Back to GetFilings.com
1
===============================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
---------------
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] 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)
---------------------
DELAWARE 33-0029027
(State or other jurisdiction of (I.R.S. Employer
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: (949) 362-5800
COMMON STOCK, $.001 PAR VALUE NASDAQ NATIONAL MARKET
(Title of each class) (Name of each exchange on which registered)
---------------------
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 23, 1999, the aggregate market value of the Common Stock of the Registrant
held by non-affiliates was $11,290,199, 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 23, 1999, 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 26, 1999, as filed with the
Securities Exchange Act of 1934, as amended, are incorporated by reference in
Part III of this Report.
===============================================================================
2
SMITH MICRO SOFTWARE, INC.
1998 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PAGE
----
PART I
Item 1. BUSINESS.......................................................................... 3
Item 2. PROPERTIES........................................................................ 22
Item 3. LEGAL PROCEEDINGS................................................................. 22
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS................................ 22
PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS......... 23
Item 6. SELECTED FINANCIAL DATA........................................................... 25
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS....................................................... 26
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK........................ 31
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................... 31
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE........................................................ 31
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS.................................................. 32
Item 11. EXECUTIVE COMPENSATION............................................................ 32
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................... 32
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................... 32
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................... 33
-------------------------
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. SUCH STATEMENTS ARE SUBJECT TO A NUMBER OF RISKS AND
UNCERTAINTIES THAT COULD CAUSE THE ACTUAL RESULTS OF THE COMPANY TO MATERIALLY
DIFFER FROM THOSE ANTICIPATED. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE
ON THESE FORWARD-LOOKING STATEMENTS THAT SPEAK ONLY AS THE DATE HEREOF. THE
COMPANY DISCLAIMS ANY OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS TO THESE FORWARD LOOKING STATEMENTS THAT MAY BE MADE TO REFLECT EVENTS
OR CIRCUMSTANCES OCCURRING SUBSEQUENT TO THE FILING OF THIS FORM 10-K WITH THE
SECURITIES AND EXCHANGE COMMISSION OR OTHERWISE TO REVISE OR UPDATE ANY ORAL OR
WRITTEN FORWARD LOOKING STATEMENT THAT MAY BE MADE FROM TIME TO TIME BY OR ON
BEHALF OF THE COMPANY. READERS ARE ALSO URGED TO CAREFULLY REVIEW AND CONSIDER
THE VARIOUS DISCLOSURES MADE BY THE COMPANY THAT DESCRIBE CERTAIN FACTORS WHICH
AFFECT THE COMPANY'S BUSINESS, INCLUDING THE "RISK FACTORS" COMMENCING ON PAGE
14 OF THIS ANNUAL REPORT AND IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
2
3
PART I
ITEM 1. BUSINESS
GENERAL
Smith Micro Software, Inc. develops and sells communications software
for personal and business use. Our objective is to enhance human interaction by
giving users the ability to communicate through multimedia technologies over
analog and digital platforms. Smith Micro's products enable personal
communication through telephony, fax, multimedia email, data, paging, video
security and video conferencing.
Recently, we have been developing new products that leverage off of our
core technologies to address the consumer's use of the Internet and corporate
intranets. We intend to leverage our experience and position with original
equipment manufacturers, commonly referred to as OEMs, to deploy these new
product releases. Additionally, we are expanding our customer base to include
manufacturers that produce devices that take advantage of the high bandwidth
Internet connectivity such as cable and xDSL modems. Our corporate products are
designed to provide cost effective and efficient methods of communicating that
take advantage of corporate local and wide area networks, including the Internet
or intranet.
We began as a provider of fax and data communication software and
continue to be a leading provider to modem manufacturers (based upon units
included with analog modems sold through resellers and retailers in the United
States.) Smith Micro was incorporated in California in November 1983 and
reincorporated in Delaware in July 1995.
INDUSTRY BACKGROUND
Businesses and consumers are using the Internet to communicate,
transact business, share information and access vast information resources. The
increasing demand for Internet access is driving the adoption of new technology
that enhances the Internet experience. These advances are found in multimedia
personal computers and Internet access devices such as analog modems, cable
modems, xDSL modems and network interface cards and software solutions. A
research group, International Data Corporation, suggests that the number of
worldwide Web users will grow dramatically in the future. Web users will
increase from 87 million in 1997 to approximately 502 million worldwide by the
year 2003. In 1997, 17% of web users made purchases over the Internet, a figure
that is projected to be 36% in 2003. In addition, the dollar amount of
transactions over the Internet is expected to increase from $15 billion in 1997
to an approximation of $1.3 trillion in 2003.
Manufacturers of connectivity devices such as analog modems, cable
modems, xDSL modems and network interface cards enable personal computer
communication using direct connections, or connections over the Internet,
intranets, Local Area Networks and Wide Area Networks. By adopting new
technology, these manufacturers have been able to deliver products with 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 98, Windows NT, Windows 3.x and Macintosh, and the desire to
differentiate products, present a significant communication software challenge.
These 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. Instead, these manufacturers
typically bundle software from outside providers with their hardware.
Demand for personal computer communication software products is
generated by three distinct sources: original equipment manufacturer customers,
retail end-user consumers and corporate/government customers, who purchase large
quantities of user licenses for installations over large networks. OEMs,
consisting primarily of modem, Internet access device, camera, video capture
card and personal computer manufacturers, 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.
3
4
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.
Emerging telephony applications can provide full duplex speakerphones, complex
voicemail functions, and an enhanced 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. These devices improve the functionality and
efficiency of voice, fax, 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.
SMITH MICRO STRATEGY AND PRODUCTS
Smith Micro offers software products for Windows 98, Windows 95,
Windows NT, Windows 3.x and Macintosh operating systems. We believe that our
strong engineering focus and our relationships with analog modem, cable modem,
xDSL modem, camera, video capture card, personal computer and chip manufacturers
enable us to develop communication software in anticipation of changes in
product design and to customize our OEM software to meet specific customer
requirements.
To address the complexity of personal computer communication, we have
consistently developed products that are intuitive and easy to use. We believe
that our experience in providing products to the OEM market, where software is
required to enable new hardware devices to be put into service quickly and
relatively effortlessly, provides us with a significant competitive advantage.
Our strategy is to build upon the easy-to-use reputation of our OEM software
products to encourage new users to migrate to our retail products as they
require higher levels of functionality.
In order to serve the market's evolving demands for connectivity, we
intend to offer solutions beyond our core fax and data communication software.
We offer products that support Internet telephony, video conferencing, video
email, video security, paging and Internet chat. In the emerging fields of
personal computer-based wireless and cellular communication, our software for PC
Cards is currently being shipped by 3Com Corporation, 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 we have developed software to support these emerging
technologies.
Smith Micro has traditionally focused on the OEM and, more recently,
the corporate/government and retail channels. Our OEM fax, data and video
products are bundled with the analog modems, cable modems, xDSL modems, cameras,
video capture cards and personal computers of many of the world's leading
manufacturers or providers of such products. In addition, we currently offer a
line of easy-to-use, retail communication software products that are designed to
address the needs of the expanding base of personal computer users. Our retail
software products are sold to distributors, retail stores, Internet stores and
our Web site. We intend to broaden our retail product line and expand the
functionality of these products as well as our OEM products with additional
introductions of products designed for the Windows 98, Windows 95, Windows NT
and Macintosh operating systems. We also offer Internet telephony and video
teleconferencing products to our OEM and retail channel customers. We have also
focused significant attention on our third channel, the corporate/government
marketplace. During 1998, we acquired the network fax software technology of
Mitek Systems, Inc. and completed the development of an IP fax gateway module.
The IP fax gateway module allows companies to save on long distance charges
using existing intranets or wide area networks, commonly known as WANs. The fax
server passes the fax to the company's server that will have the lowest toll
charge required to deliver the fax to its desired recipient. We are currently
developing additional Internet functionality that would further enhance IP
protocol distribution (over the Internet and intranet) of fax documents.
4
5
We believe that a key competitive feature of our products is the
ability to switch seamlessly among fax, video conferencing, telephony, and data
functions without interruption to the user. Our 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 our current OEM products that are
designed to work on Windows 95, Windows 98, Windows NT, Windows 3.x and/or the
Macintosh operating systems:
PRODUCT NAME FUNCTIONALITY (PLATFORM) LANGUAGES
------------ ------------------------ ---------
QuickLink(R) Data and fax (Windows) English and 15 other languages
QuickLink(R) MessageCenter Data, fax and voicemail (Windows) English and 9 other languages
conexs.com(TM) User authorized Internet phone, chat and video English
phone (Windows)
Internet CommSuite(TM) Telephony, multi-media email, video English
teleconferencing, video security, chat and fax
via the Internet (Windows)
VideoLink(TM) Video conferencing (Windows) English
VideoLink(TM)Mail Multi-media email (Windows) English and 15 other languages
QuickLink(R) Page Paging (Windows) English
MacComCenter(TM) Data and fax (Macintosh) English and Japanese
MacComCenter(TM) with voice Data, fax and voice (Macintosh) English and Japanese
QuickLink provides integrated data communication and fax capabilities
that allow users to send, receive and manage all fax activities in the
foreground or background. In addition, this product enables fax broadcasting to
an unlimited number of locations and the data communication functionality allows
users to transfer files between computers.
QuickLink MessageCenter 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's 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 to 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. Special features
allow mailboxes to be individually configured, initiate a pager notification
each time a voice message or fax is received and, through alphanumeric pagers,
notify users of the number of faxes, voicemail and memos in the mailbox.
5
6
conexs.com is a service offering real-time person-to-person
communications over the Internet. The conexs.com service identifies users via
their legitimate email address that then becomes their "telephone number" and
allows them to hold an Internet phone or chat session with another individual.
If the user is video enabled, they can then hold a video phone conversation. The
use of the user's email address as the telephone number provides for a level of
authentication that allows the user to build a list of individuals that can call
you as well as building in call blocking of unauthorized or unsolicited callers.
conexs.com supports the International Telecommunications Union, commonly
referred to as the ITU, H.323 standard for interoperability for the Internet and
intranets.
Internet CommSuite offers a comprehensive set of person-to-person
Internet communication tools in one easy-to-use interface. Internet CommSuite
lets users throughout the world communicate over the Internet using its phone,
video phone, multimedia e-mail, fax or chat capabilities. This product was
optimized for the newer broadband technologies such as cable modem, xDSL modems
and network interface devices, however, it also functions with analog modems.
Internet CommSuite is ITU H.323 compliant.
VideoLink is a family of video conferencing products that enables video
and audio communication over the Internet or between two locations using a
standard analog modem connection that uses plain old telephone service, commonly
known as POTS, or an integrated services digital network, commonly known as an
ISDN. Our VideoLink 323 product supports the ITU H.323 standard and our
VideoLink 324 supports the ITU H.324 standard for interoperability over POTS or
Plain Old Telephone Service.
VideoLink Mail is an application that allows the recording of a video
and audio message that can be saved in a highly compressed format as a self
extracting file. The file can be sent via an email attachment over the Internet.
The recipient can then play the message just by double clicking on the
attachment.
QuickLink Page 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 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.
MacComCenter provides integrated data communication and fax
capabilities that allow users to send, receive and manage all fax activities in
the foreground or background for the Macintosh. This product enables fax
broadcasting to multiple locations and its data communication functionality
allows users to transfer files between computers.
MacComCenter with voice adds telephony to the functionality included in
MacComCenter that will support multiple mailboxes, each configurable to receive
voice, fax and data into a specific mailbox. We have incorporated many of the
features found in our QuickLink MessageCenter product into MacComCenter with
voice.
6
7
Retail, Corporate and VAR Products
The following chart lists our current retail, corporate and VAR
products that are designed to work on Windows 95, Windows 98, Windows NT,
Windows 3.x and/or the Macintosh operating systems:
PRODUCT NAME FUNCTIONALITY (PLATFORM) LANGUAGES
------------ ------------------------ ---------
HotFax(R) Data and fax (Windows) English
HotFax(R) MessageCenter Data, fax and voice (Windows) English, German, Italian
and Spanish
HotFaxShare(TM) Fax over a LAN (Server: Windows; Client: Windows English and German
and Macintosh) The IP Fax Gateway module routes
faxes across a WAN to a company's server that can
take advantage of lower toll charges
Internet CommSuite(TM) Telephony, multi-media email, video English
teleconferencing, video security, chat and fax via
the Internet (Windows)
MacComCenter(TM) Plus Data, fax and voice (Macintosh) English and Japanese
HotPage(R) Paging software (Windows) English
VideoLink(TM) Mail Video and audio messaging (Windows) English
HotFax(R) is our 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 faxes and the unattended upload and
broadcast of faxes at a scheduled time. It also provides users with the ability
to modify faxes with graphics intact, use a personal computer as a data host and
to share data like a bulletin board service, create custom cover pages with
imported graphics and preview faxes, including cover pages.
