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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
COMMISSION FILE NUMBER 0-26536
SMITH MICRO SOFTWARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 33-0029027
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
51 COLUMBIA, SUITE 200, ALISO VIEJO, CA 92656
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (714) 362-5800
COMMON STOCK, $.001 PAR VALUE NASDAQ NATIONAL MARKET
(Title of each class) (Name of each exchange on which registered)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.001 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES (X) NO ( )
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ].
The Registrant does not have different classes of Common Stock. As of
March 24, 1998, the aggregate market value of the Common Stock of the Registrant
held by non-affiliates was $14,938,098, based upon the closing sale price of
such stock on that date. For purposes of such calculation, only executive
officers, board members, and beneficial owners of more than 10% of the Company's
outstanding Common Stock are deemed to be affiliates.
As of March 24, 1998, there were 14,074,698 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders currently expected to be held on May 14, 1998, as filed with the
Securities Exchange Act of 1934, as amended, are incorporated by reference in
Part III of this Report.
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SMITH MICRO SOFTWARE, INC.
1997 FORM 10-K ANNUAL REPORT
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. BUSINESS................................................................... 3
Item 2. PROPERTIES................................................................. 24
Item 3. LEGAL PROCEEDINGS.......................................................... 24
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS......................... 24
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.. 25
Item 6. SELECTED FINANCIAL DATA.................................................... 27
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS................................................................. 28
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK....... 33
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................ 33
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................................ 33
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS........................................... 33
Item 11. EXECUTIVE COMPENSATION..................................................... 33
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............. 33
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................. 33
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K................................................................... 34
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THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 PROVIDES A "SAFE
HARBOR" FOR FORWARD-LOOKING STATEMENTS. THE STATEMENTS CONTAINED IN THIS ANNUAL
REPORT ON FORM 10-K THAT ARE NOT STATEMENTS OF HISTORICAL FACT MAY BE FORWARD
LOOKING STATEMENTS SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES. THE FOLLOWING
FACTORS, TOGETHER WITH THOSE ADDITIONAL RISKS DISCUSSED IN THIS ANNUAL REPORT ON
FORM 10-K (PARTICULARLY IN "RISK FACTORS" COMMENCING ON PAGE 15), COULD CAUSE
THE ACTUAL RESULTS OF THE COMPANY TO MATERIALLY DIFFER FROM THOSE ANTICIPATED BY
FORWARD LOOKING STATEMENTS HEREIN SET FORTH: DEMAND FOR COMMUNICATION SOFTWARE;
DEMAND FOR MODEMS AND OTHER ELECTRONIC COMMUNICATION DEVICES; NATIONAL, REGIONAL
AND INTERNATIONAL ECONOMIC CONDITIONS AFFECTING THE SUPPLY OF AND DEMAND FOR
COMMUNICATION SOFTWARE, MODEMS OR OFFERINGS BY THE COMPANY; THE COMPANY'S
ABILITY TO COMPETE IN AND SELL ITS PRODUCTS THROUGH THE RETAIL CHANNEL AND
ORIGINAL EQUIPMENT MANUFACTURERS (OEM) DISTRIBUTION CHANNEL; THE COMPANY'S
ABILITY TO COMPETE AND SELL ITS PRODUCTS THROUGH THE CORPORATE AND GOVERNMENT
MARKETPLACE; DEMAND FOR THE COMPANY'S PRODUCTS; THE COMPANY'S ABILITY TO
MAINTAIN ITS CUSTOMER BASE AND TO EXPAND THAT BASE; AND THE COMPANY'S ABILITY TO
ANTICIPATE AND ADJUST TO TECHNOLOGICAL SHIFTS AND CHANGES IN THE ELECTRONIC
COMMUNICATION SOFTWARE AND HARDWARE INDUSTRIES. ALL FORWARD LOOKING STATEMENTS
CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K SHOULD BE CONSIDERED IN THE LIGHT
OF THESE AND ANY OTHER FACTORS WHICH MIGHT CAUSE THE COMPANY'S FUTURE
PERFORMANCE TO MATERIALLY DIFFER FROM THAT ANTICIPATED BY THIS ANNUAL REPORT ON
FORM 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
Smith Micro Software, Inc. ("Smith Micro" or the "Company") provides
personal computer software that enables facsimile ("fax"), video, data and
telephony communication. The Company believes it is the leading provider of
communication software to modem manufacturers (based on units included with
modems sold through resellers and retailers in the United States). The Company
intends to leverage its position in the original equipment manufacturer ("OEM")
market to address the retail, corporate and government marketplace for its
products. Smith Micro focuses on designing integrated, easy to use software
products that incorporate the most advanced features of communication hardware
devices such as modems, multi-line fax modem boards and Internet access devices
such as xDSL and cable modems. The Company was incorporated in California in
November 1983 and reincorporated in Delaware in July 1995.
INDUSTRY BACKGROUND
Businesses and consumers are using personal computers, network servers,
modems and Internet access devices for an increasing number of communication
applications. The ability to send and receive fax transmissions with a personal
computer has created significant demand in recent years for modems with fax
capabilities. Moreover, analog modems and Internet access devices are
increasingly used to access vast information resources, share information and
transact business through on-line services and the Internet. The flexibility
necessitated by an increasingly mobile workforce has fueled demand for products
that facilitate remote connectivity between individuals and their corporate
networks. These applications have created a demand for hardware and software
products that facilitate communication between personal computer users and their
information sources.
Modem manufacturers produce hardware to enable personal computer
communication over land or wireless systems. By adopting technological advances,
driven primarily by advances in chip design, modem manufacturers have been able
to deliver products with increasing price performance, higher transmission
speeds and increased functionality. The rapid pace of these changes, the need to
support a variety of operating systems including Windows 95, Windows NT,
Macintosh, DOS, Windows 3.x, and the soon to be released Windows 98, and the
desire to differentiate products which incorporate identical chipsets, present a
significant communication software challenge. Modem manufacturers generally
focus on hardware and do not find it cost effective to develop software
internally to meet the evolving needs of communication software for multiple
platforms. These modem manufacturers typically bundle software from outside
providers with their modems. This software is the technology that enables the
modems to communicate video, fax, data, telephony and other forms of
information.
Demand for personal computer communication software products is
generated by three distinct sources: OEM customers, consisting primarily of
modem, Internet access device, camera, video capture card and personal computer
manufacturers, retail end-user consumers and corporate/government customers,
which purchase large quantities of user licenses for installations over large
networks. OEMs purchase software and bundle or pre-load it with their products.
This software provides basic functionality and effectively serves the needs of
most users. Users with more complex communication requirements typically seek
software with more features in the retail market.
As communication hardware device manufacturers develop and adopt
emerging technology, thereby expanding the functionality of communication
devices, communication software must be continually enhanced to provide
integrated, easy to use solutions to enable this functionality to be utilized.
Historically, modems and the communication software associated with such modems
were used for the transmission and receipt of data information only. Later,
modem functionality was expanded to incorporate the sending and receiving of fax
transmissions, a function which required increasingly sophisticated
communication software. More recently, modem chip manufacturers have designed
chips with voice capabilities that will allow manufacturers of modems and
computers to replace the functions of small office and home telephone systems.
It is anticipated that these emerging telephony
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applications will provide full duplex speaker phones, complex voicemail
functions, and a dramatically new level of information management capabilities
to the home and small office. In addition, video conferencing, which
traditionally has been available only to high end corporate board rooms at a
cost of thousands of dollars, has reached the desktop, with solutions that are
affordable for the home and small office. Most recently, communication hardware
device manufacturers have introduced devices such as cable and xDSL modems that
enable high speed Internet access and open the potential for efficiently sending
and receiving fax, voice, data and video transmissions over the Internet or
intranets. The functionality of communication software must continue to evolve
to keep pace with consumer expectations, future hardware functions and the
rapidly changing competitive environment.
As modem and other communication hardware device functionality
increases, manufacturers and consumers alike have increasingly sought an
integrated, easy to use software solution to enable communication devices to
perform their functions. The Company believes that the widespread use of
personal computers in home and office environments will bring with it an
increasing number of new "nontechnical" users. In this environment, it will be
critically important to provide easy to use, fully integrated, intuitive
software solutions to both OEMs and end users alike.
SMITH MICRO STRATEGY AND PRODUCTS
The Company offers software products for Windows 95, Windows 98 (when
available), Windows NT, Windows 3.x, Macintosh and DOS operating systems. Smith
Micro believes that its strong engineering focus and its relationships with
analog modem, cable modem, xDSL modem, camera, video capture card, personal
computer and modem chip manufacturers enable it to develop communication
software in anticipation of changes in product design and customize its OEM
software to meet specific customer requirements.
To address the complexity of personal computer communication, Smith
Micro has consistently developed products that are intuitive and easy to use.
The Company believes that its experience in providing products to the OEM
industry, where software is required to enable a new hardware device to be put
into service quickly and relatively effortlessly, is a significant competitive
advantage. The Company's strategy is to build upon the easy-to-use reputation of
its OEM software products to encourage these new users to migrate to the
Company's retail products as they require higher levels of functionality.
To serve the market's evolving demands for connectivity, Smith Micro's
goal is to offer solutions beyond its core fax and data communication software.
The Company offers products that support video conferencing, video email,
paging, telephony, remote access and modem sharing. In the emerging fields of
personal computer-based wireless and cellular communication, the Company's
software for PC Cards is currently being shipped by 3Com Corporation ("3Com")
(which includes 3Com Mobile Communications Division as well as U.S. Robotics
Corporation and MegaHertz), Best Data, Viking Components and IBM among others.
In addition, modems capable of supporting full duplex speakerphone and other
telephony applications are beginning to gain market acceptance and the Company
has developed software to support these emerging technologies.
Smith Micro has traditionally focused on the OEM and, more recently, the
corporate/government and retail channels. The Company's OEM fax and data and
video products are bundled with the modems, cameras and personal computers of
many of the world's leading manufacturers of such products. In addition, the
Company currently offers a line of easy-to-use retail communication software
products that address the needs of the expanding base of personal computer
users. The Company's retail software products are sold to distributors, retail
stores and direct to end-users through electronic stores. The Company intends to
broaden its retail product line and expand the functionality of these products
as well as its OEM products with additional introductions of 32-bit products
designed for the Windows 98, Windows 95 and Windows NT operating systems. The
Company also offers personal computer-based, video teleconferencing products to
its OEM and retail channel customers. In addition, the Company has begun to
focus on a third channel, the corporate/government marketplace. In January 1998,
the Company acquired the network fax software technology of Mitek Systems, Inc.
The acquired software is focused on the fax requirements of the enterprise
customer. The software includes a local area network ("LAN") product that began
shipping in 1998
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and two applications under development that would enhance IP protocol
distribution (over the Internet and intranet) of fax documents.
The Company believes that a key competitive feature of its products is
the ability to switch seamlessly among fax, video conferencing, telephony, and
data functions without interruption to the user. The Company's principal
products automatically recognize whether an incoming call is a voice call, fax
transmission or data transmission. In addition, a user can send fax, data,
telephonic, or video conferencing transmissions without exiting one application
and entering another.
OEM Products
The following chart lists the Company's current OEM products:
FUNCTIONALITY
PRODUCT NAME (PLATFORM) LANGUAGES
- --------------------------- -------------------------------------- ------------------------
QuickLink(TM) Data and fax (Windows 3.x, Windows English, English (UK),
95, Windows NT and Windows 98) French, German, Japanese
and Spanish
QuickLink(TM) MessageCenter Data, fax and voicemail (Windows English, French, German
3.x, Windows 95, Windows NT and and Japanese
Windows 98)
VideoLink(TM) Message Center Video teleconferencing, data, fax English
and voice (Windows 3.x,
Windows 95, Windows NT and Windows 98)
VideoLink(TM) 324/323 Video conferencing (Windows 3.x, English
VideoLink(TM) 323 Windows 95, Windows NT and Windows 98)
VideoLink(TM) 324
VideoLink(TM)
VideoLink(TM)Mail Video and audio messaging (Windows English and 15 other
3.x, Windows 95, Windows NT and languages
Windows 98)
QuickLink(TM) Page Paging (Windows 3.x, Windows 95, English
Windows NT and Windows 98)
MacComCenter(TM) with Voice Data, fax and voice (Macintosh) English and Japanese
MacComCenter(TM) Data and fax (Macintosh) English and Japanese
QuickLink, the Company's flagship product line, provides integrated data
communication and fax capabilities allowing users to send, receive and manage
all fax activities in the background or foreground. In addition, these products
enable the broadcasting of faxes to an unlimited number of locations. These
products also offer data communication functionality that allow users to
transfer files between computers and call electronic bulletin board systems and
on-line services.
QuickLink MessageCenter for Windows provides integrated data
communication, fax and computer telephony functions, including voicemail and
full duplex speakerphone capabilities (when supported by the proper modem) in
one package. QuickLink MessageCenter features include multiple mailboxes and
remote retrieval of voicemail. In addition, sending and receiving faxes from
within any Windows application as well as data communication upload and
downloads can take place entirely in the background, allowing users to continue
work in other applications. Users can call and request fax documents with the
fax-on-demand feature by using the touch-tone keypad on their fax machine and
can configure each mailbox individually and have the product send a pager
notification each time a voice
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message or fax is received. Moreover, through alphanumeric pagers, users can be
notified of the number of faxes, voicemail and memos in the mailbox.
VideoLink MessageCenter includes the video conferencing capabilities
provided by VideoLink and the data, fax and voice mail functionality provided in
QuickLink MessageCenter. All of these functions are incorporated in a single,
fully integrated application.
VideoLink 324/323, VideoLink323, VideoLink324 and VideoLink are video
conferencing products that enable video and audio communication over the
Internet through a third party video server connection or between two locations
using a standard analog modem connection using plain old telephone service
("POTS") or Integrated Services Digital Network ("ISDN"). VideoLink 323 supports
the International Telecommunications Union (ITU) H.323 standard for
interoperability for the Internet and intranets and VideoLink 324 supports the
ITU H.324 standard for interoperability over POTS.
VideoLink Mail is an application that allows the recording of a video
and audio message which can be saved as a self extracting file which can then be
sent via an email attachment over the Internet. The recipient can then play the
message just by double clicking on the attachment. VideoLink Mail's video and
audio data compression technology creates smaller files for email.
QuickLink Page is paging software that works in conjunction with
Microsoft Exchange, Messaging or Outlook in Windows 95, Windows 98 (when
available) and Windows NT and as a stand-alone application that will allow users
to send messages to numeric or alphanumeric pagers. Filters are built in to the
product so that the user can define parameters under which HotPage will send the
message. The user can also compose a message and send it directly to an
alphanumeric pager.
MacComCenter with Voice is an integrated data communication and fax
product for the Macintosh which adds telephony to the integrated data
communication and fax functionality developed specifically for the Macintosh
environment and will support multiple mailboxes, each configurable to receive
voice, fax and data into a specific mailbox. The Company has incorporated many
of the features found in the QuickLink MessageCenter product into MacComCenter
with Voice.
MacComCenter is an integrated data communication and fax product for the
Macintosh. The product enables the broadcasting of faxes to multiple locations.
It also offers data communication functionality that allows users to transfer
files between computers and call electronic bulletin board systems and on-line
services.
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Retail Products
The following chart lists the Company's current retail products and
retail products currently under development:
PRODUCT NAME FUNCTIONALITY (PLATFORM) LANGUAGES
- -------------------------- ----------------------------------------------- --------------------
HotFaxShare(TM) Fax over a LAN (Server: Windows NT, English and German
(under development) Windows 95 and Windows 98 and Client:
Windows 3.x, Windows 95, Windows NT and
Windows 98)
IntraFax(TM) Fax over the Internet and intranets English
(under development) (Server: Windows NT, Windows 95 and
Windows 98 and Client: Windows 3.x,
Windows 95, Windows NT and Windows 98)
AudioVision(TM) Video conferencing (Windows 3.x, Windows English and 15
95, Windows NT and Windows 98) other languages
VideoLink(TM) Mail Pro Video and audio messaging (Windows 3.x, English
Windows 95, Windows NT and Windows 98)
HotFax(R) MessageCenter Data, fax and voice (Windows 3.x, Windows English, French,
95, Windows NT and Windows 98) German, Portuguese
and Spanish
HotFax(R) Data and fax (Windows 3.x, Windows 95, English
Windows NT and Windows 98)
HotFax(R) for DOS Data and fax (DOS) English
MacComCenter(TM) Plus with Data, fax and voice (Macintosh) English and Japanese
Voice
HotPage(R) Paging software (Windows 3.x, Windows 95, English
Windows NT and Windows 98)
HotLine(R) for Windows Telephony application (Windows 3.x, English
Windows 95, Windows NT and Windows 98)
HotLine(R) for DOS Telephone dialer (DOS) English
CrossConnect(R) Outbound modem over a LAN and inbound
remote control (Windows 3.x, Windows 95,
Windows NT, Windows 98 and DOS)
Database Products:
FaxUSA Fax database (any platform) English
National Directory Telephone and address database (any English
Electronic Edition platform)
HotFaxShare is a fax solution that handles fax creation, transmission
and incoming fax routing for companies with high fax volume or with several
computer users connected to a LAN. It is an open platform solution and is
independent of the type and size of the LAN. Faxes can be sent from any network
workstation effortlessly
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from Windows 3.x, Windows 95, Windows 98, Windows NT or DOS applications.
