-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CXLLwkc++/x+ABGJAcsb0s31mJUFPvachtpW040AfDvD6tC3hLI6jsn5PTlX2Ja+ pMMwRdlU43CK8yQ9JCE6IA== 0000892569-99-001407.txt : 19990517 0000892569-99-001407.hdr.sgml : 19990517 ACCESSION NUMBER: 0000892569-99-001407 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990514 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMITH MICRO SOFTWARE INC CENTRAL INDEX KEY: 0000948708 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330029027 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-26536 FILM NUMBER: 99623351 BUSINESS ADDRESS: STREET 1: 51 COLUMBIA STREET 2: STE 200 CITY: ALISO VIEJO STATE: CA ZIP: 92656 BUSINESS PHONE: 7143625800 MAIL ADDRESS: STREET 1: 51 COLUMBIA STREET 2: STE 200 CITY: ALISO VIEJO STATE: CA ZIP: 92656 10-Q 1 FORM 10-Q FOR THE QUARTER ENDED 3/31/99. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED MARCH 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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 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 ( ) --- --- As of April 30, 1999, there were 14,504,417 shares of Common Stock outstanding. 2 SMITH MICRO SOFTWARE, INC. FORM 10-Q TABLE OF CONTENTS
Page ---- PART I. FINANCIAL INFORMATION CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1999 (UNAUDITED) AND DECEMBER 31, 1998 3 UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 4 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998 5 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 6 MANAGEMENT'S DISCUSSION AND ANALYSIS 9 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 20 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 21 SIGNATURES 23
FORWARD LOOKING STATEMENTS THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 PROVIDES A "SAFE HARBOR" FOR FORWARD-LOOKING STATEMENTS. THE STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q 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-Q 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 12 OF THIS QUARTERLY REPORT AND IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." 2 3 SMITH MICRO SOFTWARE, INC. CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share and Per Share Data)
March 31, December 31, 1999 1998 ----------- ------------ (unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 11,299 $ 12,699 Accounts receivable, net of allowances for doubtful accounts and other adjustments of $1,715 (1999) and $1,255 (1998) 4,504 4,093 Income taxes receivable 1,302 931 Deferred tax asset 470 470 Inventories 468 629 Prepaid expenses and other current assets 386 423 -------- -------- Total current assets 18,429 19,245 EQUIPMENT AND IMPROVEMENTS, net 334 350 DEFERRED TAX ASSET 336 336 OTHER ASSETS 307 304 INTANGIBLE ASSETS, net 445 568 -------- -------- $ 19,851 $ 20,803 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,039 $ 1,373 Accrued liabilities 1,259 1,185 -------- -------- Total current liabilities 2,298 2,558 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: 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 (1999 and 1998) 14 14 Additional paid-in capital 21,250 21,250 Accumulated deficit (3,711) (3,019) -------- -------- Total stockholders' equity 17,553 18,245 -------- -------- $ 19,851 $ 20,803 ======== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 3 4 SMITH MICRO SOFTWARE, INC. UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Share and Per Share Data)
For the Three Months Ended March 31, ---------------------- 1999 1998 -------- -------- NET REVENUES $ 2,866 $ 3,266 COST OF REVENUES 736 866 -------- -------- GROSS PROFIT 2,130 2,400 OPERATING EXPENSES: Selling and marketing 1,533 768 Research and development 891 786 General and administrative 892 836 -------- -------- Total operating expenses 3,316 2,390 -------- -------- OPERATING INCOME (LOSS) (1,186) 10 INTEREST INCOME 138 180 -------- -------- INCOME (LOSS) BEFORE INCOME TAXES (1,048) 190 INCOME TAX EXPENSE (BENEFIT) (356) 77 -------- -------- NET INCOME (LOSS) $ (692) $ 113 ======== ======== NET INCOME (LOSS) PER SHARE, basic and diluted $ (0.05) $ 0.01 ======== ======== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 14,075 14,076 ======== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 4 5 SMITH MICRO SOFTWARE, INC. UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
For The Three Months Ended March 31, ---------------------- 1999 1998 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (692) $ 113 Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 215 167 Provision for doubtful accounts and other adjustments to accounts receivable 460 (659) Change in operating accounts: Accounts receivable (871) (4) Income taxes receivable (371) 78 Inventories 161 (21) Prepaid expenses and other assets (160) Accounts payable and accrued liabilities (260) 402 -------- -------- Net cash used in operating activities (1,358) (84) CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of technology (458) Capital expenditures (42) (18) -------- -------- Net cash used in investing activities (42) (476) -------- -------- NET DECREASE IN CASH AND CASH EQUIVALENTS (1,400) (560) CASH AND CASH EQUIVALENTS, beginning of period 12,699 14,367 -------- -------- CASH AND CASH EQUIVALENTS, end of period $ 11,299 $ 13,807 ======== ========
