MobileSmith, Inc. - Quarter Report: 2007 June (Form 10-Q)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
_________________
FORM
10-Q
_________________
(Mark
One)
x Quarterly
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934
For
the quarterly period ended June 30, 2007
OR
o Transition
report pursuant to Section 13 of 15(d) of the Securities Exchange Act of
1934
Commission
File Number: 001-32634
_________________
SMART
ONLINE, INC.
(Exact
name of registrant as specified in its charter)
_________________
|
Delaware
|
95-4439334
|
|
(State
or other jurisdiction of
|
(I.R.S.
Employer
|
|
incorporation
or organization)
|
Identification
No.)
|
|
2530
Meridian Parkway, 2nd Floor
Durham,
North Carolina
|
27713
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(919)
765-5000
(Registrant's
telephone number, including area code)
_________________
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
o
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
o
|
Accelerated
Filer
o
|
Non-accelerated
Filer
x
|
Indicate
by check mark whether the registrant is a shell company (as defined in rule
12b-2 of the Exchange Act). Yes
o
No
x
As
of
August 10, 2007, there were approximately 17,930,000 shares of the registrant's
common stock outstanding.
|
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|
Page
No.
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||
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2
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3
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4
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5
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14
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27
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27
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27
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29
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29
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39
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40
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41
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SMART
ONLINE, INC.
|
Assets
|
June
30,
2007
(unaudited)
|
December
31,
2006
|
|||||
|
CURRENT
ASSETS:
|
|
|
|||||
|
Cash
and Cash Equivalents
|
$
|
3,628,253
|
$
|
326,905
|
|||
|
Restricted
Cash (See Note 5)
|
250,000
|
250,000
|
|||||
|
Accounts
Receivable, Net
|
934,270
|
247,618
|
|||||
|
Prepaid
Expenses
|
90,929
|
100,967
|
|||||
|
Deferred
Financing Costs (See Note 5)
|
451,884
|
-
|
|||||
|
Total
current assets
|
$
|
5,355,336
|
$
|
925,490
|
|||
|
PROPERTY
AND EQUIPMENT, Net
|
$
|
179,107
|
$
|
180,360
|
|||
|
INTANGIBLE
ASSETS, Net
|
3,250,783
|
3,617,477
|
|||||
|
GOODWILL
|
2,696,642
|
2,696,642
|
|||||
|
OTHER
ASSETS
|
90,107
|
13,040
|
|||||
|
TOTAL
ASSETS
|
$
|
11,571,975
|
$
|
7,433,009
|
|||
|
Liabilities
and Stockholders' Equity
|
|||||||
|
CURRENT
LIABILITIES:
|
|||||||
|
Accounts
Payable
|
$
|
759,584
|
$
|
850,730
|
|||
|
Accrued
Registration Rights Penalty
|
244,725
|
465,358
|
|||||
|
Current
Portion of Notes Payable (See Note 6)
|
1,128,359
|
2,839,631
|
|||||
|
Deferred
Revenue
|
671,456
|
313,774
|
|||||
|
Accrued
Liabilities
|
344,665
|
301,266
|
|||||
|
Total
Current Liabilities
|
$
|
3,148,789
|
$
|
4,770,759
|
|||
|
|
|||||||
|
LONG-TERM
LIABILITIES:
|
|||||||
|
Long-Term
Portion of Notes Payable (See Note 6)
|
$
|
2,427,000
|
$
|
825,000
|
|||
|
Deferred
Revenue
|
33,473
|
11,252
|
|||||
|
Total
Long-Term Liabilities
|
2,460,473
|
836,252
|
|||||
|
Total
Liabilities
|
$
|
5,609,262
|
$
|
5,607,011
|
|||
|
COMMITMENTS
AND CONTINGENCIES
|
|||||||
|
STOCKHOLDERS'
EQUITY:
|
|||||||
|
Common
Stock, $.001 Par Value, 45,000,000 Shares Authorized, Shares Issued
and
Outstanding:
June
30, 2007 - 17,927,137; December 31, 2006 - 15,379,030
|
17,927
|
15,379
|
|||||
|
Additional
Paid-in Capital
|
65,818,590
|
59,159,919
|
|||||
|
Accumulated
Deficit
|
(59,873,804
|
)
|
(57,349,300
|
)
|
|||
|
Total
Stockholders' Equity
|
5,962,713
|
1,825,998
|
|||||
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
$
|
11,571,975
|
$
|
7,433,009
|
|||
The
accompanying notes are an integral part of these financial
statements.
SMART
ONLINE, INC.
|
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
||||||||
|
June
30, 2007
|
June
30, 2006
|
June
30, 2007
|
June
30, 2006
|
||||||||||
|
REVENUES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Integration
Fees
|
|
$
|
5,000
|
|
$
|
26,667
|
|
$
|
5,000
|
|
$
|
176,410
|
|
|
Syndication
Fees
|
|
15,000
|
|
57,352
|
|
|
30,000
|
|
|
126,267
|
|
||
|
Subscription
Fees (See Note 3)
|
|
576,600
|
|
501,093
|
|
|
1,209,583
|
|
|
1,046,767
|
|
||
|
Professional
Services Fees
|
|
317,900
|
|
232,466
|
|
|
606,479
|
|
|
464,201
|
|
||
|
License
Fees
|
280,000
|
|
-
|
280,000
|
337,500
|
||||||||
|
Other
Revenue
|
|
9,429
|
|
18,416
|
|
|
15,254
|
|
|
40,312
|
|
||
|
Total
Revenues
|
|
$
|
$1,203,929
|
|
$
|
835,994
|
|
$
|
2,146,316
|
|
$
|
2,191,457
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
COST
OF REVENUES
|
|
$
|
111,489
|
|
$
|
79,100
|
|
$
|
187,909
|
|
$
|
181,204
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
GROSS
PROFIT
|
|
$
|
1,092,440
|
|
$
|
756,894
|
|
$
|
1,958,407
|
|
$
|
2,010,253
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|
|||||
|
General
and Administrative
|
|
1,051,314
|
|
1,638,994
|
|
|
2,164,005
|
|
|
3,629,098
|
|
||
|
Sales
and Marketing
|
|
473,668
|
|
239,088
|
|
|
942,915
|
|
|
531,912
|
|
||
|
Research
and Development
|
|
685,915
|
|
392,824
|
|
|
1,262,610
|
|
|
823,201
|
|
||
|
Total
Operating Expenses
|
|
$
|
2,210,897
|
|
$
|
2,270,906
|
|
$
|
4,369,530
|
|
$
|
4,984,211
|
|
|
|
|
|
|
|
|
|
|
|
|||||
|
LOSS
FROM CONTINUING OPERATIONS
|
|
(1,118,457
|
)
|
(1,514,012
|
)
|
|
(2,411,123
|
)
|
|
(2,973,958
|
)
|
||
|
|
|
|
|
|
|
|
|
||||||
|
OTHER
INCOME (EXPENSE):
|
|
|
|
|
|
|
|
||||||
|
Interest
Expense, Net
|
|
(126,759
|
)
|
(64,643
|
)
|
|
(261,787
|
)
|
|
(139,056)
|
|||
|
Gain
on Debt Forgiveness
|
|
-
|
|
144,351
|
|
|
4,600
|
|
|
144,351
|
|||
|
Writeoff
of Investment
|
|
-
|
|
-
|
|
|
-
|
|
|
(25,000
|
)
|
||
|
Other
Income
|
|
30,478
|
|
1,562,500
|
|
|
143,808
|
|
|
1,562,500
|
|||
|
|
|
||||||||||||
|
Total
Other Income (Expense)
|
|
$
|
(96,281)
|
|
$
|
1,642,208
|
|
(113,379
|
)
|
|
1,542,795
|
||
|
NET
INCOME/(LOSS) FROM CONTINUING OPERATIONS
|
|
(1,214,738
|
)
|
128,196
|
|
(2,524,502
|
)
|
|
(1,431,163
|
)
|
|||
|
DISCONTINUED
OPERATIONS
|
|
|
|
|
|
|
|
||||||
|
Loss
of Operations of Smart CRM, net of tax
|
|
-
|
|
(156,571
|
)
|
|
-
|
|
|
(196,135
|
)
|
||
|
NET
LOSS ATTRIBUTED TO COMMON STOCKHOLDERS
|
|
$
|
(1,214,738
|
)
|
(28,375
|
)
|
$
|
(2,524,502
|
)
|
$
|
(1,627,298
|
)
|
|
|
NET
LOSS PER SHARE:
|
|
|
|
|
|
|
|
||||||
|
Continuing
Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
and Fully Diluted
|
|
$
|
(0.07
|
)
|
$
|
0.01
|
|
$
|
(0.15
|
)
|
$
|
(0.10
|
)
|
|
Discontinued
Operations
|
|
|
|
|
|
||||||||
|
Basic
and Fully Diluted
|
|
$
|
-
|
$
|
(0.01
|
)
|
$
|
-
|
$
|
(0.01
|
)
|
||
|
Net
Loss Attributed to Common Stockholders
|
|
||||||||||||
|
Basic
and Fully Diluted
|
|
$
|
(0.07
|
)
|
|
0.00
|
|
(0.15
|
)
|
|
(0.11
|
)
|
|
|
SHARES
USED IN COMPUTING NET LOSS PER SHARE
|
|
|
|
|
|
||||||||
|
Basic
|
|
|
17,252,639
|
|
15,096,415
|
|
16,728,010
|
15,052,205
|
|||||
|
Fully
Diluted
|
|
|
17,252,639
|
|
|
15,356,015
|
|
16,728,010
|
|
15,052,205
|
|||
The
accompanying notes are an integral part of these financial
statements.
SMART
ONLINE, INC.
(unaudited)
|
|
Three
Months
Ended
June
30, 2007
|
Six
Months
Ended
June
30, 2007
|
Three
Months
Ended
June
30, 2006
|
Six
Months
Ended
June
30, 2006
|
|||||||||
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|||||||||||||
|
Net
Loss
|
$
|
(1,214,738
|
)
|
$
|
(2,524,502
|
)
|
$
|
128,196
|
$
|
(1,431,163
|
)
|
||
|
Adjustments
to reconcile Net Loss to Net Cash used
in Operating Activities:
|
|||||||||||||
|
Depreciation
and Amortization
|
210,652
|
420,418
|
170,237
|
334,207
|
|||||||||
|
Amortization
of Deferred Financing Costs
|
112,971
|
207,112
|
-
|
||||||||||
|
Bad
Debt Expense
|
-
|
-
|
2,500
|
65,817
|
|||||||||
|
Takeback
of Investor Relation Shares
|
-
|
-
|
(1,562,500
|
)
|
(1,562,500
|
)
|
|||||||
|
Stock
Option Related Compensation Expense
|
223,285
|
380,018
|
191,550
|
449,014
|
|||||||||
|
Writeoff
of Investment
|
-
|
-
|
-
|
25,000
|
|||||||||
|
Registration
Rights Penalty
|
-
|
(320,632
|
)
|
121,415
|
229,313
|
||||||||
|
Gain
on Debt Forgiveness
|
-
|
(4,600
|
)
|
(144,351
|
)
|
(144,351
|
)
|
||||||
|
Changes
in Assets and Liabilities:
|
|||||||||||||
|
Accounts
Receivable
|
(650,160
|
)
|
(686,651
|
)
|
385,295
|
53,122
|
|||||||
|
Prepaid
Expenses
|
10,938
|
10,035
|
1,117
|
63,906
|
|||||||||
|
Other
Assets
|
-
|
(1,760
|
)
|
(25,000
|
)
|
(24,571
|
)
|
||||||
|
Deferred
Revenue
|
432,027
|
380,476
|
19,286
|
(96,483
|
)
|
||||||||
|
Accounts
Payable
|
(75,827
|
)
|
(86,495
|
)
|
291,290
|
540,940
|
|||||||
|
Accrued
and Other Expenses
|
1,090
|
44,312
|
(58,124
|
)
|
35,195
|
||||||||
|
Cash
Flow from Discontinued Operations
|
-
|
-
|
(11,822
|
)
|
109,669
|
||||||||
|
Net
Cash used in Operating Activities
|
$
|
(949,762
|
)
|
$
|
(2,182,269
|
)
|
$
|
(490,911
|
)
|
$
|
(1,352,885
|
)
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|||||||||||||
|
Purchases
of Furniture and Equipment
|
(41,217
|
)
|
(51,976
|
)
|
(4,896
|
)
|
(7,345
|
)
|
|||||
|
Purchase
of Tradename
|
(2,033
|
)
|
(2,033
|
)
|
-
|
-
|
|||||||
|
Cash
Flow from Discontinued Operations
|
-
|
-
|
182,017
|
(146,591
|
)
|
||||||||
|
Smart
CRM Advances
|
-
|
-
|
(203,681
|
)
|
56,098
|
||||||||
|
Net
Cash provided by (used in) Investing Activities
|
$
|
(43,250
|
)
|
$
|
(54,009
|
)
|
$
|
(26,560
|
)
|
$
|
(97,838
|
)
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|||||||||||||
|
Repayments
on Notes Payable
|
(305,315
|
)
|
(1,559,272
|
)
|
(459,323
|
)
|
(1,006,594
|
)
|
|||||
|
Debt
Borrowings
|
-
|
1,450,000
|
-
|
221,734
|
|||||||||
|
Restricted
Cash
|
-
|
-
|
103,301
|
(196,455
|
)
|
||||||||
|
Issuance
of Common Stock
|
-
|
5,748,607
|
1,000,000
|
2,022,100
|
|||||||||
|
Expenses
Related to Form S-1 Filing
|
(101,709
|
)
|
(101,709
|
)
|
-
|
-
|
|||||||
|
Cash
Flow from Discontinued Operations
|
-
|
-
|
(171,898
|
)
|
(171,898
|
)
|
|||||||
|
Net
Cash provided by Financing Activities
|
$
|
(407,024
|
)
|
$
|
5,537,626
|
$
|
472,080
|
$
|
868,887
|
||||
|
NET
INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS
|
$
|
(1,400,036
|
)
|
$
|
3,301,348
|
$
|
(45,391
|
)
|
$
|
(581,836
|
)
|
||
|
CASH
AND CASH EQUIVALENTS,
BEGINNING
OF PERIOD
|
$
|
5,028,289
|
$
|
326,905
|
$
|
898,521
|
$
|
1,434,966
|
|||||
|
CASH
AND CASH EQUIVALENTS, END
OF PERIOD
|
$
|
3,628,253
|
$
|
3,628,253
|
$
|
853,130
|
$
|
853,130
|
|||||
|
Supplemental
Disclosures:
|
|||||||||||||
|
Cash
Paid during the Period for Interest:
|
$
|
109,596
|
$
|
182,866
|
$
|
71,043
|
$`
|
136,279
|
|||||
|
Cash
Paid for Taxes
|
-
|
-
|
-
|
-
|
|
||||||||
The
accompanying notes are an integral part of these financial
statements.