Individual and broadcast faxes can be sent immediately or scheduled for later
transmission. It can support up to 24 channels (fax lines).
IntraFax is a client/server fax gateway that allows faxes to be sent
automatically throughout the world, over the Internet or intranet, thereby
reducing international long distance telephone charges. This TCP/IP-based
product allows a fax to be sent directly out of any Windows-based application
and will select the appropriate route, either the Internet or the company's LAN
or its wide area network ("WAN") by using a least cost routing technique. With
this process, it determines the fax server closest to the recipient and the fax
is then sent as a local call. Another feature built into IntraFax is I-Paper
which allows for a standard fax machine to be connected to the IntraFax server
and can then send faxes over the LAN, WAN, Internet or intranet.
AudioVision is a video conferencing software product that works over the
existing telephone lines or POTS, ISDN, the Internet or intranets. It works with
any digital camera plugged into the parallel port on the computer or with an
analog camera plugged into a video capture card. It also supports the industry
ITU H.324 standard for interoperability over POTS. AudioVision includes a
feature called VideoLink Mail Pro that allows the user to record a video and
audio message, save it as an executable file and send it via email as an
attachment to another individual who can then play the message. The latest
version also includes other features such as a virtual VCR, a whiteboard, and
plug-in multi-user games that can be played by both parties while holding a
video conference.
VideoLink Mail Pro is an application that allows the recording of a
video and audio message which can be saved in a highly compressed format as a
self extracting file which can then be sent via an email attachment over the
Internet. The recipient can then play the message just by double clicking on the
attachment.
HotFax(R) MessageCenter is a fully integrated data, fax and voice mail
application. The product includes all of the features of HotFax for Windows 3.x,
Windows 95, Windows 98 and Windows NT mentioned below. It allows the user to
configure multiple mailboxes that will accept voice, fax or data messages. The
product installs as a Windows 95, Windows 98, Windows NT or Windows 3.x
application. The application can send a pager notification each time a voice
message or fax is received. If configured for an alphanumeric pager, the
notification will specifically identify the number of faxes, voice mail and
memos in the mailbox.
HotFax(R) is the Company's integrated data and fax retail product.
HotFax for Windows 3.x, Windows 95, Windows 98 and Windows NT provides the
mobile user with a fax host for the remote retrieval of received faxes and the
unattended upload and broadcast of faxes at a scheduled time. It also provides
users with the ability to retrieve faxes from a remote location, modify faxes
with graphics intact, use a personal computer as a data host and share data like
a bulletin board service, create custom cover pages with imported graphics and
preview faxes, including cover pages.
HotFax(R) DOS is an integrated fax and data communication product for
the DOS operating environment. HotFax DOS provides the mobile user a fax host
for the remote retrieval of received faxes and unattended upload and broadcast
of faxes at a scheduled time. It also provides users with the ability to
retrieve faxes from a remote location, modify faxes with graphics intact, use a
personal computer as a data host and share data similar to a bulletin board
service.
MacComCenter Plus with Voice is configured as the Company's retail
Macintosh data, fax and telephony communication software product. It allows the
user to configure multiple mailboxes that will accept voice, fax or data
messages. It includes OCR for converting incoming transmissions into text files
and gives users the ability to send true WYSIWYG faxes from an application that
has print capabilities. Users are also able to create custom cover pages with
imported graphics, preview entire faxes, including cover pages, retrieve faxes
from a remote location, and share data similar to a bulletin board service with
a data host.
HotPage(R) is paging software that works in conjunction with Microsoft
Exchange, Messaging or Outlook in Windows 95, Windows 98 and Windows NT and as a
stand-alone application that will allow users to send messages to numeric or
alphanumeric pagers. With Microsoft Exchange, any incoming e-mail that is placed
into the in-box can
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be sent to an alphanumeric pager. Filters are built in so that the user can
define certain parameters under which HotPage will send the message. The user
can also compose a message and send it directly to an alphanumeric pager.
HotLine(R) for Windows and HotLine for DOS are telephony products for
the personal computer user. HotLine for Windows allows users to create unlimited
xBase-compatible phone books that can be accessed from within any Windows
application. It supports Caller ID, which first displays the inbound caller's
phone number, and then pulls up caller information by auto-searching and
matching up the appropriate record from one of the program's user-defined
databases when used with appropriate hardware technology. HotLine for Windows
also supports modems with full-duplex speakerphone capabilities which eliminate
the echo and one-way communication limitations of conventional speaker phones.
Included with HotLine for Windows is the American Business Sampler, a sample
database of more than 2,500 business names, addresses and telephone numbers.
Other databases, like the Company's National Directory Electronic Edition
database, can be imported directly into HotLine for Windows. The DOS version of
HotLine is similar in its overall purpose, but has a more limited set of
features.
CrossConnect(R) is a modem-sharing product for LANs. CrossConnect
expands the capability of the modems on both Novell IPX and NetBIOS LANs by
providing an integrated outbound software product for sharing modems connected
anywhere on the LAN and by providing remote access on the LAN for users away
from the office. The outbound function supports a mixed environment of DOS and
Windows users on the same LAN. The inbound function allows users away from the
office LAN to dial into the network environment and gain access to a node. After
doing so, the remote user can use CrossConnect for outbound communications,
accessing private or public telephone books, and communicating through a shared
modem on the LAN to bulletin boards, on-line services or any host computer. This
remote process occurs in the background, so that the personal computer with the
shared modem will not be interrupted during the communication.
FaxUSA is an xBase-compatible database. When used along with software
products like HotFax, it enables users to locate the names and fax numbers of
over 100,000 businesses across the United States. FaxUSA includes SIC codes and
is updated annually to provide users with current information for their
marketing, sales and other needs.
National Directory Electronic Edition is an xBase-compatible database.
When used along with software products like HotLine, it enables users to locate
the names, telephone numbers and mailing addresses of over 100,000 businesses,
spanning over 1,300 industry categories, across the United States. National
Directory Electronic Edition includes SIC codes and provides current listings,
updated annually, in all area codes.
SALES AND MARKETING
The Company sells its communication software products worldwide to OEM
customers that bundle or pre-load the Company's software with their hardware
products and to distributors and retailers that sell the product to end user
customers. The Company has begun to focus on a third channel, the
corporate/government marketplace. In January 1998, the Company acquired the
network fax software technology of Mitek Systems, Inc. The acquired software is
focused on the fax requirements of the enterprise customer. The software
includes a LAN product that began shipping in 1998 and two applications under
development that would enhance IP protocol distribution of fax documents. The
Company is also developing video and fax products to address vertical markets to
be distributed through channels established by corporate partners.
OEM Sales
The Company has OEM relationships with many of the major modem
manufacturers worldwide. The Company's customers include 3Com (including U.S.
Robotics Corporation and its Megahertz subsidiary), IBM, Taicom (Taiwan), Sirius
Technologies (Australia), Sitre (Spain) and Boca Research. Each of these
manufacturers bundles the Company's software products with its own hardware
products. Approximately 22.4% and 13.3% of the Company's OEM revenues for the
twelve months ended December 31, 1997 and 1996, respectively, were derived from
OEM customers outside of the United States. Products translated into Japanese,
German and French accounted
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for approximately 2.3% and 9.2% of the Company's OEM revenues for the twelve
months ended December 31, 1997 and 1996, respectively. Recent translations allow
the Company to provide certain products in 15 foreign languages.
The OEM modem market continues to evolve. Many personal computer
manufacturers now bundle modems and communication software with their products.
In some cases, personal computer manufacturers are pre-loading communication
software onto hard drives. Moreover, modem chips are under development which
will put modem functionality on the motherboard of the personal computer,
eliminating the need for a separate modem. In light of these trends, the Company
has expanded its OEM relationships with personal computer manufacturers. In
addition, the Company has opened dialogues with many other non-modem
manufacturers due to the development of high speed Internet access devices such
as cable and xDSL modems and with developers of multi-port fax hardware devices
as a result of its recent acquisition of technology assets from Mitek Systems,
Inc.
The cycle from the placement of an OEM order to shipping is very short.
OEM customers generally operate under a just-in-time system and order software
to be delivered as needed by their manufacturing operations. The Company
generally ships its products as orders are received. As a result, the Company
has relatively little backlog at any given time and does not consider backlog to
be a significant indicator of future performance. Moreover, the Company does not
generally produce software in advance of anticipated orders and therefore has
insignificant amounts of inventory. As a result of the foregoing, revenues in
any quarter are substantially dependent on orders booked in that quarter.
During 1997, 1996 and 1995 the Company's three largest OEM customers and
their affiliates, including 3Com, accounted for 56.9%, 62.9% and 66.8% of net
revenues, respectively. In June 1997, 3Com Corporation ("3Com") acquired U.S.
Robotics Corporation ("U.S. Robotics"), to date the Company's largest customer
based on the percentage of revenues, as a wholly owned subsidiary. 3Com and its
affiliates accounted for more than 10% of the Company's net revenues in 1997,
1996 and 1995. Motorola accounted for more than 10% of revenue in 1996. The
Company's major customers could reduce their orders of the Company's products in
favor of a competitor's product or for any other reason. The loss of any of the
Company's major OEM customers would have a material adverse effect on the
Company's business, results of operations and financial condition.
In April 1996, the Company entered into an OEM agreement having an
initial one year term with a wholly-owned subsidiary of U.S. Robotics (now a
subsidiary of 3Com). The agreement superseded a previous agreement between the
parties and automatically renews at the end of each one year term unless a party
provides at least 60 days notice of its intent to terminate the agreement at the
end of the then-current term. During 1997, the agreement automatically renewed
according to its terms and certain other 3Com entities (hereinafter 3Com, its
affiliates and their subsidiaries will be referred to as "3Com entities") were
added as parties pursuant to new addenda to the agreement. Under the terms of
the agreement, the Company granted certain pricing incentives to the 3Com
entities in consideration for which the Company became the provider of fax,
data, voice and telephony communications software for such 3Com entities. In
addition, under the terms of the agreement, certain of the 3Com entities agreed
to place Smith Micro retail products and commercials for such products on
certain of their compact disks. The agreement does not require any 3Com entity
to purchase any minimum quantity of Smith Micro products and may be terminated
by a party thereto at any time for any reason upon 90 days' prior written
notice.
The Company sells directly to modem and personal computer manufacturers
using an in-house sales staff based in Aliso Viejo, California. The Company
recently established sales operations in Europe and Australia to expand
international presence. The Company allows its OEM customers to return unused
software. To date, however, such returns have been infrequent.
Retail Sales
While historically the Company has generated its revenues primarily from
the OEM market, it also sells retail products that are designed to complement or
upgrade its OEM products. Retail sales represented 5.2%, 16.5% and 6.0% of net
revenues for 1997, 1996 and 1995, respectively.
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The Company has a separate sales staff that handles retail sales and
works closely with Smith Micro's retail distributors on the management of
orders, inventory levels, sell-through to retailers, as well as promotions and
marketing activities. Domestically, the Company's retail products are sold by
independent distributors including Ingram Micro and Tech Data. In addition, the
retail sales force is responsible for contacting major retail customers to
generate demand for the Company's retail products in the retail distribution
channel. During 1997, the Company began to develop retail outlets using the
Internet by selling product through the Company's web site and electronic
distributors. The delivery of retail products derived from Internet sales is
direct to the customer through electronic download or shipment from the Company,
depending on the customer's preference.
The Company allows distributors and retailers to return products without
charge or penalty. In addition, there are times when the Company updates
products and requests the distributors of the products to replace inventory on
the shelves with the new version in what is called a stock rotation. A component
of the Company's revenue recognition policy is that the Company calculates an
allowance for product returns based on its historical experience with product
returns. If retail sales of the Company's products increase, the risk of product
returns will increase. While the Company's revenue recognition policy
contemplates this risk, it is possible that returns may occur in excess of the
Company's previous experience, causing the Company to revise its estimates and
increase the allowances for such returns.
The Company employs direct mail programs to offer end-users upgrades to
the Company's retail products. The Company advertises in selected computer
end-user and re-seller publications and periodically introduces promotions and
incentive offers such as special pricing for the purchase of upgrades. The
Company also participates in major trade shows, professional conferences and
personal computer user group events to reach its target markets.
Corporate and Government Sales
During 1997 the Company began selling to the corporate/government
marketplace while building the infrastructure necessary to sell to these two
customer bases. In January 1998, the Company acquired the network fax software
technology of Mitek Systems, Inc. The acquired software is designed to address
the fax requirements of the enterprise customer. The software includes a LAN
product that began shipping in 1998 and two applications under development that
would enhance IP protocol distribution of fax documents. The Company anticipates
upgrading the LAN product with HotFaxShare during 1998. The Company intends to
continue to focus its sales and marketing efforts for its video and fax
technologies through direct sales and sales through value added resellers
("VARs") that specialize in selling to enterprise customers. Sales in this
marketplace tend to be made in single volume orders, typically for site
licenses, and are often accompanied by maintenance programs. The Company's
pricing structure in this marketplace currently accommodates multi-level, volume
purchase with discounts for larger single orders. The maintenance program
provides technical support and automatic product upgrades under specifically
defined terms. In addition, the Company is continuing with the development of
vertical market products for the medical, insurance, and security industries
among others. Vertical market products, such as telemedicine for the medical
industry, will be distributed through channels established by VARs and other
corporate partners.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
The Company provides technical support and customer service by
telephone, mail, fax, modem, its customer bulletin board service, an Internet
web site and through a forum that it operates on CompuServe. Certain of the
Company's OEM customers provide their own primary customer support functions and
rely on the Company for back-up customer support, while support functions for
other OEM customers are provided solely by the Company.
PRODUCT DEVELOPMENT
The software industry is characterized by frequent changes in technology
and evolving user needs. The Company works closely with its current OEM
customers to determine future user needs and to anticipate changes in
technology. Modem functionality is determined by the capabilities of the modem
chip and, accordingly, the
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Company maintains close relationships with the major modem chip manufacturers
and develops software in tandem with modem chip development. These highly
interactive development approaches extend to modem manufacturers as well, where
Smith Micro works with modem developers in an attempt to provide fully tested
software when new modems are released. Engineering relationships with Rockwell,
IBM, Cirrus Logic, Intel, Texas Instruments and others as well as with the
Company's major OEM modem customers are central to the product development
efforts of the Company. In addition, the Company participates in software
product developer programs sponsored by Microsoft, Intel, IBM and Apple.
The Company believes that it must be responsive to the specific
customization requests of its OEM customers. With this need for flexibility in
mind, the Company has completely redeveloped the code base from which its
products are created. Its object-oriented C++ modular code base is designed to
allow significant customization and enhancements of features within tight
development schedules.
As of December 31, 1997, the Company had a product development staff of
31 engineers and quality assurance and product testing specialists. The Company
plans to add additional software engineers and product testing personnel in the
future.
MANUFACTURING
The Company's software is sold in three forms. The software is sold in
the form of a kit which includes disks or a CD-ROM and a manual. In addition,
the Company permits certain of its OEM customers to duplicate their own disks or
CD-ROMs and the Company controls that process through the use of serialized
labels sold to those customers. This method of sale does not require the Company
to provide a disk or manual. Also, the Company grants licenses to certain OEM
customers that enable those customers to pre-load a copy of the Company's
software onto a personal computer's hard drive. With the corporate sales
program, the Company offers site licenses under which a corporate user is
allowed to distribute copies of the software to users within the corporate
sites.
The Company relies on third party suppliers who provide the components
used in its kitted products. These components include disks, CD-ROMs and printed
manuals. Disk shortages have occurred in the past and there can be no assurance
that shortages will not recur. If the Company cannot obtain a sufficient
quantity of disks, CD-ROMs or other components, or cannot obtain disks, CD-ROMs
or other components at prices at least comparable to prices paid currently, the
Company's business, results of operations and financial condition could be
adversely affected.