HotFax(R) MessageCenter is a fully integrated data, fax and voice mail
application. This product includes all of the features of HotFax for Windows
3.x, Windows 95,Windows 98 and Windows NT. It also 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.
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. This product 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 from Windows 95, Windows 98, Windows NT,
Windows 3.x or Macintosh applications. Individual and broadcast faxes can be
sent immediately or scheduled for later transmission. The product can support up
to 24 channels (fax lines). With the IP Fax Gateway option, faxes can be routed
over the corporate intranet or over the Internet to another HotFaxShare server
that is closer to the destination which therefore reduces or eliminates long
distance telephone company charges.
Internet CommSuite offers a comprehensive set of person-to-person
Internet communication tools in one easy-to-use interface. Internet CommSuite
lets users throughout the world communicate over the Internet using its phone,
video phone, multimedia e-mail, fax or chat capabilities. This product was
optimized for the newer
7
8
broadband technologies such as cable modem, xDSL modems and network interface
devices, however, it also functions with analog modems. Internet CommSuite is
ITU H.323 compliant.
MacComCenter Plus with Voice is configured as our 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 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.
VideoLink Mail is an application that allows the recording of a
video and audio message that can be saved in a highly compressed format as a
self extracting file. The file can be sent via an email attachment over the
Internet. The recipient can then play the message just by double clicking on the
attachment.
SALES AND MARKETING
We sell our communication software products worldwide to OEM customers,
who bundle or pre-load our software with their hardware products, to
distributors and retailers, who sell the product to end user customers, and to
the corporate/government marketplace. We develop video and fax products to
address vertical markets, such as telemedicine to be distributed through
channels established by corporate partners. In addition, we are developing
"conexs.com," a product that will provide Internet telephony services and
messaging services that will hold faxes and audio and video messages during
times that the user is not logged in to the Internet. This product will also
offer security features like caller authentication and call blocking.
OEM Sales
Our OEM market continues to evolve as we continue to offer new
communications products and OEMs adopt new technologies and change their
software bundling techniques. Historically, our OEM customer base consisted
primarily of analog modem manufacturers. However, in light of these recent
trends, we have expanded our OEM customer base to include personal computer,
camera, cable modem and xDSL modem manufacturers, Internet service providers and
content providers. Our OEM customers include 3Com (including U.S. Robotics
Corporation and its Megahertz subsidiary), Brother Industries Ltd., Compaq
Computer Corporation, Hewlett Packard Company, Gateway (Japan), Philips Consumer
Electronics B.V. (Netherlands), IBM, Taicom (Taiwan), Sirius Technologies
(Australia), Sitre (Spain) and Best Data. Each of these manufacturers
bundles or pre-loads Smith Micro's software products with its own hardware
products. As a percent of our net revenues, traditional analog modem
manufacturers generated revenues of approximately 43.3% for 1998, 79.6% for 1997
and 68.6% for 1996. OEM customers outside of the United States made up
approximately 20.6% of our revenues for 1998, 22.4% for 1997 and 13.3% for 1996.
We have translated our products into as many as 18 languages to allow our OEM
customers the flexibility of offering multi-language products that meet the
needs of their worldwide markets.
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. We generally ship
our products as we receive orders. Additionally, an increasing percentage of our
OEM revenue is derived from royalties accrued by customers that are authorized
to replicate our software products on a CD or to pre-load our software on a
personal computer. As a result of these two factors, we have relatively little
backlog at
8
9
any given time and we do not consider backlog to be a significant indicator of
future performance. Moreover, we generally do not produce software in advance of
anticipated orders and therefore have insignificant amounts of inventory. As a
result of the foregoing, our revenues in any quarter are substantially dependent
on orders booked in that quarter.
Our three largest OEM customers, including 3Com Corporation, and their
affiliates accounted for 35.1% of our net revenues in 1998, 56.9% in 1997 and
62.9% in 1996. In June 1997, 3Com acquired U.S. Robotics Corporation, which has
been our largest customer to date based on percentage of revenues. Sales to 3Com
and its affiliates accounted for more than 10% of our net revenues in 1998, 1997
and 1996. Sales to Motorola also accounted for more than 10% of our net revenues
in 1996. Our major customers could reduce their orders of our products in favor
of a competitor's product or for any other reason. The loss of any of our major
OEM customers, decisions by a significant OEM customer to substantially decrease
purchases or our inability to collect receivables from these customers could
have an adverse effect on our business, financial condition and results of
operations.
In April 1996, we 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 us 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
1998, the agreement automatically renewed according to its terms and during 1997
certain other 3Com entities were added as parties pursuant to new addenda to the
agreement (we refer to 3Com, its affiliates and their subsidiaries as 3Com
entities in this Annual Report). Under the terms of the agreement, we granted
certain pricing incentives to the 3Com entities in consideration for which we
became the provider of fax, data, and 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. In December
1998, we entered into an additional OEM agreement with 3Com that covers
purchases by the 3Com entities for upgraded versions of certain products covered
by prior OEM agreements. These agreements do not require any 3Com entity to
purchase any minimum quantity of our products and may be terminated by a party
thereto at any time for any reason upon 60 days' prior written notice.
We sell directly to OEM customers using our in-house sales staff based
in Aliso Viejo, California, the United Kingdom and Australia. We allow our OEM
customers to return unused software. To date, however, such returns have been
infrequent.
Retail Sales
While historically we have generated our revenue primarily from the OEM
market, we also sell retail products that are designed to complement or upgrade
our OEM products. As a percentage of our net revenues, retail sales represented
26.4% of 1998, 5.2% of 1997 and 16.5% of 1996.
Smith Micro has a separate sales staff that handles retail sales and we
work closely with our retail distributors on the management of orders, inventory
levels, sell-through to retailers, as well as promotions and marketing
activities. Domestically, our retail products are sold by independent
distributors including Ingram Micro and Tech Data. In addition, our retail sales
force is responsible for contacting major retail customers to generate demand
for our retail products in the retail distribution channel. We continue to
develop Internet retail outlets by selling product through our web site and
electronic distributors. End user customers can receive delivery of our Internet
retail products through electronic download or via shipment of a retail package.
Smith Micro allows distributors and retailers to return products
without charge or penalty. In addition, there are times when we update products
and request the distributors of our products to replace inventory on the shelves
with the new version in what is called a stock rotation. A component of our
revenue recognition policy is that we calculate an allowance for product returns
based on our historical experience with product returns. If retail sales of our
products increase, the risk of product returns will increase. While our revenue
recognition policy
9
10
contemplates this risk, it is possible that returns may occur in excess of our
previous experience, causing us to revise our estimates and increase the
allowances for such returns.
We employ direct mail programs to offer end-users upgrades from our OEM
products to our retail products. We advertise in selected computer end-user and
re-seller publications and periodically introduce promotions and incentive
offers such as special pricing for the purchase of upgrades. We also participate
in major trade shows, professional conferences and personal computer user group
events to reach our target markets.
Corporate and Government Sales
During 1997 Smith Micro began selling to the corporate/government
marketplace while building the infrastructure necessary to sell to these two
customer bases. In January 1998, we acquired the network fax software technology
of Mitek Systems, Inc. Through this acquisition, we acquired software that is
designed to address the fax requirements of the corporate customer. During 1998
we developed the acquired network fax product into the currently shipping
product, HotFaxShare and we released a newly developed IP Gateway module. We
continue to develop IP protocol functionality. We intend to continue to focus
our sales and marketing efforts for our video and fax technologies through
direct sales and sales through value added resellers, commonly known as VARs,
that specialize in selling to corporate customers. Sales in this marketplace
tend to be made in single volume orders, typically for site licenses, and are
often accompanied by maintenance programs. Our pricing structure in this
marketplace currently accommodates multi-level, volume purchase with discounts
for larger single orders. Our maintenance program provides technical support and
automatic product upgrades under specifically defined terms. In addition, we are
continuing to develop vertical market products for the medical, insurance, and
security industries among others. During 1998, we began working with Eastman
Kodak to develop video technology for the healthcare industry. 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
Smith Micro provides technical support and customer service through our
Internet web site, by telephone, by mail and via fax. Certain of our OEM
customers provide their own primary customer support functions and rely on us
for back-up customer support, while other OEM customers rely solely on us to
provide support functions.
PRODUCT DEVELOPMENT
The software industry is characterized by frequent changes in
technology and evolving user needs. We work closely with our current OEM
customers to help us determine future user needs and anticipate changes in
technology. Software functionality depends upon the capabilities of the
hardware, accordingly, we maintain relationships with hardware and chip
manufacturers and we develop our software in tandem with their development. Our
engineering relationships with chip manufacturers such as Conexant, IBM, Cirrus
Logic, Intel, Texas Instruments, Analog Devices, 8 x 8, Brooktree, Broadcom and
others, as well as with our major OEM hardware customers, are central to our
product development efforts. In addition, we participate in software product
developer programs sponsored by Microsoft, Intel, IBM and Apple.
We believe that we must be responsive to the specific customization
requests of our OEM and corporate customers. With this need for flexibility in
mind, our object-oriented C++ modular code base is designed to allow significant
customization and enhancements of features within tight development schedules.
As of December 31, 1998, we had a product development staff of 29
engineers and quality assurance and product testing specialists. We plan to add
additional software engineers and product testing personnel in the future.
10
11
MANUFACTURING
Smith Micro software is sold in three forms. First, our software is
sold in the form of an OEM kit or retail package that includes disks or a
CD-ROM, a manual and certain other documentation or marketing material. Second,
we permit certain of our OEM customers to duplicate their own disks or CD-ROMs
and pay a usage based royalty. This method of sale does not require us to
provide a disk or manual. Finally, we grant licenses to certain OEM customers
that enable those customers to pre-load a copy of our software onto a personal
computer's hard drive. With the corporate sales program, we offers site licenses
under which a corporate user is allowed to distribute copies of the software to
users within the corporate sites.
We rely on third party suppliers who provide the components for our
software product kits. These components include disks, CD-ROMs and printed
manuals. Disk shortages have occurred in the past and may recur in the future.
If we 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 the prices we currently pay, our 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.
We rely on third party suppliers to provide CD-ROM components and
CD-ROM replication for the CD-ROMs that are placed in many of our product kits.
The equipment to replicate CD-ROMs is very costly making it unlikely that we
will add this capability internally. This leaves us dependent on CD-ROM
replication facilities for both the timing and pricing of our software produced
in CD-ROM format. This could impair our ability to deliver products to our
customers. In addition, any price increases that we experience could reduce
gross margins, which would have an adverse effect on our business, results of
operations and financial condition.
We duplicate most of the diskettes that are placed in certain of our
OEM product kits at our 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 we operate
a second shift from time to time to accommodate customer delivery requirements.
We have outside production alternatives in the event of a disruption of our
Aliso Viejo operations. We use outside vendors for the printing of labels,
manuals and packaging.
COMPETITION
The markets in which we operate 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
change. Smith Micro competes with other software vendors for access to
distribution channels, retail shelf space and the attention of customers. We
also compete with other software companies in our efforts to acquire software
technology developed by third parties and in attracting qualified personnel.
We believe that the principal competitive factors affecting the
communication software market include product features and ease of use,
willingness of the vendor to customize the product to fit customer-specific
needs, product reputation, product quality, product performance, price, customer
service and support and the effectiveness of sales and marketing efforts.
Although we believe that our products currently compete favorably with respect
to these factors, there can be no assurance that we can maintain our 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 communication
software market and because rapidly changing technology is constantly creating
new opportunities in this market, we expect new competitors to enter the market.
We also believe that competition from established and emerging software
companies will continue
11
12
to intensify as fax and data applications merge with video and audio
applications and the emerging cellular, wireless and Internet telephony markets
develop. The market in which we compete has been characterized by the
consolidation of established communication software suppliers and we believe
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 our business and results of operations.
Our software products compete primarily with Symantec, Cheyenne, White
Pine, Intel, Microsoft, VocalTec and Right Fax, among others for communication
software products. Some of our 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
effect on our business, results of operations and financial condition.