Smart
Online, Inc.
1.
Summary of Business and Significant Accounting Policies
Description
of Business -
Smart
Online, Inc. (the “Company”) was incorporated in the State of Delaware in 1993.
The Company develops and markets Internet-delivered Software-as-a-Service
(“SaaS”) software applications and data resources to help start and run small
businesses. Subscribers access the Company’s products through the websites of
its private label syndication partners, including major companies and financial
institutions, and its portal at www.onebiz.com. Corporate information on the
Company can be found at www.smartonline.com.
Basis
of Presentation-
The
accompanying balance sheet as of June 30, 2007 and the statements of operations
and cash flows for the three and six months ended June 30, 2007 and 2006 are
unaudited. The balance sheet as of December 31, 2006 is obtained from the
audited financial statements as of that date. The accompanying statements should
be read in conjunction with the audited financial statements and related notes,
together with management's discussion and analysis of financial position and
results of operations, contained in the Company's Annual Report on Form 10-K
for
the year ended December 31, 2006 filed with the Securities and Exchange
Commission (the “SEC”) on March 30, 2007 (the “2006 Annual
Report”).
The
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States (“U.S. GAAP”). In the opinion of the
Company's management, the unaudited statements in this Quarterly Report on
Form
10-Q include all normal and recurring adjustments necessary for the fair
presentation of the Company's statement of financial position as of June 30,
2007, and its results of operations and cash flows for the three months and
six
months ended June 30, 2007 and June 30, 2006. The results for the three months
and six months ended June 30, 2007 are not necessarily indicative of the results
to be expected for the fiscal year ending December 31, 2007.
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 and development
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.
Significant
Accounting Policies -
In the
opinion of the Company's management, the significant accounting policies used
for the three months and six months ended June 30, 2007 are consistent with
those used for the years ended December 31, 2006, 2005 and 2004. Accordingly,
please refer to the 2006 Annual Report for our significant accounting
policies.
Reclassifications
- Certain
prior year amounts have been reclassified to conform with current year
presentation. These reclassifications had no effect on previously reported
net
income or shareholders’ equity.
Revenue
Recognition -
The
Company has recently begun to derive revenue from the license of software
platforms along with the sale of associated maintenance, consulting, and
application development. The arrangement may include delivery in
multiple-element arrangements if the customer purchases any combination of
products and/or services. The Company uses the residual method pursuant to
American Institute of Certified Public Accountants (“AICPA”) Statement of
Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. This
method allows Smart Online to recognize revenue for delivered elements when
such
element has vendor specific objective evidence (“VSOE”) of the fair value of the
delivered element. If VSOE can not be determined or maintained for an element,
it could impact revenues as all or a portion of the revenue from the
multiple-element arrangement may need to be deferred.
If
multiple-element arrangements involve significant development, modification
or
customization or if it is determined that certain elements are essential to
the
functionality of other elements within the arrangement, revenue is deferred
until all elements necessary to the functionality are provided. The
determination of whether the arrangement involved significant development,
modification or customization could be complex and require the use of
judgment.
The
amount of revenue to be recognized from development and consulting services
is
typically based on the amount of work performed within a given period. This
is
typically based on estimates involving total costs to complete and the stage
of
completion. The assumptions and estimates made to determine such figures may
affect the timing of revenue recognition. Changes in estimates of progress
to
completion and costs to complete are accounted for as cumulative catch-up
adjustments.
Under
SOP
97-2, provided the arrangement does not require significant development,
modification or customization, revenue is recognized when all of the following
criteria have been met:
|
1.
|
persuasive
evidence of an arrangement exists.
|
|
2.
|
delivery
has occurred.
|
|
3.
|
the
fee is fixed or determinable, and
|
|
4.
|
collectibility
is probable.
|
If
at the
inception of an arrangement, the fee is not fixed or determinable, revenue
is
deferred until the arrangement fee becomes due and payable. If collectibility
is
deemed not probable, revenue is deferred until payment is received or collection
becomes probable, whichever is earlier. The determination of whether fees are
collectible required judgment and the amount and timing of revenue
recognition could change if different assessments had been made. In addition,
payment terms may vary and could be collectible over several months, but not
greater than one year.
Fiscal
Year -
The
Company's fiscal year ends December 31. References to fiscal 2006, for example,
refer to the fiscal year ending December 31, 2006.
Use
of Estimates -
The
preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions in the Company's financial
statements and notes thereto. Significant estimates and assumptions made by
management include the determination of the provision for income taxes, the
fair
market value of stock awards issued and the period over which revenue is
generated. Actual results could differ materially from those
estimates.
Software
Development Costs
- The
Company has not capitalized any direct or allocated overhead associated with
the
development of software products prior to general release. Statement of
Financial Accounting Standard (“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.
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.
Advertising
Costs -
The
Company expenses all advertising costs as they are incurred. The amounts charged
to expense during the second quarter of 2007 and 2006 were $12,095 and $395,
respectively. The amounts charged to sales and marketing expense during the
first six months of 2007 and 2006 were $15,669 and $42,315, respectively. There
were no barter advertising expenses for the three months ending June 30, 2007
and June 30, 2006 respectively, and $0 and $37,915 for the six months ended
June
30, 2007 and June 30, 2006, respectively.
Net
Loss per Share -
Basic
loss per share is computed using the weighted-average number of common shares
outstanding during the relevant periods. Diluted loss per share is computed
using the weighted-average number of common and dilutive common equivalent
shares outstanding during the relevant periods.
Common equivalent shares consist of redeemable preferred stock, stock options
and warrants that are computed using the treasury stock method.
Stock-Based
Compensation -
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 123 (revised 2004),
Share-Based Payment
(“SFAS
No. 123R”), which replaces SFAS No. 123,
Accounting for Stock-Based Compensation
(“SFAS
No. 123”), and supersedes Accounting Principles Board (“APB”) Opinion No.
25,
Accounting for Stock Issued to Employees
(“APB
No. 25”). SFAS No. 123R requires all share-based payments, including grants of
employee stock options, to be recognized in the financial statements based
on
their fair values. Under SFAS No. 123R, public companies are required to measure
the costs of services received in exchange for stock options and similar awards
based on the grant date fair value of the awards and recognize this cost in
the
income statement over the period during which an award recipient is permitted
to
provide service in exchange for the award. The pro forma disclosures previously
permitted under SFAS No. 123 are no longer an alternative to financial statement
recognition.
The
Company maintains stock-based compensation arrangements under which employees,
consultants and directors may be awarded grants of stock options and restricted
stock. Effective January 1, 2006, the Company adopted 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 accordance
with the provisions of SFAS No. 123 and (ii) compensation cost for all
share-based payments that
will
be
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 recognizes 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 $223,285 and $380,018 for
the three months and six months ended June 30, 2007, respectively.
No stock-based compensation was capitalized in the consolidated financial
statements.
The
fair
value of option grants under the Company's 2004 Equity Compensation Plan and
other stock option issuances during the three months and six months ended June
30, 2007 and June 30, 2006 was estimated using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
|
Three
Months Ended
|
Six
Months Ended
|
||||||||||||
|
June
30, 2007
|
June
30, 2006
|
June
30, 2007
|
June
30, 2006
|
||||||||||
|
Dividend
yield
|
0.0
|
%
|
0.
00
|
%
|
0.0
|
%
|
0.
00
|
%
|
|||||
|
Expected
volatility
|
150
|
%
|
140
|
%
|
150
|
%
|
150
|
%
|
|||||
|
Risk
free interest rate
|
4.92
|
%
|
5.11
|
%
|
4.92
|
%
|
5.11
|
%
|
|||||
|
Expected
lives (years)
|
5
|
5
|
5
|
5
|
|||||||||
The
expected term of the options represents the estimated period of time until
exercise or forfeiture and is based on historical experience of similar awards.
Expected volatility is based on the historical volatility of the Company’s
common stock over a period of time. The risk free interest rate is based on
the
published yield available on U.S. treasury issues with an equivalent term
remaining equal to the expected life of the option.
Compensation
expense is recognized only for option grants expected to vest. The Company
estimates forfeitures at the date of grant based on historical experience and
future expectation.
The
following is a summary of the stock option activity for the six months ended
June 30, 2007:
|
|
Shares
|
Weighted
Average
Exercise
Price
|
|||||
|
|
|||||||
|
BALANCE,
December 31, 2006
|
2,360,100
|
$
|
5.33
|
||||
|
Granted
|
20,000
|
$
|
2.80
|
||||
|
Forfeited
|
158,300
|
$
|
4.42
|
||||
|
Exercised
|
20,000
|
$
|
1.30
|
||||
|
BALANCE,
June 30, 2007
|
2,201,800
|
$
|
4.10
|
||||
Recently
Issued Accounting Pronouncements
In
September 2006, the FASB issued SFAS No. 157,
Fair
Value Measurements
(“SFAS
No. 157”). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in U.S. GAAP, and expands disclosures about fair value
measurements. SFAS No. 157 applies under other accounting pronouncements that
require or permit fair value measurements, the FASB having previously concluded
in those accounting pronouncements that fair value is a relevant measurement
attribute. Accordingly, SFAS No. 157 does not require any new fair value
measurements. However, for some entities, the application of SFAS No. 157 will
change current practices. SFAS No. 157 is effective for financial statements
for
fiscal years beginning after November 15, 2007. Earlier application is permitted
provided that the reporting entity has not yet issued financial statements
for
that fiscal year. Management does not believe that the adoption of SFAS No.
157
will have a material impact on the Company's results of operations or financial
condition once adopted.
In
February 2007, the FASB issued SFAS No. 159,
The
Fair Value Option for Financial Assets and Financial Liabilities - Including
an
amendment of FASB Statement No. 115
(“SFAS
No. 159”). SFAS No. 159 provides companies with an option to measure, at
specified election dates, many financial instruments and certain other items
at
fair value that are not currently measured at fair value. A company that adopts
SFAS No. 159 will report unrealized gains and losses on items for which the
fair
value option has been elected in earnings at each subsequent reporting date.
SFAS No. 159 also establishes presentation and disclosure requirements designed
to facilitate comparisons between entities that choose different measurement
attributes for similar types of assets and liabilities. SFAS
No.
159
is effective for fiscal years beginning after November 15, 2007. Management
does
not believe that the adoption of SFAS No. 159 will have a material impact on
the
Company's results of operations or financial condition once
adopted.
2.
PRESENTATION OF SUBSIDIARIES
As
more
fully detailed in the 2006 Annual Report, the Company completed two acquisitions
in October 2005. On October 4, 2005, the Company purchased substantially all
of
the assets of Computility, Inc., or Computility. In consideration for the
purchased assets, the Company issued the seller 484,213 shares of the Company's
common stock and assumed certain liabilities of Computility 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 $228,000 of acquisition fees. We
operated this business under the name Smart CRM, Inc. (d/b/a Computility),
or
Smart CRM.
On
October 18, 2005, the Company completed its purchase of all of the capital
stock
of iMart Incorporated, or iMart, a Michigan based company providing
multi-channel electronic commerce systems. The Company issued to iMart's
stockholders 205,767 shares of its common stock and 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 final installment
payment of approximately $1.7 million was payable in January 2007. As of January
2007, the entire purchase price was paid in full. The shares were valued at
$8.825 per share, which was the median trading price on the acquisition date.
The total purchase price for all of the outstanding iMart shares was
approximately $5.3 million including approximately $339,000 of acquisition
fees.
We
operate this subsidiary as Smart
Commerce, Inc. (d/b/a iMart), or Smart Commerce.
Upon
the
Company's successful integration of the sales force automation and customer
relationship management (“SFA/CRM”) application into its 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 or Disposal of Long-Lived Assets,
the
Company has reported the operating results for Smart CRM as discontinued
operations. For the three months and six months ended June 30, 2006, the revenue
associated with the discontinued operations were $494,328 and $1,034,534
respectively. For the three months and six months ended June 30, 2006, the
net
loss associated with the discontinued operations were $156,571 and $196,135,
respectively. Because the sale had been completed in 2006, the 2007 periods
contain no results of discontinued operations.
3.