Modem manufacturers purchase chips from a relatively limited number of
chip manufacturers. Production problems or product quality problems experienced
by a chip manufacturer could reduce modem sales or slow the growth of modem
sales.
Where the Company is selling kitted diskette product, it duplicates most
of the required disks at its Aliso Viejo, California facility. This facility is
capable of producing 50,000 duplicated disks in a single eight hour shift.
Operations are primarily conducted on a single shift basis, although the Company
operates a second shift from time to time to accommodate customer delivery
requirements. The Company has outside production alternatives in the event of a
disruption of its Aliso Viejo operations. The Company uses outside vendors for
the printing of labels, manuals and packaging.
Where the Company is selling kitted CD-ROM product, it relies on third
party suppliers to provide CD-ROM components and CD-ROM replication. The
equipment to replicate CD-ROMs is very costly making it unlikely that the
Company will add this capability internally. This leaves the Company dependent
on CD-ROM replication facilities for both the timing and pricing of the software
produced in CD-ROM format. This could impair the Company's ability to deliver
products to customers and any price increases could reduce gross margins which
could have a material adverse effect on the Company's business, results of
operations and financial condition.
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COMPETITION
The markets in which the Company operates are highly competitive and
subject to rapid changes in technology. The strategic directions of major
personal computer hardware manufacturers and operating system developers are
also subject to changes. The Company competes with other software vendors for
access to distribution channels, retail shelf space and the attention of
customers. The Company also competes with other software companies in its
efforts to acquire software technology developed by third parties and in
attracting qualified personnel. These actions may result in increased price
competition.
The Company believes that the principal competitive factors affecting
the market include product features and ease of use, willingness of the vendor
to customize the product to fit customer-specific needs, product reputation,
quality, performance, price, customer service and support, and the effectiveness
of sales and marketing efforts. Although the Company believes that its products
currently compete favorably with respect to such factors, there can be no
assurance that the Company can maintain its competitive position against current
and potential competitors, especially those with significantly greater
financial, marketing, service, support, technical and other resources.
Because there are relatively low barriers to entry in the software
market and because rapidly changing technology is constantly creating new
opportunities, the Company expects additional competition from other established
and emerging software companies as fax and data applications merge with video
and audio applications and the emerging cellular, wireless and telephony markets
develop. The Company also believes that the market in which it competes has been
characterized by the consolidation of established communication software
suppliers and that this trend, which may lead to the creation of additional
large and better-financed competitors, may continue. Increased competition could
result in price reductions, reduced gross margins and loss of market share, any
of which could have a material adverse effect on the Company's business and
results of operations.
The Company competes primarily with Symantec, Cheyenne, White Pine and
VDONet in the OEM market, and with Symantec, Global Village and Quarterdeck in
the retail market for communication software products. Some of the Company's
competitors have a retail emphasis and offer OEM products with a reduced set of
features. The opportunity for retail upgrade sales may induce these and other
competitors to make OEM products available at their own cost or even at a loss.
Such a pricing strategy could have an adverse affect on the Company's business,
results of operations and financial condition.
Symantec and many of the Company's other current and prospective
competitors have significantly greater financial, marketing, service, support,
technical and other resources than the Company. Moreover, these companies may
introduce additional products that are competitive with those of the Company,
and there can be no assurance that the Company's products would compete
effectively with such products. The Company believes that its ability to compete
depends on elements both within and outside its control, including the success
and timing of new product development and introduction by the Company and its
competitors, product performance and price, distribution and customer support.
There can be no assurance that the Company will be able to compete successfully
with respect to these and other factors. The Company believes that the market
for its software products has been and will continue to be characterized by
significant price competition. A material reduction in the price of the
Company's products could negatively affect the Company's profitability.
Many of the Company's existing and potential OEM customers are major
manufacturers of modems and have substantial technological capabilities. These
customers may currently be developing, or may in the future develop, products
that compete directly with the Company's products and may, therefore,
discontinue purchases of the Company's products. The Company's future
performance is substantially dependent upon the extent to which existing OEM
customers elect to purchase communication software from the Company rather then
design and develop their own software. In light of the fact that the Company's
customers are not contractually obligated to purchase any of the Company's
products, there can be no assurance that the Company's existing OEM customers
will continue to rely, or expand their reliance, on the Company as an external
source for communication software.
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The Company also faces competition from Microsoft, which dominates the
personal computer software industry. Due to its market dominance and the fact
that it is the publisher of the most prevalent personal computer operating
systems, DOS and Windows, Microsoft represents a significant competitive threat
to all personal computer software vendors, including the Company.
PROPRIETARY RIGHTS AND LICENSES
Although the Company believes that its products do not infringe on the
intellectual property rights of others, there can be no assurance that such a
claim will not be asserted against the Company in the future. The failure of the
Company to protect its proprietary information could have a material adverse
effect on the Company's business, results of operations and financial condition.
From time to time, the Company has received and may receive in the
future communications from third parties asserting that trademarks used by the
Company or features or content of certain of the Company's products infringe
upon intellectual property rights held by such third parties. As the number of
trademarks, patents, copyrights and other intellectual property rights in the
Company's industry increases, and as the coverage of these patents and rights
and the functionality of products in the market further overlap, the Company
believes that products based on its technology may increasingly become the
subject of infringement claims. Moreover, any of these proceedings could also
result in an adverse decision as to the priority of the Company's inventions.
Such results would materially adversely affect the Company, and may also require
the Company to obtain one or more licenses from third parties. There can be no
assurance that the Company would be able to obtain any such required licenses
upon reasonable terms, if at all, and the failure by the Company to obtain such
licenses could have a material adverse effect on its business, results of
operations and financial condition.
The Company's success is dependent upon its software code base, its
programming methodologies and other intellectual properties. To protect its
proprietary technology, the Company relies on a combination of trade secret,
nondisclosure and copyright and trademark law which may afford only limited
protection. Prior to becoming a publicly held entity, the Company did not
require its employees to sign proprietary information and inventions agreements
stipulating, among other things, software ownership rights. There can be no
assurance that the steps taken by the Company will be adequate to deter
misappropriation of its proprietary information, will prevent the successful
assertion of an adverse claim to software utilized by the Company or that the
Company will be able to detect unauthorized use and take effective steps to
enforce its intellectual property rights.
In selling its products, the Company relies primarily on "shrink wrap"
licenses that are not signed by licensees and, therefore, may be unenforceable
under the laws of certain jurisdictions. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to as great an extent
as do the laws of the United States. There can be no assurance that the
Company's means of protecting its proprietary rights will be adequate or that
the Company's competitors will not independently develop similar technology. In
addition, the Company licenses technology on a non-exclusive basis from several
companies for inclusion in its products and anticipates that it will continue to
do so in the future. The inability of the Company to continue to license these
technologies or to license other necessary technologies for inclusion in its
products, or substantial increases in royalty payments under these third party
licenses could have a material adverse effect on its business, results of
operations and financial condition.
EMPLOYEES
As of December 31, 1997, the Company had a total of 75 employees, of
which 31 were engaged in engineering, 12 were in sales and marketing, 13 were in
customer support, 12 were in finance and administration and 7 were in
manufacturing. The Company utilizes temporary labor to assist during periods of
increased manufacturing volume. None of the Company's employees is represented
by a labor union. The Company has not experienced any work stoppages, and
considers its relations with its employees to be good.
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RISK FACTORS
This Annual Report on Form 10-K contains forward looking statements which
involve risks and uncertainties and the Company's actual results may materially
differ from the results anticipated in those statements. Factors that might
cause such a difference include, without limitation, those discussed in this
section, in the Management's Discussion and Analysis of Financial Condition and
Results of Operations section and elsewhere in this Annual Report on Form 10-K.
All such factors should be considered in evaluating the Company and a decision
to invest in the Company.
Fluctuations in Quarterly Operating Results. Certain of the Company's
significant customers and other modem manufacturers have announced in recent
quarters that there was an increase of inventory in the channel and that the
slower than expected rollout of V.90 standard 56K modems may reduce their rates
of growth during subsequent quarters. The rate at which this inventory is moved
out of the channel could have a significant impact on the Company's operating
results in future quarters. The Company's operating results have in the past
fluctuated, and may in the future fluctuate, from quarter to quarter as a result
of a number of factors including, but not limited to, the size and timing of
orders from, and shipments to, major customers; the ability to maintain or
increase gross margins; the ability of the Company's customers to obtain
financing for the purchase of the Company's products; changes in pricing
policies or price reductions by the Company or its competitors; variations in
the Company's sales channels or the mix of product sales; the timing of new
product announcements and introductions by the Company or its competitors and
customers; the availability and cost of supplies; the financial stability of
major customers; market acceptance of new products, applications and product
enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements; the Company's ability to
control costs; possible delays in the shipment of new products; the Company's
success in expanding its sales and marketing programs; deferrals of customer
orders in anticipation of new products, applications, product enhancements or
operating systems; changes in Company strategy; personnel changes; and general
economic factors. The Company's software products are generally shipped as
orders are received and accordingly, the Company has historically operated with
little backlog. As a result, sales in any quarter are dependent on orders booked
and shipped in that quarter and are not predictable with any degree of
certainty. In addition, the Company's expense levels are based, in part, on its
expectations as to future revenues. If revenue levels are below expectations,
operating results are likely to be adversely affected. The Company's net income
may be disproportionately affected by a reduction in revenues because of fixed
costs related to generating its revenues. While the Company has not historically
experienced seasonality in its sales, many of the Company's OEM customers
experience seasonality in their sales, and the Company's sales may, in the
future, be subject to seasonality particularly as its sales of retail products
increase. Quarterly results in the future may be influenced by these or other
factors and, accordingly, there may be significant variations in the Company's
quarterly operating results. Further, the Company's historical operating results
are not necessarily indicative of future performance for any particular period
and there can be no assurance that the Company's recent revenue growth or its
profitability will continue on a quarterly or annual basis. Due to all of the
foregoing factors, it is possible that in some future quarter the Company's
operating results may be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected.
Reliance on 3Com Corporation. In June 1997, 3Com acquired U.S. Robotics,
to date the Company's largest customer based on the percentage of revenues, as a
wholly owned subsidiary. There can be no assurance that 3Com's acquisition of
U.S. Robotics will not result in a change in U.S. Robotics' purchasing habits, a
decrease in new orders by U.S. Robotics, delays in orders previously made by
U.S. Robotics, or the loss of U.S. Robotics as a customer entirely.
Sales to 3Com entities (primarily to U.S. Robotics and its subsidiaries)
represented 43.1%, 46.4% and 52.1% of the Company's net revenues in 1997, 1996
and 1995, respectively. The Company expects that the 3Com entities, including U.
S. Robotics and its subsidiaries, will continue to account for a significant
portion of the Company's revenues in future periods. In April 1996, the Company
entered into an OEM agreement having an initial one year term with a
wholly-owned subsidiary of U.S. Robotics. The agreement superseded a previous
agreement between the parties and automatically renews at the end of each one
year term unless a party provides at least 60 days notice of its intent to
terminate the agreement at the end of the then-current term. During 1997, the
agreement automatically renewed according to its terms and certain other 3Com
entities were added as parties pursuant to new
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addenda to the agreement. Under the terms of the agreement, the Company granted
certain pricing incentives to the 3Com entities in consideration for which the
Company became the provider of fax, data, voice and telephony communications
software for such 3Com entities. In addition, under the terms of the agreement,
certain of the 3Com entities agreed to place Smith Micro retail products and
commercials for such products on certain of their compact disks. The agreement
does not require any 3Com entity to purchase any minimum quantity of Smith Micro
products and may be terminated by a party at any time thereto for any reason
upon 90 days prior written notice. As a result, there can be no assurance that
the 3Com entities will continue to purchase the Company's products.
While the Company believes that it has been the principal supplier of
OEM communication software products to U.S. Robotics, there can be no assurance
that U.S. Robotics and the other 3Com entities to which the Company sells
products will not seek additional sources for such products in the future.
Accordingly, there can be no assurance that sales to the 3Com entities will
reach or exceed in any future period the historical levels of sales to U.S.
Robotics. A substantial decrease or delay in sales to the 3Com entities would
have a material adverse effect on the Company's business, results of operations
and financial condition.
Concentration of Customer Revenues. In addition to the 3Com entities,
including U.S. Robotics, the Company has in the past derived, and expects in the
future to derive, a significant portion of its revenues from a relatively small
number of customers. The Company's three largest customers, including the 3Com
entities, represented approximately 56.9%, 70.8% and 66.8% of the Company's net
revenues during 1997, 1996 and 1995, respectively. The Company expects that it
will continue to be dependent upon relatively large orders from major OEM
customers for a significant portion of its revenues in future periods, although
none of them is obligated to purchase any products. Accordingly, there can be no
assurance that any sales to these entities, individually or as a group, will
continue or, if continued, will reach or exceed historical levels in any future
period. Any substantial decrease or delay in sales to one or more of these
entities would have a material adverse effect on the Company's business, results
of operations and financial condition. In addition, certain of the Company's OEM
customers have in the past and may in the future acquire competitors or be
acquired by competitors, causing further consolidation in the modem industry.
Previous acquisitions in the modem industry have often caused the purchasing
departments of the combined companies to reevaluate their purchasing decisions.
There can be no assurance that such acquisitions will not result in a change in
a current customer's purchasing habits, including a loss of the customer, a
decrease in orders from that customer or a delay in orders previously made by
the customer. Moreover, acquisitions involving existing OEM customers may cause
the concentration of the Company's customer revenues to increase if the combined
companies continue to purchase the Company's software products. Although the
Company maintains allowances for doubtful accounts, the insolvency of one or
more of the other major customers of the Company could substantially impair the
Company's business, results of operations and financial condition.
Product Concentration. The Company has in the past derived, and may in
the future derive, a significant portion of its revenues from a relatively small
number of products. The sale of QuickLink related products represented
approximately 81.3%, 69.4% and 84.0% of the Company's net revenues during 1997,
1996 and 1995, respectively. The Company expects that revenues from these
products will continue to account for a substantial portion of the Company's
total revenues in the foreseeable future. Declines in the revenues from these
software products, whether as a result of competition, technological change,
price pressures or other factors, would have a material adverse effect on the
Company's business, results of operations and financial condition. Further, life
cycles of the Company's products are difficult to estimate due in large measure
to the recent emergence of the Company's market, the effect of new products,
applications or product enhancements, technological changes in the communication
software industry in which the Company operates and future competition. The
Company's future financial performance will depend in part on the successful
development, introduction and market acceptance of new products, applications
and product enhancements. There can be no assurance that the Company will
continue to be successful in marketing its current products or any new products,
applications or product enhancements.
Technological Change. The communication software market for personal
computers is characterized by rapid technological change, changing customer
needs, frequent product introductions and evolving industry standards. The
introduction of products incorporating new technologies and the emergence of new
industry standards could render the Company's existing products obsolete and
unmarketable. The Company's future success will depend upon
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its ability to develop and introduce new software products (including new
releases, applications and enhancements) on a timely basis that keep pace with
technological developments and emerging industry standards and address the
increasingly sophisticated needs of its customers. There can be no assurance
that the Company will be successful in developing and marketing new products
that respond to technological changes or evolving industry standards, that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these new products, or
that its new products will adequately meet the requirements of the marketplace
and achieve market acceptance. If the Company is unable, for technological or
other reasons, to develop and introduce new products in a timely manner in
response to changing market conditions or customer requirements, the Company's
business, results of operations and financial condition would be materially
adversely affected.
Microsoft is the leading developer of operating systems for personal
computers. There can be no assurance that the Company will successfully develop
new versions of its software products that will operate on future Microsoft
operating systems, or that any such development, even if successful, will be
completed concurrently with or prior to introductions by competitors of
communication software products for those new operating systems. Any such
failure or delay could affect the Company's competitive position or lead to
product obsolescence in the future.
While the Company ships software to a number of computer manufacturers,
its primary OEM customers are modem manufacturers. The Company is aware that
technology is being developed to enable the functions of the modem to be
performed by a chip embedded into the computer. This development, if and when it
comes to market, could impair the business of those of the Company's customers
that rely on the existence of a separate modem component for their continued
success. A downturn in the business of one or more of its principal customers
could adversely affect the Company's business, results of operations and
financial condition.
