-----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, LdEd/M2pMH8o6yp+Ee2fxijtf2B2wnAWsh1WVq5Fma1rFMkohz5HuNDdEQuCO1PG wsRPv1DG/pW9Hm8OpZJ4UA== 0000892569-98-000885.txt : 19980331 0000892569-98-000885.hdr.sgml : 19980331 ACCESSION NUMBER: 0000892569-98-000885 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NASD 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-K SEC ACT: SEC FILE NUMBER: 000-26536 FILM NUMBER: 98579283 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-K 1 FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1997 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, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ COMMISSION FILE NUMBER 0-26536 SMITH MICRO SOFTWARE, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) --------------------- DELAWARE 33-0029027 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 51 COLUMBIA, SUITE 200, ALISO VIEJO, CA 92656 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (714) 362-5800 COMMON STOCK, $.001 PAR VALUE NASDAQ NATIONAL MARKET (Title of each class) (Name of each exchange on which registered) --------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.001 PAR VALUE Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES (X) NO ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]. The Registrant does not have different classes of Common Stock. As of March 24, 1998, the aggregate market value of the Common Stock of the Registrant held by non-affiliates was $14,938,098, based upon the closing sale price of such stock on that date. For purposes of such calculation, only executive officers, board members, and beneficial owners of more than 10% of the Company's outstanding Common Stock are deemed to be affiliates. As of March 24, 1998, there were 14,074,698 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the Annual Meeting of Stockholders currently expected to be held on May 14, 1998, as filed with the Securities Exchange Act of 1934, as amended, are incorporated by reference in Part III of this Report. ================================================================================ 2 SMITH MICRO SOFTWARE, INC. 1997 FORM 10-K ANNUAL REPORT ---------------------------- TABLE OF CONTENTS
PAGE ---- PART I Item 1. BUSINESS................................................................... 3 Item 2. PROPERTIES................................................................. 24 Item 3. LEGAL PROCEEDINGS.......................................................... 24 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS......................... 24 PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.. 25 Item 6. SELECTED FINANCIAL DATA.................................................... 27 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................................................. 28 Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK....... 33 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA................................ 33 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................................ 33 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS........................................... 33 Item 11. EXECUTIVE COMPENSATION..................................................... 33 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............. 33 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................. 33 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................................................................... 34
------------------------- THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 PROVIDES A "SAFE HARBOR" FOR FORWARD-LOOKING STATEMENTS. THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE NOT STATEMENTS OF HISTORICAL FACT MAY BE FORWARD LOOKING STATEMENTS SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES. THE FOLLOWING FACTORS, TOGETHER WITH THOSE ADDITIONAL RISKS DISCUSSED IN THIS ANNUAL REPORT ON FORM 10-K (PARTICULARLY IN "RISK FACTORS" COMMENCING ON PAGE 15), COULD CAUSE THE ACTUAL RESULTS OF THE COMPANY TO MATERIALLY DIFFER FROM THOSE ANTICIPATED BY FORWARD LOOKING STATEMENTS HEREIN SET FORTH: DEMAND FOR COMMUNICATION SOFTWARE; DEMAND FOR MODEMS AND OTHER ELECTRONIC COMMUNICATION DEVICES; NATIONAL, REGIONAL AND INTERNATIONAL ECONOMIC CONDITIONS AFFECTING THE SUPPLY OF AND DEMAND FOR COMMUNICATION SOFTWARE, MODEMS OR OFFERINGS BY THE COMPANY; THE COMPANY'S ABILITY TO COMPETE IN AND SELL ITS PRODUCTS THROUGH THE RETAIL CHANNEL AND ORIGINAL EQUIPMENT MANUFACTURERS (OEM) DISTRIBUTION CHANNEL; THE COMPANY'S ABILITY TO COMPETE AND SELL ITS PRODUCTS THROUGH THE CORPORATE AND GOVERNMENT MARKETPLACE; DEMAND FOR THE COMPANY'S PRODUCTS; THE COMPANY'S ABILITY TO MAINTAIN ITS CUSTOMER BASE AND TO EXPAND THAT BASE; AND THE COMPANY'S ABILITY TO ANTICIPATE AND ADJUST TO TECHNOLOGICAL SHIFTS AND CHANGES IN THE ELECTRONIC COMMUNICATION SOFTWARE AND HARDWARE INDUSTRIES. ALL FORWARD LOOKING STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K SHOULD BE CONSIDERED IN THE LIGHT OF THESE AND ANY OTHER FACTORS WHICH MIGHT CAUSE THE COMPANY'S FUTURE PERFORMANCE TO MATERIALLY DIFFER FROM THAT ANTICIPATED BY THIS ANNUAL REPORT ON FORM 10-K. 2 3 PART I ITEM 1. BUSINESS GENERAL Smith Micro Software, Inc. ("Smith Micro" or the "Company") provides personal computer software that enables facsimile ("fax"), video, data and telephony communication. The Company believes it is the leading provider of communication software to modem manufacturers (based on units included with modems sold through resellers and retailers in the United States). The Company