SUBSCRIPTION REVENUE
Effective
January 1, 2007, a major customer executed a letter of clarification which
more
definitively defined the roles and responsibilities of each party. Individual
Business Owners (“IBOs”) associated with this customer are provided e-commerce,
domain name and email services. In exchange for marketing these services to
its
IBOs, the customer is paid a marketing fee. At the inception of the business
relationship, it was agreed that the customer would collect the gross service
fee from the IBO; the customer would retain its marketing fee and remit the
net
remaining cash. Because the roles and responsibilities of each party were
vaguely defined in the past, revenue was recorded only on the net cash received.
Following the execution of the letter of clarification and in accordance with
Emerging Issues Task Force (“EITF”) 99-19, Reporting
Revenue Gross as a Principal versus Net as an Agent, this
revenue is now recorded as the gross amount paid by the IBO and a sales and
marketing expense for the marketing services rendered by the customer.
Ultimately, the effect on net income is nil; however, subscription revenue
and
sales and marketing expense are effectively and appropriately grossed up.
Because the new accounting method was triggered by a clarification to the
existing agreement and not by a change from one accepted accounting method
to
another, the 2006 subscription revenue was not retroactively adjusted as would
be required by Statement of Financial Accounting Standard (“SFAS”) No.
154,
Accounting Changes and Error Corrections - a replacement of APB Opinion No.
20
and FASB Statement No. 3.
For the
three months and six months ended June 30, 2007, this accounting method resulted
in approximately $227,000 and $488,000, respectively, of additional subscription
revenue and a corresponding charge to sales and marketing expense.
4.
INDUSTRY SEGMENT INFORMATION
SFAS
No.
131,
Disclosures about Segments of an Enterprise and Related
Information
(“SFAS
No. 131”), 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 the Company manages
its
operations and how its chief operating decision maker views
results.
Smart
Commerce revenue is generally composed of subscription fees, professional
services fees and licensing fees related to domain name subscriptions,
e-commerce or networking consulting or networking maintenance
agreements.
The
Smart
Online segment generates revenue from the development and distribution of
internet-delivered SaaS small business applications through a variety of
subscription, licensing, 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 three months ended June 30, 2007:
|
|
Smart
Online,
Inc.
|
Smart
Commerce,
Inc.
|
Consolidated
|
|||||||
|
REVENUES:
|
|
|
|
|||||||
|
Integration
Fees
|
$
|
5,000
|
$
|
-
|
$
|
5,000
|
||||
|
Syndication
Fees
|
15,000
|
-
|
15,000
|
|||||||
|
Subscription
Fees
|
14,142
|
562,458
|
576,600
|
|||||||
|
Professional
Services Fees
|
-
|
317,900
|
317,900
|
|||||||
|
License
Fees
|
280,000
|
-
|
280,000
|
|||||||
|
Other
Revenues
|
5,486
|
3,943
|
9,429
|
|||||||
|
Total
Revenues
|
$
|
319,628
|
$
|
884,301
|
$
|
1,203,929
|
||||
|
|
||||||||||
|
COST
OF REVENUES
|
$
|
35,746
|
$
|
75,743
|
$
|
111,489
|
||||
|
|
||||||||||
|
OPERATING
EXPENSES
|
$
|
1,476,554$1,522,754
|
$
|
688,143
|
$
|
2,210,897
|
||||
|
|
||||||||||
|
OPERATING
INCOME (LOSS)
|
$
|
(1,238,872
|
)
|
$
|
120,415
|
$
|
(1,118,457
|
)
|
||
|
|
||||||||||
|
OTHER
INCOME (EXPENSE)
|
$
|
(62,689
|
)
|
$
|
(33,592
|
)
|
$
|
(96,281
|
)
|
|
|
|
||||||||||
|
NET
INCOME/(LOSS) BEFORE INCOME TAXES
|
$
|
(1,301,561
|
)
|
$
|
86,823
|
$
|
(1,214,738
|
)
|
||
|
|
||||||||||
|
TOTAL
ASSETS
|
$
|
8,010,665
|
$
|
3,561,310
|
$
|
11,571,975
|
||||
The
following table shows the Company's financial results by reportable segment
for
the six months ended June 30, 2007:
|
|
Smart
Online,
Inc.
|
Smart
Commerce,
Inc.
|
Consolidated
|
|||||||
|
REVENUES:
|
|
|
|
|||||||
|
Integration
Fees
|
$
|
5,000
|
$
|
-
|
$
|
5,000
|
||||
|
Syndication
Fees
|
30,000
|
-
|
30,000
|
|||||||
|
Subscription
Fees
|
27,533
|
1,182,050
|
1,209,583
|
|||||||
|
Professional
Services Fees
|
-
|
606,479
|
606,479
|
|||||||
|
License
Fees
|
280,000
|
-
|
280,000
|
|||||||
|
Other
Revenues
|
5,686
|
9,568
|
15,254
|
|||||||
|
Total
Revenues
|
$
|
3348,219
|
$
|
1,798,097
|
$
|
2,146,316
|
||||
|
|
||||||||||
|
COST
OF REVENUES
|
$
|
48,776
|
$
|
139,133
|
$
|
187,909
|
||||
|
|
||||||||||
|
OPERATING
EXPENSES
|
$
|
2,986,145
|
$
|
1,383,385
|
$
|
4,369,530
|
||||
|
|
||||||||||
|
OPERATING
INCOME (LOSS)
|
$
|
(2,686,702
|
)
|
$
|
275,579
|
$
|
(2,411,123
|
)
|
||
|
|
||||||||||
|
OTHER
INCOME (EXPENSE)
|
$
|
(41,682
|
)
|
$
|
(71,697
|
)
|
$
|
(113,379
|
)
|
|
|
|
||||||||||
|
NET
INCOME/(LOSS) BEFORE INCOME TAXES
|
$
|
(2,728,384
|
)
|
$
|
203,882
|
$
|
(2,524,502
|
)
|
||
|
|
||||||||||
|
TOTAL
ASSETS
|
$
|
8,010,665
|
$
|
3,561,310
|
$
|
11,571,975
|
||||
5.
CURRENT ASSETS
Accounts
Receivable, Net
The
Company evaluates the need for an allowance for doubtful accounts based on
specifically identified amounts that management believes to be uncollectible.
Management also records an additional allowance based on management's assessment
of the general financial conditions affecting its customer base. If actual
collections experience changes, revisions to the allowance may be required.
Based on these criteria, management has recorded an allowance for doubtful
accounts of approximately $65,000 and $65,000 as of June 30, 2007 and December
31, 2006, respectively.
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. Those
operating metrics relate to Smart Commerce’s actual results of operations as
compared to certain projections provided to Fifth Third at the inception of
the
loan. Meeting or failing to meet those metrics relate only to the release of
cash as described above. Failure to meet these metrics does not, however, result
in an acceleration of the debt. Fifth
Third Bank is currently evaluating the June 30, 2007 results to make a
determination regarding the scheduled cash release.
Deferred
Financing Costs
In
order
to secure a modification to a line of credit with Wachovia Bank, NA, or
Wachovia, (see Note 6 - Notes Payable), Atlas Capital, S.A., or Atlas, provided
the Company with a modified letter of credit. In exchange for the modified
letter of credit, the Company issued Atlas a warrant to purchase 444,444 shares
of common stock at $2.70 per share (see Note 7 - Stockholders' Equity). The
fair
value of that warrant using the Black-Scholes model was $734,303 as measured
at
the time the warrant was issued. Such amount was recorded as deferred financing
costs and will be amortized to interest expense in the amount of $37,657 per
month over the remaining period of the modified line of credit, which is
scheduled to expire in August 2008. As of June 30, 2007, the deferred financing
costs that will be amortized to interest expense over the next twelve months,
or
$451,884, were classified as current assets with the remaining $75,307
classified as non-current and included in other assets.
6.
NOTES PAYABLE
As
of
June 30, 2007, the Company had notes payable totaling $3,555,359. The detail
of
these notes is as follows:
|
Note
Description
|
Short-Term
Portion
|
Long-Term
Portion
|
TOTAL
|
Maturity
|
Rate
|
|||||||||||
|
Wachovia
Credit Line
|
-
|
$
|
2,052,000
|
$
|
2,052,000
|
Aug
`08
|
Libor
+ 0.9
|
%
|
||||||||
|
Fifth
Third Loan
|
$
|
900,000
|
375,000
|
1,275,000
|
Nov
`08
|
Prime
+ 1.5
|
%
|
|||||||||
|
Acquisition
Fee (iMart)
|
$
|
209,177
|
-
|
209,177
|
Oct
‘07
|
8
|
%
|
|||||||||
|
Acquisition
Fee (Computility)
|
19,182
|
-
|
19,182
|
Mar
‘07
|
8
|
%
|
||||||||||
|
TOTAL
|
$
|
1,128,359
|
$
|
2,427,000
|
$
|
3,555,359
|
||||||||||
On
January 24, 2007, the Company entered into an amendment to its line of credit
with Wachovia. 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. Interest accrues 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 $2,500,000 issued by HSBC Private
Bank
(Suisse) S.A. with Atlas as account party. As of June 30, 2007, the Company
has
drawn down approximately $2.1 million on the line of credit.
7.
STOCKHOLDERS' EQUITY
Common
Stock and Warrants
In
the
second quarter of 2007, a total of 55,000 shares of restricted stock were issued
to the Company’s independent directors in accordance with the Company’s board
compensation policy. The restrictions on such shares lapse over the subsequent
four quarters
provided
that the director remains on the board of directors. In addition, a total of
49,500 shares of restricted stock were issued to three employees, one of whom
is
an officer. One-third of these restricted shares vested upon grant with the
remaining shares to vest over the next two years provided the employee remains
employed by the Company.
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 proceeds to the Company were $6 million and the Company
has
incurred issuance costs of approximately $637,000 as of June 30, 2007. Under
the
SPA, the Company 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.
These warrants contain a provision for cashless exercise and must be exercised,
if at all, 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
30 days of the closing of the private placement, and to have the registration
statement declared effective 60 days after actual filing, or 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 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.
On
April 3, 2007, the Company filed the registration statement within the extended
filing obligation period, thereby avoiding the first potential
penalty.
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.
As
incentive to modify a letter of credit relating to the Wachovia line of
credit (see Note 6 - Notes Payable), 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
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 amendments to registration rights agreements between such investors
and the Company.
Equity
Compensation Plans
The
Company maintains three equity compensation plans. In the second quarter of
2007, a total of 55,000 shares of restricted stock were issued to the Company’s
independent directors in accordance with the Company’s board compensation
policy. The restrictions on such shares lapse over the following four quarters
provided that the director remains on the board of directors. In addition,
a
total of 49,500 shares of restricted stock were issued to three employees,
one
of whom is an officer. One-third of these restricted shares vested upon grant
with the remaining shares to vest over the next two years provided the employee
remains employed by the Company.
On
April
11, 2007, the Company entered into a stock option agreement for the purchase
up
to 20,000 shares of the Company’s common stock at an exercise price of $2.80 per
share with an independent member of the Company’s Board of Directors. Under the
terms of the option agreement, this option vests in equal quarterly increments
on February 16, 2007, May 16, 2007, August 16, 2007, and November 16, 2007
if
this director is serving as a member of the Company’s Board of Directors on such
dates. These dates were selected so that all shares will have vested by the
first anniversary of this directors appointment to the Board. In the event
of a
change of control or reorganization of the Company (both as defined in the
option agreement), the option vests as to all shares on the date of such
event.
In
June
2007, the Company limited the issuance of shares of its common stock reserved
under its 2004 Equity Compensation Plan (the
“2004
Plan”) to awards of restricted or unrestricted stock. Also in June 2007, the
non-interested members of the Company’s Board of Directors approved an offer for
holders of outstanding options with an exercise price of $2.50 per share or
greater, including such options held by the Company’s named executive
officers and directors, to exchange the outstanding options for a certain number
of shares of restricted stock. In this offer, the Company intends to divide
the
outstanding options into classes based on the exercise price and the remaining
expected life of the option and to use the Black-Scholes valuation model in
its
determination of the exchange ratios for the several classes of eligible
options. The Company targets using exchange ratios such that the
eligible options surrendered for cancellation would exceed the number of shares
of restricted stock that would be received in exchange for such options. The
exchange offer has not commenced and will not commence until certain actions
are
taken by the Company, including the filing of a tender offer statement and
offer
to exchange on Schedule TO to be filed with the SEC.
The
following table summarizes information about stock options outstanding at June
30, 2007:
|
Currently
Exercisable
|
||||||||||
|
Exercise
Price
|
Number
of
Shares
Outstanding
|
Average
Remaining
Contractual
Life
(Years)
|
Weighted
Average
Exercise
Price
|
Number
of
Shares
|
Weighted
Average
Exercise
Price
|
|||||
|
From
$1.30 to $1.43
|
575,000
|
1.5
|
$
1.41
|
575,000
|
$
1.41
|
|||||
|
From
$2.50 to $3.50
|
432,500
|
7.2
|
$
3.34
|
287,624
|
$
3.42
|
|||||
|
$5.00
|
211,600
|
8
|
$
5.00
|
136,600
|
$
5.00
|
|||||
|
$7.00
|
150,000
|
8.3
|
$
7.00
|
50,000
|
$
7.00
|
|||||
|
From
$8.61 to $9.00
|
571,500
|
8.2
|
$
8.71
|
120,300
|
$
8.72
|
|||||
|
From
$9.60 to $9.82
|
261,200
|
1.0
|
$
9.82
|
160,240
|
$
9.82
|
|||||
Dividends
The
Company has not paid any cash dividends through June 30, 2007.
8.
MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
The
Company derives a significant portion of its revenues from certain customer
relationships. The following is a summary of customers that represent greater
than ten percent of total revenues for their respective time
periods:
|
|
Three
Months Ended
June
30, 2007
|
|||||||||
|
|
Revenues
|
%
of Total
Revenues
|
||||||||
|
Customer
E
|
Professional
Services
|
$
|
244,478
|
20
|
%
|
|||||
|
Customer
F
|
Subscription
|
$
|
336,295
|
28
|
%
|
|||||
|
Customer
C
|
License
Fees
|
$
|
280,000
|
23
|
%
|
|||||
|
Others
|
Various
|
$
|
343,156
|
29
|
%
|
|||||
|
Total
|
|
$
|
1,203,929
|
100
|
%
|
|||||
|
|
Three
Months Ended
June
30, 2006
|
|||||||||
|
|
Revenues
|
%
of Total
Revenues
|
||||||||
|
Customer
F
|
Subscription
|
$
|
491,463
|
59
|
%
|
|||||
|
Others
|
Various
|
$
|
344,531
|
41
|
%
|
|||||
|
Total
|
|
$
|
835,994
|
100
|
%
|
|||||
|
|
Six
Months Ended
June
30, 2007
|
|||||||||
|
|
Revenues
|
%
of Total
Revenues
|
||||||||
|
Customer
E
|
Professional
Services
|
$
|
426,555
|
20
|
%
|
|||||
|
Customer
F
|
Subscription
|
$
|
648,279
|
30
|
%
|
|||||
|
Customer
C
|
License
Fees
|
$
|
280,000
|
13
|
%
|
|||||
|
Others
|
Various
|
$
|
791,482
|
37
|
%
|
|||||
|
Total
|
|
$
|
2,146,316
|
100
|
%
|
|||||
|
|
Six
Months Ended
June
30, 2006
|
|||||||||
|
|
Revenues
|
%
of Total
Revenues
|
||||||||
|
Customer
E
|
Professional
Services
|
$
|
662,283
|
30
|
%
|
|||||
|
Customer
F
|
Subscription
|
$
|
1,013,273
|
46
|
%
|
|||||
|
Others
|
Various
|
$
|
515,901
|
24
|
%
|
|||||
|
Total
|
|
$
|
2,191,457
|
100
|
%
|
|||||
9.
COMMITMENTS AND CONTINGENCIES
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's common stock based upon the
developer attaining certain milestones. As of June 30, 2007, the Company
has paid $366,667 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 June 30, 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 had engaged in any criminal or fraudulent conduct
with
respect to the Company.
10.
SUBSEQUENT EVENTS
Effective
July 2, 2007, the Company entered into another amendment to the Investor RRA
to
extend the registration effectiveness obligation date to July 31, 2007. If
the
registration statement was not declared effective by July 31, 2007, the Company
was obligated to pay the penalty set forth in Note 7 - “Stockholder’s
Equity,”
above, with the prorated portion to be calculated beginning on July 3,
2007, the effectiveness obligation date under the Investor RRA. The registration
statement filed by the Company was declared effective by the SEC on July 31,
2007, and the Company avoided any obligation to pay the potential
penalty.
On
July
20, 2007, the Company issued 27,427 shares in satisfaction of late registration
penalty obligations to certain investors who did not enter into amendments
to
certain registration rights agreements. These penalties were incurred as a
result of the Company’s failure to timely file a registration statement
including certain shares owned by these investors pursuant to registration
rights agreements between these investors and the Company.
On
July
30, 2007, certain of the Company’s affiliates have also entered into lock-up
agreements covering a portion of their shares (the “Lock-Up Agreements”). These
agreements restrict the sale of 1,296,623 shares of the Company’s common stock.
Under the terms of these Lock-Up Agreements, these affiliates cannot sell,
pledge, grant or otherwise transfer the shares subject to the agreement for
one
year following July 31, 2007. After one year, 2.5% of these shares per quarter
are released from these restrictions on a pro rata basis among these affiliates.
All remaining shares will be released from the Lock-Up Agreements on July 31,
2009. These Lock-Up Agreements will otherwise terminate at the following times:
(A) if the Registration Statement on Form S-1 filed by the Company and declared
effective on July 31, 2007 (the “Registration Statement”) is terminated, the
earlier of (i) the date of termination if no shares were sold, or (ii) the
date
any proceeds received from public investors are placed in the mail for return;
(B) the date the Company’s common stock is listed on a national securities
exchange, or (C) 30 days following the date the persons signing these Lock-Up
Agreements are no longer affiliates.
On
April
3, 2007, the Company originally filed the Registration Statement. As indicated
above, the Registration Statement was declared effective by the SEC on July
31,
2007. A total of 8,707,051 shares of common stock were included on the
Registration Statement.
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Information
set forth in this Quarterly Report on Form 10-Q contains various forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933
and
Section 21E of the Securities Exchange Act of 1934, or the Exchange Act.
Forward-looking statements consist of, among other things, trend analyses,
statements regarding future events, future financial performance, our plan
to
build our business and the related expenses, our anticipated growth, trends
in
our business, the effect of foreign currency exchange rate and interest rate
fluctuations on our business, the potential impact of current litigation or
any
future litigation, the potential availability of tax assets in the future and
related matters, and the sufficiency of our capital resources, all of which
are
based on current expectations, estimates, and forecasts, and the beliefs and
assumptions of our management. Words such as “expect,” “anticipate,” “project,”
“intend,” “plan,” “estimate,” variations of such words, and similar expressions
are also intended to identify such forward-looking statements. 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 below, under “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
We
develop and market Internet-delivered Software-as-a-Service, or SaaS, software
applications and data resources for small businesses. We reach small businesses
through syndication arrangements with other companies that private label our
software applications through their corporate web sites and our own website
at
www.onebiz.com. Our syndication relationships provide a cost and time effective
way to market our products and services to the small business sector. We also
provide solutions to companies developing customized IT applications through
the
licensing of our platforms.
We
currently operate Smart Online in two segments. Those segments are our core
operations, or the Smart Online segment, and the operations of our wholly-owned
subsidiary Smart Commerce, Inc., or the Smart Commerce segment. The Smart Online
segment generates revenues from the development and distribution of
internet-delivered SaaS small business applications through a variety of
subscription, licensing, integration and syndication channels. The Smart
Commerce segment generally generates revenue from subscription fees and
professional services fees related to domain name subscriptions and e-commerce,
networking consulting or network maintenance agreements. 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.
Sources
of Revenue
We
derive
revenues from the following sources:
|
·
|
Subscription
fees - monthly fees charged to end-users for access to our SaaS
applications.
|
|
·
|
License
fees - fees charged for licensing of platforms or applications. Licenses
may be perpetual or for a specific
term.
|
|
·
|
Integration
fees - fees charged to partners to integrate their products into
our
syndication platform.
|
|
·
|
Syndication
fees
|
|
o
|
fees
charged to syndication partners to create a customized private-label
site.
|
|
o
|
barter
revenue derived from syndication agreements with media
companies.
|
|
·
|
Professional
services 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, original equipment manufacturer, or OEM,
contracts and miscellaneous other
revenues.
|
Our
current primary focus is to target established companies that have both a
substantial base of small business customers as well as a recognizable and
trusted brand name. We are also seeking to establish partnerships with smaller
companies catering to the small business customer base that we view as more
ready to adopt new technologies. Our goal is to enter into partnerships with
these 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. In addition, we are also
targeting larger or developing enterprises that are developing a customized
application delivery system or IT solution that might utilize our
OneBiz
SM
or iDSA
platforms as a solution. Such enterprises might wish to use our platform(s)
as
the framework into which they will plug their own or other third-party
application, or they might wish to use all or some of our existing applications.
Such solutions generally would generate licensing and subscription revenue
for
us if the customer desires that our applications be made a part of their
solution.
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 the aggregating entity. We offer new subscribers
a
limited free use period and notify such free users that we will terminate access
it they fail to become paid subscribers within a certain period of time. We
expect lower net subscription fees from subscribers at the private label
syndication websites of our partners than from our main portal since our
syndication agreements require us to share revenue generated from syndication
sites with each respective partner. In the first half of 2007, 98% of our
subscription revenue was generated by our Smart Commerce segment, and the
remaining 2% by our Smart Online segment. As of June 30, 2007, we had an
aggregate of approximately 10,800 subscribers: approximately 10,300 through
our
Smart Commerce segment and approximately 500 through our Smart Online
segment.
Recently,
we began charging our partners a fee for a license to our platforms, where
we
used to include such a license in exchange for only subscription revenue share
and syndication fees, if any. Licensing revenue consists of perpetual or term
license agreements for the use of the Smart Online OneBiz platform, the Smart
Commerce iDSA platform, or any of our applications. Perpetual license revenue
is
typically recorded in the period the license is sold and meets the requirements
of American Institute of Certified Public Accountants Statement of Position
97-2, Software
Revenue Recognition;
specifically, that there is evidence of an arrangement, the product has been
delivered, the fee is fixed and determinable and collection is reasonably
assured. The revenue associated with term licenses is typically recorded over
the period of the license. In the first half of 2007, 100% of our licensing
revenue was generated 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 integration partner to
generate additional traffic to its own website or revenue for its own product
while expanding the range of our products and services. 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 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 generally 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 appropriate 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 the
first
half of 2007 and we expect this decrease to continue through the remaining
fiscal year. In the first half of 2007, 100% of our syndication and integration
revenue was generated by our Smart Online segment.
Professional
services fees are fees generated from consulting services often directly
associated with other projects that 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 the first half
of
2007, 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. In the first
half
of 2007, 63% of our other revenues was generated by our Smart Online and the
remaining 37% was generated by our Smart Commerce segment.
Cost
of Revenues
Cost
of
revenues is primarily composed of salaries associated with maintaining and
supporting integration and syndication partners and
the
cost of external hosting facilities associated with maintaining and supporting
integration and syndication partners. Historically, we do not capitalize any
costs associated with the development of our products and platforms. Statement
of Financial Accounting Standards, or SFAS, No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed,
or SFAS
No. 86, requires capitalization of certain software development costs subsequent
to the establishment of technological feasibility. Based on our 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.
Operating
Expenses
In
previous years, our efforts have been primarily focused on basic product
development and integration. In the fourth quarter of 2006, we shifted our
focus
toward driving subscription revenue while concentrating our development efforts
on enhancements and customization of our proprietary platforms. In the early
part of 2007, we also began to focus on licensing our platform products. As
of
August 13, 2007, we had 61 employees. Most employees perform multiple
functions.
Research
and Development.
Historically, we have not capitalized any costs associated with the development
of our products and platforms. 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 hire additional personnel in both segments to enhance and
customize our platforms and applications.
Sales
and Marketing.
Historically, we have 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. As we begin to grow the number of
subscribers to our products, we expect sales and marketing expense to increase
due to the percentages of revenue we may be required to pay to partners as
marketing fees.
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. We anticipate general and administrative expenses will
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
significantly in 2006 as a result of the suspension of trading of our securities
by the Securities and Exchange Commission, or the SEC, the related SEC
investigation, and the internal investigation of matters relating to that
suspension. Our expenses related to these matters have decreased to an
immaterial amount in the fourth quarter of 2006 and first half of 2007. 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 of 2002.
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 as long as a significant number of options are outstanding.
In
addition, in June 2007, we limited the issuance of awards under our 2004 Equity
Compensation Plan (the “2004 Plan”) to awards of restricted or unrestricted
stock, and do not anticipate any further stock option awards to be granted
under
the 2004 Plan.
Critical
Accounting Policies and Estimates
Our
discussion and analysis of financial condition and results of operations is
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
and sales returns, 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. Management has consistently applied the same critical
accounting policies and estimates which are fully described in our Annual Report
on Form 10-K for the year ended December 31, 2006.
Effective
January 1, 2007, a major customer executed a letter of clarification which
more
definitively defined the roles and responsibilities of each party. Individual
Business Owners, or IBOs, associated with this customer are provided e-commerce,
domain name and email services. In exchange for marketing these services to
its
IBOs, the customer is paid a marketing fee. At the inception of the business
relationship, it was agreed that the customer would collect the gross service
fee from the IBO; the customer would retain its marketing fee and remit the
net
remaining cash. Because the roles and responsibilities of each party were
vaguely defined in the past, revenue was recorded only on the net cash received.
Following the execution of the letter of clarification and in accordance with
Emerging Issues Task Force, or EITF, 99-19, Reporting
Revenue Gross as a Principal versus Net as an Agent,
this
revenue is now recorded as the gross amount paid by the IBO and a sales and
marketing expense for the marketing services rendered by the customer.
Ultimately, the effect on net income is nil; however, subscription revenue
and
sales and marketing expense are effectively and appropriately grossed up.
Because the new accounting method was triggered by a clarification to the
existing agreement and not by a change from one accepted accounting method
to
another, the 2006 subscription revenue was not retroactively adjusted as would
be required by SFAS No. 154,
Accounting Changes and Error Corrections - a replacement of APB Opinion No.
20
and FASB Statement No. 3,
or SFAS
No. 154. For the three months and six months ended June 30, 2007, this
accounting method resulted in approximately $227,000 and $488,000, respectively,
of additional subscription revenue and a corresponding charge to sales and
marketing expense.
The
Company has recently begun to derive revenue from the license of software
platforms along with the sale of associated maintenance, consulting, and
application development. The arrangement may include delivery in
multiple-element arrangements if the customer purchases any combination of
products and/or services. The Company uses the residual method pursuant to
American Institute of Certified Public Accountants, or the AICPA, Statement
of
Position 97-2, Software Revenue Recognition, or SOP 97-2, as amended. This
method allows Smart Online to recognize revenue for delivered elements when
such
element has vendor specific objective evidence, or VSOE, of the fair value
of
the delivered element. If VSOE can not be determined or maintained for an
element, it could impact revenues as all or a portion of the revenue from the
multiple-element arrangement may need to be deferred.