Many of our other current and prospective competitors have
significantly greater financial, marketing, service, support, technical and
other resources than Smith Micro. Moreover, these companies may introduce
additional products that are competitive with ours, and our products may not
compete effectively with such products. We believe that our ability to compete
depends on elements both within and outside of our control, including the
success and timing of new product development and introduction, product
performance, price, distribution and customer support. We may not be able to
compete successfully with respect to these and other factors. We believe that
the market for our software products has been and will continue to be
characterized by significant price competition. A material reduction in the
price of our products could negatively affect our profitability.
Many of our existing and potential OEM customers have substantial
technological capabilities. These customers may currently be developing, or may
in the future develop, products that compete directly with our products. In such
event, these customers may discontinue purchases of our products. Our future
performance is substantially dependent upon the extent to which existing OEM
customers elect to purchase communication software from us rather then design
and develop their own software. In light of the fact that our customers are not
contractually obligated to purchase any of our products, they may cease to rely,
or fail to expand their reliance, on us as an external source for communication
software in the future.
We also face 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,
Windows, Microsoft represents a significant competitive threat to all personal
computer software vendors, including Smith Micro.
PROPRIETARY RIGHTS AND LICENSES
Although we believe that our products do not infringe on the
intellectual property rights of others, such a claim may be asserted against us
in the future. If we fail to protect our proprietary information, our business,
results of operations and financial condition could be materially and adversely
affected.
From time to time, we have received and may receive in the future
communications from third parties asserting that trademarks used by us or
features or content of certain of our products infringe upon intellectual
property rights held by such third parties. As the number of trademarks,
patents, copyrights and other intellectual property rights in our industry
increases, and as the coverage of these patents and rights and the functionality
of products in the market further overlap, we believe that our products, with
their existing 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 our inventions. Such results would materially and
adversely affect us, and may also require us to obtain one or more licenses from
third parties. We may not be able to obtain any such required licenses upon
reasonable terms, if at all, and the failure by us to obtain such licenses could
have an adverse effect on our business, results of operations and financial
condition.
12
13
Our success is dependent upon our software code base, our programming
methodologies and other intellectual properties. To protect our proprietary
technology, we rely on a combination of trade secret, nondisclosure and patent,
copyright and trademark law that may afford only limited protection. We apply
for various patents and trademarks to protect intellectual property. Prior to
becoming a publicly held entity, we did not require our employees to sign
proprietary information and inventions agreements stipulating, among other
things, software ownership rights. The steps that we have taken to protect our
proprietary technology may not be adequate to deter misappropriation of our
proprietary information or prevent the successful assertion of an adverse claim
to software utilized by us. In addition, we may not be able to detect
unauthorized use of our intellectual property rights or take effective steps to
enforce those rights.
In selling our products, we primarily rely 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 our proprietary rights to as great an extent as do the laws of
the United States. The means we use to protect our proprietary rights may not be
adequate. Moreover, our competitors may independently develop similar technology
to ours. We also license technology on a non-exclusive basis from several
companies for inclusion in our products and anticipate that we will continue to
do so in the future. If we are unable to continue to license these technologies
or to license other necessary technologies for inclusion in our products, or if
we experience substantial increases in royalty payments under these third party
licenses, our business, results of operations and financial condition could be
materially and adversely affected.
EMPLOYEES
As of December 31, 1998, Smith Micro had a total of 79 employees, of
which 29 were engaged in engineering, 17 were in sales and marketing, 13 were in
customer support, 13 were in finance and administration and 7 were in
manufacturing. We utilize temporary labor to assist during periods of increased
manufacturing volume. None of our employees is represented by a labor union. We
have not experienced any work stoppages, and consider our relations with our
employees to be good.
13
14
RISK FACTORS
This Annual Report on Form 10-K contains forward-looking statements that 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 Smith Micro and a decision to invest
in the company.
Our Quarterly Operating Results are Subject to Significant Fluctuations
that Could Adversely Impact Our Stock Price. Our quarterly operating results
have fluctuated significantly in the past and may continue to vary from quarter
to quarter due to a number of factors. Many of these factors are not in our
control. These factors include:
o the size and timing of orders from, and shipments to, our
major customers;
o our ability to maintain or increase gross margins;
o changes in pricing policies or price reductions by us or our
competitors;
o variations in the our sales channels or the mix of our product
sales;
o the timing of new product announcements and introductions by
us, our competitors or customers;
o the availability and cost of supplies;
o the financial stability of our major customers;
o the market acceptance of our new products, applications and
product enhancements;
o our ability to develop, introduce and market new products,
applications and product enhancements;
o possible delays that we may face in the shipment of new
products;
o our success in expanding our sales and marketing programs;
o deferrals of orders by our customers in anticipation of new
products, applications, product enhancements or operating
systems;
o changes in our strategy; and
o personnel changes.
While we historically have not experienced significant fluctuations in
our sales from season to season, we may face greater seasonality in our sales in
the future. Many of our OEM customers experience seasonality in their sales,
which may affect their buying patterns from us. In addition, as we increase our
sales of retail products, we expect to experience greater seasonality in our
sales.
Due to all of the foregoing factors, and the other risks discussed in
this section, you should not rely on quarter-to-quarter comparisons of our
operating results as an indication of our future performance. It is possible
that in some future periods our results of operations may be below the
expectations of public market analysts and investors. In that event, the price
of our Common Stock would likely decline.
Because We Currently Operate With Little Backlog, Our Revenues in Each
Quarter are Substantially Dependent on Orders Booked and Shipped in that
Quarter. We operate with little backlog because we generally ship our software
products as we receive orders and because our royalty revenue is based upon our
customers' actual usage in a given period. Accordingly, we recognize revenue
shortly after orders are received or royalty reports are generated. As a result,
our sales in any quarter are dependent on orders that we book and ship in that
quarter. This makes it difficult for us to predict what our revenues and
operating results will be in any quarter. If orders in the first month or two of
a quarter fall short of expectations, it is likely that we will not meet our
revenue targets for that quarter. If this happens, our quarterly operating
results would be adversely affected.
An Unexpected Shortfall in Revenue May Adversely and Disproportionately
Affect Our Business Because Our Expenses are Largely Fixed. Our expense levels
are based, in part, on our expectations of our future revenues and a significant
portion of our expenses is fixed. As a result, we may not be able to adjust our
spending rapidly enough to compensate for an unexpected shortfall in revenue.
Therefore, if revenue levels fall below our
14
15
expectations, our operating results and net income are likely to be adversely
and disproportionately affected.
We Depend on 3Com Corporation for a Significant Portion of our
Revenues. In the past we have derived a substantial portion of our revenues from
sales to 3Com Corporation, primarily to its wholly-owned subsidiary, U.S.
Robotics, and subsidiaries of U.S. Robotics. These 3Com entities represented
24.7% of our net revenues in 1998, 43.4% of our net revenues in 1997 and 46.4%
of our net revenues in 1996. The OEM agreements we have with these 3Com entities
do not require a 3Com entity to purchase any minimum quantity of our products
and may be terminated by a 3Com entity or us at any time for any reason upon 60
days prior written notice. As a result, we cannot be certain that the 3Com
entities will continue to purchase our products in substantial quantities, or at
all. While we believe that we have been the principal supplier of OEM fax, voice
and data communications software products to the U.S. Robotics product line,
3Com may seek additional sources for such products in the future. Accordingly,
our sales to the 3Com entities in the future may not reach or exceed our
historical levels of sales to U.S. Robotics. A substantial decrease or delay in
sales to the 3Com entities would have an adverse effect on our business, results
of operations and financial condition.
We Depend Upon a Small Number of OEM Customers. Sales to our three
largest OEM customers, including 3Com Corporation, accounted for approximately
35.1% of our net revenues in 1998, 56.9% of our net revenues in 1997 and 62.9%
of our net revenues in 1996. We expect that we will continue to be dependent
upon relatively large orders from our major OEM customers for a significant
portion of our revenues in future periods. However, none of these customers is
obligated to purchase any of our products. Accordingly, we cannot be certain
that these customers will continue to place large orders for our products in the
future, or purchase our products at all. Our customers may acquire products from
our competitors or develop their own products that compete directly with ours.
Any substantial decrease or delay in our sales to one or more of these entities
would have an adverse effect on our business, results of operations and
financial condition. In addition, certain of our OEM customers have in the past
and may in the future acquire competitors or be acquired by competitors, causing
further industry consolidation. In the past, such acquisitions have caused the
purchasing departments of the combined companies to reevaluate their purchasing
decisions. If one of our major OEM customers engages in an acquisition in the
future, it could change its current purchasing habits. In that event, we could
lose the customer, experience a decrease in orders from that customer or a delay
in orders previously made by that customer. Moreover, if one of our existing OEM
customers acquires another existing OEM customer, the concentration of our
revenues from the combined companies could increase if the combined companies
continue to purchase our software products. Although we maintain allowances for
doubtful accounts, the insolvency of one or more of our major customers could
substantially impair our business, results of operations and financial
condition.
Our Operating Results Have Been Substantially Dependent upon One Family
of Products Sold to Original Equipment Manufacturers . In the past we have
derived a significant portion of our revenues from a relatively small number of
products and will likely continue to do so in the future. Sales of our QuickLink
related products represented approximately 58.8% of our net revenues in 1998,
81.3% of our net revenues in 1997 and 69.4% of our net revenues in 1996. We
expect that revenues from these products will continue to account for a
substantial portion of our total revenues in the foreseeable future. If our
revenues from these software products decline, whether as a result of
competition, technological change, price pressures or other factors, our
business, results of operations and financial condition could be seriously
impaired.
Our Efforts to Develop a Market for Our Retail Software Products
Require Substantial Investments that May Adversely Affect Our Operating Margins.
We are continuing our efforts to develop a market for our retail communication
software products. We recently added Internet CommSuite to our existing line of
retail software products that includes HotFax MessageCenter, HotFax, VideoLink
Mail, MacComCenter HotPage and HotFaxShare. Sales of our retail products
represented approximately 26.4% of our net revenues in 1998, 5.2% of our net
revenues in 1997 and 16.5% of our net revenues in 1996. In order to strengthen
our product recognition and build distribution channels for our retail products,
we will have to make significant investments in advertising, trade shows, public
relations, distributor relationships and a dedicated sales force. Accordingly,
our retail sales may not provide us with the same contribution margin to
operating income that we have historically achieved on our OEM sales.
15
16
We May Not be Able to Develop and Maintain Relationships with
Distributors and Retailers to Sell Our Retail Software Products. We rely on
distributors, retailers, Internet distributors and value added resellers,
commonly known as VARs, to market and distribute our retail software products.
We may not be successful in recruiting VARs and retailers to represent us. Our
ability to maintain distributor and retailer relationships is largely a function
of our sales volume. If we do not meet certain minimum volume requirements, we
may not be able to maintain our relationships with our current distributors and
retailers. Our agreements with retailers and VARs are not exclusive and in many
cases may be terminated by either party without cause. Many of our retailers and
VARs carry product lines that are competitive with our retail software products.
These retailers and VARs may not give a high priority to the marketing of our
products or may not continue to carry our products. In addition, our retailers
and VARs may change their inventory strategies, with little or no warning to us.
In many cases, such changes in inventory strategy may not be related to end user
demand. If this happens, our business, results of operations and financial
condition may be adversely affected.
Our Risk of Product Returns Will Increase as Our Retail Sales Increase.
We typically allow the retailers and VARs who sell our retail software products
to return our products without charge or penalty. As part of our revenue
recognition policy, we calculate an allowance for product returns based on our
historical experience. If retail sales of our products increase, our risk of
product returns will increase. While our revenue recognition policy contemplates
this risk, it is possible that returns may occur in excess of our previous
experience. If this happens, we would have to revise our estimates and increase
our allowances for such returns. Excessive or unanticipated returns could
adversely affect our business, results of operations and financial condition.
Rapid Technological Change Could Render Our Products Obsolete. The
communication software market in which we operate is characterized by rapid
technological change, changing customer needs, frequent product introductions
and evolving industry standards. These factors make it difficult for us to
estimate the life cycles of our products. Our future success will depend upon
our 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 our customers. We may experience
difficulties that could delay or prevent our development, introduction and
marketing of new products. If we are unable to develop and introduce new
products in a timely manner in response to changing market conditions or
customer requirements, or technological or other reasons, our business, results
of operations and financial condition would be adversely affected.
Microsoft is the leading developer of operating systems for personal
computers. We may not be able to successfully develop new versions of our
software products that will operate on future Microsoft operating systems. Even
if we are able to develop such new versions, we may not be able to do so
concurrently with or prior to introductions by our competitors of communication
software products for those new operating systems. Any such failure or delay
could affect our competitive position or lead to obsolescence of our products in
the future.