intends to leverage its position in the original equipment manufacturer ("OEM") market to address the retail, corporate and government marketplace for its products. Smith Micro focuses on designing integrated, easy to use software products that incorporate the most advanced features of communication hardware devices such as modems, multi-line fax modem boards and Internet access devices such as xDSL and cable modems. The Company was incorporated in California in November 1983 and reincorporated in Delaware in July 1995. INDUSTRY BACKGROUND Businesses and consumers are using personal computers, network servers, modems and Internet access devices for an increasing number of communication applications. The ability to send and receive fax transmissions with a personal computer has created significant demand in recent years for modems with fax capabilities. Moreover, analog modems and Internet access devices are increasingly used to access vast information resources, share information and transact business through on-line services and the Internet. The flexibility necessitated by an increasingly mobile workforce has fueled demand for products that facilitate remote connectivity between individuals and their corporate networks. These applications have created a demand for hardware and software products that facilitate communication between personal computer users and their information sources. Modem manufacturers produce hardware to enable personal computer communication over land or wireless systems. By adopting technological advances, driven primarily by advances in chip design, modem manufacturers have been able to deliver products with increasing price performance, higher transmission speeds and increased functionality. The rapid pace of these changes, the need to support a variety of operating systems including Windows 95, Windows NT, Macintosh, DOS, Windows 3.x, and the soon to be released Windows 98, and the desire to differentiate products which incorporate identical chipsets, present a significant communication software challenge. Modem manufacturers generally focus on hardware and do not find it cost effective to develop software internally to meet the evolving needs of communication software for multiple platforms. These modem manufacturers typically bundle software from outside providers with their modems. This software is the technology that enables the modems to communicate video, fax, data, telephony and other forms of information. Demand for personal computer communication software products is generated by three distinct sources: OEM customers, consisting primarily of modem, Internet access device, camera, video capture card and personal computer manufacturers, retail end-user consumers and corporate/government customers, which purchase large quantities of user licenses for installations over large networks. OEMs purchase software and bundle or pre-load it with their products. This software provides basic functionality and effectively serves the needs of most users. Users with more complex communication requirements typically seek software with more features in the retail market. As communication hardware device manufacturers develop and adopt emerging technology, thereby expanding the functionality of communication devices, communication software must be continually enhanced to provide integrated, easy to use solutions to enable this functionality to be utilized. Historically, modems and the communication software associated with such modems were used for the transmission and receipt of data information only. Later, modem functionality was expanded to incorporate the sending and receiving of fax transmissions, a function which required increasingly sophisticated communication software. More recently, modem chip manufacturers have designed chips with voice capabilities that will allow manufacturers of modems and computers to replace the functions of small office and home telephone systems. It is anticipated that these emerging telephony 3 4 applications will provide full duplex speaker phones, complex voicemail functions, and a dramatically new level of information management capabilities to the home and small office. In addition, video conferencing, which traditionally has been available only to high end corporate board rooms at a cost of thousands of dollars, has reached the desktop, with solutions that are affordable for the home and small office. Most recently, communication hardware device manufacturers have introduced devices such as cable and xDSL modems that enable high speed Internet access and open the potential for efficiently sending and receiving fax, voice, data and video transmissions over the Internet or intranets. The functionality of communication software must continue to evolve to keep pace with consumer expectations, future hardware functions and the rapidly changing competitive environment. As modem and other communication hardware device functionality increases, manufacturers and consumers alike have increasingly sought an integrated, easy to use software solution to enable communication devices to perform their functions. The Company believes that the widespread use of personal computers in home and office environments will bring with it an increasing number of new "nontechnical" users. In this environment, it will be critically important to provide easy to use, fully integrated, intuitive software solutions to both OEMs and end users alike. SMITH MICRO STRATEGY AND PRODUCTS The Company offers software products for Windows 95, Windows 98 (when available), Windows