If
multiple-element arrangements involve significant development, modification
or
customization or if it is determined that certain elements are essential to
the
functionality of other elements within the arrangement, revenue is deferred
until all elements necessary to the functionality are provided. The
determination of whether the arrangement involved significant development,
modification or customization could be complex and require the use of
judgment.
The
amount of revenue to be recognized from development and consulting services
is
typically based on the amount of work performed within a given period. This
is
typically based on estimates involving total costs to complete and the stage
of
completion. The assumptions and estimates made to determine such figures may
affect the timing of revenue recognition. Changes in estimates of progress
to
completion and costs to complete are accounted for as cumulative catch-up
adjustments.
Under
SOP
97-2, provided the arrangement does not require significant development,
modification or customization, revenue is recognized when all of the following
criteria have been met:
|
1.
|
persuasive
evidence of an arrangement exists.
|
|
2.
|
delivery
has occurred.
|
|
3.
|
the
fee is fixed or determinable, and
|
|
4.
|
collectibility
is probable.
|
If
at the
inception of an arrangement, the fee is not fixed or determinable, revenue
is
deferred until the arrangement fee becomes due and payable. If collectibility
is
deemed not probable, revenue is deferred until payment is received or collection
becomes probable, whichever is earlier. The determination of whether fees are
collectible requires judgment and the amount and timing of revenue
recognition could change if different assessments had been made. In addition,
payment terms may vary and could be collectible over several months, but not
greater than one year.
Overview
of Results of Operations for the Three Months Ended June 30, 2007 and June
30,
2006
|
|
|
Three
Months Ended
June
30, 2007
|
|
Three
Months Ended
June
30, 2006
|
|
||
|
REVENUES:
|
|
|
|
|
|
|
|
|
Integration
Fees
|
|
$
|
5,000
|
|
$
|
26,667
|
|
|
Syndication
Fees
|
|
|
15,000
|
|
|
57,352
|
|
|
Subscription
Fees
|
|
|
576,600
|
|
|
501,093
|
|
|
Professional
Services Fees
|
|
|
317,900
|
|
|
232,466
|
|
|
License
Fees
|
280,000
|
-
|
|||||
|
Other
Revenue
|
|
|
9,429
|
|
|
18,416
|
|
|
Total
Revenues
|
|
|
1,203,929
|
|
|
835,994
|
|
|
|
|
|
|
|
|
|
|
|
COST
OF REVENUES
|
|
|
111,489
|
|
|
79,100
|
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
1,092,440
|
|
|
756,894
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|
General
and Administrative
|
|
|
1,051,314
|
|
|
1,638,994
|
|
|
Sales
and Marketing
|
|
|
473,668
|
|
|
239,088
|
|
|
Research
and Development
|
|
|
685,915
|
392,824
|
|
||
|
|
|
|
|
||||
|
Total
Operating Expenses
|
|
|
2,210,897
|
2,270,906
|
|
||
|
|
|
|
|
||||
|
LOSS
FROM CONTINUING OPERATIONS
|
|
|
(1,118,457
|
)
|
(1,514,012
|
)
|
|
|
|
|
|
|||||
|
OTHER
INCOME (EXPENSE):
|
|
|
|||||
|
Interest
Expense, Net
|
|
|
(126,759
|
)
|
(64,643
|
)
|
|
|
Gain
on Debt Forgiveness
|
|
|
-
|
144,351
|
|||
|
Other
Income
|
|
|
30,478
|
1,562,500
|
|||
|
|
|
|
|||||
|
Total
Other Income (Expense)
|
|
|
(96,281
|
)
|
1,642,208
|
||
|
NET
INCOME (LOSS) FROM CONTINUING OPERATIONS
|
|
|
(1,214,738
|
)
|
128,196
|
||
|
DISCONTINUED
OPERATIONS
|
|
|
|||||
|
Loss
of Operations of Smart CRM, net of tax
|
|
|
-
|
(156,571
|
)
|
||
|
NET
LOSS
|
|
|
|
||||
|
Net
loss attributed to common stockholders
|
|
$
|
(1,214,738
|
)
|
$
|
(28,375
|
)
|
|
NET
LOSS PER SHARE:
|
|
|
|
|
|
|
|
|
Continuing
Operations
|
|
|
|
||||
|
Basic
and Fully Diluted
|
|
$
|
(0.07
|
)
|
0.01
|
||
|
Discontinued
Operations
|
|
|
|||||
|
Basic
and Fully Diluted
|
|
$
|
-
|
(0.01
|
)
|
||
|
Net
Loss Attributed to Common Stockholders
|
|
|
|||||
|
Basic
and Fully Diluted
|
|
$
|
(0.07
|
)
|
0.00
|
||
|
SHARES
USED IN COMPUTING NET LOSS PER SHARE
|
|
|
|
||||
|
Basic
|
|
|
17,252,639
|
15,096,415
|
|
||
|
Fully
Diluted
|
|
|
17,252,639
|
15,356,015
|
|
||
The
following table shows our consolidated statements of operations data expressed
as a percentage of revenue for the periods indicated:
|
|
|
Three
Months
Ended
June
30,
2007
|
|
Three
Months Ended
June
30,
2006
|
|
||
|
|
|
|
|
|
|
||
|
REVENUES:
|
|
|
|
|
|
|
|
|
Integration
fees
|
|
|
0
|
%
|
|
3
|
%
|
|
Syndication
fees
|
|
|
1
|
%
|
|
7
|
%
|
|
Subscription
fees
|
|
|
49
|
%
|
|
60
|
%
|
|
Professional
services fees
|
|
|
26
|
%
|
|
28
|
%
|
|
License
Fees
|
23
|
%
|
0
|
%
|
|||
|
Other
revenues
|
|
|
1
|
%
|
|
2
|
%
|
|
Total
revenues
|
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
COST
OF REVENUES
|
|
|
9
|
%
|
|
9
|
%
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
91
|
%
|
|
91
|
%
|
|
|
|
|
|
|
|
|
|
|
OPERATING
EXPENSES:
|
|
|
|
|
|
|
|
|
General
and administrative
|
|
|
87
|
%
|
|
196
|
%
|
|
Sales
and marketing
|
|
|
39
|
%
|
|
29
|
%
|
|
Research
and Development
|
|
|
57
|
%
|
|
47
|
%
|
|
|
|
|
|
|
|
|
|
|
Total
operating expenses
|
|
|
183
|
%
|
|
272
|
%
|
|
|
|
|
|
|
|
|
|
|
LOSS
FROM OPERATIONS
|
|
|
(92
|
%)
|
|
(181
|
%)
|
|
|
|
|
|
|
|
|
|
|
OTHER
INCOME (EXPENSE):
|
|
|
|
|
|
|
|
|
Interest
income (expense), net
|
|
|
(11
|
%)
|
|
(8
|
%)
|
|
Other
income
|
|
|
3
|
%
|
|
187
|
%
|
|
Writeoff
of investment
|
|
|
0
|
%
|
|
0
|
%
|
|
Gain
on debt forgiveness
|
|
|
0
|
%
|
|
17
|
%
|
|
DISCONTINUED
OPERATIONS
|
|
|
|
|
|
|
|
|
Loss
of Operations of Smart CRM, net of tax
|
0
|
%
|
(19
|
%)
|
|||
|
|
|
|
|
|
|
|
|
|
NET
INCOME(LOSS)
|
|
|
(100
|
%)
|
|
(4
|
%)0
|
Overview
of Results of Operations of the Three Months Ended June 30,
2007
Total
revenues were $1,204,000 for the second quarter of 2007 compared to $836,000
for
the second quarter of 2006, representing an increase of $368,000, or 44%. Gross
profit increased $335,000 or 44% to $1,092,000 from $757,000. Operating expenses
decreased $60,000 or 3% to $2,211,000 from $2,271,000. Loss from continuing
operations narrowed to $1,118,000 from $1,514,000, a decrease of $396,000 or
26%, while net loss from continuing operations widened by $1,343,000 from a
gain
of $128,000 to a loss of $1,215,000. Net loss attributed to common stockholders
for the three months ended June 30, 2007 increased $1,186,000 to $1,215,000
from
$28,000. The net loss for the three months ended June 30, 2006 included other
non-cash income of $1,562,500 related to the takeback of certain investor
relation shares.
Comparison
of the Results of Operations for the Three Months Ended June 30, 2007 and June
30, 2006
Revenue.
Total
revenues were $1,204,000 for the second quarter of 2007 compared to $836,000
for
the second quarter of 2006
representing
an increase of $368,000 or 44%. This increase is primarily attributable to
increases in revenue from license fees of $280,000, subscription fees of $76,000
and professional fees of $86,000, which were offset by decreases in integration
revenue of $22,000 and other revenues of $9,000.
Revenues
from license fees increased to $280,000 for the second quarter of 2007 from
$0
for the second quarter of 2006, and represented 23% of our consolidated revenue
for the second quarter of 2007. This increase is attributable to there being
one
platform license sale in our Smart Online segment in the second quarter of
2007
as compared to none for the same period in 2006.
Subscription
revenues increased $76,000, or 15%, to $577,000 for the second quarter of 2007
from $501,000 for the second quarter of 2006. This increase was due to
approximately $227,000 of additional revenue recorded in the three months ended
June 30, 2007 due to our adoption of gross revenue reporting. As discussed
above, certain subscription revenues that were recorded net for the three months
ended June 30, 2006 were recorded as gross for the three months ended June
30,
2007. Because the new accounting method was triggered by a clarification to
an
existing agreement and not by a change from one accepted accounting method
to
another, the 2006 subscription revenues were not retroactively adjusted as
would
be required by SFAS No. 154. Therefore, subscription revenues for the three
months ended June 30, 2007 are not recorded in the same manner as subscription
revenues for the three months ended June 30, 2006.
Had
revenue from this customer been recognized net (making it comparable to the
three months ended June 30, 2006), subscription revenues for the three months
ended June 30, 2007 would have been approximately $349,000 as compared to
approximately $501,000 in the same period of 2006. The decrease of approximately
$152,000, or 30%, is related to the decrease in volume related to the 2006
restructuring of a major customer of the Smart Commerce segment which has been
partially offset by the addition of new customers from new partners.
Revenues
from professional services fees, all of which are derived from our Smart
Commerce segment, increased $86,000, or 37%, to $318,000 for the second quarter
of 2007 from $232,000 for the second quarter of 2006. This increase was
attributable to the addition of one new customer as well as additional services
being provided to one existing customer.
Integration
revenues decreased $22,000, or 81%, to $5,000 for the second quarter of 2007
as
compared to $27,000 for the same period in 2006. The 2007 and 2006 periods
also
included $0 and $5,000 of revenue derived from barter transactions,
respectively. Almost all integration contract revenue was recognized by the
end
of 2006 and no new integration agreements have been entered at this time. As
we
have shifted our focus to growing subscription and license revenue, we have
not
sought any new or additional integration partners.
Syndication
revenues decreased $42,000, or 74%, to $15,000 for the second quarter of 2007
as
compared to $57,000 for the same period in 2006. In the past, we have sought
and
received syndication fees as part of our contracts with partners to set up
private label websites. Currently, as part of our efforts to increase the number
of subscribers to our services through these partnerships, we are no longer
seeking contracts which include such syndication fees and are focusing on
increasing subscription revenues from end subscribers. The $15,000 of recognized
syndication revenues in the second quarter of 2007 relates to a monthly hosting
fee in the amount of $5,000 from one syndication partner.
Other
revenue decreased $9,000, or 50%, to $9,000 for the second quarter of 2007
as
compared to $18,000 for the same period in 2006. This revenue is generated
from
non-core activities such as sales of shrink-wrapped products, OEM contracts
and
miscellaneous other revenues.
Cost
of Revenues
Cost
of
revenues increased $32,000, or 41%, to $111,000 in the second quarter of 2007
from $79,000 in the second quarter 2006, primarily as a result of increased
hosting costs at our Smart Commerce segment related to hosting for additional
customers, which resulted in an increase in cost of revenues of approximately
$30,000.
Operating
Expenses
Operating
expenses decreased $60,000, or 3%, to $2,211,000 for the second quarter of
2007
from $2,271,000 during the second quarter of 2006. This decrease was primarily
due to a decrease in general and administrative expenses of approximately
$588,000. This decrease was offset by an increase in sales and marketing
expenses of approximately $235,000 and an increase in research and development
expenses of approximately $293,000.
General
and Administrative
-
General and administrative expenses decreased by $588,000, or 36%,
to $1,051,000 for the second quarter of 2007 from $1,639,000 in the same
quarter of 2006. This decrease was primarily due to a reduction of $393,000
in
legal fees as the second quarter of 2006, which included legal expense related
to the SEC matter and our own internal investigation. Compensation expense
required by SFAS No. 123R decreased $32,000 from the prior period as there
have
been minimal options granted from the second quarter of 2006 through the end
of
the second quarter of 2007, and the number of expirations exceeded
the
grants.
In addition, wage expense in the Smart Online segment decreased $20,000 from
the
prior period as certain officers agreed to have their salaries reduced for
a
limited period, registration right penalties decreased $121,000 as we
reached agreements with certain stockholders regarding penalties in the first
half of 2007, and the amount of interest associated with the iMart Incorporated,
or iMart, purchase price agreement decreased in the amount of $50,000 as the
purchase price was paid in full during the first quarter of 2007. Travel expense
decreased $17,000 and rent expense decreased $15,000 in the Smart Online
segment.