In March 1997, modem manufacturers shipped the first 56K modems (modems
which download information at speeds up to 56,000 bits per second) for retail
sale. 56K modems were initially based on either one of two incompatible
standards, the x2 standard adopted by 3Com or the K56flex standard adopted by
Rockwell International and Lucent Technologies. This incompatibility, combined
with the failure of the modem industry to adopt an industry-wide standard for
such modems, caused some modem manufacturers to delay the launch of proprietary
56K modems and caused consumers to delay purchases of the new modems. The
company believes that its business, results of operations and financial
condition since the launch of the 56K modems have been directly and adversely
affected by the incompatibly of the 56K modem standards and the resulting
confusion created thereby in the marketplace. In February 1998, the ITU
(international standards governing body) voted on a draft of a 56K modem
standard, V.90, and plans to formally approve it during the next ITU meeting in
September 1998. Both competing 56K modem groups have announced that they intend
to support the V.90 standard by moving forward with all new modems and by
providing downloadable flash memory upgrades for currently owned X2 and K56flex
technology modems. The shipment of the V.90 compliant modems began in early 1998
and there can be no assurance that the Company will not continue to be adversely
affected by the previous incompatibility issues or that other technological
changes in the communications industry will not similarly affect the Company,
its results of operations or financial condition.
Competitive Threat from Microsoft and Other Operating Systems. The
Company faces competition from Microsoft, which dominates the personal computer
software industry. Due to its market dominance and the fact that it is the
publisher of the most prevalent personal computer operating platforms, DOS and
Windows, Microsoft represents a significant competitive threat to all personal
computer software vendors, including the Company. In addition, Windows 95 and
Windows NT, the latest Microsoft operating systems, include capabilities now
provided by certain of the Company's OEM and retail software products, including
the Company's principal product, QuickLink. If the communications capabilities
of Windows 95, Windows NT or other operating systems are adopted by users, sales
of the Company's products could decline. The Company is uncertain of the level
of communication capabilities that will be included in Microsoft's pending
release of Windows 98. The communication capabilities of Windows 98 may
adversely affect the purchasing decisions of OEMs and end users with regards to
the Company's communication software products. If so, sales of the Company's
products could be adversely affected.
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Competition. The markets in which the Company operates are highly
competitive and subject to rapid changes in technology. The strategic directions
of major personal computer hardware manufacturers and operating system
developers are also subject to changes. The Company competes with other software
vendors for access to distribution channels, retail shelf space and the
attention of customers. The Company also competes with other software companies
in its efforts to acquire software technology developed by third parties. These
factors may result in increased price competition. Additionally, there can be no
assurance that competitors will not develop or acquire products that are
superior to the Company's products or that achieve greater market acceptance.
The Company's retail products face significant competition. For example,
HotFax MessageCenter and HotFax, the Company's principal retail products,
compete directly with Symantec's WinFax Pro 8.0. Symantec is well established in
the retail distribution channel. There can be no assurance that HotFax
MessageCenter, HotFax, AudioVision, VideoLink Mail Pro, HotPage or any other of
the Company's retail product lines will capture a significant share of the
retail market for communication software. In addition, the Company's retail
video conferencing product, AudioVision, competes in a new and rapidly changing
software market. Some of the current competitors in the video conferencing
retail software market are White Pine and VocalTech, and there can be no
assurance that the Company will compete successfully with these and any future
competitors in the retail video conferencing software market. In the OEM
distribution channel, the Company has several competitors, among them Symantec,
Cheyenne, White Pine and VDONet. Some of the Company's competitors have a retail
emphasis and offer OEM products with a reduced set of features. The opportunity
for retail upgrade sales may induce these and other competitors to make OEM
products available at their own cost or even at a loss. Such a pricing strategy
could have an adverse affect on the Company's business, results of operations
and financial condition.
Symantec currently makes certain complementary products that are sold
separately. Symantec may be able to enhance its competitive position by bundling
certain of these products to attract customers seeking integrated,
cost-effective software applications. The Company also believes that the market
in which it competes has been characterized by the consolidation of established
communication software suppliers and that this trend, which may lead to the
creation of additional large and well-financed competitors, may continue. In
addition, other competitors have entered the market. Moreover, because there are
low barriers to entry into the software market, the Company believes that
competition will increase in the future. To remain competitive, the Company
believes that it will need to make continuing investments in research and
development and sales and marketing. There can be no assurance that the Company
will have sufficient resources to make such investments, or that it will be
successful in its research and development or sales and marketing efforts.
Symantec and many of the Company's current and prospective competitors
have significantly greater financial, marketing, service, support, technical and
other resources than the Company. Moreover, these companies may introduce
additional products that are competitive with those of the Company, and there
can be no assurance that the Company's products would compete effectively with
such products. The Company believes that its ability to compete depends on
elements both within and outside its control, including the success and timing
of new product development, product performance and price, distribution and
customer support and introduction by the Company and its competitors of new
products. There can be no assurance that the Company will be able to compete
successfully with respect to these and other factors. The Company believes that
the market for its software products has been and will continue to be
characterized by significant price competition. A material reduction in the
price of the Company's products could negatively affect the Company's
profitability.
Many of the Company's existing and potential OEM customers are major
manufacturers of modems and have substantial technological capabilities. These
customers may currently be developing, or may in the future develop, products
that compete directly with the Company's products and may, therefore,
discontinue purchases of the Company's products. The Company's future
performance is substantially dependent upon the extent to which existing OEM
customers elect to purchase communication software from the Company rather than
design and develop their own software. In light of the fact that the Company's
customers are not contractually obligated to purchase any of the Company's
products, there can be no assurance that the Company's existing OEM customers
will continue to rely, or expand their reliance, on the Company as an external
source for communication software.
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Dependence on New Product Offerings. The Company's future success will
depend, in significant part, on its ability to successfully develop and
introduce new software products and improved versions of existing software
products on a timely basis and in a manner that will allow such products to
achieve broad customer acceptance. There can be no assurance that new products
will be introduced on a timely basis, if at all. If new products are delayed or
do not achieve market acceptance, the Company's business, results of operations
and financial condition will be materially adversely affected. In the past, the
Company has experienced delays in purchases of its products by customers
anticipating the launch of new products by the Company. There can be no
assurance that material order deferrals in anticipation of new product
introductions will not occur. There can also be no assurance that the Company
will be successful in developing, introducing on a timely basis and marketing
such software or that any such software will be accepted in the market.
Retail Product Strategy Unproven. The Company's revenues have
historically been generated almost entirely on the strength of its OEM sales.
The Company has developed retail products with expanded functionality from its
OEM products and expects to introduce other products in the retail distribution
channel as well. The Company's ability to maintain distributor and retailer
relationships is largely a function of volumes. If the Company does not meet
certain minimum volume requirements, it will not be able to maintain its
relationships. The Company continues to work on strengthening product
recognition and distribution and there can be no assurance that the Company's
retail marketing plan will succeed. Further, while retail products provide
higher unit revenues than OEM products, retail distribution entails
significantly higher costs. These costs include advertising, trade shows, public
relations and the expenses related to the development and maintenance of a sales
force dedicated to the retail distribution effort. Accordingly, there can be no
assurance that retail sales will provide the margins that the Company has been
able to achieve on its OEM sales or that distributor and retailer minimum volume
requirements will be met.
In implementing its retail sales strategy, the Company relies on
distributors, retailers, internet distributors and value added resellers
(collectively, "resellers") for the marketing and distribution of HotFax
MessageCenter, HotFax, AudioVision, VideoLink Mail Pro, HotPage and its other
retail products. The Company's agreements with resellers are not exclusive and
in many cases may be terminated by either party without cause. Many of the
Company's resellers carry product lines that are competitive with those of the
Company. There can be no assurance that these resellers will give a high
priority to the marketing of the Company's products or that resellers will
continue to carry the Company's products. These resellers typically are allowed
to return products without charge or penalty. A component of the Company's
revenue recognition policy is that the Company calculates an allowance for
product returns based on its historical experience. If retail sales of the
Company's products increase, the risk of product returns will increase. While
the Company's revenue recognition policy contemplates this risk, it is possible
that returns may occur in excess of the Company's previous experience, causing
the Company to revise its estimates and increase the allowances for such
returns. Excessive or unanticipated returns could materially adversely affect
the Company's business, results of operations and financial condition. The
Company's results of operations could also be materially adversely affected by
changes in reseller inventory strategies, which could occur rapidly, and in many
cases, may not be related to end user demand. There can be no assurance that the
Company will be successful in recruiting resellers to represent it. Any of these
anticipated changes in the Company's distribution channels could materially
adversely affect the Company's business, results of operations and financial
condition.
Corporate and Government Product and Marketing Strategy Unproven. The
Company's revenues have historically been generated almost entirely on the
strength of its OEM sales. Since the second quarter of 1997 the Company has been
adding, and plans to continue to add, the infrastructure necessary to support a
focus on the corporate and government markets. In January 1998, the Company
acquired network fax software technology from Mitek Systems, Inc. as a part of
its strategy to address this market. The corporate market includes vertical
applications that are industry specific and require the investment of
engineering resources. There can be no assurance that the additional
infrastructure required in sales and marketing to the corporate and government
markets, or the investment in engineering resources for applications specific to
such markets, will yield significant sales growth for the Company or provide the
margins the Company has achieved historically on its OEM sales.
Potential for Undetected Errors. Software products as complex as those
offered by the Company may contain undetected errors. The Company has in the
past discovered software errors in certain of its products and has
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experienced delayed or lost revenues during the period required to correct these
errors. There can be no assurance that, despite testing by the Company and by
current and potential customers, errors will not be found in new or existing
products after commencement of commercial shipments, resulting in loss of or
delay in market acceptance or the recall of such products, which could have a
material adverse effect upon the Company's business, results of operations and
financial condition. The Company provides customer support for most of its
products. The Company is preparing to launch several new products. If these
products are flawed or are more difficult to use than traditional Company
products, customer support costs could rise and customer satisfaction levels
could fall.
Pre-Load and Royalty Based Software Market. The Company primarily sells
its software in a form that includes a disk and a manual. Some of the Company's
customers "pre-load" the Company's software onto a CD, diskette or the hard
drive of a personal computer and pay a royalty based on units produced or
shipped. These arrangements eliminate the need for a disk and may eliminate the
need for a manual. The pre-load arrangements produce smaller unit revenues for
the Company and eliminate the Company's ability to generate revenues from its
production facilities. The Company believes these facilities contribute profits
to the Company. Currently, the Company has the capability to produce its
products in-house on 3 1/2-inch diskettes. The Company does not currently have
the capability to produce CD-ROMs and the cost to develop such production
capability may be prohibitive. As the size of software programs grow, CD-ROM is
becoming a more prominent medium. The Company currently contracts CD-ROM
production to specialized CD-ROM facilities. In the event of a shift of this
kind, more of the Company's relationships would involve product pre-loads and
CD-ROM production and the Company's business, results of operations and
financial condition could be adversely affected.
Acceptance of Video Related Products. The Company's video communication
software sales volume has achieved only modest growth and has not become a
significant part of net revenues. Video communication software products compete
in a new and rapidly changing market and there can be no assurance that such
products will receive or gain market acceptance. Lack of market acceptance of
such products, or delays in or non-completion of the development of new video
communication software products, could have an adverse impact on the Company's
business, results of operations and financial condition. In addition, video
communication software products compete against those of several competitors,
including White Pine, Connectix, Intel, Microsoft, VocalTech and VDONet, some of
whom have greater financial and other resources than the Company, and there can
be no assurance that the Company will be able to compete successfully against
these and any future competitors in the video conferencing software market.
Dependence Upon Key Personnel. The Company's future performance depends
in significant part upon the continued service of William Smith and Rhonda
Smith, the Company's co-founders, and other key technical and senior management
personnel. The Company is dependent on its ability to identify, hire, train,
retain and motivate high quality personnel, especially highly skilled engineers
involved in the ongoing research and development required to develop and enhance
the Company's communication software products and introduce enhanced future
applications. The industry is characterized by a high level of employee mobility
and aggressive recruiting of skilled personnel. There can be no assurance that
the Company's current employees will continue to work for the Company. Loss of
services of key employees could have a material adverse effect on the Company's
business, results of operations and financial condition. In addition, the
Company may need to grant additional options and provide other forms of
incentive compensation to attract and retain key personnel.
Fluctuations in Gross Margins. The Company has experienced fluctuations
in gross margins from quarter to quarter, primarily as a result of changes in
the mix of retail and OEM sales. Other factors that can contribute to margin
fluctuations are inventory obsolescence as a result of new retail product
releases and return of retail product, price competition, expediting costs, and
changes in OEM sales mix and the related variances in OEM product pricing. An
erosion of the gross margins as a result of any of the aforementioned reasons or
for any other reasons not contemplated by the Company at this time, could have a
material adverse affect on the Company's operating results.
Duplication of Software. The Company duplicates all of its diskette
software at its Aliso Viejo, California facility. The Company believes that its
internal duplication capability provides it with a competitive advantage since
it
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eliminates the profit margin required by outside duplication sources and enables
a high degree of scheduling control. This concentration of production does,
however, expose the Company to the risk that production could be disrupted by
natural disaster or other events, such as the presence of a virus in the
Company's duplicators. The Company believes that it could retain outside
duplication alternatives quickly, but there is no assurance that it could do so
or, if such arrangements could be made, that duplication could take place in an
economical or timely manner. When CD-ROMs are required, the Company uses outside
third parties for CD-ROM replication. The equipment to replicate CD-ROMs is very
costly making it unlikely that the Company will add this capability internally.
Because the Company is dependent on CD-ROM replication facilities for both the
timing and pricing of the software produced in CD-ROM format, any adverse
changes in the timing of such replication could impair the Company's ability to
deliver products to customers and any price increases could reduce gross margins
which, in each case, could have a material adverse effect on the Company's
business, results of operations and financial condition.
Reliance on Third Party Suppliers; Shortage of Modem Chips. The Company
relies on third party suppliers who provide the components used in its kitted
products. These components include disks, CDs and printed manuals. Disk
shortages have occurred in the past and there can be no assurance that shortages
will not recur. If the Company cannot obtain a sufficient quantity of disks or
other components, or cannot obtain disks or other components at prices at least
comparable to prices paid currently, the Company's business, results of
operations and financial condition could be adversely affected.
Modem manufacturers purchase chips from a relatively limited number of
chip manufacturers. Production problems or product quality problems experienced
by a chip manufacturer could reduce modem sales or slow the growth of modem
sales. Chip manufacturers have a limited capacity to produce chips. This
capacity cannot be quickly expanded and the capital investment to expand
capacity is high. If chip suppliers are unable to meet demand, the growth of
modem sales will slow.
International Sales. The Company presently operates in foreign markets
and intends to expand its international presence. As a percentage of total net
revenues, international net revenues increased to 24.3% during the twelve months
ended December 31, 1997 from 14.4% for the twelve months ended December 31,
1996. Net revenues generated outside the United States remained constant at
approximately $2.9 million for the twelve months ended December 31, 1997 and
1996. International business is subject to risks in addition to those inherent
in the Company's United States business including substantially different
regulatory requirements in different jurisdictions, varying technical standards,
tariffs and trade barriers, political and economic instability, reduced
protection for intellectual property rights in certain countries, difficulties
in staffing and maintaining foreign operations, difficulties in managing
distributors, potentially adverse tax consequences, foreign currency exchange
fluctuations, the burden of complying with a wide variety of complex foreign
laws and treaties and the possibility of difficulties in collecting accounts
receivable. There can be no assurance that the Company will be able to continue
to generate significant international sales. While the Company does not
currently accept payment in foreign currencies and invoices all of its sales in
U.S. dollars, there can be no assurance that the Company will be able to
continue this policy if it is able to grow international sales. If the Company
begins to receive payment in foreign currencies, it is likely to be subjected to
the risks of foreign currency losses due to fluctuations in foreign currency
exchange rates. In addition, in the event the Company is successful in doing
business outside of the United States, the Company may also face economic,
political and foreign currency situations that are substantially more volatile
than those commonly experienced in the United States. There can be no assurance
that any of these factors will not have a material adverse effect on the
Company's business, results of operations and financial condition.
Intellectual Property Rights. The Company's success is dependent upon
its software code base, its programming methodologies and other intellectual
properties. To protect its proprietary technology, the Company relies on a
combination of trade secret, nondisclosure and copyright and trademark law which
may afford only limited protection. The Company owns United States trademark
registrations for certain of its trademarks, including QuickLink Gold, HotFax,
HotPage, HotLine, HotDesk and CrossConnect but has not yet obtained
registrations for all of its trademarks in the United States or other countries,
such as for the mark QuickLink. Prior to becoming a publicly held entity, the
Company did not require its employees to sign proprietary information and
inventions agreements stipulating, among other things, software ownership
rights. In addition, the Company has recently
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started the patent application process for a number of technologies that could
provide additional protection for existing products and products under
development. There can be no assurance that the steps taken by the Company will
be adequate to deter misappropriation of its proprietary information or will
prevent the successful assertion of an adverse claim to software utilized by the
Company or that the Company will be able to detect unauthorized use and take
effective steps to enforce its intellectual property rights. In selling its
products, the Company relies primarily on "shrink wrap" licenses that are not
signed by licensees and, therefore, may be unenforceable under the laws of
certain jurisdictions. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to as great an extent as do the laws of
the United States. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology. Further, although
the Company believes that its services and products do not infringe on the
intellectual property rights of others, there can be no assurance that such a
claim will not be asserted against the Company in the future. The failure of the
Company to protect its proprietary information could have a material adverse
effect on the Company's business, results of operations and financial condition.
