Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this
Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company.
See
definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
|
Large
accelerated filer o
|
Accelerated
filer o
|
|
Non-accelerated
filer o
(Do
not check if a smaller reporting company)
|
Smaller
reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes o No x
The
aggregate market value of common stock held by non-affiliates of the registrant
as of June 29, 2007 was approximately $24,932,947.50 (based on the closing
sale
price of $2.70 per share).
The
number of shares of the registrant’s Common Stock, $0.001 par value per share,
outstanding as of March 19, 2008 was 18,184,628.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the definitive Proxy Statement to be delivered to shareholders in connection
with the Annual Meeting of Shareholders to be held June 19, 2008 are
incorporated by reference into Part III.
TABLE
OF CONTENTS
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PART
I
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Item
1.
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Business
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Item
1A.
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Risk
Factors
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Item
1B.
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Unresolved
Staff Comments
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Item
2.
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Properties
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Item
3.
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Legal
Proceedings
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Item
4.
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Submission
of Matters to a Vote of Security Holders
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PART
II
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Item
5.
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Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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Item
6.
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Selected
Financial Data
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Item
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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Item
7A.
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Quantitative
and Qualitative Disclosures About Market Risk
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Item
8.
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Financial
Statements and Supplementary Data
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Item
9.
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Changes
In and Disagreements with Accountants on Accounting and Financial
Disclosure
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Item
9A.
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Controls
and Procedures
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Item
9A(T).
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Controls
and Procedures
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Item
9B.
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Other
Information
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PART
III
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Item
10.
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Directors,
Executive Officers and Corporate Governance
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Item
11.
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Executive
Compensation
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Item
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder
Matters
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Item
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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Item
14.
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Principal
Accounting Fees and Services
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PART
IV
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Item
15.
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Exhibits,
Financial Statement Schedules
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SIGNATURES
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EXHIBIT INDEX
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PART
I
Special
Note Regarding Forward-Looking Statements
This
Annual Report on Form 10-K contains forward-looking statements, within the
meaning of Section 27A of the Securities Act of 1933, or the Securities Act,
and
Section 12E of the Securities Exchange Act of 1934, or the Exchange Act,
regarding our plans, objectives, expectations, intentions, future financial
performance, future financial condition, and other statements that are not
historical facts. You can identify these statements by our use of the future
tense, or by forward-looking words such as “may,” “will,” “expect,”
“anticipate,” “believe,” “intend,” “estimate,” “continue,” and other similar
words and phrases. Examples of sections containing forward-looking statements
include “Part I - ITEM 1. BUSINESS” and “Part II - ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.” These
forward-looking statements are subject to risks, uncertainties, and assumptions
that are difficult to predict. Therefore, actual results may differ materially
and adversely from those expressed in any forward-looking statements. Readers
are directed to risks and uncertainties identified in “Part I - ITEM 1A. RISK
FACTORS” and elsewhere in this report for factors that may cause actual results
to be different than those expressed in these forward-looking statements. Except
as required by law, we undertake no obligation to revise or update publicly
any
forward-looking statements for any reason.
ITEM
1. BUSINESS
General
In
this
Annual Report on Form 10-K, we refer to Smart Online, Inc. as “Smart Online,”
the “Company,” “us,” “we,” and “our.” Smart Online was incorporated in Delaware
in August 1993 and became a public company through a self registration in
February 2005. Smart Online’s common stock trades on the OTC Bulletin Board, or
the OTCBB, under the symbol “SOLN.”
We
develop and market software products and services targeted to small businesses
that have less than 50 employees. Our software products and services are
delivered via a Software-as-a-Service, or SaaS, model. Our goal is to be the
leading provider of SaaS applications in specific target market segments. We
sell our SaaS products and services primarily through private label marketing
partners. Our SaaS products and services are designed to be a value added
solution that further strengthens our marketing partners’ existing solutions and
drives additional revenue from their customer bases.
We
generate revenue from two sources. Our first and primary revenue source is
derived from sales of our SaaS applications for business management, web
marketing, and e-commerce. Our second revenue source is derived from sales
of
consulting services that allow us to create custom business solutions that
meet
our partners’ marketing and information processing requirements. One of our
current focuses is to design our consulting services to complement our SaaS
applications, and we expect to provide complementary products and services
in
the future.