We
are
currently disputing our insurance carrier's refusal to cover certain legal
expenses related to the SEC matter. We contend that these legal expenses should
be reimbursed by our insurance carrier. Because the outcome of this dispute
is
unclear, we have expensed all legal costs incurred and we will account for
any
insurance reimbursement, should there be any, in the period such amounts are
reimbursed.
Sales
and Marketing
- Sales
and marketing expense increased to $474,000 in the second quarter of 2007 from
$239,000 in the second quarter of 2006, an increase of $235,000, or
98%. As
detailed in the Revenue section above, in the Smart Commerce segment, there
was
approximately $227,000 of additional revenue recorded in the three months ended
June 30, 2007 due to our adoption of gross revenue reporting. A corresponding
increase in sales and marketing expense of $227,000 was recorded in association
with the new gross accounting method.
Research
and Development
-
Research and development expense increased to $686,000 in the second quarter
of
2007 from $393,000 in the second quarter of 2006, an increase of approximately
$293,000, or 75%. This increase primarily is due to increased expenses from
the
Smart Online segment, including increases of $116,000 in consulting expense
for
our accounting application, $105,000 for wages for additional staffing, and
moving expenses of $6,000 associated with the relocation of employees from
the
Smart Commerce segment’s out of state office. In addition, the Smart Commerce
segment incurred approximately $55,000 of additional wages with the hiring
of
new research and development personnel to implement new partnership signings.
We
expect research and development expenses to increase during the last half of
2007 as a result of anticipated hiring of additional research and development
personnel for both the Smart Online and Smart Commerce segments to enhance
and
customize our platforms and applications.
Other
Income (Expense)
We
incurred net interest expense of $127,000 during the second quarter of 2007
and
$65,000 of net interest expense during the second quarter of 2006. Interest
expense increased as a direct result of the notes payable related to the iMart
and Computility, Inc., or Computility, acquisitions, including notes related
to
non-compete agreements. Additionally, interest expense of approximately $32,000
was incurred during the second quarter of 2007 on our revolving line of credit
with Wachovia Bank, NA, or Wachovia. Second quarter 2007 interest income
totaling $55,000 was earned on money market account deposits compared to $2,000
earned for the same period in 2006. The second quarter 2007 interest income
increase was attributable to the interest earned on the cash proceeds of the
February 2007 private placement described in Note 7, “Stockholders’ Equity,” to
the consolidated financial statements in this report.
We
realized a gain of $0 during the second quarter of 2007 from negotiated and
contractual releases of outstanding liabilities compared to $144,000 gain from
debt forgiveness in the second quarter of 2006.
One
of
the assets purchased as part of the iMart acquisition was a $25,000 investment
in a privately held company that was a customer of iMart's. Management
determined that it is likely that such investment is currently worthless, so
the
entire $25,000 investment had been written off in the second quarter of 2006.
Also in the second quarter of 2006, we reserved 100% of the approximately
$65,000 of the accounts receivable due from that customer. We did not have
similar expenses in the second quarter of 2007.
Overview
of Results of Operation for the Six Months Ended June 30, 2007 and
2006
|
|
|
Six
Months Ended
June
30, 2007
|
|
Six
Months Ended
June
30, 2006
|
|
||
|
REVENUES:
|
|
|
|
|
|
|
|
|
Integration
Fees
|
|
$
|
5,000
|
|
$
|
176,410
|
|
|
Syndication
Fees
|
30,000
|
126,267
|
|
||||
|
Subscription
Fees
|
1,209,583
|
1,046,767
|
|
||||
|
Professional
Services Fees
|
606,479
|
464,201
|
|
||||
|
License
Fees
|
280,000
|
337,500
|
|||||
|
Other
Revenue
|
15,254
|
40,312
|
|
||||
|
Total
Revenues
|
2,146,316
|
2,191,457
|
|
||||
|
|
|
||||||
|
COST
OF REVENUES
|
187,909
|
181,204
|
|
||||
|
|
|
||||||
|
GROSS
PROFIT
|
1,958,407
|
2,010,253
|
|
||||
|
|
|
||||||
|
OPERATING
EXPENSES:
|
|
||||||
|
General
and Administrative
|
2,164,005
|
3,629,098
|
|
||||
|
Sales
and Marketing
|
942,915
|
531,912
|
|
||||
|
Research
and Development
|
1,262,610
|
823,201
|
|
||||
|
Total
Operating Expenses
|
|
|
4,369,530
|
4,984,211
|
|
||
|
|
|
|
|||||
|
LOSS
FROM CONTINUING OPERATIONS
|
|
|
(2,411,123
|
)
|
(2,973,958
|
)
|
|
|
|
|
|
|||||
|
OTHER
INCOME (EXPENSE):
|
|
|
|||||
|
Interest
Expense, Net
|
|
|
(261,787
|
)
|
(139,056
|
)
|
|
|
Gain
on Debt Forgiveness
|
|
|
4,600
|
144,351
|
|||
|
Writeoff
of Investment
|
|
|
-
|
(25,000
|
)
|
||
|
Other
Income
|
|
|
143,808
|
1,562,500
|
|||
|
Total
Other Income (Expense)
|
|
|
(113,379
|
)
|
1,542,795
|
||
|
NET
LOSS FROM CONTINUING OPERATIONS
|
|
|
(2,524,502
|
)
|
(1,431,163
|
)
|
|
|
DISCONTINUED
OPERATIONS
|
|
|
|||||
|
Loss
of Operations of Smart CRM, net of tax
|
|
|
-
|
(196,135
|
)
|
||
|
NET
LOSS
|
|
|
|
|
|
|
|
|
Net
loss attributed to common stockholders
|
|
$
|
(2,524,502
|
)
|
$
|
(1,627,298
|
)
|
|
NET
LOSS PER SHARE:
|
|
|
|
|
|
|
|
|
Continuing
Operations
|
|
|
|
||||
|
Basic
and Fully Diluted
|
|
$
|
(0.15
|
)
|
(0.10
|
)
|
|
|
Discontinued
Operations
|
|
|
|||||
|
Basic
and Fully Diluted
|
|
$
|
-
|
(0.01
|
)
|
||
|
Net
Loss Attributed to Common Stockholders
|
|
|
|||||
|
Basic
and Fully Diluted
|
|
$
|
(0.15
|
)
|
(0.11
|
)
|
|
|
SHARES
USED IN COMPUTING NET LOSS PER SHARE
|
|
|
|
||||
|
Basic
and Fully Diluted
|
|
|
16,728,010
|
15,052,205
|
|
||
The
following table shows our consolidated statements of operations data expressed
as a percentage of revenue for the periods indicated:
|
|
|
Six
Months
Ended
June
30,
2007
|
|
Six
Months Ended
June
30,
2006
|
|
||
|
|
|
|
|
|
|
||
|
REVENUES:
|
|
|
|
|
|
|
|
|
Integration
fees
|
|
|
0
|
%
|
|
8
|
%
|
|
Syndication
fees
|
|
|
1
|
%
|
|
6
|
%
|
|
Subscription
fees
|
|
|
57
|
%
|
|
48
|
%
|
|
Professional
services fees
|
|
|
28
|
%
|
|
21
|
%
|
|
License
fees
|
|
|
13
|
%
|
|
15
|
%
|
|
Other
revenues
|
|
|
1
|
%
|
|
2
|
%
|
|
Total
revenues
|
|
|
100
|
%
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
COST
OF REVENUES
|
|
|
9
|
%
|
|
8
|
%
|
|
|
|
|
|
|
|
|
|
|
GROSS
PROFIT
|
|
|
91
|
%
|
|
92
|
%
|
|
|
|
|
|
|
|
||
|
OPERATING
EXPENSES:
|
|
|
|
|
|
||
|
General
and administrative
|
|
|
101
|
%
|
|
166
|
%
|
|
Sales
and marketing
|
|
|
44
|
%
|
|
24
|
%
|
|
Development
|
|
|
59
|
%
|
|
38
|
%
|
|
|
|
|
|
|
|
||
|
Total
operating expenses
|
|
|
204
|
%
|
|
228
|
%
|
|
|
|
|
|
|
|
||
|
LOSS
FROM OPERATIONS
|
|
|
(113
|
%)
|
|
(136
|
%)
|
|
|
|
|
|
|
|
||
|
OTHER
INCOME (EXPENSE):
|
|
|
|
|
|
||
|
Interest
income (expense), net
|
|
|
(12
|
%)
|
|
(6
|
%)
|
|
Other
income
|
|
|
6
|
%
|
|
71
|
%
|
|
Writeoff
of investment
|
|
|
0
|
%
|
|
(1
|
%)
|
|
Gain
on debt forgiveness
|
|
|
0
|
%
|
|
7
|
%
|
|
DISCONTINUED
OPERATIONS
|
|
|
|
|
|
||
|
Loss
of Operations of Smart CRM, net of tax
|
0
|
%
|
(9
|
%)
|
|||
|
|
|
|
|
|
|
||
|
NET
INCOME
|
|
|
|
|
|
||
|
(Loss)
|
|
|
(119
|
%)
|
|
(74
|
%)
|
Overview
of Results of Operations for the Six Months Ended June 30,
2007
Total
revenues were $2,146,000 for the six months ended June 30, 2007 compared to
$2,191,000 for the six months ended June 30, 2006, representing a decrease
of
$45,000, or 2%. Gross profit decreased $52,000, or 3%, to $1,958,000 from
$2,010,000. Operating expenses decreased $614,000 or 12% to $4,370,000 from
$4,984,000. Loss from continuing operations narrowed by $563,000, or 19%, to
$2,411,000 from $2,974,000 while net loss from continuing operations widened
by
$1,094,000, or 76%, to $2,525,000 from $1,431,000. Net loss attributable to
common stockholders for the six months ended June 30, 2007 increased $898,000,
or 55%, to $2,525,000 from $1,627,000. The net loss for the six months ended
June 30, 2006 included other non-cash income of $1,562,500 related to the
takeback of certain investor relation shares.
Comparison
of the Results of Operations for the Six Months Ended June 30, 2007 and June
30,
2006
Revenue.
Total
revenues were $2,146,000 for the first half 2007 compared to $2,191,000 for
the
first half of 2006, representing a decrease of $45,000, or 2%. This decrease
is
primarily attributable to decreases in integration revenue of $171,000,
syndication revenue of $96,000, license fees of 58,000, and other revenues
of
$25,000, which were offset by increases in subscription fees of $163,000 and
professional services fees of $142,000.
Revenues
from license fees decreased by $58,000, or 17%, to $280,000 for the first half
of 2007 from $338,000 for the first half of 2006, representing 15% of our
consolidated revenue for the second half of 2007. This decrease is attributable
to there being one smaller platform license sale (from the Smart Online segment)
in the first half of 2007 as compared to one license sale (in the Smart Commerce
segment) for the same period in 2006.
Subscription
revenues increased $163,000, or 16%, to $1,210,000 for the six months ended
June
30, 2007 from $1,047,000 for the six months ended June 30, 2006. This increase
was due to approximately $488,000 of additional revenue recorded in the six
months ended June 30, 2007 due to our adoption of gross revenue reporting offset
by a decrease of approximately $326,000 related to the restructuring at one
of
our customers. As discussed above, certain subscription revenues that were
recorded net for the six months ended June 30, 2006 were recorded gross for
the
six months ended June 30, 2007. Because the new accounting method was triggered
by a clarification to an existing agreement and not by a change from one
accepted accounting method to another, the 2006 subscription revenues were
not
retroactively adjusted as would be required by SFAS No. 154.
Therefore, subscription revenues for the six months ended June 30, 2007 are
not
recorded in the same manner as subscription revenues for the six months ended
June 30, 2006. Had revenue from this customer been recognized net (making it
comparable to the six months ended June 30, 2006), subscription revenues for
the
six months ended June 30, 2007 would have been approximately $721,000 as
compared to approximately $1,047,000 in the same period of 2006. The decrease
of
approximately $326,000, or 31%, is related to the decrease in volume related
to
the 2006 restructuring of a major customer, which has been partially offset
by
the addition of new customers from new partners.
Revenues
from professional services fees, all of which are derived from our Smart
Commerce segment, increased to $606,000 for the six months ended June 30, 2007
from $464,000 for the six months ended June 30, 2006. This increase was
attributable to the addition of one new customer as well as additional services
being provided to one existing customer.
Integration
revenues decreased $171,000, or 97%, to $5,000 for the six months ended June
30,
2007 as compared to $176,000 for the same period in 2006. The 2007 and 2006
periods also included $0 and $5,000 of revenue derived from barter transactions,
respectively. Almost all integration contract revenue was recognized by the
end
of 2006 and no new integration agreements have been entered at this time. As
we
have shifted our focus to growing subscription revenue, we have not sought
any
new or additional integration partners.
Syndication
revenues decreased $96,000, or 76%, to $30,000 for the six months ended June
30,
2007 as compared to $126,000 for the same period in 2006. In the past, we have
sought and received syndication fees as part of our contracts with partners
to
set up private label websites. Currently, as part of our efforts to increase
the
number of subscribers to our services through these partnerships, we are no
longer seeking contracts which include such revenues and are focusing on
increasing subscription revenues. The $30,000 of recognized syndication revenues
in the six months ended June 30, 2007 relates to a monthly hosting fee in the
amount of $5,000 from one syndication partner.
Other
revenue was approximately $15,000 for the six months ended June 30, 2007 as
compared to $40,000 for the comparable period in 2006. Other revenue relates
primarily to smaller OEM contracts and other miscellaneous
revenues.