From time to time, the Company has received and may receive in the
future communications from third parties asserting that the Company's trade name
or features, content, or trademarks of certain of the Company's products
infringe upon intellectual property rights held by such third parties. Should
there be a successful challenge to the Company's use of any of its trademarks,
the Company could incur significant expenses in connection therewith and
experience a loss of goodwill related thereto.
The Company has received correspondence from third parties separately
asserting that the Company's fax products may be violative of certain patents
held by each of the parties. No litigation has been initiated by these parties
and the Company is attempting to resolve all such assertions.
As the number of trademarks, patents, copyrights and other intellectual
property rights in the Company's industry increases, and as the coverage of
these patents and rights and the functionality of products in the market further
overlap, the Company believes that products based on its technology may
increasingly become the subject of infringement claims. Such claims could
materially adversely affect the Company, and may also require the Company to
obtain one or more licenses from third parties. There can be no assurance that
the Company would be able to obtain any such required licenses upon reasonable
terms, if at all, and the failure by the Company to obtain such licenses could
have a material adverse effect on its business, results of operations and
financial condition. In addition, the Company licenses technology on a
non-exclusive basis from several companies for inclusion in its products and
anticipates that it will continue to do so in the future. The inability of the
Company to continue to license these technologies or to license other necessary
technologies for inclusion in its products, or substantial increases in royalty
payments under these third party licenses, could have a material adverse effect
on its business, results of operations and financial condition.
Litigation in the software development industry has increasingly been
used as a competitive tactic both by established companies seeking to protect
their existing position in the market and by emerging companies attempting to
gain access to the market. If the Company is forced to defend itself against a
claim, whether or not meritorious, the Company could be forced to incur
substantial expense and diversion of management attention, and may encounter
market confusion and reluctance of customers to purchase the Company's software
products.
Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used in many companies may need
to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the computer industry concerning the potential effects
associated with such compliance.
The Company currently offers software products that are designed to be
Year 2000 compliant. However, there can be no assurance that such products do
not contain undetected errors or defects associated with Year 2000 date
functions.
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The Company has received confirmation from vendors of certain purchased
software used for internal operations that current releases or upgrades are
designed to be Year 2000 compliant, if installed. The Company is in the process
of determining whether to upgrade the current system or purchase a new system
that is designed to be Year 2000 compliant. The Company anticipates that all
internally used software will be designed to be Year 2000 compliant prior to
operational requirements for Year 2000 data.
The Company currently believes that becoming Year 2000 compliant will
not have a significant impact on the financial position or results of operations
of the Company. Although the Company is not aware of any material operational
issues or costs associated with preparing its software products or internal
information systems for the year 2000, there can be no assurances that the
Company will not experience serious unanticipated negative consequences and/or
material costs caused by undetected errors or defects in the technology used in
its internal systems, which are composed predominantly of third party software
and hardware.
Concentration of Ownership. As of March 24, 1998, William Smith and
Rhonda Smith beneficially owned, as community property, approximately 69.5% of
the outstanding shares of the Company. William Smith and Rhonda Smith are
married to one another and, acting together, will have the ability to elect the
Company's directors and determine the outcome of any corporate action requiring
stockholder approval, irrespective of how other stockholders of the Company may
vote. This concentration of ownership may have the effect of delaying or
preventing a change in control of the Company.
Potential Effect of Anti-Takeover Provisions. The Company's Certificate
of Incorporation and Bylaws contain provisions that may discourage or prevent
certain types of transactions involving an actual or potential change in control
of the Company, including transactions in which the stockholders might otherwise
receive a premium for their shares over then current market prices, and may
limit the ability of the stockholders to approve transactions that they may deem
to be in their best interest. In addition, the Board of Directors has the
authority to fix the rights and preferences of shares of the Company's Preferred
Stock and to issue such shares, which may have the effect of delaying or
preventing a change in control of the Company, without action by the Company's
stockholders. Certain provisions of Delaware law applicable to the Company,
including Section 203 of the Delaware General Corporation Law, could also have
the effect of delaying, deferring or preventing a change of control of the
Company. It is possible that the provisions in the Company's Certificate of
Incorporation and Bylaws, the ability of the Board of Directors to issue the
Company's Preferred Stock, and Section 203 of the Delaware General Corporation
Law may have the effect of delaying, deferring or preventing a change of control
of the Company without further action by the stockholders, may discourage bids
for the Company's Common Stock at a premium over the market price of the Common
Stock and may adversely affect the market price of the Common Stock and the
voting and other rights of the holders of Common Stock.
Possible Volatility of Stock Price. The trading price of the Common
Stock is likely to be subject to significant fluctuations in response to
variations in quarterly operating results, the gain or loss of significant
orders, changes in management, announcements of technological innovations or new
products by the Company, its customers or its competitors, legislative or
regulatory changes, general trends in the industry and other events or factors.
In addition, the stock market has experienced extreme price and volume
fluctuations which have particularly affected the market price for many high
technology companies similar to Smith Micro, and which have often been unrelated
to the operating performance of these companies. These broad market fluctuations
may adversely affect the market price of the Company's Common Stock. Further,
factors such as announcements of new contracts or product offerings by the
Company or its competitors and market conditions for stocks similar to that of
the Company could have significant impact on the market price of the Common
Stock.
Shares Eligible for Future Sale. No prediction can be made as to the
effect, if any, that future sales of Company Common Stock or the availability of
such Common Stock for future sales will have on the market price of the
Company's Common Stock. As of March 24, 1998, the Company had 14,074,698 shares
of Common Stock outstanding. Of this amount, the 9,781,670 shares held by
William Smith and Rhonda Smith became available for sale in the public market
(subject to the volume and other applicable restrictions of Rule 144) following
the
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expiration in September 1997 of a two year lock-up agreement with certain
representatives of the underwriters of the Company's initial public offering
which consummated in September 1995. Sales of a substantial number of shares of
Common Stock by William Smith, Rhonda Smith or any other person, either
individually or when aggregated with sales by other persons, could adversely
affect the market price of the Common Stock.
ITEM 2. PROPERTIES
The Company's principal administrative, sales and marketing, customer
support and research and development facility is located in approximately 33,000
square feet of space in Aliso Viejo, California. This facility is leased by the
Company through March 31, 2003. The Company also leases a facility of
approximately 3,600 square feet in Beaverton, Oregon pursuant to a lease which
extends through February 28, 2000, a facility of approximately 1,500 square feet
in Boulder, Colorado pursuant to a lease which extends through May 31, 1998, a
facility of approximately 1,500 square feet in Calgary, Alberta pursuant to a
lease that extends through July 31, 1999 and a facility of approximately 900
square feet in Plano, Texas, pursuant to a lease which extends through June 30,
1998. The Company believes that suitable additional or alternative space will be
available in the future on commercially reasonable terms as needed.
ITEM 3. LEGAL PROCEEDINGS
The Company and its PCI Video Products, Inc. subsidiary ("PCI Video")
have been named parties to a lawsuit, Virtual Ambiance, Inc. v. Video
Conferencing Communications. Inc., et al., filed August 11, 1997 in the Superior
Court of the State of California for the County of Orange, Case No. 782856. The
complaint alleges causes of action against the Company and PCI Video for
negligent misrepresentation, fraud, declaratory relief, breach of covenant of
good faith and fair dealing, and civil conspiracy, involves a dispute over the
licensing of video conferencing software, and seeks consequential and punitive
damages against all defendants. The Company and PCI Video demurred to the
complaint, and the court on March 24, 1998 dismissed the causes of action for
declaratory relief and breach of the covenant of good faith and fair dealing,
and ordered the plaintiff to amend its remaining causes of action to conform
with state pleading requirements. Accordingly, the Company and PCI Video have
not answered the complaint. The Company and PCI Video believe the claims against
them lack any merit and have no factual basis. The Company and PCI Video are
vigorously defending the case and intend to continue to do so.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of stockholders during the
quarter ended December 31, 1997.
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "SMSI." The high and low closing sale prices for the Company's Common
Stock as reported by Nasdaq are set forth below for the periods indicated.
High Low
--------- --------
YEAR ENDED DECEMBER 31, 1997:
First Quarter $ 5 1/2 $ 2 7/8
Second Quarter 4 1/2 2
Third Quarter 3 1/2 1 7/8
Fourth Quarter 3 7/8 1 5/8
YEAR ENDED DECEMBER 31, 1996:
First Quarter 9 3/4 5 1/2
Second Quarter 16 7/8 8 3/8
Third Quarter 12 1/4 5 1/8
Fourth Quarter 6 1/4 4 3/4
YEAR ENDED DECEMBER 31, 1995:
Third Quarter (from September 19, 1995) 14 1/2 9 7/8
Fourth Quarter 13 1/2 5 1/4
On March 24, 1998, the closing sale price for the Company's Common Stock
as reported by Nasdaq was $3.50.
HOLDERS
As of March 24, 1998, there were 85 holders of record of the Company's
Common Stock.
DIVIDENDS
The Company has never paid any cash dividends on its Common Stock and
has no current plans to do so.
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USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
The effective date of the Company's first registration statement (the
"Registration Statement") filed on Form S-1 (Registration No. 33-95096) under
the Securities Act of 1993, as amended, was September 18, 1995. The class of
securities registered was Common Stock. The offering commenced on September 19,
1995 and all securities were sold in the offering. The managing underwriters for
the offering were Hambrecht & Quist LLC and Oppenheimer & Co., Inc.
Pursuant to the Registration Statement, the Company sold 1,700,000
shares of its Common Stock for an aggregate offering price of $20,400,000, and
certain selling stockholders sold 2,210,000 shares of the Common Stock of the
Company for an aggregate offering price of $26,520,000.
The Company incurred expenses of $2,262,000 of which $1,428,000
represented underwriting discounts and commissions and $834,000 represented
other expenses. All such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after total expenses were $18,138,000.
As of December 31, 1997, of the net proceeds from the offering,
$4,188,000 was used to repay amounts due under a promissory note issued by the
Company to certain of its stockholders as a part of a distribution of retained
earnings in connection with the Company's prior S corporation status, $3,011,000
was used in the Company's acquisition of Performance Computing Incorporated
which was consummated in March 1996 and the remainder has been invested in U. S.
Government obligations and corporate bonds. The use of the proceeds from the
offering does not represent a material change in the use of the proceeds
described in the prospectus which is part of the Registration Statement.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to the Company's
consolidated statements of operations for the years ended and consolidated
balance sheets as of December 31, 1997, 1996, 1995 and 1994 are derived from the
audited Consolidated Financial Statements of the Company. The following
information should be read in conjunction with the Consolidated Financial
Statements of the Company and the related notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included elsewhere in this Annual Report on Form 10-K.
YEAR ENDED DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994
-------- -------- -------- -------
(in thousands, except per share data)
STATEMENT OF OPERATIONS DATA:
Net revenues $11,684 $22,091 $18,012 $10,372
Cost of revenues 3,853 6,795 5,887 3,128
------- ------- ------- -------
Gross profit 7,831 15,296 12,125 7,244
Operating expenses:
Selling and marketing 3,525 2,939 1,995 1,559
Research and development 3,266 3,324 1,621 1,126
General and administrative 4,191 3,796 2,555 1,956
Acquired in-process research
and development 5,169
------- ------- ------- -------
Total operating expenses 10,982 15,228 6,171 4,641
------- ------- ------- -------
Operating income (loss) (3,151) 68 5,954 2,603
Interest income 725 849 308 13
------- ------- ------- -------
Income (loss) before income taxes (2,426) 917 6,262 2,616
Income tax expense (benefit) (1) (839) 2,436 810 49
------- ------- ------- -------
Net income (loss) $(1,587) $(1,519) $ 5,452 $ 2,567
======= ======= ======= =======
Net loss per share, basic and dilutive $ (0.11) $ (0.11)
======= =======
Pro forma net income (1) $ 3,757
=======
Pro forma net income per share, basic and
dilutive (1) $ 0.30
=======
Weighted average shares used in computation 14,075 13,992 12,627
======= ======= =======
AS OF DECEMBER 31,
--------------------------------------------
1997 1996 1995 1994
------- ------- ------- ------
Balance Sheet Data:
Total assets $21,755 $24,107 $23,662 $3,240
Total liabilities 1,512 2,277 3,417 608
Retained earnings (accumulated deficit) (1,021) 566 2,085 2,610
Total stockholders' equity 20,243 21,830 20,245 2,632
(1) Prior to the effective date of the initial public offering, the Company was
treated as an S corporation pursuant to the Internal Revenue Code.
Subsequent to the effective date of the initial public offering, the
Company's tax status reverted to that of a C corporation. The pro forma
information presented on the statement of operations data reflect a
provision for income taxes in 1995 as if the Company had been taxed as a C
corporation for the entire year, assuming effective tax rates that would
have been in effect at such time. The principal difference between the
effective pro forma tax rate and the statutory federal tax rate relates to
state taxes and research and development tax credits.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Smith Micro, founded in 1982, develops and sells personal computer
communication software. The Company's communication software products include
fax, video conferencing, video email, telephony and data transmission products.
The Company shipped its first data communication software product in 1985 and,
since that time, the Company's revenues have been primarily the result of the
market acceptance of its OEM fax and data communication software products. The
Company began providing video communication products in 1996 to both OEM and
retail customers. In January 1998, the Company purchased certain fax software
assets of Mitek Systems, Inc. to provide LAN, Internet and intranet fax
transmission solutions designed for the corporate market.
The Company recognizes revenues from sales of its software as completed
products are shipped and from royalties from customers who are authorized to
duplicate the Company's software. Any material reduction in demand for the
Company's products would have a material adverse effect on the Company's
business, results of operations and financial condition. The Company has
continued to expand its business by introducing new products and its future
success will depend in part on the continued introduction of new and enhanced
OEM, retail and corporate products that achieve market acceptance. Revenues are
net of estimated returns and other adjustments at the time the products are
shipped. The Company has allowed its customers to return unused software,
constituting 26.8%, 16.8% and 2.3% of the Company's net revenues for 1997, 1996
and 1995, respectively. Returns include stock rotation for new versions of
retail product releases that were 14.6%, 6.8% and 0.0% of the Company's net
revenues for 1997, 1996 and 1995, respectively.
A small number of customers have historically accounted for a
substantial portion of the Company's revenues. In June 1997, 3Com Corporation
("3Com") acquired U.S. Robotics Corporation ("U.S. Robotics"), to date the
Company's largest customer based on the percentage of revenues, as a wholly
owned subsidiary. Sales to 3Com (primarily U.S Robotics and its subsidiaries),
accounted for approximately 43.1%, 46.4% and 52.1% in 1997, 1996, and 1995,
respectively. During 1997, 1996, and 1995, the Company's three largest OEM
customers, including 3Com, accounted for 56.9%, 62.9% and 66.8%, respectively,
of net revenues. Any reduction, delay or change in orders from such customers
could have a material adverse affect on the Company's business, results of
operations and financial condition.
In April 1996, the Company entered into an OEM agreement having an
initial one year term with a wholly-owned subsidiary of U.S. Robotics (now a
subsidiary of 3Com). The agreement superseded a previous agreement between the
parties and automatically renews at the end of each one year term unless a party
provides at least 60 days notice of its intent to terminate the agreement at the
end of the then-current term. During 1997, the agreement automatically renewed
according to its terms and certain other 3Com entities (hereinafter 3Com, its
affiliates and their subsidiaries will be referred to as "3Com" entities) were
added as parties pursuant to new addenda to the agreement. Under the terms of
the agreement, the Company granted certain pricing incentives to the 3Com
entities in consideration for which the Company became the provider of fax,
data, voice and telephony communications software for such 3Com entities. In
addition, under the terms of the agreement, certain of the 3Com entities agreed
to place Smith Micro retail products and commercials for such products on
certain of their compact disks. The agreement does not require any 3Com entity
to purchase any minimum quantity of Smith Micro products and may be terminated
by a party thereto at any time for any reason upon 90 days prior written notice.