Microsoft Poses a Significant Competitive Threat to Us. We face
competition from Microsoft, which is the publisher of the most prevalent
personal computing operating platforms, Windows, Windows NT and DOS. Due to its
market dominance, Microsoft represents a significant competitive threat to all
personal computer software vendors, including us. The latest Microsoft operating
systems, Windows 98, Windows 95 and Windows NT, include capabilities now
provided by certain of our OEM and retail software products, including our
principal product, QuickLink. If the communications capabilities of Windows 98,
Windows 95, Windows NT or other operating systems are adopted by users, sales of
our products could decline.
We Face Significant Competition from Other Companies. We operate in
markets that are highly competitive and subject to rapid changes in technology.
We compete with other software vendors for access to distribution channels,
retail shelf space and the attention of customers. We also compete with other
software companies in our efforts to acquire software technology developed by
third parties. Competitive pressures could reduce our market share or require us
to reduce the prices of our products, either of which could have an adverse
effect on our business, results of operations and financial condition.
16
17
We face significant competition from software vendors in the retail
market. Our principal fax related retail products, HotFax MessageCenter and
HotFax, compete directly with Symantec's WinFax Pro. Our new Internet
communications software products, Internet CommSuite and conexs.com, compete
with product offerings by Microsoft, Intel, White Pine, VDONet and VocalTech,
among others. In addition, because there are low barriers to entry into the
software market, we expect significant competition from other established and
emerging software companies in the future. Furthermore, many of our existing and
potential OEM customers may acquire or develop products that compete directly
with our products.
Many of our current and prospective competitors have significantly
greater financial, marketing, service, support, technical and other resources
than we do. As a result, they may be able to adapt more quickly to new or
emerging technologies and changes in customer requirements or to devote greater
resources to the promotion and sale of their products. There is also a
substantial risk that announcements of competing products by large competitors
such as Microsoft and Symantec could result in the cancellation of orders by
retailers, distributors or other customers in anticipation of the introduction
of such new products. In addition, some or our competitors, such as Symantec,
currently make complementary products that are sold separately. Such competitors
could decide to enhance their competitive position by bundling their products to
attract customers seeking integrated, cost-effective software applications. Some
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.
We also expect competition to increase as a result of software industry
consolidations, which may lead to the creation of additional large and
well-financed competitors. Increased competition is likely to result in price
reductions, fewer customer orders, reduced margins and loss of market share, any
of which could adversely affect our business, results of operations and
financial condition.
We believe that our ability to compete depends on elements both within
and outside of our control, including:
o the success and timing of new product development;
o product performance;
o price;
o distribution; and
o customer support.
We cannot be certain that we will be able to compete successfully with respect
to these and other factors or that the competitive pressures that we face will
not adversely affect our business, results of operations and financial
condition.
Our Future Success Will Depend on Our Ability to Develop and Introduce
New Product Offerings. Our future success will depend, in significant part, on
our ability to successfully develop and introduce new software products and
improved versions of our existing software products on a timely basis and in a
manner that will allow such products to achieve broad customer acceptance. We
cannot be certain that we will be able to develop and introduce new products on
a timely basis, if at all, or that any new products that we do develop will be
accepted in the market. If new products are delayed or do not achieve market
acceptance, our business, results of operations and financial condition will be
adversely affected. In the past, we have experienced delays in purchases of our
products by customers anticipating the launch of new products by us.
Accordingly, it is possible that our customers may defer material orders in the
future in anticipation of new product introductions. If this happens, our
business, results of operations and financial condition may be adversely
affected.
Our Efforts to Sell Our Products in the Corporate and Government
Marketplaces May Not be Successful and May Adversely Affect Our Operating
Margins. In the past, we have generated our revenues almost entirely from OEM
sales. We began selling to the corporate/government marketplace while building
the infrastructure necessary to sell to these two customer bases in 1997. In
January 1998, we acquired the network fax software technology of Mitek Systems,
Inc. Through this acquisition, we acquired software that is designed to address
the fax requirements of the corporate/government customer. During 1998 we
developed the acquired network fax product into the
17
18
currently shipping product, HotFaxShare and we released a newly developed IP
Gateway module. Although we continue to invest resources in the research and
development of products for the corporate and government markets, and in
building the additional infrastructure required to market and sell products in
these markets, we cannot be certain that our efforts will yield any significant
sales growth. In addition, because we have had to make substantial investments
to develop, market and sell products for these markets, sales of such products
may not provide the operating margins historically achieved by us for OEM sales.
Our Products May Contain Undetected Software Errors. Our software
products are complex and may contain undetected errors. In the past, we have
discovered software errors in certain of our products and have experienced
delayed or lost revenues during the period it took to correct these errors.
Although we test our products along with our current and potential OEM
customers, it is possible that errors may be found in our new or existing
products after we have commenced commercial shipment of those products. These
undetected errors, could result in adverse publicity, loss of revenues, delay in
market acceptance of our products or claims against us by customers, all of
which could seriously impair our business, results of operations and financial
condition.
Our Customers May Continue to Switch to the Pre-Loaded or CD-ROM
Versions of Our Products, Which May Adversely Affect Our Operating Results. We
primarily sell our software in a kit that includes a disk or CD-ROM and a
manual. However, some of our customers "pre-load" our software onto a CD,
diskette or the hard drive of a personal computer and pay us a royalty based on
units produced or shipped. These arrangements eliminate the need for us to
provide a disk or CD-ROM and may eliminate the need for a manual. The pre-load
arrangements produce smaller unit revenues for us and eliminate our ability to
generate revenues from our production facilities. We believe that our production
facilities contribute profits to our operations. Currently, we have the
capability to produce our products in-house on 3 1/2-inch diskettes. However, we
do not currently have the capability to produce CD-ROMs internally and the cost
to develop such production capability may be prohibitive. As the size of
software programs grows, CD-ROM is becoming a more prominent medium. We
currently contract CD-ROM production to specialized CD-ROM facilities. If more
of our customers request product pre-loads and CD-ROM versions of our products,
our operating results could be adversely affected.
Our Future Success Will Depend on the Level of Market Acceptance of Our
Internet Communications Products and Video Related Products. We continue to
focus significant resources on the development and introduction of Internet and
video communications products. Such products compete in new and rapidly changing
markets and we cannot be certain that our products will receive or gain market
acceptance. Our Internet communications software product was released in
September 1998. This software product includes a number of Internet
communications tools such as telephony, fax, multimedia e-mail, video
conferencing, video security and others. Our initial sales of this product were
made to retail channels and do not include significant orders from OEM
customers. We introduced our first video communications software in 1996. Since
that time, our sales volume for such product has achieved only modest growth and
has not become a significant part of net revenues. Lack of market acceptance for
our Internet or video communications products or other similar products could
have an adverse impact on our business, results of operations and financial
condition. In addition, we may experience delays in or non-completion of the
development of new Internet or video communications software products, which
could adversely affect our competitive position in these markets. Our Internet
and video communications software products compete against those of several
competitors, including White Pine, Logitech, Intel, Microsoft, VocalTech and
VDONet, some of whom have greater financial and other resources than we do. We
cannot be certain that we will be able to compete successfully against these and
any future competitors in the Internet communications or video conferencing
software markets.
18
19
Our Planned Expansion of Our International Business Activities May Make
Us More Susceptible to Global Economic Factors, Foreign Business Practices and
Currency Fluctuations. We presently operate in foreign markets and intend to
expand our international presence. International net revenues represented 22.8%
of our total net revenues in 1998, 24.3% of our total net revenues in 1997 and
14.4% of our total net revenues in 1996. We may not be able to continue to
generate significant international sales. Our international business activities
are subject to a number of risks, including:
o difficulties in managing distributors;
o difficulties in staffing and maintaining foreign operations;
o foreign currency exchange fluctuations;
o the possibility of difficulties in collecting accounts
receivable.
o varying technical standards;
o substantially different regulatory requirements in different
jurisdictions;
o tariffs and trade barriers;
o political and economic instability;
o reduced protection for our intellectual property rights in
certain countries;
o potentially adverse tax consequences;
o burdens associated with complying with a wide variety of
complex foreign laws and treaties; and
While we currently do not accept payment in foreign currencies and
invoice all of our sales in U.S. dollars, we may not be able to continue this
policy if we are able to grow international sales. If we begin to receive
payment in foreign currencies, we are likely to be subjected to the risks of
foreign currency losses due to fluctuations in foreign currency exchange rates.
In addition, if we are successful in growing our business outside of the United
States, we may also face economic, political and foreign currency situations
that are substantially more volatile than those commonly experienced in the
United States. If this happens, our business, results of operations and
financial condition could be adversely affected.
We Must Continue to Hire and Retain Key Personnel in an Intensely
Competitive Labor Market. Our future performance depends in significant part
upon the continued service of our senior management and other key technical
personnel. We are dependent on our 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 our
communication software products and introduce enhanced future applications. The
software industry is characterized by a high level of employee mobility and an
aggressive approach to the recruiting of skilled personnel. Our inability to
attract and retain the highly trained technical personnel that are essential to
our product development, marketing and service and support teams may limit the
rate at which we can generate revenue and develop new products or product
enhancements. This could have an adverse effect on our business, results of
operations and financial condition. In order to attract and retain key
personnel, we may need to grant additional options and provide other forms of
incentive compensation.
Because We Rely on Third Party Suppliers, We Have Limited Control Over
Component Costs and Product Delivery Schedules. We rely on third party suppliers
to provide us with the components for our product kits. These components include
disks, CDs and printed manuals. We also rely on third parties for CD-ROM
replication. In the past, we have experienced disk shortages and may experience
such shortages in the future. If we cannot obtain a sufficient quantity of disks
or other components we may not be able to deliver products to our customers on a
timely basis. Similarly, if the CD-ROM replication facilities that we use do not
deliver our requirements on schedule, we may not be able to deliver products in
a CD-ROM format to our customers on a timely basis. Any delays that we
experience in delivering our products to customers could impair our customer
relationships and adversely impact our business. In addition, if our third party
suppliers raise their prices for disks or other components or CD-ROM replication
services, our gross margins would be reduced. If this happens, our business,
results of operations and financial condition would be adversely affected.
We Duplicate All of Our Disks at One Facility and May Not be Able to
Find Alternate Arrangements in an Economic or Timely Manner in the Event of a
Disruption at That Facility. We duplicate all of our diskette software
19
20
at our Aliso Viejo, California facility. As a result, if our production at this
facility is disrupted by natural disaster or another event, such as the presence
of a virus in our duplicators, we cannot be certain that we could find an
alternative arrangement in timely manner. Even if we are able to find an
alternate duplication facility or a third party to duplicate our diskette
software for us, we cannot be certain that we would be able to obtain such
alternatives at commercially reasonable prices.
We May be Unable to Adequately Protect Our Intellectual Property and
Other Proprietary Rights. Our success is dependent upon our software code base,
our programming methodologies and other intellectual properties. In order to
protect our proprietary technology, we rely on a combination of trade secret,
nondisclosure and copyright and trademark law. However, these measures afford us
only limited protection. We currently own United States trademark registrations
for certain of our trademarks, but we have not yet obtained registrations for
all of our trademarks in the United States or other countries. In addition,
prior to becoming a publicly held entity, we did not require our employees to
sign proprietary information and inventions agreements stipulating to our
software ownership rights. We only recently started the patent application
process for a number of technologies relating to our existing products and
products under development. Furthermore, we rely primarily on "shrink wrap"
licenses that are not signed by the end user and, therefore, may be
unenforceable under the laws of certain jurisdictions. Accordingly, despite the
precautions we have taken to protect our intellectual property and proprietary
rights, it is possible that third parties may copy or otherwise obtain our
rights without our authorization. It is also possible that third parties may
independently develop technologies similar to ours. It may be difficult for us
to detect unauthorized use of our intellectual property and proprietary rights.
We may be subject to claims of intellectual property infringement as
the number of trademarks, patents, copyrights and other intellectual property
rights asserted by companies in our industry grows and the coverage of these
patents and other rights and the functionality of software products increasingly
overlap. From time to time, we have received communications from third parties
asserting that our trade name or features, content, or trademarks of certain of
our products infringe upon intellectual property rights held by such third
parties. We have also received correspondence from third parties separately
asserting that our fax products may infringe on certain patents held by each of
the parties. Although we are not aware that any of our products infringe on the
proprietary rights of others, third parties may claim infringement by us with
respect to our current or future products. Infringement claims, whether with or
without merit, could result in time-consuming and costly litigation, divert the
attention of our management, cause product shipment delays or require us to
enter into royalty or licensing agreements with third parties. If we are
required to enter into royalty or licensing agreements, they may not be on terms
that are acceptable to us. Unfavorable royalty or licensing agreements could
seriously impair our business, results of operations and financial condition.