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS. 5 6 SMITH MICRO SOFTWARE, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation - The accompanying unaudited consolidated financial statements have been prepared by Smith Micro Software, Inc. ("Smith Micro" or the "Company") pursuant to Securities and Exchange Commission regulations. The accompanying unaudited consolidated financial statements reflect the operating results and financial position of Smith Micro Software, Inc. and its wholly-owned subsidiaries. All significant intercompany amounts have been eliminated in consolidation. In the opinion of management, such information contains all adjustments necessary for a fair presentation of the results of such periods. The results of operations for the three months ended March 31, 1999 are not necessarily indicative of the results to be expected for the full year ended December 31, 1999. The accompanying unaudited consolidated financial statements should be read in conjunction with the audited financial statements included in the Company's report on Form 10-K for the year ended December 31, 1998 as footnotes and certain financial presentations are condensed or omitted from generally accepted accounting principles presentation requirements, pursuant to the SEC rules and regulations. 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 March 31, 1999. 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. 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 service 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. 6 7 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 March 31, 1999, 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. 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 March 31, 1999. 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 Income (Loss) Per Share - The Company has adopted 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. 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. 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 nonowner sources. For each of the three month periods ending March 31, 1999 and 1998, there was no difference between net income, as reported, and comprehensive income. Reclassifications - Certain reclassifications have been made to the 1998 financial statements to conform to the 1999 presentation. 2. ACQUISITIONS On April 9, 1999, Smith Micro acquired all of the outstanding capital stock (the "Acquisition") of STF Technologies, Inc., a Missouri corporation ("STF') in exchange for $1.0 million in cash and 409,164 shares of Smith Micro Common Stock. STF is a developer and publisher of fax and communications software products for the Apple Macintosh computer. STF is headquartered in Concordia, Missouri and as a result of this Acquisition, STF became a wholly owned subsidiary of Smith Micro. The aggregate number of shares delivered was determined by dividing $1.0 million by the average closing price on the Nasdaq National Market of a 7 8 share of Smith Micro Common Stock as reported in the Wall Street Journal for the ten (10) consecutive trading days ending on the trading day immediately prior to the closing date. The cash portion of the Acquisition consideration was funded with proceeds received in connection with Smith Micro's initial public offering in September, 1995. During 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 ("LANs"), the Internet and intranets. 8 9 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 3.3% for the three months ended March 31, 1999, and 5.1% for the year ended December 31, 1998 and 26.8% in 1997. As a percentage of our net revenues, returns for stock rotation were 0.9% for the three months ended March 31, 1999, and 0.6% in 1998 and 14.6% in 1997. 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 (including its affiliates and subcontractors), accounted for approximately 17.3% of our net revenues for the three months ended March 31, 1999, 24.7% of our net revenues in 1998 and 43.4% of our net revenues in 1997. Our three largest OEM customers, including 3Com, accounted for the following portions of our net revenues: 32.9% in the three months ended March 31, 1999, 35.1% in 1998 and 56.9% in 1997. 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. 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. 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. 9 10 RESULTS OF OPERATIONS The following table sets forth for the periods indicated, the percentages of net revenues represented by each item in the Company's statement of income.
For The Three Months Ended March 31, -------------------- 1999 1998 ------ ------ Net revenues 100.0% 100.0% Cost of revenues 25.7% 26.5% ------ ------ Gross profit 74.3% 73.5% Operating expenses: Selling and marketing 53.5% 23.5% Research and development 31.1% 24.1% General and administrative 31.1% 25.6% ------ ------ Total operating expenses 115.7% 73.2% ------ ------ Operating income (loss) (41.4)% 0.3% Interest income 4.8% 5.5% ------ ------ Income (loss) before income taxes (36.6)% 5.8% Income tax expense (benefit) (12.4)% 2.3% ------ ------ Net income (loss) (24.2)% 3.5% ====== ======
NET REVENUES Our net revenues decreased 12.2% to $2.9 million in the three months ended March 31, 1999 from $3.3 million in the three months ended March 31, 1998. 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 for certain fax products and pricing pressures within the analog modem industry. In response to these factors, our revenues from sales to 3Com in the first quarter of 1999 decreased 58.2% when compared to the same quarter of 1998. This decrease in our revenues from analog modem manufacturers was partially offset by an increase in retail revenues and an increase in revenues from all other types of OEM customers, including PC manufacturers. GROSS PROFIT Gross profit represents net revenues, less cost of revenues, which includes costs of materials, costs related to the operations of the Company's duplicating facilities, freight charges and royalties to licensors. Gross profit decreased 11.3% to $2.1 million in the three months ended March 31, 1999 from $2.4 million in the three months ended March 31, 1998. As a percentage of net revenues, gross profit increased to 74.3% in the three months ended March 31, 1999 from 73.5% in the three months ended March 31, 1998. Our decrease in gross profit is primarily due to the decrease in net revenues. Our gross profit as a percentage of net revenues improved slightly from an increased percentage of revenue from royalty agreements, cost control measures and increased manufacturing efficiencies that were partially were offset by an increased allowance for slow-moving and obsolete inventory. SELLING AND MARKETING EXPENSES Our selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary considerably from quarter to quarter based on the timing of trade shows and new product introductions. Our selling and marketing expenses increased 99.6% to $1.5 million in the