While the Company believes that it has been the principal supplier of OEM
communication software products to U.S. Robotics, there can be no assurance that
the 3Com entities, including U.S. Robotics, will not seek additional sources for
such products in the future. Accordingly, there can be no assurance that sales
to the U.S. Robotics and the other 3Com entities to which the Company sells
products in any future period will reach or exceed the historical levels of
sales to U.S. Robotics. A substantial decrease or delay in sales to the 3Com
entities would have a material adverse effect on the Company's business, results
of operations and financial condition.
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The OEM product ordering cycle beginning from placement of an order to
shipping is very short. OEM customers generally operate under a just-in-time
system and order software to be delivered as needed by their manufacturing
operations. The Company's products are generally shipped as orders are received
and, accordingly, the Company has historically operated with little backlog, and
does not consider backlog to be a significant indication of future performance.
As a result, sales in any quarter are dependent on orders booked and shipped in
that quarter and are not predictable with any degree of certainty. Moreover, the
Company does not generally produce software in advance of orders and therefore
has not maintained a material amount of inventory.
Inventory in the retail channel exposes the Company to product returns.
This exposure is considered when the allowance is made for product returns.
Substantial returns of product from the retail channel could have a material
adverse affect on the Company's business, results of operations and financial
condition.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Financial Statements and related notes thereto
included elsewhere. Historical results of operations, percentage relationships
and any trends that may be inferred from the discussion below are not
necessarily indicative of the operating results for any future period.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, the
percentages of net revenues represented by each item in the Company's statement
of income.
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995 1994
--------- --------- --------- ---------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 33.0% 30.8% 32.7% 30.2%
--------- --------- --------- ---------
Gross profit 67.0% 69.2% 67.3% 69.8%
Operating expenses:
Selling and marketing 30.2% 13.3% 11.1% 15.0%
Research and development 27.9% 15.0% 9.0% 10.8%
General and administrative 35.9% 17.2% 14.2% 18.9%
Acquired in-process research
and development 23.4%
--------- --------- --------- ---------
Total operating expenses 94.0% 68.9% 34.3% 44.7%
--------- --------- --------- ---------
Operating income (loss) -27.0% 0.3% 33.0% 25.1%
Interest income 6.2% 3.8% 1.7% 0.1%
--------- --------- --------- ---------
Income (loss) before income taxes -20.8% 4.1% 34.7% 25.2%
Income tax expense (benefit) -7.2% 11.0% 4.5% 0.5%
--------- --------- --------- --------
Net income (loss) -13.6% -6.9% 30.2% 24.7%
========= ========= ========= =========
1997 COMPARED TO 1996
Net Revenues
Net revenues decreased 47.1% to $11.7 million for 1997 from $22.1
million for 1996. This decrease consisted of a 40.7% and 82.2% decrease in OEM
and retail sales, respectively, in 1997 compared with 1996. The OEM decrease was
the result of a combination of decreased unit volume that the Company believes
was primarily driven by the lack of a 56K modem standard during 1997 and an
increased percentage of net revenues resulting from royalty agreements. These
reasons for the decrease were reflected in the decrease in revenue from 3Com and
Motorola of 50.5% and 77.0%, respectively. The decrease in retail sales was
primarily driven by slower than
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anticipated sales of the video communication software product lines that the
Company believes continues to be impacted by the consumer's lack of acceptance
of current video technology and pricing.
Gross Profit
Gross profit represents net revenues, less cost of sales, which includes
cost of materials, costs related to the operations of the Company's duplication
facilities, freight charges and royalties to licensors. Gross profit decreased
48.8% to $7.8 million in 1997 from $15.3 million in 1996 and gross profit as a
percentage of net revenues decreased to 67.0% in 1997 compared to 69.2% in 1996.
An increased percentage of revenue from royalty agreements, cost control
measures and increased manufacturing efficiencies helped the Company achieve
only a slight decrease in gross profit percentage despite the 47.1% decrease in
sales. Gross profits as a percentage of net revenues decreased primarily due to
the decrease in net revenue, an increase in inventory write-offs resulting from
releases of new version retail product releases during 1997 and an increase in
royalty expenses primarily related to video products shipped.
Operating Expenses
Selling and marketing expenses consist primarily of personnel costs,
advertising costs, sales commissions and trade show expenses. These expenses
vary significantly from quarter to quarter based on the timing of trade shows
and product introductions. Selling and marketing expenses increased 19.9% to
$3.5 million in 1997 from $2.9 million in 1996. As a percent of net revenues,
sales and marketing increased to 30.2% in 1997 from 13.3% in 1996. Sales and
marketing expenditures increased primarily due to promotional campaigns in the
retail channel during the first half of the year combined with an increase in
personnel.
Research and development expenses consist primarily of personnel and
equipment costs required to conduct the Company's software development efforts.
Research and development expenses remained constant at $3.3 million in 1997
compared to 1996. As a percentage of net revenues, research and development
expenditures increased to 27.9% in 1997 from 15.0% in 1996. An increase in the
amortization of purchased technologies related to video communication software
was offset by a decrease in all other research and development expense
categories. To date, the Company has not capitalized any software development
expenses, since the Company's development efforts have been completed
concurrently with the establishment of technological feasibility. However,
significant new products developed in the future may require the capitalization
of certain software development expenses.
General and administrative expenses include expenses related to the
general operations of the Company. General and administrative expenses increased
10.4% to $4.2 million in 1997 from $3.8 million in 1996. As a percentage of net
revenues, general and administrative expenditures increased to 35.9% in 1997
from 17.2% in 1996. The Company's cost control efforts reduced general and
administrative expenses in most categories, particularly salaries and benefits,
however, this reduction was offset by an increase in bad debt reserves. Bad debt
reserves were increased due to slower payment patterns from customers that were
largely influenced by slower than anticipated sales of retail video
communication software products.
Income Taxes
During 1997, the Company's income tax benefit was 34.6% of the loss
before income taxes. Income tax benefit was $839,000 in 1997 and the income tax
expense was $2.4 million in 1996. The effective tax rate during 1996 differed
from the statutory federal rate of 35.0% principally because of nondeductible
acquired in-process research and development costs of $1.8 million and state
taxes.
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1996 COMPARED TO 1995
Net Revenues
Net revenues increased 22.6% to $22.1 million for 1996 from $18.0
million for 1995. This increase was due to increased retail and OEM sales. Net
revenues from retail sales increased approximately 212% to $3.4 million in 1996
from $1.1 million in 1995. As a consequence, retail sales grew as a percentage
of net revenues to 15.8% for 1996 from 5.8% for 1995. In addition, net revenues
from sales to U.S. Robotics increased approximately 9% to $10.2 million in 1996
from $9.4 million in 1995. However, as a percentage of net revenues, sales to
U.S. Robotics decreased to 46.4% during 1996 from 52.1% during 1995. Sales to
Motorola increased 220% to $2.8 million in 1996 from $.9 million in 1995.
Gross Profit
Gross profit represents net revenues, less cost of sales, which includes
cost of materials, costs related to the operations of the Company's duplication
facilities, freight charges and royalties to licensors. Gross profit increased
26.2% to $15.3 million in 1996 from $12.1 million in 1995 and increased as a
percentage of net revenues to 69.2% from 67.3% over the same periods. The
increase in gross margins as a percentage of net revenues for 1996 was primarily
due to the fact that retail sales as a percent of net revenues increased and, in
addition, during 1996 the Company made arrangements with several of it's large
OEM customers to charge for products on a royalty schedule instead of producing
kitted products for them.
Operating Expenses
Selling and marketing expenses consist primarily of personnel costs,
advertising costs, sales commissions and trade show expenses. These expenses
vary significantly from quarter to quarter based on the timing of trade shows
and product introductions. Sales and marketing expenses increased 47.3% to $2.9
million in 1996 from $2.0 million in 1995. As a percent of net revenues, sales
and marketing increased to 13.3% in 1996 from 11.1% in 1995. Sales and marketing
expenditures increased due to additional personnel, increased presence in trade
shows, increased channel marketing programs, and increased print advertising
campaigns. Additional channel marketing programs have been necessary as the
company expands in the retail channel.
Research and development expenses consist primarily of personnel and
equipment costs required to conduct the Company's software development efforts.
Research and development expenses increased 105% to $3.3 million in 1996 from
$1.6 million for 1995. As a percentage of net revenues, research and development
expenditures also increased to 15.0% in 1996 from 9.0% in 1995. This increase is
attributed primarily to the additional personnel related to the acquisition of
Performance Computing Incorporated in the first quarter of 1996.
General and administrative expenses include expenses related to the
general operations of the Company. General and administrative expenses increased
48.6% to $3.8 million in 1996 from $2.6 million in 1995. As a percentage of net
revenues, general and administrative expenditures increased to 17.2% in 1996
from 14.2% in 1995. The increase in expenditures is due to the additional
personnel in technical support, accounting and administrative functions who were
added throughout the year.
Income Taxes
Prior to the Company's initial public offering in September 1995, the
Company had been treated as an S corporation for federal and certain state
income tax purposes. Income tax expense was $2.4 million and $810,000 for 1996
and 1995, respectively. Concurrent with the closing of the public offering, the
Company recorded a deferred tax asset of $122,800 to reflect the deferred taxes
of the Company as a C corporation. The pro forma net income for 1995 reflects a
provision for income taxes assuming effective tax rates in effect for each
period presented. This effective tax rate differs from the statutory federal
rate of 34.0% principally because of state taxes and research and development
credits.
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LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its operations primarily
through cash generated from operations. Net cash provided by operating
activities was $102,000 and $4.5 million for 1997 and 1995, respectively. Net
cash used in operations in 1996 was $288,000. The increase in cash provided by
operations in 1997 was primarily due to a decrease in accounts receivable that
was offset by a net loss for the year. The decrease in cash provided from
operations in 1996 was primarily the result of increased accounts receivable and
income taxes receivable, and increased operating costs, primarily in research
and development expenditures. Net cash provided by operating activities for 1995
consisted primarily of net income and an increase in accrued liabilities, offset
by an increase in accounts receivable.
Cash used in investing activities was $222,000, $2.5 million and
$384,000 for 1997, 1996 and 1995, respectively. Cash used in investing
activities during 1997 and 1995 consisted primarily of the acquisition of
property and equipment including the purchase of computers and production
equipment with a similar amount spent in 1996. During 1996, however, the primary
use of cash for investing activities related to the purchase of Performance
Computing Incorporated in the first quarter of 1996.
During 1997, the Company did not use or generate cash from financing
activities. Net cash used in financing activities during 1996 was $1.8 million
was primarily for the repayment of notes to founders. For 1995, net cash
provided by financing activities was $14.3 million. This was related to the
Company's initial public offering and was partially offset by distributions to
the S corporation stockholders.
At December 31, 1997, the Company had $14.4 million in cash and cash
equivalents and $19.3 million of working capital. The Company had $3.8 million
in accounts receivable, net of allowance for doubtful accounts and other
adjustments. The Company currently anticipates that capital expenditures will
not vary significantly from recent years. During early 1998, the Company used
$420,000 in cash to acquire certain fax software providing fax over LANs, the
Internet and intranets and related assets from Mitek Systems, Inc. The Company
has no other significant capital commitments.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. These date code
fields will need to accept four digit entries to distinguish 21st century dates
from 20th century dates. As a result, in less than two years, computer systems
and/or software used in many companies may need to be upgraded to comply with
such "Year 2000" requirements. Significant uncertainty exists in the computer
industry concerning the potential effects associated with such compliance.
The Company currently offers software products that are designed to be
Year 2000 compliant. However, there can be no assurance that such products do
not contain undetected errors or defects associated with Year 2000 date
functions.
The Company has received confirmation from vendors of certain purchased
software used for internal operations that current releases or upgrades are
designed to be Year 2000 compliant, if installed. The Company is in the process
of determining whether to upgrade the current system or purchase a new system
that is designed to be Year 2000 compliant. The Company anticipates that all
internally used software will be designed to be Year 2000 compliant prior to
operational requirements for Year 2000 data.
The Company currently believes that becoming Year 2000 compliant will
not have a significant impact on the financial position or results of operations
of the Company. Although the Company is not aware of any material operational
issues or costs associated with preparing its software products or internal
information systems for the year 2000, there can be no assurances that the
Company will not experience serious unanticipated negative consequences
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33
and/or material costs caused by undetected errors or defects in the technology
used in its internal systems, which are composed predominantly of third party
software and hardware.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and schedule, as listed
under Item 14, appear in a separate section of this Annual Report on Form 10-K
beginning on page F-1 and S-1, respectively.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During the three years prior to the date of the most recent financial
statements and the subsequent interim period, the Company has not had a change
in its independent auditors nor have there been any disagreements between the
Company and its independent auditors.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The sections titled "Executive Officers of the Company," "Directors and
Nominees" and "Compliance with Section 16(a) of the Exchange Act" appearing in
the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders is
incorporated herein by reference
ITEM 11. EXECUTIVE COMPENSATION
The section titled "Executive Compensation and Related Information"
appearing in the Company's Proxy Statement for the 1998 Annual Meeting of
Stockholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section titled "Principal Stockholders" appearing in the Company's
Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS
The Company's financial statements appear in a separate section of this
Annual Report on Form 10-K beginning on the pages referenced below:
PAGE
Independent Auditors' Report....................................................................F-1
Consolidated Balance Sheets as of December 31, 1997 and 1996....................................F-2
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 1997...........................................................F-3
Consolidated Statements of Stockholders Equity for each of the three
years in the period ended December 31, 1997..................................................F-4
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1997...............................................................F-5
Notes to Consolidated Financial Statements for each of the three years
in the period ended December 31, 1997........................................................F-7
(2) FINANCIAL STATEMENT SCHEDULE
The Company's financial statement schedule appears in a separate section
of this Annual Report on Form 10-K on the pages referenced below. All other
schedules have been omitted as they are not applicable, not required or the
information is included in the consolidated financial statements or the notes
thereto.
PAGE
Independent Auditors' Report....................................................................S-1
Schedule II - Valuation and Qualifying Accounts for each of the three years in
the period ended December 31, 1997............................................................S-2
(3) EXHIBITS
Exhibit
No. Title Method of Filing
- -------- ----------------------------------- -------------------------------------------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1
Incorporation of the Company to the Registrant's Registration Statement
No. 33-95096
3.2 Amended and Restated Bylaws of the Incorporated by reference to Exhibit 3.2
Company. to the Registrant's Registration Statement
No. 33-95096
4.1 Specimen certificate representing Incorporated by reference to Exhibit 4.1
shares of Common Stock of the to the Registrant's Registration Statement
Company. No. 33-95096
10.1 Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1
to the Registrant's Registration Statement
No. 33-95096
10.2 1995 Stock Option/Stock Issuance Incorporated by reference to Exhibit 10.2
Plan. to the Registrant's Registration Statement
No. 33-95096
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35
10.3 Form of Notice of Grant of Stock Incorporated by reference to Exhibit 10.3
Option under 1995 Stock Option/Stock to the Registrant's Registration Statement
Issuance Plan. No. 33-95096
10.4 Form of 1995 Stock Option Agreement Incorporated by reference to Exhibit 10.4
under 1995 Stock Option /Stock to the Registrant's Registration Statement
Issuance Plan. No. 33-95096
10.5 Form of 1995 Stock Purchase Incorporated by reference to Exhibit 10.5
Agreement under 1995 Stock to the Registrant's Registration Statement
Option/Stock Issuance Plan. No. 33-95096
10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6
September 30, 1991, by and between to the Registrant's Registration Statement
the Company and Crandell Development No. 33-95096
Corporation.
10.7 Application Program Interface Retail Incorporated by reference to Exhibit 10.7
License Agreement July 28, 1992 by to the Registrant's Registration Statement
and between the Company and Rockwell No. 33-95096
International Corporation.
10.8 Application Program Interface Incorporated by reference to Exhibit 10.8
License Agreement July 28, 1992 by to the Registrant's Registration Statement
and between the Company and Rockwell No. 33-95096
International Corporation.
10.9 Rockwell High Speed Interface Incorporated by reference to Exhibit 10.9
License Agreement dated June 2, to the Registrant's Registration Statement
1994, by and between the Company and No. 33-95096
Rockwell International Corporation.
10.10 Letter Agreement dated February 22, Incorporated by reference to Exhibit 10.10
1994, by and between the Company and to the Registrant's Registration Statement
Rockwell International Corporation. No. 33-95096
10.11 Letter Agreement dated April 22, Incorporated by reference to Exhibit 10.11
1993, by and between the Company and to the Registrant's Registration Statement
Rockwell International Corporation. No. 33-95096
10.12 Software Distribution Agreement Incorporated by reference to Exhibit 10.12
dated May 8, 1995, by and between to the Registrant's Registration Statement
the Company and International No. 33-95096
Business Machines Corporation.