History
During
the early stages of our development, we offered application-specific software
using the “shrink-wrapped” method of distribution of diskettes and CD-ROMs,
primarily through large office supply retailers such as Staples. In 2000, we
made a significant change in our business strategy, and moved away from the
development and sale of shrink-wrapped software products, bypassed the
Application Service Provider, or ASP, model (where software can be accessed
from
the server by only one designated PC), and began developing SaaS applications
for sale over the Internet.
Unlike
the shrink wrapped distribution method that requires the end user to install,
configure, and maintain hardware, software, and network services internally
to
support the software applications, or the ASP model that permits access to
the
software resident on a server by a user from one dedicated PC, our proprietary
multi-tenant SaaS applications allow small businesses to subscribe and access
those applications via a browser from any PC on an as needed basis, with very
little or no installation or maintenance required by the end
user.
A
portion
of our early stage SaaS sales and marketing strategy was to sell direct to
the
end user as well as through private label marketing partners. However, direct
sales are no longer part of our marketing plan and we now sell primarily through
syndication arrangements with our private label partners, who in turn market
our
SaaS applications to their customer bases.
In
October 2005, we acquired substantially all of the assets of Computility, Inc.,
or Computility, based in Des Moines, Iowa. Computility was a privately held
developer and distributor of sales force automation and customer relationship
management, or SFA/CRM, software applications. We operated this business under
the name Smart CRM, Inc. (d/b/a Computility), or Smart CRM. Upon our integration
of Smart CRM’s SFA/CRM application into our OneBizSM
platform, we determined that the remaining operations of Smart CRM, specifically
consulting and network management, were not integral to our ongoing operations
and business model. On September 29, 2006, we sold these non-integral Smart
CRM
assets to Alliance Technologies, Inc., or Alliance, and reclassified Smart
CRM
as a discontinued operation. For further information, see Note 14,
“Dispositions,” in our consolidated financial statements included in this Annual
Report on Form 10-K.
The
Smart
CRM assets sold to Alliance included the SFA/CRM software application developed
and sold by Smart CRM and its predecessor in interest, Computility. We retained
all rights relating to the derivative SFA/CRM SaaS application developed by
us
with Smart CRM and incorporated into our SaaS offerings.
In
October 2005, we purchased all of the capital stock of iMart Incorporated,
or
iMart, a Michigan-based company providing multi-channel e-commerce systems.
We
currently operate this business as our wholly-owned subsidiary, Smart Commerce,
Inc., or Smart Commerce.
Consistent
with Statement of Financial Accounting Standards, or SFAS, No. 131, Disclosures
about Segments of an Enterprise and Related Information,
we have
defined two reportable operating segments based on factors such as geography,
how we manage our operations, and how the chief operating decision-maker views
results. Those two segments are our core operations, or the Smart Online
segment, and the operations of our wholly-owned subsidiary, or the Smart
Commerce segment. We are currently evaluating the factors that will form the
basis of our segmentation going forward.
The
Smart
Commerce segment’s revenues are derived primarily from subscriptions to our
multi-channel e-commerce systems, including domain name registration and email
solutions, e-commerce solutions, website design, and website hosting, as well
as
consulting services. During 2007, we began integrating the e-commerce product
line into our Smart Online segment. In 2007, our Smart Commerce segment
generated 92% of our total consolidated revenue.
The
Smart
Online segment generates revenues from the development and distribution of
internet-delivered
SaaS
small business applications through a variety of subscription, integration,
and
syndication channels. In 2007, our Smart Online segment generated 8% of our
total consolidated revenue.
We
include costs such as corporate general and administrative expenses and
share-based compensation expenses that are not allocated to specific segments
in
the Smart Online segment, which includes the parent or corporate
segment.
Principal
Products and Services
Our
principal products and services include:
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·
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SaaS
applications for business management, web marketing, and
e-commerce;
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·
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services
that are designed to complement our product offerings and allow us
to
create custom business solutions that fit our end users’ and channel
partners’ needs; and
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·
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software
business tools that assist customers in developing written
content.
|
Our
SaaS
applications are designed to allow end users to access and work on information
securely from any location where an Internet browser can be accessed. These
applications include:
e-Commerce–
Our
e-commerce applications are designed to give customers the capability to conduct
transactions online. These applications also include inventory query, shopping
cart, financial transactions, shipping, domain name registration and business
to
business communication for small businesses. We provide website design and
launch and other consulting services in connection with these applications.