Our Business May be Adversely Affected by Unexpected Year 2000
Problems. Many currently installed computer systems and software applications
are coded to accept only two digit entries to identify the year in the date code
field, without considering the impact of the change in the century. As a result,
in less than one year, computer systems and/or software used by many companies
may need to be upgraded to comply with such "Year 2000" requirements. We believe
that Year 2000 issues could encompass our own software products, internal
systems used to operate and monitor our business and our third party vendors and
customers.
We currently offer software products that are designed to be Year 2000
compliant. Our software products do not utilize dates in their primary
functions. We have evaluated our software products and their interaction with
hardware, such as fax machines, and possible software applications, such as word
processors, and believe that Year 2000 problems will not effect the
functionality of its software products. However, it is possible that our
products, or the hardware or software applications used by a customer, may
contain undetected errors or defects associated with Year 2000 date functions.
We believe that we have identified substantially all of the major
internal systems and software applications that are important to the operation
and monitoring of our business. We have obtained confirmation from vendors of
certain purchased systems and software applications used in our internal
operations that current releases or upgrades, if installed, are designed to be
Year 2000 compliant. We have recently completed the installation of such
upgrades to our current systems. We have recently completed the installation of
such upgrades
20
21
to our current systems. We believe that with the upgrades, modifications and
conversions we have made to date, the Year 2000 issue will not have a material
impact on our internal systems. However, it is possible that the systems and
software applications used for our internal operations contain undetected errors
or defects associated with Year 2000 date functions.
We are currently in the process of evaluating our critical external
relationships, including relationships with both third party vendors and
customers, to determine the extent to which we may be vulnerable to the failure
of such third parties to resolve their own Year 2000 issues. We are gathering
information through direct communication with third parties, SEC filings,
information provided by the third parties' corporate web sites and product
marketing documentation. Third parties being evaluated include, among others,
software duplication vendors, freight companies, payroll service providers and
our largest customers. Where practicable, we will assess and attempt to mitigate
our risks with respect to failure of these entities to be Year 2000 ready. The
effect, if any, on our results of operations from the failure of such parties to
be Year 2000 ready is not reasonably estimable.
Although we are not aware of any material operational issues or costs
associated with preparing our products or internal information systems for the
Year 2000, it is possible that we may experience serious unanticipated negative
consequences and/or material costs caused by undetected errors or defects in the
technology used in our internal systems, which are composed predominantly of
third party software and hardware. If we are not completely successful in
mitigating our internal and external Year 2000 risks, we could experience a
system failure or disruptions in our operations, including, among other things,
a temporary inability to process transactions, send invoices, or engage in
similar normal business activities. Any of these problems, if they occur, would
have an adverse effect on our business, results of operations and financial
condition.
Our Officers and Directors Could Control Matters Submitted to Our
Stockholders. As of March 23, 1999, William Smith, the President, Chief
Executive Officer and Chairman of the Board of the company, and Rhonda Smith,
the Secretary, Treasurer and Vice-Chairman of the Board of our company,
beneficially owned approximately 69.3% 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 our directors and determine the outcome of any
corporate action requiring stockholder approval, including a merger or business
combination, irrespective of how you may vote. This concentration of ownership
may discourage a potential acquirer from making an offer to buy our company,
which, in turn, could adversely affect the market price of our common stock.
Provisions of Our Charter and Bylaws and Delaware Law Could Make a
Takeover of Our Company Difficult. Our certificate of incorporation and bylaws
contain provisions that may discourage or prevent a third party from acquiring
us, even if doing so would be beneficial to our stockholders. For instance, our
certificate of incorporation authorizes the board of directors to fix the rights
and preferences of shares of any series of preferred stock, without action by
our stockholders. As a result, the board can authorize and issue shares of
preferred stock, which could delay or prevent a change of control because the
rights given to the holders of such preferred stock may prohibit a merger,
reorganization, sale or other extraordinary corporate transaction. In addition,
we are organized under the laws of the State of Delaware and certain provisions
of Delaware law may have the effect of delaying or preventing a change in our
control.
The Price of Our Stock Has Been Volatile and Could Continue to
Fluctuate Substantially. The market price of our common stock has been volatile
and could fluctuate substantially in response to a variety of factors that are
out of our control, in addition to our financial performance. Furthermore, stock
prices for many high technology companies, including our own fluctuate widely
for reasons that may be unrelated to the operating performance.
Future Sales of Our Common Stock Could Cause the Price of Our Shares to
Decline. As of March 23, 1999, we had 14,074,698 shares of Common Stock
outstanding. Of this amount, the 9,758,670 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) in September 1997,
following the expiration of a two year lock-up agreement with certain
representatives of the underwriters of our initial public offering, which
consummated in September 1995. Sales of a substantial number of shares of our
common stock by William Smith, Rhonda Smith or any other
21
22
person, either individually or when aggregated with sales by other persons,
could adversely affect the market price of our common stock.
ITEM 2. PROPERTIES
Our 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. We have leased this facility through March
31, 2003. We also lease 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, 1999, 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, 1999. We believe that
suitable additional or alternative space will be available in the future on
commercially reasonable terms as needed.
ITEM 3. LEGAL PROCEEDINGS
Smith Micro 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. In
October 1998, Smith Micro and PCI Video successfully obtained a terminating
sanction against Virtual Ambiance, resulting in immediate dismissal of the
lawsuit with prejudice.
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, 1998.
22
23
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
MARKET INFORMATION
Smith Micro's common stock is traded on the Nasdaq National Market
under the symbol "SMSI." The high and low closing sale prices for our common
stock as reported by Nasdaq are set forth below for the periods indicated.
High Low
-------- -------
YEAR ENDED DECEMBER 31, 1998:
First Quarter $ 5 9/16 $1 9/16
Second Quarter 4 7/16 2 1/4
Third Quarter 2 3/4 1 1/4
Fourth Quarter 4 3/8 1 7/16
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
On March 23, 1999, the closing sale price for our common stock as
reported by Nasdaq was $2.63.
HOLDERS
As of March 23, 1999, there were 95 holders of record of our common
stock.
DIVIDENDS
We have never paid any cash dividends on our common stock and we have
no current plans to do so.
23
24
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
The effective date of Smith Micro's first 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, we sold 1,700,000 shares of
common stock for an aggregate offering price of $20,400,000, and certain of our
stockholders sold 2,210,000 shares of our common stock for an aggregate offering
price of $26,520,000.
We 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 us after total expenses were $18,138,000.
As of December 31, 1998, we had used the net proceeds from the offering
as follows: $4,188,000 to repay amounts due under a promissory note issued by us
to certain of our stockholders as a part of a distribution of retained earnings
in connection with our prior S corporation status, $3,011,000 for our
acquisition of Performance Computing Incorporated, which was consummated in
March 1996, $458,000 for our acquisition of technology assets from Mitek
Systems, Inc., which was consummated in January 1998 and $190,000 for other
acquisitions of technology assets during 1998. We have invested the remainder of
the net proceeds from the offering 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 that is part of
the registration statement.
24
25
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data with respect to Smith Micro's
consolidated statements of operations for the years ended and consolidated
balance sheets as of December 31, 1998, 1997, 1996 and 1995 are derived from the
audited Consolidated Financial Statements of Smith Micro Software Inc.. 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,
-----------------------------------------------
1998 1997 1996 1995
-------- -------- -------- --------
(in thousands, except per share data)
Statement of Operations Data:
Net revenues $ 9,547 $ 11,684 $ 22,091 $ 18,012
Cost of revenues 2,898 3,853 6,795 5,887
-------- -------- -------- --------
Gross profit 6,649 7,831 15,296 12,125
Operating expenses:
Selling and marketing 3,779 3,525 2,939 1,995
Research and development 3,262 3,266 3,324 1,621
General and administrative 3,443 4,191 3,796 2,555
Acquired in-process research and development 5,169
-------- -------- -------- --------
Total operating expenses 10,484 10,982 15,228 6,171
-------- -------- -------- --------
Operating income (loss) (3,835) (3,151) 68 5,954
Interest income 725 725 849 308
-------- -------- -------- --------
Income (loss) before income taxes (3,110) (2,426) 917 6,262
Income tax expense (benefit) (1) (1,112) (839) 2,436 810
-------- -------- -------- --------
Net income (loss) $ (1,998) $ (1,587) $ (1,519) $ 5,452
======== ======== ======== ========
Net loss per share, basic and dilutive $ (0.14) $ (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 14,075 13,992 12,627
======== ======== ======== ========
As of December 31,
-----------------------------------------------
1998 1997 1996 1995
-------- -------- -------- --------
(in thousands, except per share data)
Balance Sheet Data:
Total assets $ 20,803 $ 21,755 $ 24,107 $ 23,662
Total liabilities 2,558 1,512 2,277 3,417
Retained earnings (accumulated deficit) (3,019) (1,021) 566 2,085
Total stockholders' equity 18,245 20,243 21,830 20,245
- ----------
(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.
25
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Smith Micro Software, Inc. develops and sells communications software
for personal and business use. Our objective is to enhance human interaction by
giving users the ability to communicate through multimedia technologies over
analog and digital platforms. Smith Micro's products enable personal
communication through telephony, fax, multimedia email, data, paging, video
security and video conferencing.
Recently, we have been developing new products that leverage off our
core technologies to address the consumer's use of the Internet and corporate
intranets. We intend to leverage our experience and position with the original
equipment manufacturers to deploy these new product releases. Additionally, we
are expanding our customer base to include manufacturers that produce devices
that take advantage of the high bandwidth Internet connectivity such as cable
and xDSL modems. The Company's corporate products are designed to provide cost
effective and efficient methods of communicating that take advantage of
corporate local and wide area networks, including the Internet or intranet.
We shipped our first data communication software product in 1985 and,
since that time, we have generated revenues primarily from the market acceptance
of our OEM fax and data communication software products. We began providing
video communication products in 1996 to both OEM and retail customers. In
January 1998, we purchased certain fax software assets of Mitek Systems, Inc. to
provide LAN, Internet and intranet fax transmission solutions designed for the
corporate market. In September 1998, we shipped our first Internet
communications software product. This multi-purpose product provides for
integrated telephony, multimedia e-mail, video security, fax, video conferencing
and text based chat functionality over the Internet and other IP protocol
services such as LANs and WANs. Designed to take advantage of high bandwidth
technology, this product functions over a variety of IP connectivity hardware
including xDSL modems, cable modems, network interface devices and analog
modems.
We recognize revenues from sales of our software as completed products
are shipped and from royalties generated as authorized customers duplicate our
software. Any material reduction in demand for our products would have an
adverse effect on our business, results of operations and financial condition.
We continue to introduce new products; and our 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. We have allowed our
customers to return unused software and to rotate stock for new versions of
retail releases. As a percentage of our net revenues, returns constituted 5.1%
in 1998, 26.8% in 1997 and 16.8% in 1996. As a percentage of our net revenues,
returns for stock rotation were 0.6% in 1998, 14.6% in 1997 and 6.8% in 1996.
A small number of our customers have historically accounted for a
substantial portion of our revenues. In June 1997, 3Com Corporation acquired our
largest customer to date, U.S. Robotics Corporation. Sales to 3Com, primarily
U.S Robotics and its subsidiaries, accounted for approximately 24.7% of our net
revenues in 1998, 43.4% of our net revenues in 1997 and 46.4% of our net
revenues in 1996. Our three largest OEM customers, including 3Com, accounted for
the following portions of our net revenues: 35.1% in 1998, 56.9% in 1997 and
62.9% in 1996. Any reduction, delay or change in orders from such customers
could have an adverse effect on our business, results of operations and
financial condition.
The OEM product ordering cycle beginning from placement of an order to
shipment 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. We generally ship our products as we receive orders; and,
accordingly, we have historically operated with little backlog. We do not
consider backlog to be a significant indication of future performance. As a
result, our sales in any quarter are dependent on orders booked and shipped in
that quarter and are not predictable with any degree of certainty. Moreover, we
generally do not produce software in advance of orders and, therefore, have not
maintained a material amount of software inventory.
26
27
Inventory in the retail channel exposes us to product returns. We
consider this exposure when we establish allowances for product returns.
Substantial returns of product from the retail channel could have an adverse
effect on our 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 in this Annual Report. Historical results of operations,
percentage relationships and any trends that may be inferred from the discussion
below are not necessarily indicative of our 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 our statement of income.