NT, Windows 3.x, Macintosh and DOS operating systems. Smith Micro believes that its strong engineering focus and its relationships with analog modem, cable modem, xDSL modem, camera, video capture card, personal computer and modem chip manufacturers enable it to develop communication software in anticipation of changes in product design and customize its OEM software to meet specific customer requirements. To address the complexity of personal computer communication, Smith Micro has consistently developed products that are intuitive and easy to use. The Company believes that its experience in providing products to the OEM industry, where software is required to enable a new hardware device to be put into service quickly and relatively effortlessly, is a significant competitive advantage. The Company's strategy is to build upon the easy-to-use reputation of its OEM software products to encourage these new users to migrate to the Company's retail products as they require higher levels of functionality. To serve the market's evolving demands for connectivity, Smith Micro's goal is to offer solutions beyond its core fax and data communication software. The Company offers products that support video conferencing, video email, paging, telephony, remote access and modem sharing. In the emerging fields of personal computer-based wireless and cellular communication, the Company's software for PC Cards is currently being shipped by 3Com Corporation ("3Com") (which includes 3Com Mobile Communications Division as well as U.S. Robotics Corporation and MegaHertz), Best Data, Viking Components and IBM among others. In addition, modems capable of supporting full duplex speakerphone and other telephony applications are beginning to gain market acceptance and the Company has developed software to support these emerging technologies. Smith Micro has traditionally focused on the OEM and, more recently, the corporate/government and retail channels. The Company's OEM fax and data and video products are bundled with the modems, cameras and personal computers of many of the world's leading manufacturers of such products. In addition, the Company currently offers a line of easy-to-use retail communication software products that address the needs of the expanding base of personal computer users. The Company's retail software products are sold to distributors, retail stores and direct to end-users through electronic stores. The Company intends to broaden its retail product line and expand the functionality of these products as well as its OEM products with additional introductions of 32-bit products designed for the Windows 98, Windows 95 and Windows NT operating systems. The Company also offers personal computer-based, video teleconferencing products to its OEM and retail channel customers. In addition, the Company has begun to focus on a third channel, the corporate/government marketplace. In January 1998, the Company acquired the network fax software technology of Mitek Systems, Inc. The acquired software is focused on the fax requirements of the enterprise customer. The software includes a local area network ("LAN") product that began shipping in 1998 4 5 and two applications under development that would enhance IP protocol distribution (over the Internet and intranet) of fax documents. The Company believes that a key competitive feature of its products is the ability to switch seamlessly among fax, video conferencing, telephony, and data functions without interruption to the user. The Company's principal products automatically recognize whether an incoming call is a voice call, fax transmission or data transmission. In addition, a user can send fax, data, telephonic, or video conferencing transmissions without exiting one application and entering another. OEM Products The following chart lists the Company's current OEM products:
FUNCTIONALITY PRODUCT NAME (PLATFORM) LANGUAGES - --------------------------- -------------------------------------- ------------------------ QuickLink(TM) Data and fax (Windows 3.x, Windows English, English (UK), 95, Windows NT and Windows 98) French, German, Japanese and Spanish QuickLink(TM) MessageCenter Data, fax and voicemail (Windows English, French, German 3.x, Windows 95, Windows NT and and Japanese Windows 98) VideoLink(TM) Message Center Video teleconferencing, data, fax English and voice (Windows 3.x, Windows 95, Windows NT and Windows 98) VideoLink(TM) 324/323 Video conferencing (Windows 3.x, English VideoLink(TM) 323 Windows 95, Windows NT and Windows 98) VideoLink(TM) 324 VideoLink(TM) VideoLink(TM)Mail Video and audio messaging (Windows English and 15 other 3.x, Windows 95, Windows NT and languages Windows 98) QuickLink(TM) Page Paging (Windows 3.x, Windows 95, English Windows NT and Windows 98) MacComCenter(TM) with Voice Data, fax and voice (Macintosh) English and Japanese MacComCenter(TM) Data and fax (Macintosh) English and Japanese