Our
e-commerce offerings are designed to help direct marketers increase sales,
better leverage corporate resources, and deliver superior customer
service.
SFA/CRM–
Our
SFA/CRM application is designed to allow end users to create standardized
processes to define their sales approach, create marketing plans, and monitor
and guide sales activities. Companies can utilize the customer service
management feature to create, monitor, and track service requests. Companies
can
also display and present their business data with built-in report templates
designed to provide information on sales activity, pipeline activity, revenue,
and other relevant business data.
Business
Dashboard–
Our
Business Dashboard application provides a snapshot of real-time business
information in a single view, allowing users to monitor key business information
about their company and employees. Examples of business information that end
users may view on the dashboard include a list of key documents for the user,
daily events scheduled, express packages shipped by a user, or a list of new
employees. The dashboard displays different information to each user based
upon
their job function and access levels within the company.
Accounting–
Our
Accounting application is targeted for end users that want to create and
maintain their accounting records online in a secure fashion, but do not have
the resources to utilize traditional accounting applications designed for larger
businesses. The Accounting application enables an end user to create invoices,
record payments, print checks, produce real-time financial statements and
reports, as well as manage accounts receivable and payable.
Human
Resource Center–
Our
Human Resource, or HR, Center application is designed to allow companies to
manage their daily human resources needs, including employee information, HR
documents, performance reviews and compensation. The HR Center application
also
allows employers to manage the attendance records of each employee by creating
and assigning vacation, sick leave, civil leave, and leave under other policies
to each individual employee. The application allows an end user manager to
monitor and approve or decline as needed time-off requests and automatically
track how much time each employee has available on a per policy basis.
Calendar–
Our
Calendar application is a full function, easy-to-use online calendar. The
Calendar application features daily, weekly, and monthly views, together with
a
mini-calendar that allows the end user to quickly browse to any date. Automated
email reminders can be initiated, indicating notification of an upcoming event.
In addition, employees may collaborate with their colleagues by sharing their
calendar and events. This application also includes a to-do list to set up
tasks, assign priorities and due dates, and mark tasks as complete as they
are
finished.
Contacts–
Our
Contacts application is designed to provide companies with an online business
contact management system. Contacts can be sorted by group or alphabetically.
End users can add, edit, and remove contact groups as needed, or they can use
the default set of groups. Furthermore, contacts may be shared between
colleagues.
In
addition to our SaaS application, we offer a variety of business tools through
the private label sites of some of our marketing partners. Our business tools
include Business Plan Writer, Business Letters, Business and Legal Forms,
Marketing Plan Writer, Job Description Writer, Employee Policy Manual Writer,
Government Forms, and Business Guides.
We
also
provide services that are designed to complement our product offerings and
allow
us to create custom business solutions that fit our channel partners’ needs. The
services offered to our partners include business consulting, graphics design,
website content syndication, specialized compensation calculation, inventory
management, domain name registration, personalized email creation, express
package tracking, business plan writing, e-commerce tax services, e-mail
marketing, web analytics, warehouse order fulfillment, and business and personal
calculators.
Mode
of Operations
Software-as-a-Service
Model–
We
follow the SaaS model for delivering our products and services to our marketing
partners’ end users. The on demand SaaS model developed using multi-tenant
architecture enables end users to visit a website and use the SaaS applications,
all via a web browser, with no installation, no special information technology
knowledge, and no maintenance. The SaaS application is transformed into a
service that can be used anytime and anywhere by the end user. Multi-tenant
SaaS
applications also permit us to add needed functionality to our applications
in
one location for the benefit of all end users. This capability allows us to
provide upgrades universally.
Integration
and Sharing –
Our
SaaS applications permit the sharing of information (with selectivity and
control options) between members of an organization. Each company that
subscribes to our SaaS applications via our marketing partner can have multiple
members or employees who share information with one another. Information entered
by one employee can be shared and modified by one or more other employees who
have the appropriate access authority. Several of the applications within our
applications are integrated with one another. Integration means that certain
applications communicate and share information with other applications and
are
updated in real time.