three months ended March 31, 1999 from $768,000 in the three months ended March 31, 1998. As a percent of net revenues, selling and marketing expenses increased to 53.5% of net revenues in 10 11 the three months ended March 31, 1999 from 23.5% in the three months ended March 31, 1998. The increase in selling and marketing expenses is primarily due to promotional campaigns in retail channel for our fax and Internet communications products. Additionally, the company expanded its sales and marketing teams to cover its Internet telephony and network fax product lines. RESEARCH AND DEVELOPMENT EXPENSES Our research and development expenses consist primarily of personnel and supply costs required to conduct the Company's software development activities, and the amortization of acquired technology assets. Our research and development expenses increased 13.4% to $891,000 in the three months ended March 31, 1999 from $786,000 in the three months ended March 31, 1998. As a percent of net revenues, our research and development expenses increased to 31.1% for the three months ended March 31, 1999 from 24.1% for the three months ended March 31, 1998. Our increase in research in development expenses was primarily associated with development expenses related to our Internet and network communications products and an increase in the amortization of acquired technology assets. GENERAL AND ADMINISTRATIVE EXPENSES Our general and administrative expenses represent operating expenses that are not included as costs of sales, selling and marketing or research and development. Our general and administrative expenses increased 6.7% to $892,000 in the three months ended March 31, 1999 from $836,000 in at her the three months ended March 31, 1998. An increase in professional services was offset by a reduced provision for bad debt. As a percent of net revenues, general and administrative expenses increased to 31.1% of net revenues in the three months ended March 31, 1999 from 25.6% in the three months ended March 31, 1998. INCOME TAXES For the three months ended March 31, 1999, our income tax benefit was 34.0% of the loss before income taxes. The income tax benefit was $356,000 for the three months ended March 31, 1999 based on a loss before income taxes of $1.0 million. compared to an income tax expense of $77,000 for the three months ended March 31, 1998 based on income before income taxes of $190,000. LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its operations primarily through cash generated from operations and from proceeds generated by its initial public offering in 1995. Net cash used in operating activities was $1.3 million in the three months ended March 31, 1999 compared to $0.1 million used in operations in the three months ended March 31, 1998. The primary uses of cash during the three months ended March 31, 1999 were the Company's net loss and an increase in accounts receivable. During the three months ended March 31, 1999, the Company used no cash in investing activities. On April 9, 1999, Smith Micro acquired all of the outstanding capital stock STF Technologies, Inc., in exchange for $1.0 million in cash and 409,164 shares of Smith Micro Common Stock. STF, headquartered in Concordia, Missouri, is a developer and publisher of fax and communications software products for the Apple Macintosh computer. At March 31, 1999, the Company had $11.3 million in cash and cash equivalents and $16.1 million of working capital. The Company had $4.5 million of accounts receivable, net of allowance for doubtful accounts and other adjustments. The Company has no significant capital commitments, and currently anticipates that growth in capital expenditures will not vary significantly from recent periods. YEAR 2000 COMPLIANCE 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. 11 12 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 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. We have developed a contingency plan to work around unexpected Year 2000 issues that may arise. Our contingency plan includes, among other things, the use of manual processing, the use of Year 2000 compliant personal computer software alternatives and a program to obtain inventory through numerous alternate vendors. This contingency plan is designed to facilitate the ongoing operation and monitoring of our business. Any of these problems, if they occur, would have an adverse effect on our business, results of operations and financial condition. RISK FACTORS This Quarterly Report on Form 10-Q 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 Form 10-Q. 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; 12 13 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 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 (including its affiliates and subcontractors). These 3Com entities represented 17.3% of our net revenues in the three months ended March 31, 1999, 24.7% of our net revenues in 1998 and 43.4% of our net revenues in 1997. 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 the 3Com entities (including its affiliates and subcontractors). 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 32.9% of our net revenues in the three months ended March 31, 1999, 35.1% of our net revenues in 1998 and 56.9% of our net revenues in 1997. 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 13 14 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 41.3% of our net revenues in the three months ended March 31, 1999, 58.8% of our net revenues in 1998 and 81.3% of our net revenues in 1997. 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. In the second half of 1998, we 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 36.7% of our net revenues in the three months ended March 31, 1999, 26.4% of our net revenues in 1998 and 5.2% of our net revenues in 1997. 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. 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 14 15 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. 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 15 16 designed to address the fax requirements of the corporate/government 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. 