QuickLink, the Company's flagship product line, provides integrated data communication and fax capabilities allowing users to send, receive and manage all fax activities in the background or foreground. In addition, these products enable the broadcasting of faxes to an unlimited number of locations. These products also offer data communication functionality that allow users to transfer files between computers and call electronic bulletin board systems and on-line services. QuickLink MessageCenter for Windows provides integrated data communication, fax and computer telephony functions, including voicemail and full duplex speakerphone capabilities (when supported by the proper modem) in one package. QuickLink MessageCenter features include multiple mailboxes and remote retrieval of voicemail. In addition, sending and receiving faxes from within any Windows application as well as data communication upload and downloads can take place entirely in the background, allowing users to continue work in other applications. Users can call and request fax documents with the fax-on-demand feature by using the touch-tone keypad on their fax machine and can configure each mailbox individually and have the product send a pager notification each time a voice 5 6 message or fax is received. Moreover, through alphanumeric pagers, users can be notified of the number of faxes, voicemail and memos in the mailbox. VideoLink MessageCenter includes the video conferencing capabilities provided by VideoLink and the data, fax and voice mail functionality provided in QuickLink MessageCenter. All of these functions are incorporated in a single, fully integrated application. VideoLink 324/323, VideoLink323, VideoLink324 and VideoLink are video conferencing products that enable video and audio communication over the Internet through a third party video server connection or between two locations using a standard analog modem connection using plain old telephone service ("POTS") or Integrated Services Digital Network ("ISDN"). VideoLink 323 supports the International Telecommunications Union (ITU) H.323 standard for interoperability for the Internet and intranets and VideoLink 324 supports the ITU H.324 standard for interoperability over POTS. VideoLink Mail is an application that allows the recording of a video and audio message which can be saved as a self extracting file which can then be sent via an email attachment over the Internet. The recipient can then play the message just by double clicking on the attachment. VideoLink Mail's video and audio data compression technology creates smaller files for email. QuickLink Page is paging software that works in conjunction with Microsoft Exchange, Messaging or Outlook in Windows 95, Windows 98 (when available) and Windows NT and as a stand-alone application that will allow users to send messages to numeric or alphanumeric pagers. Filters are built in to the product so that the user can define parameters under which HotPage will send the message. The user can also compose a message and send it directly to an alphanumeric pager. MacComCenter with Voice is an integrated data communication and fax product for the Macintosh which adds telephony to the integrated data communication and fax functionality developed specifically for the Macintosh environment and will support multiple mailboxes, each configurable to receive voice, fax and data into a specific mailbox. The Company has incorporated many of the features found in the QuickLink MessageCenter product into MacComCenter with Voice. MacComCenter is an integrated data communication and fax product for the Macintosh. The product enables the broadcasting of faxes to multiple locations. It also offers data communication functionality that allows users to transfer files between computers and call electronic bulletin board systems and on-line services. 6 7 Retail Products The following chart lists the Company's current retail products and retail products currently under development:
PRODUCT NAME FUNCTIONALITY (PLATFORM) LANGUAGES - -------------------------- ----------------------------------------------- -------------------- HotFaxShare(TM) Fax over a LAN (Server: Windows NT, English and German (under development) Windows 95 and Windows 98 and Client: Windows 3.x, Windows 95, Windows NT and Windows 98) IntraFax(TM) Fax over the Internet and intranets English (under development) (Server: Windows NT, Windows 95 and Windows 98 and Client: Windows 3.x, Windows 95, Windows NT and Windows 98) AudioVision(TM) Video conferencing (Windows 3.x, Windows English and 15 95, Windows NT and Windows 98) other languages VideoLink(TM) Mail Pro Video and audio messaging (Windows 3.x, English Windows 95, Windows NT and Windows 98) HotFax(R) MessageCenter Data, fax and voice (Windows 3.x, Windows English, French, 95, Windows NT and Windows 98) German, Portuguese and Spanish HotFax(R) Data and fax (Windows 3.x, Windows 95, English Windows NT and Windows 98) HotFax(R) for DOS Data and fax (DOS) English MacComCenter(TM) Plus with Data, fax and voice (Macintosh) English and Japanese Voice HotPage(R) Paging software (Windows 3.x, Windows 95, English Windows NT and Windows 98) HotLine(R) for Windows Telephony application (Windows 3.x, English Windows 95, Windows NT and Windows 98) HotLine(R) for DOS Telephone dialer (DOS) English CrossConnect(R) Outbound modem over a LAN and inbound remote control (Windows 3.x, Windows 95, Windows NT, Windows 98 and DOS) Database Products: FaxUSA Fax database (any platform) English National Directory Telephone and address database (any English Electronic Edition platform)