Cost
of Revenues
Cost
of
revenues increased $7,000, or 4%, to $188,000 in the six months ended June
30,
2007, from $181,000 in the comparable period in 2006, primarily as a result
of
increased hosting costs at our Smart Commerce segment related to hosting for
additional customers, which resulted in an increase in cost of revenues of
approximately $30,000. The majority of this increase was offset by an overall
reduction of personnel at the Smart Commerce segment.
Operating
Expenses
Operating
expenses decreased $614,000, or 12%, to $4,370,000 for the six months ended
June
30, 2007 from $4,984,000 for the six months ended June 30, 2006. This decrease
was primarily due to a decrease in general and administrative expenses of
approximately $1,465,000. This decrease was offset by an increase in sales
and
marketing expenses of approximately $411,000 and an increase in research and
development expenses of approximately $440,000.
General
and Administrative
-
General and administrative expenses decreased by $1,465,000 or 40%
to $2,164,000 for the six months ended June 30, 2007 from $3,629,000 in the
same period of 2006. This decrease was primarily due to a reduction of $869,000
in legal fees as the six months ended June 30, 2006 included legal expense
related to the SEC matter and our own internal investigation. Compensation
expense required by SFAS No. 123R decreased $115,000 from the prior period
as
there have been minimal options
granted
from the six months ended June 30, 2006 through the end of the six months ended
June 30, 2007, and the number of expirations exceeded the grants. General and
administrative wage expense decreased $83,000 from the prior period related
to
the elimination of non-essential positions. Registration right penalties
decreased $206,000 as certain stockholders settled in the six months ended
June
30, 2007 and no additional penalties were accrued for those individuals.
Accounting expense was reduced by approximately $124,000 in the first half
of
2007 as compared to the same period in 2006 through the hiring of a full-time
Chief Financial Officer and the elimination of using outside firms to provide
those services. In the six months ended June 30, 2006, general and
administrative expenses also included $51,000 for market research on our
securities and $23,000 for recruiting our current Chief Financial Officer,
and
we did not have similar expenses in the six months ended June 30,
2007.
We
are
currently disputing our insurance carrier's refusal to cover certain legal
expenses related to the SEC matter. We contend that these legal expenses should
be reimbursed by our insurance carrier. Because the outcome of this dispute
is
unclear, we have expensed all legal costs incurred and we will account for
any
insurance reimbursement, should there be any, in the period such amounts are
reimbursed.
Sales
and Marketing
- Sales
and marketing expense was $943,000 for the six months ended June 30, 2007 from
$532,000 in the six months ended June 30, 2006, an increase of $411,000, or
77%.
As
detailed in the Revenue section above, due to our adoption of gross revenue
reporting, for the six months ended June 30, 2007, we recorded approximately
$488,000 of additional revenue and an equivalent increase in sales and marketing
expense. This increase was offset by several decreases in sales and marketing
expense in the Smart Online segment, including a $38,000 reduction in barter
advertising expense and a $50,000 decrease in revenue share expense, as we
paid
our partners a fee in the six months ended June 30, 2006 for a syndication
contract and had no similar expense in the six months ended June 30,
2007.
Generally,
we expect we will have to increase sales and marketing expenses before we can
substantially increase our revenue from sales of subscriptions. We have
increased investment in sales and marketing by increasing the number of direct
sales personnel and increasing penetration within our existing customer base,
expanding our domestic selling and marketing activities, building brand
awareness and participating in additional marketing programs, and we are
planning to continue to increase these investments.
Research
and Development
-
Research and development expense increased to $1,263,000 in the six months
ended
June 30, 2007 from $823,000 in the six months ended June 30, 2006, an increase
of approximately $440,000, or 53%. This increase is due to several factors
in
the Smart Online segment, including increases of $226,000 in consulting expense
for our accounting application and an increase of $122,000 for wages for
additional staffing. At our Smart Commerce segment, our research and development
wages increased by approximately $100,000 and our consulting expense increased
by approximately $31,000 related to additional staff and support required to
accommodate our new customers.
Other
Income (Expense)
We
incurred net interest expense of $262,000 during the six months ended June
30,
2007 and $139,000 of net interest expense during the six months ended June
30,
2006. Interest expense increased as a direct result of approximately $207,000
of
interest expense related to the amortization of deferred financing costs of
the
warrants issued to Atlas Capital, S.A., or Atlas. Additionally, interest expense
of approximately $59,000 was incurred during the six months ended June 30,
2007
on our revolving line of credit with Wachovia and $77,000 of interest expense
related to the Smart Commerce loan with Fifth Third Bank. Interest income for
our Smart Online segment totaling $80,000 was earned on money market account
deposits compared to $5,000 earned for the same period in 2006. The first half
of 2007 interest income increase was attributable to the interest earned on
the
cash proceeds of the February 2007 private placement described in Note 7,
“Stockholders’ Equity,” to the consolidated financial statements in this report
under Item 2, Unregistered Sales of Equity Securities and Use of
Proceeds.
We
realized a gain of $5,000 during the six months ended June 30, 2007 from
negotiated and contractual releases of outstanding liabilities as compared
to
$144,000 in the six months ended June 30, 2006.
One
of
the assets purchased as part of the iMart acquisition was a $25,000 investment
in a privately held company that was a customer of iMart's. Management
determined that it is likely that such investment is currently worthless, so
the
entire $25,000 investment had been written off in the six months ended June
30,
2006. Also in the six months ended June 30, 2006, we reserved for 100% of the
approximately $65,000 of the accounts receivable due from that customer. We
did
not have similar expenses in the six months ended June 30, 2007.
Provision
for Income Taxes
We
have
not recorded a provision for income tax expense because we have been generating
net losses. Furthermore, we have not recorded an income tax benefit for the
second quarter of 2007 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. We have approximately
$35,000,000
in net operating loss carryforwards, which may be utilized to offset future
taxable income.
Liquidity
and Capital Resources
At
June
30, 2007, our principal sources of liquidity were unrestricted cash and cash
equivalents totaling $3,628,000 and accounts receivable of $934,000. As of
August 10, 2007, our principal sources of liquidity were cash and cash
equivalents totaling approximately $3,727,000 and accounts receivable of
approximately $812,000.
However,
$250,000 of our cash is restricted under the loan agreement with Fifth Third
Bank. 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 we meet certain debt covenants regarding
operating metrics for Smart Commerce. Those operating metrics relate to Smart
Commerce’s actual results of operations as compared to certain projections
provided to Fifth Third Bank at the inception of the loan. Meeting or failing
to
meet those metrics relate only to the release of cash as described above.
Failure to meet these metrics does not, however, result in an acceleration
of
the debt. Fifth Third Bank is currently evaluating the June 30, 2007 results
to
make a determination regarding the scheduled cash release. As of June 30, 2007,
we have drawn approximately $2.1 million of our $2.5 million line of credit,
leaving approximately $400,000 available for our operations.
At
June
30, 2007, we had working capital of approximately $2.2 million.
Cash
Flow from Operations.
Cash
flows used in operations for the six months ended June 30, 2007 totaled
$2,182,000, up from $1,353,000 for the six months ended June 30, 2006. This
increase was primarily due to increased accounts receivable as well as the
loss
of cash flow from discontinued operations.
Cash
Flow from Financing Activity.
For the
six months ended June 30, 2007, we generated a total of $5,538,000 net cash
from
our financing activities, up from $869,000 for the six months ended June 30,
2006. This net cash was generated through both equity and debt financing, as
described below.
Equity
Financing.
In a
transaction that closed on February 21, 2007, we sold an aggregate of 2,352,941
shares of our common stock to two new investors, or the Investors. The private
placement shares were sold at $2.55 per share pursuant to a Securities Purchase
Agreement, or the SPA, between us and each of the Investors. The aggregate
gross
proceeds were $6 million, and we incurred issuance costs of approximately
$637,000 as of July 30, 2007. These costs were higher than the $585,000
originally anticipated due to state securities law filing requirements along
with the associated legal fees. 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.
Debt
Financing.
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. 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 certain debt covenants regarding
operating metrics for Smart Commerce are met. Those operating metrics relate
to
Smart Commerce’s actual results of operations as compared to certain projections
provided to Fifth Third Bank at the inception of the loan. Meeting or failing
to
meet those metrics relate only to the release of cash as described above.
Failure to meet these metrics does not, however, result in an acceleration
of
the debt. Fifth Third Bank is currently evaluating the June 30, 2007 results
to
make a determination regarding the scheduled cash release. As of August 10,
2007, our outstanding principal balance on this debt was approximately
$1,200,000.
On
November 14, 2006, we entered into a revolving credit arrangement with Wachovia,
or the line of credit, for $1.3 million which can be used for general working
capital. Any advances made on the line of credit were 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. Interest accrues on the
unpaid principal balance at the LIBOR Market Index Rate plus 0.9%. On January
24, 2007, we entered into an amendment to the line of credit. The amendment
resulted in an increase in the line of credit from $1.3 million to $2.5 million.
The pay-off date was also extended from August 1, 2007 to August 1, 2008. The
line of credit is secured by our deposit account at Wachovia and an irrevocable
standby letter of credit in the amount of $2,500,000 issued by HSBC Private
Bank
(Suisse) S.A. with Atlas as account party. Atlas and we have separately agreed
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. 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. As of August 10, 2007, we have drawn down approximately $2.1 million
on the line of credit.
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 11 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.
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. At June 30,
2007, our unrestricted cash was $3,628,000. 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 6, “Notes Payable,” to the consolidated financial
statements). At June 30, 2007, the outstanding principal balance on these loans
was $1,275,000 and $2,052,000, 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.
Not
applicable.
As
required by paragraph (b) of Rule 13a-15 under the Exchange Act, an evaluation
was carried out under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of our disclosure controls and procedures (as defined
in
Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period
covered by this Quarterly Report. As defined in Rule 13a-15(e) and 15d-15(e)
under the Exchange Act, the term disclosure controls and procedures means
controls and other procedures of an issuer that are designed to ensure that
information required to be disclosed by the issuer in the reports that it files
or submits under the Exchange Act is recorded, processed, summarized and
reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by
an
issuer in the reports that it files or submits under the Exchange Act is
accumulated and communicated to the issuer's management, including its principal
executive and principal financial officers, or persons performing similar
functions, as appropriate to allow timely decisions regarding required
disclosure.
Based
on
their evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this Quarterly Report,
our disclosure controls and procedures were not effective because of significant
deficiencies in our internal control over financial reporting that we are in
the
process of remediating. Management first identified and reported on these
significant deficiencies and related changes to our internal controls under
Item
9A of Part II of our Annual Report on Form 10-K for the fiscal year ending
December 31, 2005, and provided an update regarding the implementation of the
new internal controls in our 2006 Annual Report. While management believes
those
controls effectively mitigate those significant deficiencies, we have not
completed our testing of all of these control changes and therefore cannot
conclude on their effectiveness. See “Changes in Internal Control Over Financial
Reporting” below for a more detailed description of the status of these internal
control changes.
Changes
to Internal Control Over Financial Reporting
There
have been no changes in our internal control over financial reporting that
occurred during the second quarter of fiscal 2007 that have materially affected,
or are reasonably likely to materially affect, our internal control 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, and
as
updated in our Annual Report on Form 10-K for the fiscayl year ending December
31, 2006, filed with the SEC on March 30, 2007, we have continued to test
internal controls added 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. In July 2006, the Audit
Committee
concluded that: (i) our Chief Executive Officer should have disclosed and sought
approval from the Board of Directors before entering into certain transactions
and arrangements, including personal loans; (ii) there was inadequate diligence
by management and the Board of Directors regarding third parties with which
we
contracted, including outside investor relations vendors, some of which were
registered brokers; (iii) management and our directors lacked sufficient
knowledge regarding rules and regulations with respect to dealings between
registered brokers and public companies, (iv) we lack clear policies regarding
the limits on the Chief Executive Officer’s authority to enter into business
transactions and agreements without Board approval; (v) there has been
inadequate legal and accounting review of material contracts; (vi) there has
been inadequate training and understanding of SEC disclosure requirements;
(vii)
there was an unintentional violation of our Securities Trading Policy by one
of
our directors as previously reported in our public filings; (viii) we have
inadequate processes for determination of independence of Board members; and
(ix) there has been a failure to communicate and stress the importance of
controls and procedures throughout our organization. The Audit Committee
investigation concluded that these deficiencies primarily resulted from our
transition from a private company to a publicly reporting company and
insufficient preparation for, focus on, and experience with compliance
requirements for a publicly reporting company
As
a
result of the findings of the Audit Committee investigation, we made the
following changes to our internal controls:
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1.
|
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
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2.
|
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.
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3.
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Our
Chief Financial Officer has been involved in communications with
investment professionals, including analysts, brokers and potential
institutional investors.
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4.
|
Our
Chief Financial Officer has been given direct reporting responsibility
to
the Audit Committee with respect to any such
communications.
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5.
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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.
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6.
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Our
outside counsel has provided periodic educational training for management
and directors by outside legal counsel and other appropriate professional
advisors.
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7.
|
We
have adopted a revised Securities Trading
Policy.
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8.
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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.
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9.
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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.
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10.
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We
entered into a contract with Ethical Advocates, Inc. for confidential
and
anonymous incident reporting.
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11.
|
Multiple
control systems have been put in place to review checks paid to officers
and directors in excess of $2,500.
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12.
|
We
now have three members of our Board who are members of the National
Association of Corporate Directors
(“NACD”).