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 did 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. 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 22.4% of our total net revenues for the three months ended March 31, 1999, 22.8% of our total net revenues in 1998 and 24.3% of our total net revenues in 1997. 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; 16 17 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 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 17 18 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 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. We have developed a contingency plan to work around unexpected Year 2000 issues that may arise. Our contingency plan includes, among other things, the use of manual processing, the use of Year 2000 compliant personal computer software alternatives and a program to obtain inventory through numerous alternate vendors. This contingency plan is designed to facilitate the ongoing operation and monitoring of our business. 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 April 30, 1999, William Smith, the President, Chief Executive Officer and Chairman of the Board of the company, and Rhonda Smith, the Vice-Chairman of the Board, Secretary and Treasurer of our company, beneficially owned approximately 67.3% 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 18 19 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 April 30, 1999, we had 14,504,417 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 person, either individually or when aggregated with sales by other persons, could adversely affect the market price of our common stock. 19 20 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company and its PCI Video Products, Inc. subsidiary ("PCI Video") have been named parties to a lawsuit, Virtual Ambiance, Inc. v. Video Conferencing Communications. Inc., et al., filed August 11, 1997 in the Superior Court of the State of California for the County of Orange, Case No. 782856. In October 1998, the Company and PCI Video successfully obtained a terminating sanction against Virtual Ambiance, resulting in immediate dismissal of the lawsuit with prejudice. ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS The effective date of the Company's first registration statement (the "Registration Statement") filed on Form S-1 (Registration No. 33-95096) under the Securities Act of 1993, as amended, was September 18, 1995. The class of securities registered was Common Stock. The offering commenced on September 19, 1995 and all securities were sold in the offering. The managing underwriters for the offering were Hambrecht & Quist LLC and Oppenheimer & Co., Inc. Pursuant to the Registration Statement, the Company sold 1,700,000 shares of its Common Stock for an aggregate offering price of $20,400,000, and certain selling shareholders sold 2,210,000 shares of the Common Stock of the Company for an aggregate offering price of $26,520,000. The Company incurred expenses of $2,262,000 of which $1,428,000 represented underwriting discounts and commissions and $834,000 represented other expenses. All such expenses were direct or indirect payments to others. The net offering proceeds to the Company after total expenses was $18,138,000. Of the net proceeds from the offering, $4,188,000 were used to repay amounts due under a promissory note issued by the Company to certain of its stockholders as part of a distribution of retained earnings in connection with the Company's prior S corporation status, $3,011,000 was used in the Company's acquisition of Performance Computing Incorporated which was consummated in March 1996, $1,000,000 was used in the acquisition of STF Technologies, Inc. which was consummated in April 1999, $458,000 was used in the acquisition of assets from Mitek Systems, Inc. in January 1998, $190,000 was used in the acquisition of other technologies, $1,700,000 has been used for working capital requirements and the remainder has been invested in U.S. Government obligations and corporate bonds. The use of the proceeds from the offering does not represent a material change in the use of the proceeds described in the prospectus that is part of the Registration Statement. 20 21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
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.
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Exhibit No. Title Method of Filing ------- ----- ---------------- 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. 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 the Registrant's Registration Statement No. 33-95096 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 Registrant's Quarterly Report on Form 10-Q for the Distribution Agreement, dated April 18, quarter ended September 30, 1996 1996, by and 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 10.22 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
22 23
Exhibit No. Title Method of Filing ------- ----- ---------------- 10.23 Software licensing and Distribution Incorporated by reference to Exhibit 10.23 to the Agreement dated December 1, 1998, by and Registrant's Annual Report on Form 10-K for the between the Company and 3Com Corporation fiscal year ended December 31, 1998 27 Financial Data Schedule. Filed Herewith
(B) REPORTS ON FORM 8-K No Current reports on Form 8-K were filed during the quarter ended March 31, 1999. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SMITH MICRO SOFTWARE, INC. May 13, 1999 By: /s/ WILLIAM W. SMITH, JR. ------------------------------------ William W. Smith, Jr. Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer) May 13, 1999 By: /s/ MARK W. NELSON ----------------------------- Mark W. Nelson Chief Financial Officer (Principal Financial Officer) 23 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 11,299 0 4,504 1,715 468 18,429 334 1,128 19,851 2,298 0 0 0 14 21,250 19,851 2,866 2,866 736 736 3,316 0 0 (1,048) (356) (692) 0 0 0 (692) (0.05) (0.05)
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