10.13 Office Building Lease, dated June Incorporated by reference to Exhibit 10.13
10, 1992, by and between the Company to the Registrant's Registration Statement
and Developers Venture Capital No. 33-95096
Corporation.
10.14 Amendment No. 1 To Office Building Incorporated by reference to Exhibit 10.14
Lease, dated July 9, 1993, by and to the Registrant's Registration Statement
between the Company and Pioneer Bank. No. 33-95096
10.15 Amendment No. 2 To Office Building Incorporated by reference to Exhibit 10.15
Lease, dated August 15, 1994, by and to the Registrant's Registration Statement
between the Company and T&C No. 33-95096
Development.
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10.16 Fourth Addendum to Office Building Incorporated by reference to Exhibit 10.16
Lease, dated April 21, 1995, by and to the Registrant's Registration Statement
between the Company and T&C No. 33-95096
Development.
10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17
Corporation Distribution. to the Registrant's Registration Statement
No. 33-95096
10.18 Smith Micro Software, Inc. Amended Incorporated by reference to Exhibit 10.21
and Restated Software Licensing and to the Registrant's Quarterly Report on
Distribution Agreement, dated April Form 10-Q for the quarter ended September
18, 1996, by and between the Company 30, 1996
and U.S. Robotics Access Corp.
10.19 Office Building Lease, dated March Incorporated by reference to Exhibit 10.19
1, 1994, by and between Performance to the Registrant's Annual Report on Form
Computing Incorporated and Petula 10-K for the fiscal year ended December
Associates, Ltd./KC Woodside. 3l, 1995
10.20 Agreement and Plan of Merger by and Incorporated by reference to Exhibit 2 to
between Smith Micro Software, Inc., the Registrant's Current Report on Form
Performance Computing Incorporated 8-K filed with the Commission on March 28,
and PCI Video Products, Inc. dated 1996
as of March 14, 1996.
10.21 Amendment No. 1, dated as of March Incorporated by reference to Exhibit 10.21
10, 1997, to Agreement and Plan of to the Registrant's Annual Report on Form
Merger by and between Smith Micro 10-K for the fiscal year ended December
Software, Inc., Performance 31, 1996
Computing Incorporated and PCI Video
Products, Inc. dated as of March 14,
1996.
10.22 Amendment No. 6 to Office Building Filed Herewith
Lease, dated February 19, 1998, by
and between the Company and World
Outreach Center.
23.1 Independent Auditors' Consent. Filed Herewith
27 Financial Data Schedule. Filed Herewith
(b) EXHIBITS ON FORM 8-K
No Current Reports on Form 8-K were filed during the quarter ended
December 31, 1997.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
SMITH MICRO SOFTWARE, INC.
Date: March 27, 1998 By: /s/ William W. Smith, Jr.
--------------------------------
William W. Smith, Jr.
Chairman of the Board,
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ William W. Smith, Jr. Chairman of the Board, March 27, 1998
- ----------------------------- President and Chief Executive Officer
William W. Smith, Jr. (principal executive officer)
/s/ Rhonda L. Smith Executive Vice President, Chief March 27, 1998
- ----------------------------- Operating Officer, Secretary,
Rhonda L. Smith Treasurer and Director
/s/ Robert W. Scheussler Senior Vice President, Chief March 27, 1998
- ----------------------------- Technical Officer, and Director
Robert W. Scheussler
/s/ Mark W. Nelson Vice President of Finance and Chief March 27, 1998
- ----------------------------- Financial Officer (principal
Mark W. Nelson financial and accounting officer)
/s/ Thomas G. Campbell Director March 27, 1998
- -----------------------------
Thomas G. Campbell
/s/ F. Terry Eger Director March 27, 1998
- -----------------------------
F. Terry Eger
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INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Smith Micro Software, Inc.:
We have audited the accompanying consolidated balance sheets of Smith Micro
Software, Inc. and subsidiary (the Company) as of December 31, 1997 and 1996,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Smith Micro Software, Inc. and
subsidiary as of December 31, 1997 and 1996, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1997 in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
February 13, 1998
F-1
39
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996
- -------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1997 1996
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $14,367 $14,487
Accounts receivable, net of allowances for doubtful accounts
and other adjustments of $1,413 (1997) and $1,822 (1996) 3,808 6,017
Income taxes receivable 1,127 520
Deferred tax asset (Note 5) 467 850
Inventories 553 561
Prepaid expenses and other current assets 503 415
------- -------
Total current assets 20,825 22,850
EQUIPMENT AND IMPROVEMENTS, net (Note 3) 444 548
DEFERRED TAX ASSET (Note 5) 139
INTANGIBLE ASSETS, net (Note 10) 347 709
------- -------
$21,755 $24,107
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 877 $ 892
Accrued liabilities (Note 4) 635 1,223
------- -------
Total current liabilities 1,512 2,115
DEFERRED TAX LIABILITY (Note 5) 162
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY (Note 9):
Preferred stock, par value $0.001 per share; 5,000,000 shares
authorized; none issued and outstanding
Common stock, par value $0.001 per share; 20,000,000 shares
authorized; 14,075,000 shares issued and outstanding
(1997 and 1996) 14 14
Additional paid-in capital 21,250 21,250
Retained earnings (accumulated deficit) (1,021) 566
------- -------
Total stockholders' equity 20,243 21,830
------- -------
$21,755 $24,107
======= =======
See notes to consolidated
financial statements.
F-2
40
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1996 1995
NET REVENUES (Note 7) $11,684 $22,091 $18,012
COST OF REVENUES 3,853 6,795 5,887
------- ------- -------
GROSS PROFIT 7,831 15,296 12,125
OPERATING EXPENSES:
Selling and marketing 3,525 2,939 1,995
Research and development 3,266 3,324 1,621
General and administrative 4,191 3,796 2,555
Acquired in-process research and development (Note 10) 5,169
------- ------- -------
Total operating expenses 10,982 15,228 6,171
------- ------- -------
OPERATING INCOME (LOSS) (3,151) 68 5,954
INTEREST INCOME 725 849 308
------- ------- -------
INCOME (LOSS) BEFORE INCOME TAXES (2,426) 917 6,262
INCOME TAX EXPENSE (BENEFIT) (Note 5) (839) 2,436 810
------- ------- -------
NET INCOME (LOSS) $(1,587) $(1,519) $ 5,452
======= ======= =======
NET LOSS PER SHARE, basic and dilutive $ (0.11) $ (0.11)
======= =======
PRO FORMA INFORMATION (unaudited) (Note 2):
Historical income before income tax expense $ 6,262
Pro forma income tax expense 2,505
-------
PRO FORMA NET INCOME $ 3,757
=======
PRO FORMA NET INCOME PER SHARE, basic and dilutive $ 0.30
=======
See notes to consolidated
financial statements.
F-3
41
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
(IN THOUSANDS)
RETAINED
COMMON STOCK ADDITIONAL EARNINGS
-------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT) TOTAL
BALANCE, January 1, 1995 12,000 $12 $ 10 $ 2,610 $ 2,632
Distributions to stockholders (5,977) (5,977)
Issuance of common stock 1,700 2 18,136 18,138
Net income 5,452 5,452
------ --- ------- ------- -------
BALANCE, December 31, 1995 13,700 14 18,146 2,085 20,245
Issuance of common stock
in acquisition 350 2,944 2,944
Exercise of common stock options 25 160 160
Net loss (1,519) (1,519)
------ --- ------- ------- -------
BALANCE, December 31, 1996 14,075 14 21,250 566 21,830
Net loss (1,587) (1,587)
------ --- ------- ------- -------
BALANCE, December 31, 1997 14,075 $14 $21,250 $(1,021) $20,243
====== === ======= ======= =======
See notes to consolidated
financial statements.
F-4
42
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997
- -------------------------------------------------------------------------------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(1,587) $(1,519) $5,452
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation and amortization 688 452 218
Write-off of in-process research and development 5,169
Provision for doubtful accounts and other adjustments
to accounts receivable (409) 1,304 122
Deferred income taxes 82 (648) (40)
Change in operating accounts, net of amounts acquired:
Accounts receivable 2,618 (3,723) (1,755)
Income taxes receivable (607) (599) 79
Inventories 8 (118) (225)
Prepaid expenses and other current assets (88) (197) (172)
Accounts payable and accrued liabilities (603) (409) 795
------- ------ -------
Net cash provided by (used in) operating activities 102 (288) 4,474
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (222) (259) (384)
Acquisition of Performance Computing, Inc. (2,211)
------- ------ -------
Net cash used in investing activities (222) (2,470) (384)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 160 18,138
Distributions to stockholders (3,840)
Repayment of notes payable to founders (1,935)
------- ------ -------
Net cash (used in) provided by financing activities (1,775) 14,298
------- ------ -------
NET (DECREASE) INCREASE IN CASH AND CASH
EQUIVALENTS (120) (4,533) 18,388
CASH AND CASH EQUIVALENTS, beginning of year 14,487 19,020 632
------- ------- -------
CASH AND CASH EQUIVALENTS, end of year $14,367 $14,487 $19,020
======= ======= =======
See notes to consolidated
financial statements.
F-5
43
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
------------------------------
1997 1996 1995
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid during the year for income taxes $206 $1,142 $771
==== ====== ====
During 1996, the Company acquired a business in a transaction summarized as
follows:
Acquired in-process research and development $5,169
Fair value of assets acquired 1,107
Value of common stock issued in transaction (2,944)
Liabilities assumed or created (1,121)
------
Cash paid, net of cash acquired $2,211
======
In conjunction with the initial public offering, the Company made S corporation
distributions to its existing stockholders equal to all the previously
undistributed S corporation earnings through the termination of the Company's S
corporation status. The distribution of $2,137,000 was made in the form of two
automobiles with a net book value of $202,000 and a promissory note payable of
$1,935,000. The note payable was fully repaid in 1996.
See notes to consolidated
financial statements.
F-6
44
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997
- -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business - Smith Micro Software, Inc. and subsidiary (the
Company) develops, manufactures and distributes personal computer software
to enable data, fax, voice and video teleconferencing communications using
modems and IP devices. A substantial majority of the Company's sales are
directly to modem and personal computer manufacturers under OEM
agreements. The Company also sells its products through independent
distributors and retail channels. The Company completed an initial public
offering of its common stock on September 18, 1995.
Basis of Presentation - The accompanying consolidated financial statements
reflect the operating results and financial position of Smith Micro
Software, Inc. and its wholly-owned subsidiary, PCI Video Products, Inc.
(PCI), (previously Performance Computing, Inc.) acquired in March 1996
(Note 10). All significant intercompany amounts have been eliminated in
consolidation.
Cash Equivalents - Cash equivalents are considered to be highly-liquid
investments with initial maturities of three months or less.
Accounts Receivable - The Company sells its products worldwide. The
Company performs ongoing credit evaluations of its customers and generally
does not require collateral. The Company maintains reserves for potential
credit losses, and those losses have been within management's
expectations. Allowances for product returns and price protection are
included in other adjustments to accounts receivable on the accompanying
balance sheets.
Inventories - Inventories consist principally of manuals and diskettes and
are stated at the lower of cost (determined by the first-in, first-out
method) or market.
Equipment and Improvements - Equipment and improvements are stated at
cost. Depreciation is computed using the straight-line method based on the
estimated useful lives of the assets, generally ranging from three to
seven years. Leasehold improvements are amortized using the straight-line
method over the shorter of the estimated useful life of the asset or the
lease term.
Intangible Assets - Intangible assets relate primarily to goodwill,
existing technology and noncompete agreements, which are amortized over
periods ranging from three to five years. The Company assesses the
recoverability of intangible assets at each balance sheet date by
determining whether the amortization of the balance over its remaining
useful life can be recovered through projected undiscounted future
operating cash flows.
Revenue Recognition - The Company recognizes revenues from sales of its
software as completed products are shipped and from royalties from
customers who are authorized to duplicate the Company's software as the
individual duplication rights are granted. The Company generally allows
F-7
45
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
its retail distributors to exchange unsold products for other products and
provides inventory price protection in the event of price reductions by
the Company. Allowances for product returns and price protection are
estimated based on previous experience and are recorded as a reduction of
revenue at the time sales are recognized. The Company provides technical
support and customer services to its customers. Such costs have
historically been insignificant.
Income Taxes - The Company accounts for income taxes under Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income
Taxes. This statement requires the recognition of deferred tax assets and
liabilities for the future consequences of events that have been
recognized in the Company's financial statements or tax returns. The
measurement of the deferred items is based on enacted tax laws. In the
event the future consequences of differences between financial reporting
bases and the tax bases of the Company's assets and liabilities result in
a deferred tax asset, SFAS No. 109 requires an evaluation of the
probability of being able to realize the future benefits indicated by such
asset. A valuation allowance related to a deferred tax asset is recorded
when it is more likely than not that some portion or all of the deferred
tax asset will not be realized.
Prior to the effective date of its initial public offering, the Company
had elected to be treated as an S corporation under Subchapter S of the
Internal Revenue Code of 1986, as amended, and comparable state tax laws.
As a result of the termination of S corporation status in conjunction with
the initial public offering, the Company became subject to federal and
state income taxes at statutory C corporation rates, changed from a cash
to accrual tax reporting basis and recorded a deferred tax asset of
$123,000 to reflect the deferred tax items accruing to the Company as of
the termination date (Note 5).
Software Development Costs - Development costs incurred in the research
and development of new software products and enhancements to existing
software products are expensed as incurred until technological feasibility
has been established. The Company considers technological feasibility to
be established when all planning, designing, coding and testing has been
completed according to design specifications. After technological
feasibility is established, any additional costs are capitalized. Through
December 31, 1997, software has been substantially completed concurrently
with the establishment of technological feasibility; and, accordingly, no
costs have been capitalized to date.
Fair Value of Financial Instruments - Pursuant to SFAS No. 107,
Disclosures about Fair Value of Financial Instruments, the Company is
required to estimate the fair value of all financial instruments included
on its balance sheet at December 31, 1997. The Company considers the
carrying value of such amounts in the financial statements to approximate
their fair value due to (1) the relatively short period of time between
origination of the instruments and their expected realization, (2)
interest rates which approximate current market rates, or (3) the overall
immateriality of the amounts.
F-8
46
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
Stock-Based Compensation - The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to
Employees.
Net Income (Loss) Per Share - The Company has adopted SFAS No. 128,
Earnings per Share (EPS), which replaces the presentation of "primary"
earnings per share with "basic" earnings per share and the presentation of
"fully diluted" earnings per share with "diluted" earnings per share. All
previously reported EPS amounts have been restated based on the provisions
of the new standard. Basic EPS amounts are based upon the weighted average
number of common shares outstanding. Diluted EPS amounts are based upon
the weighted average number of common and common equivalent shares
outstanding. Common equivalent shares include stock options using the
treasury stock method. Common equivalent shares are excluded from the
calculation of diluted EPS in loss years, as the impact is antidilutive.
There was no difference between basic and diluted EPS for each period
presented. The number of shares used in computing EPS is as follows:
1997 1996 1995
Weighted average number of shares
outstanding 14,075,000 13,992,000 12,484,000
Common stock equivalents 143,000
---------- ---------- ----------
14,075,000 13,992,000 12,627,000
=========== ========== ==========
Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting years. Actual results could differ from
those estimates.
Reclassification - Certain reclassifications have been made to the 1996
and 1995 financial statements to conform to the 1997 presentation.
New Accounting Pronouncements - In June 1997, the Financial Accounting
Standard Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income.
This statement establishes standards for the reporting of comprehensive
income and its components in a financial statement that is displayed with
the same prominence as other financial statements. Comprehensive income,
as defined, includes all changes in equity (net assets) during a period
from nonowner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency
translation adjustments and unrealized gain/loss on available-for-sale
securities. The disclosures prescribed by SFAS No. 130 are effective
beginning with the first quarter of calendar 1998.
F-9
47
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of
an Enterprise and Related Information. This statement establishes
standards for the way companies report information about operating
segments in annual financial statements. It also establishes standards for
related disclosure about products and services, geographic areas and major
customers. The Company has not yet determined the impact, if any, of
adopting this new standard. The disclosures prescribed by SFAS No. 131 are
effective for calendar 1998.
In October 1997, the American Institute of Certified Public Accountants
issued Statement of Position (SOP) 97-2, Software Revenue Recognition,
which supersedes SOP 91-1. SOP 97-2 provides guidance on when revenue
should be recognized and in what amounts for licensing, selling, leasing
or otherwise marketing computer software. The provisions of SOP 97-2 that
impact the Company are effective for financial statements for fiscal years
beginning after December 15, 1997. The Company will adopt SOP 97-2 in
fiscal 1998 and has not yet determined its impact.
