, Inc. (incorporated
herein by reference to Exhibit 2.1 to our Quarterly Report on Form
10-Q,
as filed with the SEC on November 14, 2006)
|
|
3.1
|
Articles
of Incorporation, as restated (incorporated herein by reference to
Exhibit
3.1 to our Registration Statement on Form SB-2, as filed with the
SEC on
September 30, 2004)
|
|
3.2
|
Bylaws,
as amended
|
|
4.1
|
Specimen
Common Stock Certificate (incorporated herein by reference to Exhibit
4.1
to our Registration Statement on Form SB-2, as filed with the SEC
on
September 30, 2004)
|
|
10.1*
|
2004
Equity Compensation Plan (incorporated herein by reference to Exhibit
10.1
to our Registration Statement on Form SB-2, as filed with the SEC
on
September 30, 2004)
|
|
10.2*
|
Form
of Incentive Stock Option Agreement under 2004 Equity Compensation
Plan
(incorporated herein by reference to Exhibit 10.2 to our Annual Report
on
Form 10-K, as filed with the SEC on July 11, 2006)
|
|
10.3*
|
Form
of Non-Qualified Stock Option Agreement under 2004 Equity Compensation
Plan (incorporated herein by reference to Exhibit 10.3 to our Annual
Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.4*
|
2001
Equity Compensation Plan (terminated as to future grants April 15,
2004)
(incorporated herein by reference to Exhibit 10.2 to our Registration
Statement on Form SB-2, as filed with the SEC on September 30,
2004)
|
|
10.5*
|
1998
Equity Compensation Plan (terminated as to future grants effective
April
15, 2004) (incorporated herein by reference to Exhibit 10.3 to our
Registration Statement on Form SB-2, as filed with the SEC on September
30, 2004)
|
|
10.6
|
Form
of Reorganization, Lock-Up Proxy and Release Agreement, dated January
1,
2004, between Smart Online, Inc. and certain stockholders (incorporated
herein by reference to Exhibit 10.4 to our Registration Statement
on Form
SB-2, as filed with the SEC on September 30, 2004)
|
|
10.7
|
Form
of Lock-up Agreement dated January 1, 2004 between Smart Online,
Inc. and
certain stockholders (incorporated herein by reference to Exhibit
10.5 to
our Registration Statement on Form SB-2, as filed with the SEC on
September 30, 2004)
|
|
10.8
|
Form
of Subscription Agreement with lock-up provisions between Smart Online,
Inc. and certain investors (incorporated herein by reference to Exhibit
10.6 to our Registration Statement on Form SB-2, as filed with the
SEC on
September 30, 2004)
|
|
10.9
|
Form
of Registration Rights Agreement dated as of February 1, 2004 between
Smart Online, Inc. and certain investors (incorporated herein by
reference
to Exhibit 10.7 to our Registration Statement on Form SB-2, as filed
with
the SEC on September 30, 2004)
|
|
10.10*
|
Employment
Agreement dated April 1, 2004 with Michael Nouri (incorporated herein
by
reference to Exhibit 10.8 to our Registration Statement on Form SB-2,
as
filed with the SEC on September 30, 2004)
|
|
10.11*
|
Employment
Agreement dated April 1, 2004 with Henry Nouri (incorporated herein
by
reference to Exhibit 10.9 to our Registration Statement on Form SB-2,
as
filed with the SEC on September 30, 2004)
|
|
10.12*
|
Employment
Agreement dated April 1, 2004 with Ronna Loprete (incorporated herein
by
reference to Exhibit 10.10 to our Registration Statement on Form
SB-2, as
filed with the SEC on September 29, 2004)
|
|
10.13*
|
Employment
Agreement dated April 1, 2004 with Scott Whitaker
|
|
10.14*
|
Employment
Agreement dated April 1, 2004 with Thomas
Furr
|
45
|
10.15*
|
Amendment
to the Employment Agreement dated November 9, 2005 with Thomas
Furr
|
|
10.16*
|
Employment
Agreement dated March 21, 2006 with Nicholas A. Sinigaglia (incorporated
herein by reference to Exhibit 10.1 to our Current Report on Form
8-K, as
filed with the SEC on March 27, 2006)
|
|
10.17*
|
Description
of Salary Reduction Agreements
|
|
10.18
|
Asset
Purchase Agreement dated as of October 4, 2005 by and among Smart Online,
Inc., Smart CRM, Computility, Inc. and certain shareholders of
Computility, Inc. (incorporated herein by reference to Exhibit 2.1
to our
Current Report on Form 8-K, as filed with the SEC on October 7,
2005)
|
|
10.19
|
Stock
Purchase Agreement dated as of October 17, 2005 by and among Smart
Online,
Inc., iMart Incorporated and the shareholders of iMart Incorporated
(incorporated herein by reference to Exhibit 2.1 to our Current Report
on
Form 8-K, as filed with the SEC on October 24, 2005)
|
|
10.20*
|
Employment
Agreement dated as of October 17, 2005 by and among Smart Online,
Inc.,
iMart Incorporated and Gary Mahieu (incorporated herein by reference
to
Exhibit 2.2 to our Current Report on Form 8-K, as filed with the
SEC on
October 24, 2005)
|
|
10.21
|
Letter
Agreement dated February 23, 2005 by and between Smart Online, Inc.