Year Ended December 31,
---------------------------------------
1998 1997 1996 1995
----- ----- ----- -----
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 30.4% 33.0% 30.8% 32.7%
----- ----- ----- -----
Gross profit 69.6% 67.0% 69.2% 67.3%
Operating expenses:
Selling and marketing 39.5% 30.2% 13.3% 11.1%
Research and development 34.2% 27.9% 15.0% 9.0%
General and administrative 36.1% 35.9% 17.2% 14.2%
Acquired in-process research and development 23.4%
----- ----- ----- -----
Total operating expenses 109.8% 94.0% 68.9% 34.3%
----- ----- ----- -----
Operating income (loss) -40.2% -27.0% 0.3% 33.0%
Interest income 7.6% 6.2% 3.8% 1.7%
----- ----- ----- -----
Income (loss) before income taxes -32.6% -20.8% 4.1% 34.7%
Income tax expense (benefit) -11.7% -7.2% 11.0% 4.5%
----- ----- ----- -----
Net income (loss) -20.9% -13.6% -6.9% 30.2%
===== ===== ===== =====
1998 COMPARED TO 1997
Net Revenues
Our net revenues decreased 18.3% to $9.5 million for 1998 from $11.7
million for 1997. This decrease in our revenue was the result of a decrease in
sales to our largest OEM analog modem customers, including 3Com. The decrease in
sales resulted from a combination of factors, including changes in product mix
resulting from the analog modem industry's acceptance of the V.90, 56K modem
standard, reduced demand of certain fax products and pricing pressures within
the analog modem industry. In response to these factors, our revenues from sales
to 3Com in 1998 decreased 53.4% when compared to 1997. This decrease in our
revenues from analog modem manufacturers was partially offset by an increase in
revenues from other OEM customers, including PC manufacturers, and increased
retail revenues. During 1998, net retail revenues increased approximately 313%
over 1997 net retail revenues.
Gross Profit
Gross profit represents net revenues, less cost of revenues, which
includes cost of materials, costs related to the operations of our duplication
facilities, freight charges and royalties to licensors. Our gross profit
decreased 15.1% to $6.6 million in 1998 from $7.8 million in 1997. Gross profit
as a percentage of net revenues increased to
27
28
69.6% in 1998 compared to 67.0% in 1997. The increase in our gross profit
percentage was due to a shift in our product mix, our flexible manufacturing
process and our improvement of controls over our manufacturing expenses. These
improvements were partially offset by the translation costs of certain software
products.
Operating Expenses
Our 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 7.2%
to $3.8 million in 1998 from $3.5 million in 1997. As a percent of net revenues,
sales and marketing expenses increased to 39.5% in 1998 from 30.2% in 1997. The
increase in our sales and marketing expenses in 1998 was primarily due to
increased expenditures for our major retail products, including expenditures
related to the introduction of Internet CommSuite, a multi-function Internet
communications software product. Expenditures for our corporate and VAR product
group, primarily our LAN fax products, also increased in 1998.
Our research and development expenses consist primarily of personnel
and equipment costs required to conduct our software development efforts. In
1998, research and development expenses remained constant at $3.3 million as
compared to 1997. As a percentage of net revenues, research and development
expenditures increased to 34.2% in 1998 from 27.9% in 1997. An increase in the
amortization of purchased technologies, primarily for the network fax technology
that we acquired in 1998, was offset by a reduction in salaries and benefits. To
date, we have not capitalized any of our software development expenses because
our development efforts have been completed concurrently with the establishment
of technological feasibility. However, significant new products that we develop
in the future may require the capitalization of certain software development
expenses.
Our general and administrative expenses include expenses related to our
general operations. General and administrative expenses decreased 17.8% to $3.4
million in 1998 from $4.2 million in 1997. As a percentage of net revenues,
general and administrative expenditures increased to 36.1% in 1998 from 35.9% in
1997, primarily due to the decrease in our net revenues. The overall decrease
was primarily due to the lower allowance for bad debt in 1998 and cost control
measures that reduced most expense categories during 1998.
Income Taxes
During 1998, our income tax benefit was 35.8% of the loss before income
taxes. Income tax benefit was $1.1 million in 1998 and $839,000 in 1997.
1997 COMPARED TO 1996
Net Revenues
Our net revenues decreased 47.1% to $11.7 million for 1997 from $22.1
million for 1996. This decrease consisted of a 40.7% decrease in OEM sales and
an 82.2% decrease in retail sales in 1997 compared with 1996. The OEM decrease
was the result of a combination of decreased unit volume, which we believe 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
factors contributed to decreased revenues from sales to 3Com of 50.5% in 1997
and to decreased revenues from sales to Motorola of 77.0% in 1997. The decrease
in retail sales was primarily driven by slower than anticipated sales of our
video communication software product lines. We believe that these product lines
continue to be impacted by consumers' lack of acceptance of current video
technology and pricing.
Gross Profit
Gross profit represents net revenues, less cost of revenues, which
includes cost of materials, costs related to the operations of our 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. Gross profit as a
percentage of net revenues
28
29
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 us to achieve only a slight decrease in gross
profit percentage despite the 47.1% decrease in our sales. Gross profit as a
percentage of net revenues decreased primarily due to the decrease in our net
revenues, an increase in our inventory write-offs, which resulted from releases
of new version retail product releases during 1997, and an increase in our
royalty expenses, which were primarily related to our video products.
Operating Expenses
Our 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 percentage of net
revenues, sales and marketing expenses increased to 30.2% in 1997 from 13.3% in
1996. Our sales and marketing expenditures increased primarily due to our
promotional campaigns in the retail channel during the first half of the year
combined with an increase in personnel.
Our research and development expenses consist primarily of personnel
and equipment costs required to conduct our software development efforts. Our
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 our video communication
software was offset by a decrease in all other research and development expense
categories. To date, we have not capitalized any of our software development
expenses because our development efforts have been completed concurrently with
the establishment of technological feasibility. However, significant new
products that we develop in the future may require the capitalization of certain
software development expenses.
Our general and administrative expenses include expenses related to our
general operations. 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, our
general and administrative expenditures increased to 35.9% in 1997 from 17.2% in
1996. Our 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. We increased bad debt reserves due
to slower payment patterns from our customers that were largely influenced by
slower than anticipated sales of our retail video communication software
products.
Income Taxes
During 1997, our 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.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations primarily through cash
generated from operations. Net cash used in operations was $858,000 for 1998 and
$288,000 for 1996. Net cash provided by operating activities was $102,000 in
1997. In 1998, the cash used in our operations was primarily the result of our
net loss for the year and an increase in accounts receivable that was partially
offset by an increase in accounts payable and accrued liabilities. The increases
in accounts receivable and accounts payable and accrued liabilities were
primarily due to an increase in our retail activities during the later portion
of the year. The 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.
29
30
We used $810,000 in cash in 1998, $222,000 in 1997 and $2.5 million in
1996, for investing activities. Our primary use of cash for investing activities
related to our acquisition of technology from Mitek in 1998 and the purchase of
Performance Computing Incorporated in 1996. We also invested in property and
equipment, including computers and production equipment, during each of 1998,
1997 and 1996.
During 1998 and 1997, we did not use or generate cash from financing
activities. Net cash used in financing activities during 1996 of $1.8 million
was primarily for the repayment of notes to our founders.
At December 31, 1998, we had $12.7 million in cash and cash equivalents
and $16.7 million of working capital. We had $4.1 million in accounts
receivable, net of allowance for doubtful accounts and other adjustments. We
currently anticipate that capital expenditures will not vary significantly from
recent years.
YEAR 2000 COMPLIANCE
Smith Micro is aware of issues associated with computer systems as the
year 2000 approaches. Many currently installed computer systems and software
applications are coded to accept only two digit entries to identify the year in
the date code field, without considering the impact of the change in the
century. As a result, in less than one year, computer systems and/or software
used in many companies may need to be upgraded to comply with such "Year 2000"
requirements. We believe that Year 2000 issues could affect the internal systems
used to operate and monitor our business, our third party vendors and customers
and our software products. Significant uncertainty exists in the computer
industry concerning the potential effects associated with such Year 2000 issues.
We believe that we have identified substantially all of the major
internal systems and software applications that are important to the operation
and monitoring of our business. We have obtained confirmation from vendors of
certain purchased systems and software applications used for our internal
operations that current releases or upgrades, if installed, are designed to be
Year 2000 compliant. We have recently completed the installation of such
upgrades to our current systems. We believe that with the upgrades,
modifications and conversions we have made to date, the Year 2000 issue will not
have a material impact on our internal systems. However, it is possible that the
systems and software applications used for our internal operations contain
undetected errors or defects associated with Year 2000 date functions. We
currently estimate that the total cost remaining, after December 31, 1998, to
address our Year 2000 issues is insignificant. This estimate is based on
assumptions that include our assumption that the we have already identified the
most significant Year 2000 issues and that the plans of our third party
suppliers and customers will be fulfilled in a timely manner at no cost to us.
All remaining Year 2000 issue costs will be funded through operating cash flows.
We are currently in the process of evaluating our critical external
relationships, including relationships with both third party vendors and
customers, to determine the extent to which we may be vulnerable to the failure
of such third parties to resolve their own Year 2000 issues. We are gathering
information through direct communication with third parties, SEC filings,
information provided by the third parties' corporate web sites and product
marketing documentation. Third parties being evaluated include, among others,
software duplication vendors, freight companies, payroll service providers and
our largest customers. Where practicable, we will assess and attempt to mitigate
our risks with respect to failure of these entities to be Year 2000 ready. The
effect, if any, on our results of operations from the failure of such parties to
be Year 2000 ready is not reasonably estimable.
We currently offer software products that are designed to be Year 2000
compliant. Our software products do not utilize dates in their primary
functions. We have evaluated our software products and their interaction with
hardware, such as fax machines, and possible software applications, such as word
processors, and believe that Year 2000 problems will not affect the
functionality of its software products. However, it is possible that our
products, or the hardware or software applications used by one of our customers,
may contain undetected errors or defects associated with Year 2000 date
functions.
Although we are not aware of any material operational issues or costs
associated with preparing our products or internal information systems for the
Year 2000, it is possible that we may experience serious
30
31
unanticipated negative consequences and/or material costs caused by undetected
errors or defects in the technology used in our internal systems, which are
composed predominantly of third party software and hardware. If we are not
completely successful in mitigating our internal and external Year 2000 risks,
we could experience a system failure or disruptions in our operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities. We are currently
developing contingency plans to address the Year 2000 issues that may pose a
significant risk to our ongoing operations. We believe, that under a worst case
scenario, we could continue the majority of our normal business activities with
the use of manual processing, alternate suppliers and an accelerated program of
replacement for equipment or software applications.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Smith Micro's financial instruments include cash and cash equivalents.
At December 31, 1998, the carrying values of our financial instruments
approximated fair values based on current market prices and rates.
It is our policy not to enter into derivative financial instruments. We
do not currently have any significant foreign currency exposure as we do not
transact business in foreign currencies. As such, we do not have significant
currency exposure at December 31, 1998.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Smith Micro'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, we have not had a change in our
independent auditors nor have there been any disagreements between us and our
independent auditors.
31
32
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
Smith Micro's Proxy Statement for the 1999 Annual Meeting of Stockholders is
incorporated herein by reference
ITEM 11. EXECUTIVE COMPENSATION
The section titled "Executive Compensation and Related Information"
appearing in Smith Micro's Proxy Statement for the 1999 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 Smith Micro's
Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
32
33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) FINANCIAL STATEMENTS
Smith Micro'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, 1998 and 1997.......................F-2
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 1998..............................................F-3
Consolidated Statements of Stockholders Equity for each of the three
years in the period ended December 31, 1998.....................................F-4
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1998..................................................F-5
Notes to Consolidated Financial Statements for each of the three years
in the period ended December 31, 1998...........................................F-7
(2) FINANCIAL STATEMENT SCHEDULE
Smith Micro'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, 1998...............................................S-2
(3) EXHIBITS
Exhibit
No. Title Method of Filing
------- ----- ----------------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1 to the
Incorporation of the Company Registrant's Registration Statement No. 33-95096
3.2 Amended and Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement No. 33-95096
4.1 Specimen certificate representing shares of Incorporated by reference to Exhibit 4.1 to the
Common Stock of the Company. Registrant's Registration Statement 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 Plan. Incorporated by reference to Exhibit 10.2 to the
Registrant's Registration Statement No. 33-95096
33
34
Exhibit
No. Title Method of Filing
------- ----- ----------------
10.3 Form of Notice of Grant of Stock Option Incorporated by reference to Exhibit 10.3 to the
under 1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096
10.4 Form of 1995 Stock Option Agreement under Incorporated by reference to Exhibit 10.4 to the
1995 Stock Option /Stock Issuance Plan. Registrant's Registration Statement No. 33-95096
10.5 Form of 1995 Stock Purchase Agreement under Incorporated by reference to Exhibit 10.5 to the
1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096
10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6 to the
September 30, 1991, by and between the Registrant's Registration Statement No. 33-95096
Company and Crandell Development Corporation.