Target
Market and Sales Channels
Our
consistent focus from the beginning has been to design software products and
services to help start and run small businesses with 50 or fewer employees
more
efficiently. The small business market is diverse, fragmented, yet very large
and, we believe, underserved. We have focused on offering a wide range of
software products that combine simplicity and affordability and that meet the
needs of small businesses with capabilities that typically can be afforded
only
by much larger companies. We believe the growth rate of small businesses using
web-based applications will exceed the growth rate of large enterprises.
Although our ultimate end users are small businesses and entrepreneurs who
access our software products and services via the web, we do not market our
products and services directly to these end users. Instead, we target marketing
partners that are vertical intermediaries in industries such as agriculture,
finance, telecommunications, direct selling, retail, and technology as channels
to reach these small business customers.
During
2007, we increased our revenue through a combination of the following sales
and
marketing initiatives:
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·
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soliciting
and contracting with additional marketing
partners,
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·
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actively
managing relationships with our partners to increase sales,
and
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·
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bundling
our software in packages targeted to different types of industries
within
the small business market.
|
Principal
Customers
Currently,
we consider two customers as our major customers, and the loss of either of
these customers could have a material adverse effect on our business. Both
of
these customers currently subscribe to the applications offered by, and purchase
professional services from, our Smart Commerce segment.
Britt
Worldwide, or BWW, is an entity that indirectly controls a significant number
of
independent business owners, or IBOs, who currently subscribe to our services.
The aggregate of the subscriptions from these IBOs represented approximately
24%
of our consolidated revenue for the fiscal year ended December 31, 2007. BWW
became a customer of ours after we acquired iMart in October 2005 and
represented 45% of our revenues in 2006. Although our revenue is derived from
the IBOs, BWW can influence the actions of the IBOs, so this revenue has been
aggregated for purposes of this Annual Report on Form 10-K.
UR
Association, or URA, is an entity that indirectly controls a significant number
of IBOs who currently subscribe to our services. The aggregate of the
subscriptions from these IBOs represented approximately 11% of our consolidated
revenue for the fiscal year ended December 31, 2007. URA became our customer
in
2007. Although our revenue is derived from the IBOs, URA can influence the
actions of the IBOs, so this revenue has been aggregated for purposes of this
Annual Report on Form 10-K.
Vera
Bradley Designs, Inc., or Vera Bradley, a manufacturer of high quality handbags,
luggage, and other accessories, is also a major customer. Vera Bradley accounted
for approximately 22% of our consolidated revenues for fiscal year ended
December 31, 2007. Vera Bradley became our customer in 2006 and represented
28%
of our revenues in 2006.
Research
& Development
During
2006, we devoted a substantial amount of time and effort toward the research
and
development of our OneBizSM
platform
and the associated applications. In the fourth quarter of 2006, we began to
shift our focus from research and development to the marketing of our latest
products. In the second half of 2007, as part of a general restructuring, we
began to conduct an evaluation of our technology, platforms, and applications
in
an effort to document and improve upon our current product offerings and
determine which applications, if any, should be discontinued. We expect this
process to continue through the third quarter of 2008. We also use offshore
resources to provide assistance in delivering solutions and enhancing some
applications for the SaaS marketplace.
Our
research and development costs were approximately $2.5 million and $2.0 million
in 2007 and 2006, respectively. We have not engaged in any customer-sponsored
research and development.
Competition
The
market for small business software applications in both the traditional and
SaaS
environments is highly competitive and subject to rapid changes in technology
and delivery. The direct competition we face depends on the software application
within our platforms and the delivery model capabilities of our
competitors.
We
have
two primary categories of competitors: large companies that offer a wide range
of products for small to medium-size businesses and other companies that offer
only one or two software products that compete with our broad range of software
products. Our principal direct competition comes from several large vendors
of
SaaS applications for small businesses that sell many products similar to ours.
These competitors include, but are not limited to, Microsoft, Oracle, NetSuite,
Intuit, SAP, Sage, Yahoo!, and Google.