and
Berkley Financial Services (BFS) Ltd. for financial advisory services
(incorporated herein by reference to Exhibit 10.32 to our Annual
Report on
Form 10-K, as filed with the SEC on July 11, 2006)
|
|
10.22
|
Consulting
Agreement, dated October 4, 2005, by and between Smart Online, Inc.
and
Berkley Financial Services Ltd. (incorporated herein by reference
to
Exhibit 99.1 to our Current Report on Form 8-K, as filed with the
SEC on
November 10, 2005)
|
|
10.23
|
Consulting
Agreement, dated October 26, 2005, by and between Smart Online, Inc.
and
General Investments Capital (GIC) Ltd. (incorporated herein by reference
to Exhibit 99.2 to our Current Report on Form 8-K, as filed with
the SEC
on November 10, 2005)
|
|
10.24
|
Settlement
Agreement, effective May 31, 2006, by and between Smart Online, Inc.
and
General Investments Capital (GIC) Ltd. (incorporated herein by reference
to Exhibit 99.1 to our Current Report on Form 8-K, as filed with
the SEC
on June 6, 2006)
|
|
10.25
|
Form
of Subscription Agreement, Subscriber Rights Agreement, and Dribble
Out
Agreement, dated August 17 and 21, 2006, by and between Smart Online,
Inc.
and certain investors (incorporated herein by reference to Exhibit
10.2 to
our Quarterly Report on Form 10-Q, as filed with the SEC on November
14,
2006)
|
|
10.26
|
Form
of Subscription Agreement, Subscriber Rights Agreement, and Dribble
Out
Agreement, dated June 29 and July 6, 2006, by and between Smart Online,
Inc. and certain investors (incorporated herein by reference to Exhibit
10.36 to our Annual Report on Form 10-K, as filed with the SEC on
July 11,
2006)
|
|
10.27
|
Form
of Subscription Agreement, Subscriber Rights Agreement, and Dribble
Out
Agreement, dated March 30, 2006, by and between Smart Online, Inc.
and
Atlas Capital, SA (incorporated herein by reference to Exhibit 10.37
to
our Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.28
|
Settlement
Agreement, dated August 25, 2006, by and between Smart Online, Inc.
and
Berkley Financial Services, Ltd. (incorporated herein by reference
to
Exhibit 99.1 to our Current Report on Form 8-K, as filed with the
SEC on
August 28, 2006)
|
|
10.29
|
Form
of Subscription Agreement, Registration Rights Agreement, and Dribble
Out
Agreement, dated July 19, September 7 and September 13, 2005, by
and
between Smart Online, Inc. and Atlas Capital, SA (incorporated herein
by
reference to Exhibit 10.38 to our Annual Report on Form 10-K, as
filed
with the SEC on July 11, 2006)
|
|
10.30
|
Form
of Subscription Agreement, Registration Rights Agreement, and Dribble
Out
Agreement, dated September 7, 2005, by and between Smart Online,
Inc. and
Credit Suisse Zurich (incorporated herein by reference to Exhibit
10.39 to
our Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
46
|
10.31
|
Form
of Subscription Agreement, Registration Rights Agreement, and Dribble
Out
Agreement, and Exhibits thereto, dated February 25, 2005, by and
between
Smart Online, Inc. and The Blueline Fund (incorporated herein by
reference
to Exhibit 10.40 to our Annual Report on Form 10-K, as filed with
the SEC
on July 11, 2006)
|
|
10.32*
|
Indemnification
Agreement, dated April ,14 2006, by and between Smart Online, Inc.