10.7 Application Program Interface Retail License Incorporated by reference to Exhibit 10.7 to the
Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096
Company and Rockwell International
Corporation.
10.8 Application Program Interface License Incorporated by reference to Exhibit 10.8 to the
Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096
Company and Rockwell International
Corporation.
10.9 Rockwell High Speed Interface License Incorporated by reference to Exhibit 10.9 to the
Agreement dated June 2, 1994, by and between Registrant's Registration Statement No. 33-95096
the Company and Rockwell International
Corporation.
10.10 Letter Agreement dated February 22, 1994, by Incorporated by reference to Exhibit 10.10 to the
and between the Company and Rockwell Registrant's Registration Statement No. 33-95096
International Corporation.
10.11 Letter Agreement dated April 22, 1993, by Incorporated by reference to Exhibit 10.11 to the
and between the Company and Rockwell Registrant's Registration Statement No. 33-95096
International Corporation.
10.12 Software Distribution Agreement dated May 8, Incorporated by reference to Exhibit 10.12 to the
1995, by and between the Company and Registrant's Registration Statement No. 33-95096
International Business Machines Corporation.
10.13 Office Building Lease, dated June 10, 1992, Incorporated by reference to Exhibit 10.13 to the
by and between the Company and Developers Registrant's Registration Statement No. 33-95096
Venture Capital Corporation.
10.14 Amendment No. 1 To Office Building Lease, Incorporated by reference to Exhibit 10.14 to the
dated July 9, 1993, by and between the Registrant's Registration Statement No. 33-95096
Company and Pioneer Bank.
34
35
Exhibit
No. Title Method of Filing
------- ----- ----------------
10.15 Amendment No. 2 To Office Building Lease, Incorporated by reference to Exhibit 10.15 to the
dated August 15, 1994, by and between the Registrant's Registration Statement No. 33-95096
Company and T&C Development.
10.16 Fourth Addendum to Office Building Lease, Incorporated by reference to Exhibit 10.16 to the
dated April 21, 1995, by and between Registrant's Registration Statement No. 33-95096
the Company and T&C Development.
10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17 to the
Corporation Distribution. Registrant's Registration Statement No. 33-95096
10.18 Smith Micro Software, Inc. Amended and Incorporated by reference to Exhibit 10.21 to the
Restated Software Licensing and Distribution Registrant's Quarterly Report on Form 10-Q for the
Agreement, dated April 18, 1996, by and quarter ended September 30, 1996
between the Company and U.S. Robotics Access
Corp.
10.19 Office Building Lease, dated March 1, 1994, Incorporated by reference to Exhibit 10.19 to the
by and between Performance Computing Registrant's Annual Report on Form 10-K for the
Incorporated and Petula Associates, Ltd./KC fiscal year ended December 3l, 1995
Woodside.
10.20 Agreement and Plan of Merger by and between Incorporated by reference to Exhibit 2 to the
Smith Micro Software, Inc., Performance Registrant's Current Report on Form 8-K filed with
Computing Incorporated and PCI Video the Commission on March 28, 1996
Products, Inc. dated as of March 14, 1996.
10.21 Amendment No. 1, dated as of March 10, 1997, Incorporated by reference to Exhibit 10.21 to the
to Agreement and Plan of Merger by and Registrant's Annual Report on Form 10-K for the
between Smith Micro Software, Inc., fiscal year ended December 31, 1996
Performance Computing Incorporated and PCI
Video Products, Inc. dated as of March 14,
1996.
10.22 Amendment No. 6 to Office Building Lease, Incorporated by reference to Exhibit 10.21 to the
dated February 19, 1998, by and between the Registrant's Annual Report on Form 10-K for the
Company and World Outreach Center. fiscal year ended December 31, 1997
10.23 Software Licensing and Distribution Filed Herewith. Confidential treatment being sought
Agreement dated December 1, 1998, by and with respect to certain portions of this agreement.
between the Company and 3Com Corporation Such portions have been omitted from this filing and
have been filed separately with the Securities and
Exchange Commission.
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, 1998.
35
36
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 26, 1999 By:/s/ William W. Smith, Jr.
-------------------------------------
William W. Smith, Jr.
Chairman of the Board,
President and Chief Executive Officer
Date: March 26, 1999 By /s/ Mark W. Nelson
-------------------------------------
Mark W. Nelson
Chief Financial Officer
(Principal Financial 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 26, 1999
- ------------------------------------ President and Chief Executive Officer
William W. Smith, Jr. (principal executive officer)
/s/ Rhonda L. Smith Vice-Chairman of the Board, Secretary, March 26, 1999
- ------------------------------------ Treasurer and Director
Rhonda L. Smith
/s/ Robert W. Scheussler Senior Vice President, Chief Technical March 26, 1999
- ------------------------------------ Officer, and Director
Robert W. Scheussler
/s/ Mark W. Nelson Vice President of Finance and Chief March 26, 1999
- ------------------------------------ Financial Officer (principal financial
Mark W. Nelson and accounting officer)
/s/ Thomas G. Campbell Director March 26, 1999
- ------------------------------------
Thomas G. Campbell
/s/ F. Terry Eger Director March 26, 1999
- ------------------------------------
F. Terry Eger
36
37
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, 1998 and 1997,
and the related consolidated statements of operations, stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1998.
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, 1998 and 1997, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE, LLP
Costa Mesa, California
February 12, 1999
F-1
38
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1998 1997
-------- --------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 12,699 $ 14,367
Accounts receivable, net of allowances for doubtful accounts
and other adjustments of $1,255 (1998) and $1,413 (1997) 4,093 3,808
Income taxes receivable 931 1,127
Deferred tax asset (Note 4) 470 467
Inventories 629 553
Prepaid expenses and other current assets 423 503
-------- --------
Total current assets 19,245 20,825
EQUIPMENT AND IMPROVEMENTS, net (Note 2) 350 444
DEFERRED TAX ASSET (Note 4) 336 139
OTHER ASSETS 304 58
INTANGIBLE ASSETS, net (Note 9) 568 289
-------- --------
$ 20,803 $ 21,755
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,373 $ 877
Accrued liabilities (Note 3) 1,185 635
-------- --------
Total current liabilities 2,558 1,512
COMMITMENTS AND CONTINGENCIES (Note 5)
STOCKHOLDERS' EQUITY (Note 8):
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 (1998
and 1997) 14 14
Additional paid-in capital 21,250 21,250
Accumulated deficit (3,019) (1,021)
-------- --------
Total stockholders' equity 18,245 20,243
-------- --------
$ 20,803 $ 21,755
======== ========
See notes to consolidated financial statements.
F-2
39
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Year ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
NET REVENUES (Note 6) $ 9,547 $ 11,684 $ 22,091
COST OF REVENUES 2,898 3,853 6,795
-------- -------- --------
GROSS PROFIT 6,649 7,831 15,296
OPERATING EXPENSES:
Selling and marketing 3,779 3,525 2,939
Research and development 3,262 3,266 3,324
General and administrative (Note 7) 3,443 4,191 3,796
Acquired in-process research and
development (Note 9) 5,169
-------- -------- --------
Total operating expenses 10,484 10,982 15,228
-------- -------- --------
OPERATING INCOME (LOSS) (3,835) (3,151) 68
INTEREST INCOME 725 725 849
-------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (3,110) (2,426) 917
INCOME TAX EXPENSE (BENEFIT) (Note 4) (1,112) (839) 2,436
-------- -------- --------
NET LOSS $ (1,998) $ (1,587) $ (1,519)
======== ======== ========
NET LOSS PER SHARE, basic and diluted $ (0.14) $ (0.11) $ (0.11)
======== ======== ========
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING 14,075 14,075 13,992
======== ======== ========
See notes to consolidated financial statements.
F-3
40
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
(IN THOUSANDS)
Retained
Common stock Additional earnings
------------------ paid-in (accumulated
Shares Amount capital deficit) Total
------ ------- ---------- ------------ -------
BALANCE, January 1, 1996 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
Net loss (1,998) (1,998)
------ ------- ------- ------- -------
BALANCE, December 31, 1998 14,075 $ 14 $21,250 $(3,019) $18,245
====== ======= ======= ======= =======
See notes to consolidated financial statements.
F-4
41
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
(IN THOUSANDS)
Year ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (1,998) $ (1,587) $ (1,519)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 683 688 452
Write-off of in-process research and development 5,169
Provision for doubtful accounts and other
adjustments to accounts receivable (158) (409) 1,304
Deferred income taxes (200) 82 (648)
Change in operating accounts, net of
amounts acquired:
Accounts receivable (127) 2,618 (3,723)
Income taxes receivable 196 (607) (599)
Inventories (76) 8 (118)
Prepaid expenses and other assets (224) (88) (197)
Accounts payable and accrued liabilities 1,046 (603) (409)
-------- -------- --------
Net cash provided by (used in)
operating activities (858) 102 (288)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (163) (222) (259)
Acquisition of technologies (647)
Acquisition of Performance Computing, Inc. (2,211)
-------- -------- --------
Net cash used in investing activities (810) (222) (2,470)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 160
Repayment of notes payable to founders (1,935)
-------- -------- --------
Net cash used in financing activities (1,775)
-------- -------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,668) (120) (4,533)
CASH AND CASH EQUIVALENTS, beginning of year 14,367 14,487 19,020
-------- -------- --------
CASH AND CASH EQUIVALENTS, end of year $ 12,699 $ 14,367 $ 14,487
======== ======== ========
See notes to consolidated financial statements.
F-5
42
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (CONTINUED)
- --------------------------------------------------------------------------------
(IN THOUSANDS)
DECEMBER 31,
--------------------------
1998 1997 1996
------ ------ ------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid during the year for income taxes $ -- $ 206 $1,142
====== ====== ======
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
=======
See notes to consolidated financial statements.
F-6
43
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business - Smith Micro Software, Inc. and subsidiary (the
Company) develops, manufactures and sells personal computer
communication software for personal and business use. The Company's
products allow its customers to communicate through fax, telephony,
video conferencing, multimedia email, video security, paging and data
transmission. The Company's software products allow communication over a
variety of data transmission devices that include regular telephone
lines via analog modems and over the Internet and other IP protocol
services (including the Local Area Networks and Wide Area Networks) via
connectivity hardware including cable modems, xDSL modems, network
interface devices and analog modems. A substantial portion of the
Company's sales are direct to hardware connectivity device and personal
computer manufacturers under OEM agreements. The Company also sells its
products through independent distributors and retail channels.
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. 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.
Long Lived Assets - The Company accounts for the impairment and
disposition of long-lived assets in accordance with Statement of
Financial Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of. In accordance with SFAS No. 121, long-lived assets to be held are
reviewed for events or changes in circumstances which indicate that
their carrying value may not be recoverable. The Company periodically
reviews the carrying value of long-lived assets to determine whether or
not an impairment to such value has occurred and has determined that
there was no impairment at December 31, 1998.
F-7
44
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
Goodwill and Other Intangibles - Goodwill represents the excess purchase
cost over the net assets acquired and is amortized over five years using
the straight-line method. Other intangible assets include acquired
workforce value, acquired technology and translation costs which are
being amortized using the straight-line methods over three to five
years. Accumulated amortization on goodwill and other intangible assets
amounted to $841,000 and $415,000 as of December 31, 1998 and 1997,
respectively. The Company periodically evaluates the recoverability of
goodwill based on a profitability analysis related to its product sales
and evaluates the recoverability of other intangible assets based on the
requirements of SFAS No. 121.
Revenue Recognition - The Company recognizes revenues from sales of its
software as completed products are shipped and from royalties generated
as authorized customers duplicate the Company's software. The Company
generally allows 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.
The Company has adopted Statement of Position (SOP) 97-2, Software
Revenue Recognition, issued by the American Institute of Certified
Public Accountants 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 adoption of SOP 97-2 had no material impact on the Company's
recognition of revenue.
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, 1998, software has been substantially
completed concurrently with the establishment of technological
feasibility; and, accordingly, no costs have been capitalized to date.
Income Taxes - The Company accounts for income taxes under 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.
F-8
45
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
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, 1998. 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.
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 Loss per Share - Pursuant to SFAS No. 128, Earnings per Share, the
Company provides dual presentation of "basic" and "diluted" earnings per
share (EPS). 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.