We
also
expect to face competition from new entrants that will market SaaS applications
similar to ours to small businesses. Companies that offer only one or two
products that compete with our suite of SaaS applications include:
|
·
|
Accounting
software applications: Netsuite, Intuit, SAP, Sage, Microsoft, and
others.
|
|
·
|
Human
resource software applications: ADP, Sage, and
others.
|
|
·
|
e-Commerce
solutions: Register.com, GoDaddy.com, 1and1 Internet, eBay’s Storefront,
Yahoo! Store, Microsoft, NetSuite, Intuit, and
others.
|
|
·
|
SFA/CRM
applications: Microsoft, Sage, Salesforce.com, Netsuite, and
others.
|
Although
we believe we offer highly competitive services and software, many of our
competitors do or may have greater resources and a larger number of total
customers for their products and services. In addition, a number of our
competitors already sell certain products to our current and potential
customers, as well as to systems integrators and other vendors and service
providers. These competitors may be able to respond more quickly to new or
emerging technologies and changes in customer requirements, or to devote greater
resources to the development, promotion, and sale of their products, than we
can. It is also possible that new competitors or alliances among competitors
or
other third parties may emerge and rapidly acquire market share. Increased
competition may result in price reductions, reduced gross margins, and change
in
market share, any of which could adversely impact our revenue and profitability
targets and timetables.
On
each
competitive front, we seek to compete against these larger and better financed
companies primarily by offering an extensive suite of SaaS applications that
are
useful to small businesses. We believe we offer more SaaS applications and
features specifically targeted to small businesses than most of our competitors.
We believe one distinctive value our applications offer is the integration
of
the applications. To meet our business objectives, we will need to enhance
our
current applications and continue to develop high quality and competitively
priced new applications for our SaaS offerings. If we are unable to do so,
our
revenue and profitability targets and timetables could be adversely
impacted.
To
compete effectively in the SaaS market, we plan to leverage our private label
marketing partners who sell our SaaS applications to their small business
customers. We offer existing and potential partners to private label our SaaS
applications to their small business customers as value added products and
services. This strategy is designed to enable us to compete effectively in
the
SaaS market by leveraging the marketing resources and customer relationships
of
our marketing partners.
Intellectual
Property Rights
Our
success depends, in part, upon our proprietary technology, processes, trade
secrets, and other proprietary information and our ability to protect this
information from unauthorized disclosure and use. We rely on a combination
of
copyright, trade secret, and trademark laws, confidentiality procedures,
contractual provisions, and other similar measures to protect our proprietary
information. We do not own any issued patents or have any patent applications
pending. Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or design around certain aspects of our SaaS
offerings or to obtain and use information that we regard as proprietary, and
third parties may attempt to develop similar technology independently. In
addition, the laws of some foreign countries do not protect our proprietary
rights to the same extent as do the laws of the United States, and we expect
that it will become more difficult to monitor use of our products if we develop
an international presence.
We
have
registered copyrights, trademarks and registered service marks on several
products and data services. These marks include, but are not limited to: Smart
Online, OneBiz, Smart Attorney, Smart Business Plan, iMart, and OneDomain.
As
part
of our efforts to protect our proprietary information, we enter into license
agreements with our customers and nondisclosure agreements with certain of
our
employees, consultants, and corporate partners. These agreements generally
contain restrictions on disclosure, use, and transfer of our proprietary
information for a period of three years. We also employ various physical and
technological security measures to protect our software source codes,
technology, and other proprietary information.
Employees
As
of
December 31, 2007, we had 50 full-time employees. No employees are known by
us
to be represented by a collective bargaining agreement, and we have never
experienced a strike or similar work stoppage.
Available
Information
Our
corporate information is accessible through our main web portal at www.smartonline.com.
We are
not including the information contained on our website as a part of, or
incorporating it by reference into this Annual Report on Form 10-K. Although
we
endeavor to keep our website current and accurate, there can be no guarantees
that the information on our website is up to date or correct. We make available
free of charge through our website our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after we electronically file such material
with, or furnish such material to, the Securities and Exchange Commission,
or
the SEC. These reports may be accessed by following the link under
“Investors--SEC Filings” on our website.
ITEM
1A. RISK
FACTORS
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.
Historically,
we have operated at a loss, and we continue to do so.
We
have
had recurring losses from operations and continue to have negative cash flows.