2. UNAUDITED PRO FORMA INFORMATION
Prior to the effective date of the initial public offering, the Company
was treated as an S corporation pursuant to the Internal Revenue Code.
Subsequent to the effective date of the initial public offering, the
Company's tax status reverted back to that of a C corporation.
The pro forma information presented on the statements of operations
reflect a provision for income taxes as if the Company had been taxed as a
C corporation for the entire year, assuming effective tax rates that would
have been in effect at such time. The principal difference between the
effective pro forma tax rate and the statutory federal tax rate relates to
state taxes and research and development tax credits.
F-10
48
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
3. EQUIPMENT AND IMPROVEMENTS
Equipment and improvements consist of the following (in thousands):
DECEMBER 31,
-------------------
1997 1996
Machinery and equipment $ 880 $1,057
Leasehold improvements 137 130
Office furniture and fixtures 239 232
------ ------
1,256 1,419
Less accumulated depreciation and amortization (812) (871)
------ ------
$ 444 $ 548
====== ======
4. ACCRUED LIABILITIES
Accrued liabilities consists of the following (in thousands):
DECEMBER 31,
------------------
1997 1996
Salaries and benefits $463 $ 371
Cooperative advertising rebate 131
PCI acquisition costs (Note 11) 800
Other 41 52
---- ------
$635 $1,223
==== ======
F-11
49
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
5. INCOME TAXES
A summary of income tax expense (benefit) is as follows (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
Current:
Federal $(920) $2,471 $660
State (1) 613 190
----- ------ ----
(921) 3,084 850
Deferred:
Federal 202 (552) (30)
State (120) (96) (10)
----- ------ ----
82 (648) (40)
----- ------ ----
$(839) $2,436 $810
===== ====== ====
A reconciliation of the effective tax rate from the federal statutory tax
rate is as follows:
DECEMBER 31,
--------------------------
1997 1996 1995
Federal statutory rate (35)% 35% 35%
State tax, net of federal benefit (3) 37 2
Nondeductible expense related to acquired intangibles 4 197
Re-establishment of deferred taxes due to change
in tax status (2)
Reduction on tax rate due to S corporation status (23)
Other (1) (3) 1
---- ---- ---
(35)% 266% 13%
==== ==== ===
F-12
50
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
The major components of the Company's net deferred tax asset consist of
the following (in thousands):
DECEMBER 31,
----------------
1997 1996
Various reserves $ 632 $ 801
Nondeductible accruals 97 55
Accrual to cash adjustment (163) (281)
State taxes (65) 174
Prepaid expenses (76) (61)
Credit carryforwards 81
Net operating loss carryforwards 94
Other 6
----- -----
$ 606 $ 688
===== =====
6. COMMITMENTS AND CONTINGENCIES
Leases - The Company has noncancelable operating leases for its building
facilities. Future minimum rental commitments under leases with terms of
one year or more consist of the following (in thousands):
Year ending December 31:
1998 $ 612
1999 618
2000 562
2001 566
2002 583
Thereafter 147
------
$3,088
======
Total rent expense was $539,000, $492,000 and $302,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
Litigation - The Company is subject to litigation in the normal course of
business, none of which management believes will have a material adverse
effect on the Company's financial condition or results of operations as of
December 31, 1997.
F-13
51
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
7. MAJOR CUSTOMERS AND EXPORT SALES
Sales to individual customers or customers under common control which
amounted to more than 10% of the Company's net revenues in the year
indicated were as follows:
DECEMBER 31,
------------------------------
1997 1996 1995
Customer:
1 - (OEM) 43.1% 46.4% 52.1%
2 - (OEM) 12.6
3 - (Retail) 11.8
---- ---- ----
43.1% 70.8% 52.1%
==== ==== ====
The Company has historically derived a significant portion of its revenues
from a relatively small number of customers. A decision by a significant
customer to substantially decrease or delay purchases from the Company or
the Company's inability to collect receivables from these customers could
have a material adverse effect on the Company's financial condition and
results of operations.
The Company also has international sales representing 24.3%, 14.4% and
16.6% of its net revenues for the years ended December 31, 1997, 1996 and
1995, respectively. All export sales have been denominated in U.S.
dollars.
8. PROFIT SHARING
During 1996 and 1995, the Company sponsored a profit sharing plan (the
Profit Sharing Plan) for the benefit of all employees meeting certain age
and service requirements. The Company made discretionary annual
contributions to the Profit Sharing Plan amounting to approximately
$68,000 and $100,000 for the years ended December 31, 1996, and 1995,
respectively. During 1996, the Company converted the Profit Sharing Plan
to a 401(k) plan, in which the Company matches the employee contribution
at a rate of 20%, subject to a vesting schedule. Total employer
contributions amounted to $49,000 for the year ended December 31, 1997.
F-14
52
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
9. STOCK-BASED COMPENSATION
In 1995, the Company adopted the 1995 Stock Option/Stock Issuance Plan
(the Plan). The Plan provides for issuance of, or options to be granted
for the purchase of, an aggregate of 1,000,000 shares of common stock.
Under the terms of the Plan, incentive and nonqualified options may be
granted at an exercise price not less than 100% and 85%, respectively, of
the fair market value on the grant date, with terms of up to 10 years, and
with vesting to be determined by the Board of Directors.
During 1997, the Company canceled 381,000 options held by certain
employees and simultaneously issued 381,000 options to the same employees
with a vesting period of two or three years depending upon the grant date
of the options canceled.
Stock option activity under the Plan is as follows:
WEIGHTED
NUMBER AVERAGE
OF SHARES EXERCISE
PRICE
OUTSTANDING, January 1, 1995 -- $ --
Granted (weighted average fair value of $2.55) 508,000 8.06
Canceled (57,000) 7.85
--------
OUTSTANDING, December 31, 1995 (0 exercisable) 451,000 8.08
Granted (weighted average fair value of $4.28 ) 335,000 7.70
Exercised (25,000) 6.40
Canceled (134,000) 8.64
--------
OUTSTANDING, December 31, 1996 (138,000 exercisable) 627,000 7.85
Granted (weighted average fair value of $2.12) 746,000 2.89
Canceled (565,000) 7.21
--------
OUTSTANDING, December 31, 1997 808,000 $3.72
========
F-15
53
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
Additional information regarding options outstanding as of December 31,
1997 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------- -----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
$2.88 - $3.13 683,000 9.6 $ 2.89 75,000 $2.88
$5.50 - $7.25 62,000 8.0 $ 6.07 54,000 $6.99
$9.07 - $14.00 63,000 7.8 $10.38 35,000 $11.28
------- -------
808,000 9.3 $ 3.72 164,000 $6.01
======= =======
At December 31, 1997, 167,000 shares were available for future grants
under the Stock Option Plan.
Additional Stock Plan Information - As discussed in Note 1, the Company
continues to account for its stock-based awards using the intrinsic value
method in accordance with APB Opinion No. 25 and its related
interpretations. No compensation expense has been recognized in the
financial statements for employee stock arrangements as all grants have
been made at the fair market value of the underlying shares at the date of
grant.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the
disclosure of pro forma net income (loss) and earnings per share had the
Company adopted the fair value method as of the beginning of fiscal 1995.
Under SFAS No. 123, the fair value of stock-based awards to employees is
calculated through the use of option pricing models, even though such
models were developed to estimate the fair value of freely tradable, fully
transferable options without vesting restrictions, which significantly
differ from the Company's stock option awards. These models also require
subjective assumptions, including future stock price volatility and
expected time to exercise, which greatly affect the calculated values. The
Company's calculations were made using the Black-Scholes option pricing
model with the following weighted average assumptions: expected life, 48
months following vesting; stock volatility, 86% for grants issued in 1997,
50% for grants issued in 1996 and 0% prior to the Company's initial public
offering in September 1995; risk-free interest rates, 5.9%, 6.0% and 6.2%
in 1997, 1996 and 1995, respectively; and no dividends during the expected
term. The Company's calculations are based on a single-option valuation
approach, and forfeitures or cancellations are recognized as they occur.
If the computed fair values of the 1997, 1996 and 1995 awards had been
amortized to expense over the vesting period of the awards, pro forma net
income (loss) would have been $(1,818,000), or $(.13) per share, in 1997,
$(1,846,000), or $(.13) per share, in 1996 and $3,652,000, or $.29 per
share, in 1995.
F-16
54
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED)
- --------------------------------------------------------------------------------
10. ACQUISITION
On March 14, 1996, the Company completed its acquisition of PCI, an
audio/video software solutions provider. In connection with the
acquisition, all of the outstanding PCI shares were converted into the
right to receive an aggregate of 350,000 shares of the Company's common
stock, valued at $2,944,000, and $2,100,000 in cash with an additional
$800,000 payable to the seller group contingent on the achievement of
certain milestones. Such amount was accrued as part of the purchase price;
all of the milestones were subsequently met and the entire amount was paid
during 1997. The Company also incurred direct costs of approximately
$111,000 related to the acquisition.
The Company obtained an independent valuation of the net assets acquired
in the purchase transaction which resulted in the allocation of the
purchase price to $1,107,000 of identified assets, $321,000 of liabilities
and $5,169,000 of in-process research and development. As the
technological feasibility of the in-process research and development had
not been established and such technology had no alternative future use,
the acquired in-process research and development was expensed.
In order to secure certain indemnification obligations of the sellers in
the transaction, 60,000 of the shares of common stock issued are being
held in an escrow account. The shares in escrow are being kept as security
for future claims through March 14, 1998, or until such time as certain
matters are fully resolved.
The acquisition was accounted for using the purchase method of accounting,
and PCI's operating results have been included in the accompanying
consolidated statements of operations from the date of acquisition.
The following unaudited pro forma information presents the consolidated
results of operations for the year ended December 31, 1995 had the
acquisition been consummated as of the beginning of 1995. Similar amounts
for 1996 are not presented as the pro forma impact was insignificant. The
pro forma information is not necessarily indicative of the results of
operations that would have occurred nor of future results of the combined
enterprise.
Pro forma net revenues $20,079,000
Pro forma net income $5,361,000
Pro forma net income per share $0.28
F-17
55
INDEPENDENT AUDITORS' REPORT
To the Stockholders of
Smith Micro Software, Inc.:
We have audited the consolidated financial statements of Smith Micro Software,
Inc. as of December 31, 1997 and 1996 and for each of the three years in the
period ended December 31, 1997, and have issued our report thereon dated
February 13, 1998, included elsewhere in this Annual Report on Form 10-K. Our
audits also included the financial statement schedule listed in Item 14a(2).
This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole presents fairly, in
all material respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
February 13, 1998
S-1
56
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
(IN THOUSANDS)
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
PERIOD EXPENSES DEDUCTIONS PERIOD
Allowance for doubtful accounts:
1997 $ 277 $ 589 $(268) $ 598
1996 210 561 (494) 277
1995 246 22 (58) 210
Allowance for other adjustments (1):
1997 1,545 1,746 (2,476) 815
1996 308 2,195 (958) 1,545
1995 150 573 (415) 308
(1) Other adjustments relate principally to sales returns.
S-2
57
INDEX TO EXHIBITS
Exhibit
No. Title Method of Filing
- -------- ----------------------------------- -------------------------------------------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1
Incorporation of the Company to the Registrant's Registration Statement
No. 33-95096
3.2 Amended and Restated Bylaws of the Incorporated by reference to Exhibit 3.2
Company. to the Registrant's Registration Statement
No. 33-95096
4.1 Specimen certificate representing Incorporated by reference to Exhibit 4.1
shares of Common Stock of the to the Registrant's Registration Statement
Company. No. 33-95096
10.1 Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1
to the Registrant's Registration Statement
No. 33-95096
10.2 1995 Stock Option/Stock Issuance Incorporated by reference to Exhibit 10.2
Plan. to the Registrant's Registration Statement
No. 33-95096
10.3 Form of Notice of Grant of Stock Incorporated by reference to Exhibit 10.3
Option under 1995 Stock Option/Stock to the Registrant's Registration Statement
Issuance Plan. No. 33-95096
10.4 Form of 1995 Stock Option Agreement Incorporated by reference to Exhibit 10.4
under 1995 Stock Option /Stock to the Registrant's Registration Statement
Issuance Plan. No. 33-95096
10.5 Form of 1995 Stock Purchase Incorporated by reference to Exhibit 10.5
Agreement under 1995 Stock to the Registrant's Registration Statement
Option/Stock Issuance Plan. No. 33-95096
10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6
September 30, 1991, by and between to the Registrant's Registration Statement
the Company and Crandell Development No. 33-95096
Corporation.
10.7 Application Program Interface Retail Incorporated by reference to Exhibit 10.7
License Agreement July 28, 1992 by to the Registrant's Registration Statement
and between the Company and Rockwell No. 33-95096
International Corporation.
10.8 Application Program Interface Incorporated by reference to Exhibit 10.8
License Agreement July 28, 1992 by to the Registrant's Registration Statement
and between the Company and Rockwell No. 33-95096
International Corporation.
10.9 Rockwell High Speed Interface Incorporated by reference to Exhibit 10.9
License Agreement dated June 2, to the Registrant's Registration Statement
1994, by and between the Company and No. 33-95096
Rockwell International Corporation.
10.10 Letter Agreement dated February 22, Incorporated by reference to Exhibit 10.10
1994, by and between the Company and to the Registrant's Registration Statement
Rockwell International Corporation. No. 33-95096
10.11 Letter Agreement dated April 22, Incorporated by reference to Exhibit 10.11
1993, by and between the Company and to the Registrant's Registration Statement
Rockwell International Corporation. No. 33-95096
58
Exhibit
No. Title Method of Filing
- -------- ----------------------------------- -------------------------------------------
10.12 Software Distribution Agreement Incorporated by reference to Exhibit 10.12
dated May 8, 1995, by and between to the Registrant's Registration Statement
the Company and International No. 33-95096
Business Machines Corporation.
10.13 Office Building Lease, dated June Incorporated by reference to Exhibit 10.13
10, 1992, by and between the Company to the Registrant's Registration Statement
and Developers Venture Capital No. 33-95096
Corporation.
10.14 Amendment No. 1 To Office Building Incorporated by reference to Exhibit 10.14
Lease, dated July 9, 1993, by and to the Registrant's Registration Statement
between the Company and Pioneer Bank. No. 33-95096
10.15 Amendment No. 2 To Office Building Incorporated by reference to Exhibit 10.15
Lease, dated August 15, 1994, by and to the Registrant's Registration Statement
between the Company and T&C No. 33-95096
Development.
10.16 Fourth Addendum to Office Building Incorporated by reference to Exhibit 10.16
Lease, dated April 21, 1995, by and to the Registrant's Registration Statement
between the Company and T&C No. 33-95096
Development.
10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17
Corporation Distribution. to the Registrant's Registration Statement
No. 33-95096
10.18 Smith Micro Software, Inc. Amended Incorporated by reference to Exhibit 10.21
and Restated Software Licensing and to the Registrant's Quarterly Report on
Distribution Agreement, dated April Form 10-Q for the quarter ended September
18, 1996, by and between the Company 30, 1996
and U.S. Robotics Access Corp.
10.19 Office Building Lease, dated March Incorporated by reference to Exhibit 10.19
1, 1994, by and between Performance to the Registrant's Annual Report on Form
Computing Incorporated and Petula 10-K for the fiscal year ended December
Associates, Ltd./KC Woodside. 3l, 1995
10.20 Agreement and Plan of Merger by and Incorporated by reference to Exhibit 2 to
between Smith Micro Software, Inc., the Registrant's Current Report on Form
Performance Computing Incorporated 8-K filed with the Commission on March 28,
and PCI Video Products, Inc. dated 1996
as of March 14, 1996.
10.21 Amendment No. 1, dated as of March Incorporated by reference to Exhibit 10.21
10, 1997, to Agreement and Plan of to the Registrant's Annual Report on Form
Merger by and between Smith Micro 10-K for the fiscal year ended December
Software, Inc., Performance 31, 1996
Computing Incorporated and PCI Video
Products, Inc. dated as of March 14,
1996.
10.22 Amendment No. 6 to Office Building Filed Herewith
Lease, dated February 19, 1998, by
and between the Company and World
Outreach Center.
59
Exhibit
No. Title Method of Filing
- -------- ----------------------------------- -------------------------------------------
23.1 Independent Auditors' Consent. Filed Herewith
27 Financial Data Schedule. Filed Herewith