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.
Comprehensive Income - The Company has adopted SFAS No. 130, Reporting
Comprehensive Income. This statement establishes standards for the
reporting of comprehensive income and its components. Comprehensive
income, as defined, includes all changes in equity (net assets) during a
period from non-owner sources. For each of the years ended December 31,
1998, 1997 and 1996, there was no difference between net loss and
comprehensive loss.
Reclassification - Certain reclassifications have been made to the prior
years financial statements to conform to the current year presentation.
F-9
46
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
2. EQUIPMENT AND IMPROVEMENTS
Equipment and improvements consist of the following (in thousands):
December 31,
-----------------------
1998 1997
------- -------
Machinery and equipment $ 1,032 $ 880
Leasehold improvements 143 137
Office furniture and fixtures 244 239
------- -------
1,419 1,256
Less accumulated depreciation and amortization (1,069) (812)
------- -------
$ 350 $ 444
======= =======
3. ACCRUED LIABILITIES
Accrued liabilities consists of the following (in thousands):
December 31,
-----------------------
1998 1997
------ ------
Salaries and benefits $ 505 $ 463
Cooperative advertising and rebates 357 131
Manufacturers' representative commissions 114
Other 209 41
------ ------
$1,185 $ 635
====== ======
F-10
47
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
4. INCOME TAXES
A summary of income tax expense (benefit) is as follows (in thousands):
Year ended December 31,
----------------------------------
1998 1997 1996
------- ------- -------
Current:
Federal $(1,071) $ (981) $ 2,471
State 74 6 613
Foreign 85 54
------- ------- -------
(912) (921) 3,084
Deferred:
Federal 26 202 (552)
State (226) (120) (96)
------- ------- -------
(200) 82 (648)
------- ------- -------
$(1,112) $ (839) $ 2,436
======= ======= =======
A reconciliation of the provision (benefit) for income taxes to the
amount of income tax expense that would result from applying the federal
statutory rate (35%) to income before provision for taxes is as follows:
December 31,
-----------------------------------
1998 1997 1996
------- ------- -------
Federal statutory rate (35)% (35)% 35%
State tax, net of
federal benefit (3) (3) 37
Nondeductible expense
related to acquired
intangibles 3 4 197
Other (1) (1) (3)
--- --- ---
(36)% (35)% 266%
=== === ===
F-11
48
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
The major components of the Company's deferred tax assets and
liabilities are as follows (in thousands):
December 31,
---------------------
1998 1997
----- -----
Various reserves $ 564 $ 632
Nondeductible accruals 74 97
Accrual to cash adjustment (44) (163)
State taxes (153) (76)
Prepaid expenses (90) (65)
Credit carryforwards 216 81
Net operating loss carryforwards 234 94
Other 5 6
----- -----
$ 806 $ 606
===== =====
The company has state net operating loss carryforwards of approximately
$2,675,000 at December 31, 1998. These losses will begin to expire in
2002. In addition, the Company has federal foreign tax credit
carryforwards and state research and development credit carryforwards of
approximately $103,000 and $113,000, respectively, at December 31, 1998.
5. 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:
1999 $ 639
2000 562
2001 566
2002 583
2003 147
------
$2,497
======
Total rent expense was $621,000, $539,000 and $492,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
F-12
49
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
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.
6. SEGMENT INFORMATION
The Company engages in business activity in only one operating segment,
the development, marketing and sale of communication software for
personal computers. The Company's software products are developed, sold
and marketed by common departments within the Company.
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:
e DECEMBER 31,
--------------------
1998 1997 1996
---- ---- ----
Customer:
1 - (OEM) 24.7% 43.4% 46.4%
2 - (OEM) - - 12.6
3 - (Retail) - - 11.8
4 - (Retail) 19.1 - -
---- ---- ----
43.8% 43.4% 70.8%
==== ==== ====
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 22.8%, 24.3% and
14.4% of its net revenues for the years ended December 31, 1998, 1997
and 1996, respectively. Sales to customers in the Asia Pacific region
were 16.1%, 11.6% and 6.7% of its net revenues for the years ended
December 31, 1998, 1997 and 1996, respectively. All export sales have
been denominated in U.S. dollars.
7. PROFIT SHARING
The Company offers its employees 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 $42,000 and $49,000
for the years ended December 31, 1998 and 1997, respectively. Prior to
the establishment of the 401(k) plan, the Company sponsored a profit
sharing plan for the benefit of all
F-13
50
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
employees meeting certain age and service requirements. The Company
made approximately $68,000 in discretionary contributions to the profit
sharing plan for the year ended December 31, 1996.
8. STOCK-BASED COMPENSATION
In 1995, the Company adopted the 1995 Stock Option/Stock Issuance Plan
(the Plan). The Plan, as amended, provides for issuance of, or options
to be granted for the purchase of, an aggregate of 1,750,000 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
average
Number exercise
of shares price
---------- --------
OUTSTANDING, January 1, 1996 (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 (164,000 exercisable) 808,000 3.72
Granted (weighted average fair value of $1.34) 507,000 1.61
Canceled (152,000) 3.38
---------
OUTSTANDING, December 31, 1998 1,163,000 2.85
=========
F-14
51
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
Additional information regarding options outstanding as of December 31,
1998 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
--------- ----------- ---------------- -------- ----------- --------
$1.44 - $ 2.25 450,000 9.7 $ 1.56 - -
$2.88 - $ 3.13 618,000 8.6 $ 2.89 295,000 $ 2.89
$6.40 - $ 7.25 53,000 6.8 $ 6.85 48,000 $ 6.85
$9.07 - $14.00 42,000 6.8 $11.00 39,000 $11.09
--------- -------
1,163,000 8.7 $ 2.85 382,000 $ 4.23
========= =======
At December 31, 1998, 562,000 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 with an exercise price equal to 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 loss and loss 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, 89%, 86% and 50%
for grants issued in 1998, 1997 and 1996, respectively; risk-free
interest rates, 5.2%, 5.9% and 6.0% in 1998, 1997 and 1996,
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 1998, 1997 and 1996 awards had been
amortized to expense over the vesting period of the awards, pro forma
net loss would have been $(2,381,000), or $(.17) per share, in
1998, $(1,818,000), or $(.13) per share, in 1997 and $(1,846,000), or
$(.13) per share, in 1996.
F-15
52
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued)
- --------------------------------------------------------------------------------
9. ACQUISITIONS
In January 1998, the Company acquired certain fax technology assets from
Mitek Systems, Inc. for $458,000 in cash. The fax software acquired
provides fax functionality over Local Area Networks, the Internet and
intranets.
In March 1996, the Company completed its acquisition of Performance
Computing Incorporated (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.
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.
Pro forma unaudited consolidated results of operations for the year
ended December 31, 1996 did not differ significantly from reported
amounts and therefore are not reflected herein.
F-16
53
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, 1998 and 1997 and for each of the
three years in the period ended December 31, 1998, and have issued our
report thereon dated February 12, 1999, 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.
DELOITTE & TOUCHE, LLP
Costa Mesa, California
February 12, 1999
S-1
54
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
(IN THOUSANDS)
Additions
Balance at charged to Balance at
beginning of costs and end of
period expenses Deductions period
------------ ---------- ---------- ----------
Allowance for doubtful accounts and
other adjustments(1):
1998 $1,413 $2,227 $(2,385) $1,255
1997 1,822 2,335 (2,744) 1,413
1996 518 2,756 (1,452) 1,822
- -------------
(1) Other adjustments relate principally to sales returns.
S-2
55
EXHIBIT INDEX
Exhibit
No. Title Method of Filing
- ------- ----- ----------------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1 to the
Incorporation of the Company Registrant's Registration Statement No. 33-95096
3.2 Amended and Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement No. 33-95096
4.1 Specimen certificate representing shares of Incorporated by reference to Exhibit 4.1 to the
Common Stock of the Company. Registrant's Registration Statement 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 Plan. Incorporated by reference to Exhibit 10.2 to the
Registrant's Registration Statement No. 33-95096
10.3 Form of Notice of Grant of Stock Option Incorporated by reference to Exhibit 10.3 to the
under 1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096
10.4 Form of 1995 Stock Option Agreement under Incorporated by reference to Exhibit 10.4 to the
1995 Stock Option /Stock Issuance Plan. Registrant's Registration Statement No. 33-95096
10.5 Form of 1995 Stock Purchase Agreement under Incorporated by reference to Exhibit 10.5 to the
1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096
10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6 to the
September 30, 1991, by and between the Registrant's Registration Statement No. 33-95096
Company and Crandell Development Corporation.
10.7 Application Program Interface Retail License Incorporated by reference to Exhibit 10.7 to the
Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096
Company and Rockwell International
Corporation.
10.8 Application Program Interface License Incorporated by reference to Exhibit 10.8 to the
Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096
Company and Rockwell International
Corporation.
10.9 Rockwell High Speed Interface License Incorporated by reference to Exhibit 10.9 to the
Agreement dated June 2, 1994, by and between Registrant's Registration Statement No. 33-95096
the Company and Rockwell International
Corporation.
10.10 Letter Agreement dated February 22, 1994, by Incorporated by reference to Exhibit 10.10 to the
and between the Company and Rockwell Registrant's Registration Statement No. 33-95096
International Corporation.
10.11 Letter Agreement dated April 22, 1993, by Incorporated by reference to Exhibit 10.11 to the
and between the Company and Rockwell Registrant's Registration Statement No. 33-95096
International Corporation.
10.12 Software Distribution Agreement dated May 8, Incorporated by reference to Exhibit 10.12 to the
1995, by and between the Company and Registrant's Registration Statement No. 33-95096
International Business Machines Corporation.
10.13 Office Building Lease, dated June 10, 1992, Incorporated by reference to Exhibit 10.13 to the
by and between the Company and Developers Registrant's Registration Statement No. 33-95096
Venture Capital Corporation.
10.14 Amendment No. 1 To Office Building Lease, Incorporated by reference to Exhibit 10.14 to the
dated July 9, 1993, by and between the Registrant's Registration Statement No. 33-95096
Company and Pioneer Bank.
56
Exhibit
No. Title Method of Filing
- ------- ----- ----------------
10.15 Amendment No. 2 To Office Building Lease, Incorporated by reference to Exhibit 10.15 to the
dated August 15, 1994, by and between the Registrant's Registration Statement No. 33-95096
Company and T&C Development.
10.16 Fourth Addendum to Office Building Lease, Incorporated by reference to Exhibit 10.16 to the
dated April 21, 1995, by and between Registrant's Registration Statement No. 33-95096
the Company and T&C Development.
10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17 to the
Corporation Distribution. Registrant's Registration Statement No. 33-95096
10.18 Smith Micro Software, Inc. Amended and Incorporated by reference to Exhibit 10.21 to the
Restated Software Licensing and Distribution Registrant's Quarterly Report on Form 10-Q for the
Agreement, dated April 18, 1996, by and quarter ended September 30, 1996
between the Company and U.S. Robotics Access
Corp.
10.19 Office Building Lease, dated March 1, 1994, Incorporated by reference to Exhibit 10.19 to the
by and between Performance Computing Registrant's Annual Report on Form 10-K for the
Incorporated and Petula Associates, Ltd./KC fiscal year ended December 3l, 1995
Woodside.
10.20 Agreement and Plan of Merger by and between Incorporated by reference to Exhibit 2 to the
Smith Micro Software, Inc., Performance Registrant's Current Report on Form 8-K filed with
Computing Incorporated and PCI Video the Commission on March 28, 1996
Products, Inc. dated as of March 14, 1996.
10.21 Amendment No. 1, dated as of March 10, 1997, Incorporated by reference to Exhibit 10.21 to the
to Agreement and Plan of Merger by and Registrant's Annual Report on Form 10-K for the
between Smith Micro Software, Inc., fiscal year ended December 31, 1996
Performance Computing Incorporated and PCI
Video Products, Inc. dated as of March 14,
1996.
10.22 Amendment No. 6 to Office Building Lease, Incorporated by reference to Exhibit 10.21 to the
dated February 19, 1998, by and between the Registrant's Annual Report on Form 10-K for the
Company and World Outreach Center. fiscal year ended December 31, 1997
10.23 Software Licensing and Distribution Filed Herewith. Confidential treatment being sought
Agreement dated December 1, 1998, by and with respect to certain portions of this agreement.
between the Company and 3Com Corporation Such portions have been omitted from this filing and
have been filed separately with the Securities and
Exchange Commission.
23.1 Independent Auditors' Consent. Filed Herewith
27 Financial Data Schedule. Filed Herewith