If we do not become cash flow positive through additional financing or growth,
we may have to cease operations and liquidate our business. Our
working capital, including our line of credit with Paragon Commercial Bank,
or
Paragon, February 2007 equity financing transaction, and convertible note
financing, should fund our operations for the next 18 months. As of March 19,
2007, we have approximately $2.0 million available on our revolving line of
credit and approximately $5.2 million available through our convertible note
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, the charges filed against a former officer and a former employee filed
by the SEC and the United States Attorney General, and the pending shareholder
class action lawsuit 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 and we may have to liquidate our business.
Our
business is dependent upon the development and market acceptance of our
applications.
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. 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
or
licensing of our platforms or applications.
We
have not yet demonstrated that we have a successful business model.
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. 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. Although
we entered into agreements, including a marketing referral agreement, with
14
new partners and customers during 2007, 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.
In
addition, our end users currently do not sign long-term contracts. They have
no
obligation to renew their subscriptions for our services after the expiration
of
their initial subscription period and, in fact, they have often elected not
to
do so. Our end users also may renew for a lower-priced edition of our services
or for fewer users. Many of our end users 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. 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.
The
SEC action against us, the SEC and criminal actions brought against certain
former employees, and related stockholder and other lawsuits have damaged our
business, and they could damage our business in the future.
The
lawsuit filed against us by the SEC, the SEC and criminal actions filed against
a former officer and a former employee, the class action lawsuit filed against
us and certain current and former officers, directors, and employees, and the
lawsuit filed by a former executive officer against us has harmed our business
in many ways, and may cause further harm in the future. Since the initiation
of
these actions, our ability to raise financing from new investors on favorable
terms has suffered due to the lack of liquidity of our stock, the questions
raised by these actions, and the resulting drop in the price of our common
stock. As a result, we may have to rely solely on existing investors for such
financing, and may not raise sufficient financing, if necessary, in the
future.
Legal
and
other fees related to these actions have also reduced our cash flow. We make
no
assurance that we will not continue to experience additional harm as a result
of
these matters. The time spent by our management team and directors dealing
with
issues related to these actions detracts from the time they spend on our
operations, including strategy development and implementation. These actions
also have harmed our reputation in the business community, jeopardized our
relationships with vendors and customers, and decreased our ability to attract
qualified personnel, especially given the media coverage of these
events.
In
addition, we face uncertainty regarding amounts that we may have to pay as
indemnification to certain current and former officers, directors, and employees
under our Bylaws and Delaware law with respect to these actions, and we may
not
recover all of these amounts from our directors and officers liability insurance
policy carrier. Our
Bylaws and Delaware law generally require us to indemnify, and in certain
circumstances advance legal expenses to, current and former officers, directors,
employees, and agents against claims arising out of such person’s status or
activities as our officer, director, employee, or agent, unless such person
(i)
did not act in good faith and in a manner the person reasonably believed to
be
in or not opposed to our best interests or (ii) had reasonable cause to believe
his conduct was unlawful. As of March 19, 2008, there are SEC and criminal
actions pending against a former executive officer and a former employee who
have requested that we indemnify them and advance expenses incurred by them
in
the defense of those actions. Also, a stockholder class action lawsuit has
been
filed against us and certain of our current and
former officers, directors, and employees. The SEC, criminal, and stockholder
actions are more fully described in Part I, Item 3, “Legal Proceedings,” in this
report.
Generally,
we are required to advance defense expenses prior to any final adjudication
of
an individual’s culpability. The expense of indemnifying our current and former
directors, officers, and employees for their defense or related expenses in
connection with the current actions may be significant. Our Bylaws require
that
any director, officer, employee, or agent requesting advancement of expenses
enter into an undertaking with us to repay any amounts advanced unless it is
ultimately determined that such person is entitled to be indemnified for the
expenses incurred. This provides us with an opportunity, depending upon the
final outcome of the matters and the Board’s subsequent determination of such
person’s right to indemnity, to seek to recover amounts advanced by us. However,
we may not be able to recover any amounts advanced if the person to whom the
advancement was made lacks the financial resources to repay the amounts that
have been advanced. If we are unable to recover the amounts advanced, or can
do
so only at great expense, our operations may be substantially harmed as a result
of loss of capital.