and
David E.Y. Sarna (incorporated herein by reference to Exhibit 10.42
to our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.33*
|
Indemnification
Agreement, dated April ,14 2006, by and between Smart Online, Inc.
and
Joan Keston (incorporated herein by reference to Exhibit 10.43 to
our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.34*
|
Indemnification
Agreement, dated January 26, 2006, by and between Smart Online, Inc.
and
Tom Furr (incorporated herein by reference to Exhibit 10.44 to our
Annual
Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.35*
|
Indemnification
Agreement, dated January 26, 2006, by and between Smart Online, Inc.
and
Henry Nouri (incorporated herein by reference to Exhibit 10.45 to
our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.36*
|
Indemnification
Agreement, dated April 14, 2006, by and between Smart Online, Inc.
and
Scott Whitaker (incorporated herein by reference to Exhibit 10.46
to our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.37*
|
Indemnification
Agreement, dated January 26, 2006, by and between Smart Online, Inc.
and
Michael Nouri (incorporated herein by reference to Exhibit 10.47
to our
Annual Report on Form 10-K, as filed with the SEC on July 11,
2006)
|
|
10.38*
|
Smart
Online, Inc. Revised Board Compensation Policy, effective August
1, 2006
(incorporated herein by reference to Exhibit 10.3 to our Quarterly
Report
on Form 10-Q, as filed with the SEC on November 14,
2006)
|
|
10.39*
|
Smart
Online, Inc. Revised Board Compensation Policy, effective November
17,
2006
|
|
10.40
|
Form
of Amendments to Registration Rights Agreements and Amendments to
Subscriber Rights Agreements, dated from October 2, 2006 through
January
26, 2007, by and between Smart Online, Inc. and certain
investors
|
|
10.41*
|
Amendment
to Lock Box Agreement, dated November 8, 2006, by and between Smart
Online, Inc., Smart Commerce, Inc. and certain former shareholders
of
iMart Incorporated
|
|
10.42
|
Business
Loan Agreement, Promissory Note, Guaranty, Security Agreements and
Collateral Assignments, dated October 17, 2006 by and between Smart
Online, Inc., Smart Commerce and Fifth Third Bank
|
|
10.43
|
Promissory
Note, Loan Agreement and Security Agreement dated November 14, 2006,
by
and between Smart Online, Inc. and Wachovia Bank, NA
|
|
21.1
|
Subsidiaries
of Smart Online, Inc.
|
|
23.1
|
Consent
of Independent Registered Public Accounting Firm
|
|
31.1
|
Certification
of Chief Executive Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
|
|
31.2
|
Certification
of Chief Financial Officer Pursuant to Rule 13a-14/15d-14 as Adopted
Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
|
|
32.1
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. [This
exhibit
is being furnished pursuant to Section 905 of the Sarbanes-Oxley
Act of
2002 and shall not, except to the extent required by that Act, be
deemed
to be incorporated by reference into any document or filed herewith
for
the purposes of liability under the Securities Exchange Act of 1934,
as
amended, or the Securities Act of 1933, as amended, as the case may
be.]
|
|
32.2
|
Certification
of Chief Financial Officer to Pursuant to 18 U.S.C. Section 1350,
as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
[This
exhibit is being furnished pursuant to Section 905 of the Sarbanes-Oxley
Act of 2002 and shall not, except to the extent required by that
Act, be
deemed to be incorporated by reference into any document or filed
herewith
for the purposes of liability under the Securities Exchange Act of
1934,
as amended, or the Securities Act of 1933, as amended, as the case
may
be.]
|
*
Management contract or compensatory plan.
47