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Of
the
changes to our internal controls listed above, we continue to test the changes
numbered 6, 7 and 9 for their effectiveness. All of the other changes have
been
tested and found effective as of the end of the second quarter of fiscal 2007.
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.
During
the three months ended June 30, 2007, there were no material developments in
the
legal proceedings previously reported in our 2006 Annual Report. Please refer
to
Part I, Item 3 of our 2006 Annual Report for additional
information.
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, which 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:
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·
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Our
Financial Condition
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·
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Our
Products and Operations
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·
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Our
Market, Customers and Partners
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·
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Our
Officers, Directors, Employees and
Stockholders
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·
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Regulatory
Matters that Affect Our Business
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·
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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 continue to have
negative cashflows. If we do not rectify these deficiencies through additional
financing or growth, we may have to cease operations and liquidate our
business.
Through
June 30, 2007, we have lost an aggregate of approximately $59.9 million since
inception on August 10, 1993. During the quarters ended June 30, 2007 and 2006,
we incurred a net loss of approximately $1,200,000 and $28,000, respectively.
At
June 30, 2007, we had $2.6 million of working capital. 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 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, the timing and success of potential strategic
alliances or potential opportunities to acquire technologies or assets, and
the
suspension of trading of shares of our common stock by the SEC, and the
resulting drop in share price, trading volume and liquidity, 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.
(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 entered
into with Atlas in January 2007, it 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. In connection
with
our private financing in February 2007, we issued warrants to the investors
to
purchase an additional 1,176,471 shares of our common stock at $3.00 per share
and a warrant 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.
Depending on the share price we are able to obtain, we may have to sell a
significant number of shares in order 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 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 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. This line of credit is $2.5
million, and as of August 10, 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 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
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:
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·
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increase
our vulnerability to general adverse economic and industry
conditions;
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·
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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;
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·
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limit
our flexibility in planning for, or reacting to, changes in our business
and the industry in which we
operate;
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·
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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;
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·
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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
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·
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limit
our ability to borrow additional funds in the
future.
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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.
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 this business model may become
ineffective due to forces beyond our control that we do not currently
anticipate. In 2007, we have entered into agreements with five new partners.
However, 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 product offerings. There
can be no assurance 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' personal
and
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.
We
have limited acquisition experience, and therefore our ability as an
organization to integrate any acquired companies into our business is unproven.
Acquisitions and investments involve numerous risks, including:
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difficulties
in integrating operations, technologies, services and
personnel;
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·
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diversion
of financial and managerial resources from existing
operations;
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·
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reduction
of available cash;
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·
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risk
of entering new markets;
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·
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potential
write-offs of acquired assets;
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potential
loss of key employees;
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·
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inability
to generate sufficient revenue to offset acquisition or investment
costs;
and
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·
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delays
in customer purchases due to
uncertainty.
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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 was insufficient to cover any of
the
installment payments we have been required to make, and we have had to fund
the
difference. We amended the lock box agreement related to the acquisition in
January 2007, 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.
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 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. Most of our subscribers are in our Smart
Commerce segment. Since the first quarter of 2006, the number of subscribers
to
our software products in our Smart Online segment has 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
July
2007, the decline in the number of subscribers has continued, but has been
offset by an increase in the number of subscribers to our Smart Commerce
segment. However, 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.
(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 40% of total revenues in the second quarter
of
2007 compared to 60% of total revenues in the second quarter of 2006. 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 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
five
new partners and a marketing referral agreement. 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 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,
increase the length of time subscribers pay subscription fees and continue
to
increase the number of subscribers.
(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
signed an agreement with a company in January 2007 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 selling abroad. These
international operations are subject to a number of difficulties and special
costs, including:
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costs
of customization and localization of products for foreign
countries;
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laws
and business practices favoring local
competitors;
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·
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uncertain
regulation of electronic commerce;
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·
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compliance
with multiple, conflicting, and changing governmental laws and
regulations;
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·
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longer
sales cycles; greater difficulty in collecting accounts
receivable;
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·
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import
and export restrictions and
tariffs;
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·
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potentially
weaker protection for our intellectual property than in the United
States,
and practical difficulties in enforcing such rights
abroad;
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·
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difficulties
staffing and managing foreign
operations;
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·
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political
and economic instability.
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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 53% 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 acquirer
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 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 and disclosure requirements, including requirements under the
Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, 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 laws and regulations or significantly increase our costs. Our ability
to
fully comply with these laws and regulations is also uncertain. Our failure
to
prepare timely for and implement the reforms required by these laws and
regulations could significantly harm our business, operating results, and
financial condition. We also expect that these 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. In the past, we have 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.
(15) Remediation
of deficiencies in our internal control over financial reporting is uncertain
and may be expensive.
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 accountant's audit of our internal control over
financial reporting 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. In July 2006, the Audit Committee concluded that: (i) our Chief
Executive Officer should have disclosed and sought approval from the Board
of
Directors before entering into certain transactions and arrangements, including
personal loans; (ii) there was inadequate diligence by management and the Board
of Directors regarding third parties with which we contracted, including outside
investor relations vendors, some of which were registered brokers; (iii)
management and our directors lacked sufficient knowledge regarding rules and
regulations with respect to dealings between registered brokers and public
companies, (iv) we lack clear policies regarding the limits
on
the
Chief Executive Officer's authority to enter into business transactions and
agreements without Board approval; (v) there has been inadequate legal and
accounting review of material contracts; (vi) there has been inadequate training
and understanding of SEC disclosure requirements; (vii) there was an
unintentional violation of our Securities Trading Policy by one of our directors
as previously reported in our public filings; (viii) we have inadequate
processes for determination of independence of Board members; and (ix) there
has
been a failure to communicate and stress the importance of controls and
procedures throughout our organization. The Audit Committee investigation
concluded that these deficiencies primarily resulted from our transition from
a
private company to a publicly reporting company and insufficient preparation
for, focus on, and experience with compliance requirements for a publicly
reporting company. We reported the changes to our internal controls related
to
the Audit Committee's findings in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2005, filed with the SEC on July 11, 2006, as updated
in
our Annual Report on Form 10-K for the fiscal year ended December 31, 2006,
filed with the SEC on March 30, 2007.
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 2007 and our
stock price could decline.
(16) 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 completed a private placement financing for $6 million in February
2007; 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
(17) 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.
(18) 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;
|
|
|
·
|
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;
|
|
|
·
|
subscription
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.
(19) 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.
|
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.
(20) 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
August
10, 2007, 17,927,137 shares of our common stock were issued and outstanding
and
3,857,715 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 the 2004 Plan,
of
which at August 10, 2007, 156,000 shares were outstanding and 1,376,200 shares
are subject to outstanding stock options of the 5,000,000 shares reserved for
issuance under such plan. In June 2007, we limited the issuance of shares of
our
common stock reserved under the 2004 Plan to awards of shares of restricted
and
unrestricted common stock. Also in June 2007, our Board of Directors approved
an
offer for holders of outstanding options with an exercise price of $2.50 per
share or greater to exchange the outstanding options for a certain number of
shares of restricted stock. We target that the restriction on these shares
of
stock would lapse in four equal, quarterly increments over the year following
the acceptance of the exchange offer. The exchange offer has not commenced
and
will not commence until certain actions are taken by us, including a filing
of a
tender offer statement and offer to exchange on Scheduled TO with the SEC.
This
quarterly report on Form 10-Q is not an offer or solicitation of an offer to
sell or exchange any outstanding options. 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 of 1933.
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. Almost all of these shares
are
registered on our Registration Statement on Form S-1 (Registration No.
333-141853), or the Registration Statement, which was declared effective by
the
SEC as of July 31, 2007.
Certain
of our affiliates have also entered into other Lock-Up Agreements covering
a
portion of their shares. These agreements restrict the sale of 1,296,623 shares
of our common stock. Under the terms of these Lock-Up Agreements, these officers
cannot sell, pledge, grant or otherwise transfer the shares subject to the
agreement for one year following July 31, 2007. After one year, 2.5% of these
shares per quarter are released from these restrictions on a pro rata basis
among these affiliates. All remaining shares will be released from the Lock-Up
Agreements on July 31, 2009. These Lock-Up Agreements will otherwise terminate
at the following times: (A) if the Registration Statement is terminated, the
earlier of (i) the date of termination if no shares were sold, or (ii) the
date
any proceeds received from public investors are placed in the mail for return;
(B) the date our common stock is listed on a national securities exchange,
or
(C) 30 days following the date the persons signing these Lock-Up Agreements
are
no longer affiliates.
Our
stock
is very thinly traded. The average daily trading volume for our common stock
between November 2006 and July 2007 was approximately 14,900 shares per day.
The
number of shares that could be sold during this period was restrained by Dribble
Out Agreements, Lock-Up 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.
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.
(21) Our
securities may be subject to “penny stock” rules, which could adversely affect
our stock price and make it more difficult for our stockholders to resell their
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 $5.00 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:
|
|
·
|
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
Annual Meeting of Stockholders was held on June 20, 2007. The following matters
were submitted to a vote of the stockholders with the results shown below:
|
(a)
|
Election
of seven 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
|
|
11,099,412
|
24,400
|
|
|
Thomas
P. Furr
|
|
11,099,412
|
24,400
|
|
|
Jeffrey
W. LeRose
|
|
10,340,194
|
783,618
|
|
|
Shlomo
Elia
|
|
11,109,612
|
14,200
|
|
|
Philippe
Pouponnot
|
|
11,109,612
|
14,200
|
|
|
C.
James Meese, Jr.
|
|
10,340,194
|
783,618
|
|
|
David
E. Colburn
|
|
10,340,194
|
783,618
|
|
(b)
|
Ratification
of the appointment of Sherb & Co., LLP as independent auditors for the
fiscal year ended December 31, 2007.
|
|
Votes
For
|
|
Votes Against
|
|
Abstained
|
|
11,123,612
|
200
|
0
|
The
matters listed above are described in detail in our definitive proxy statement
dated June 4, 2007 for the Annual Meeting of Stockholders held on June 20,
2007.
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
|
|
3.1
|
Third
Amended and Restated Bylaws (incorporated herein by reference to
Exhibit
3.1 to our Current Report on Form 8-K, as filed with the SEC on May
31,
2007)
|
|
10.1
|
Form
of Restricted Stock Agreement (Non-Employee Director) under Smart
Online,
Inc.'s 2004 Equity Compensation Plan (incorporated herein by reference
to
Exhibit 10.1 to our Current Report on Form 8-K, as filed with the
SEC on
May 31, 2007)
|
|
10.2
|
Form
of Executive Officer Compensation Agreement, dated April 25, 2007,
by and
between Smart Online, Inc. and certain of its executive officers
(incorporated herein by reference to Exhibit 10.53 to Amendment No.
1 to
our Registration Statement on Form S-1 (Registration No. 333-141853),
as
filed with the SEC on June 15, 2007)
|
|
10.3
|
Form
of Amendment to Registration Rights Agreement, dated March 26, 2007,
by
and between Smart Online, Inc. and each of Magnetar Capital Master
Fund,
Ltd. and Herald Investment Management Limited on behalf of Herald
Investment Trust PLC (incorporated herein by reference to Exhibit
10.54 to
Amendment No. 3 to our Registration Statement on Form S-1 (Registration
No. 333-141853), as filed with the SEC on July 31, 2007)
|
|
Certification
of Chief Executive Officer Pursuant to Rule 13a-14(a) as Adopted
Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
Certification
of Chief Financial Officer Pursuant to Rule 13a-14(a) as Adopted
Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
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 906 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.
|
|
|
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 906 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.
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Dated:
August 14, 2007
|
|
Smart
Online, Inc.
|
|
|
|
|
|
/s/
Michael Nouri
|
|
|
Michael
Nouri
|
|
|
Principal
Executive Officer
|
|
|
|
|
|
Smart
Online, Inc.
|
|
|
|
|
|
/s/
Nicholas Sinigaglia
|
|
|
Nicholas
Sinigaglia
|
|
|
Principal
Financial Officer and
|
|
|
Principal
Accounting Officer
|
|
|
|
Exhibit
Table
|
Exhibit
No.
|
Description
|
|
3.1
|
Third
Amended and Restated Bylaws (incorporated herein by reference to
Exhibit
3.1 to our Current Report on Form 8-K, as filed with the SEC on May
31,
2007)
|
|
10.1
|
Form
of Restricted Stock Agreement (Non-Employee Director) under Smart
Online,
Inc.'s 2004 Equity Compensation Plan (incorporated herein by reference
to
Exhibit 10.1 to our Current Report on Form 8-K, as filed with the
SEC on
May 31, 2007)
|
|
10.2
|
Form
of Executive Officer Compensation Agreement, dated April 25, 2007,
by and
between Smart Online, Inc. and certain of its executive officers
(incorporated herein by reference to Exhibit 10.53 to Amendment No.
1 to
our Registration Statement on Form S-1 (Registration No. 333-141853),
as
filed with the SEC on June 15, 2007)
|
|
10.3
|
Form
of Amendment to Registration Rights Agreement, dated March 26, 2007,
by
and between Smart Online, Inc. and each of Magnetar Capital Master
Fund,
Ltd. and Herald Investment Management Limited on behalf of Herald
Investment Trust PLC (incorporated herein by reference to Exhibit
10.54 to
Amendment No. 3 to our Registration Statement on Form S-1 (Registration
No. 333-141853), as filed with the SEC on July 31, 2007)
|
|
Certification
of Chief Executive Officer Pursuant to Rule 13a-14(a) as Adopted
Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
Certification
of Chief Financial Officer Pursuant to Rule 13a-14(a) as Adopted
Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
|
|
|
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 906 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.
|
|
|
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 906 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.
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