Although
we have purchased insurance that may cover these obligations, we can offer
no
assurances that all of the amounts that may be expended by us will be recovered
under our insurance policy. It is possible that we may have an obligation to
indemnify our current and former officers, directors, and employees under the
terms of our Bylaws and Delaware law, but that there may be insufficient
coverage for these payments under the terms of our insurance policy. Therefore,
we face the risk of making substantial payments related to the defense of these
actions, which could significantly reduce amounts available to fund working
capital, capital expenditures, and other general corporate
objectives.
In
addition, our insurance policy provides that, under certain conditions, our
insurer may have the right to seek recovery of any amounts it paid to the
individual insureds or us. As of March 19, 2008, we do not know and can offer
no
assurances about whether these conditions will apply or whether the insurance
carrier will change its position regarding coverage related to the current
actions. Therefore, we can offer no assurances that our insurer will not seek
to
recover any amounts paid under its policy from the individual insureds or us.
If
such recovery is sought, then we may have to expend considerable financial
resources in defending and potentially settling or otherwise resolving such
a
claim, which could substantially reduce the amount of capital available to
fund
our operations.
Finally,
if our directors and officers liability insurance premiums increase as a result
of the current actions, our financial results may be materially harmed in future
periods. If we are unable to obtain coverage due to prohibitively expensive
premiums, we would have more difficulty in retaining and attracting officers
and
directors and would be required to self-fund any potential future liabilities
ordinarily mitigated by directors and officers liability insurance.
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
executive management team has undergone significant changes during the last
half
of 2007 and first quarter of 2008. Our success depends significantly on the
continued services of our remaining executive management personnel and
attracting additional qualified personnel. Losing any of our remaining officers
could seriously harm our business. Competition for executives is intense.
Although we have resolved the SEC charges filed against us, we may not be able
to attract highly qualified candidates to serve on our executive management
team. If we had to replace any of our other officers, we would not be able
to
replace the significant amount of knowledge that they may have about our
operations. If we cannot attract and retain qualified personnel and integrate
new members of our executive management team effectively into our business,
then
our business and financial results may suffer. In addition, 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.
Failure
to comply with the provisions of our debt financing arrangements could have
a
material adverse effect on us.
Our
revolving line of credit from Paragon is secured by an irrevocable standby
line
of credit issued by HSBC Private Bank (Suisse) SA, or HSBC, with Atlas Capital
SA, or Atlas, as account party. Our secured subordinated convertible notes
are
secured by a first-priority lien on all of our unencumbered assets, and a
primary subordinated security interest in our encumbered assets, as permitted
by
our agreements with Paragon.
If
an
event of default occurs under our debt financing arrangements and remains
uncured, then the lender could foreclose on the assets securing the debt. If
that were to occur, it would have a substantial adverse effect on our business.
In addition, making the principal and interest payments on these debt
arrangements may drain our financial resources or cause other material harm
to
our business.
Compliance
with regulations governing public company corporate governance and reporting
is
uncertain and expensive.
As
a
public company, we have incurred and will continue to 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 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
Financial Industry Regulatory Authority, or FINRA. We expect these rules and
regulations to increase our legal and financial compliance costs and to make
some activities more time consuming and costly.
For
fiscal 2007, we are required to comply with the
requirements of Section 404 of Sarbanes-Oxley 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. To comply with these requirements, we are evaluating and
testing our internal controls, and where necessary, taking remedial actions,
to
allow management to report on, and our independent auditors to attest to, our
internal control over financial reporting. As a result, we have incurred and
will continue to incur expenses and diversion of management’s time and attention
from the daily operations of the business, which may increase our operating
expenses and impair our ability to achieve profitability.
In
addition, there can be no assurance that we will be able to maintain our
schedule to complete all assessment and testing of our internal controls in
a
timely manner. Further, we cannot be certain that our
testing
of internal controls and
resulting remediation actions will yield adequate
internal
control
over
financial reporting as required by Section 404 of Sarbanes-Oxley. If we are
not
able to implement the requirements of Section 404 in a timely manner or with
adequate compliance, there could be an adverse reaction in the financial markets
due to a loss of confidence in the reliability of our financial statements,
which could adversely affect the market price of our common stock.
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 48% of our outstanding common stock. Certain of these principal
stockholders hold warrants and convertible notes, which may be exercised or
converted into additional shares of our common stock under certain conditions.
The convertible noteholders have designated a bond representative to act as
thei