HotFaxShare is a fax solution that handles fax creation, transmission and incoming fax routing for companies with high fax volume or with several computer users connected to a LAN. It is an open platform solution and is independent of the type and size of the LAN. Faxes can be sent from any network workstation effortlessly 7 8 from Windows 3.x, Windows 95, Windows 98, Windows NT or DOS applications. Individual and broadcast faxes can be sent immediately or scheduled for later transmission. It can support up to 24 channels (fax lines). IntraFax is a client/server fax gateway that allows faxes to be sent automatically throughout the world, over the Internet or intranet, thereby reducing international long distance telephone charges. This TCP/IP-based product allows a fax to be sent directly out of any Windows-based application and will select the appropriate route, either the Internet or the company's LAN or its wide area network ("WAN") by using a least cost routing technique. With this process, it determines the fax server closest to the recipient and the fax is then sent as a local call. Another feature built into IntraFax is I-Paper which allows for a standard fax machine to be connected to the IntraFax server and can then send faxes over the LAN, WAN, Internet or intranet. AudioVision is a video conferencing software product that works over the existing telephone lines or POTS, ISDN, the Internet or intranets. It works with any digital camera plugged into the parallel port on the computer or with an analog camera plugged into a video capture card. It also supports the industry ITU H.324 standard for interoperability over POTS. AudioVision includes a feature called VideoLink Mail Pro that allows the user to record a video and audio message, save it as an executable file and send it via email as an attachment to another individual who can then play the message. The latest version also includes other features such as a virtual VCR, a whiteboard, and plug-in multi-user games that can be played by both parties while holding a video conference. VideoLink Mail Pro is an application that allows the recording of a video and audio message which can be saved in a highly compressed format as a self extracting file which can then be sent via an email attachment over the Internet. The recipient can then play the message just by double clicking on the attachment. HotFax(R) MessageCenter is a fully integrated data, fax and voice mail application. The product includes all of the features of HotFax for Windows 3.x, Windows 95, Windows 98 and Windows NT mentioned below. It allows the user to configure multiple mailboxes that will accept voice, fax or data messages. The product installs as a Windows 95, Windows 98, Windows NT or Windows 3.x application. The application can send a pager notification each time a voice message or fax is received. If configured for an alphanumeric pager, the notification will specifically identify the number of faxes, voice mail and memos in the mailbox. HotFax(R) is the Company's integrated data and fax retail product. HotFax for Windows 3.x, Windows 95, Windows 98 and Windows NT provides the mobile user with a fax host for the remote retrieval of received faxes and the unattended upload and broadcast of faxes at a scheduled time. It also provides users with the ability to retrieve faxes from a remote location, modify faxes with graphics intact, use a personal computer as a data host and share data like a bulletin board service, create custom cover pages with imported graphics and preview faxes, including cover pages. HotFax(R) DOS is an integrated fax and data communication product for the DOS operating environment. HotFax DOS provides the mobile user a fax host for the remote retrieval of received faxes and unattended upload and broadcast of faxes at a scheduled time. It also provides users with the ability to retrieve faxes from a remote location, modify faxes with graphics intact, use a personal computer as a data host and share data similar to a bulletin board service. MacComCenter Plus with Voice is configured as the Company's retail Macintosh data, fax and telephony communication software product. It allows the user to configure multiple mailboxes that will accept voice, fax or data messages. It includes OCR for converting incoming transmissions into text files and gives users the ability to send true WYSIWYG faxes from an application that has print capabilities. Users are also able to create custom cover pages with imported graphics, preview entire faxes, including cover pages, retrieve faxes from a remote location, and share data similar to a bulletin board service with a data host. HotPage(R) is paging software that works in conjunction with Microsoft Exchange, Messaging or Outlook in Windows 95, Windows 98 and Windows NT and as a stand-alone application that will allow users to send messages to numeric or alphanumeric pagers. With Microsoft Exchange, any incoming e-mail that is placed into the in-box can 8 9 be sent to an alphanumeric pager. Filters are built in so that the user can define certain parameters under which HotPage will send the message. The user can also compose a message and send it directly to an alphanumeric pager. HotLine(R) for Windows and HotLine for DOS are telephony products for the personal computer user. HotLine for Windows allows users to create unlimited xBase-compatible phone books that can be accessed from within any Windows application. It supports Caller ID, which first displays the inbound caller's phone number, and then pulls up caller information by auto-searching and matching up the appropriate record from one of the program's user-defined databases when used with appropriate hardware technology. HotLine for Windows also supports modems with full-duplex speakerphone capabilities which eliminate the echo and one-way communication limitations of conventional speaker phones. Included with HotLine for Windows is the American Business Sampler, a sample database of more than 2,500 business names, addresses and telephone numbers. Other databases, like the Company's National Directory Electronic Edition database, can be imported directly into HotLine for Windows. The DOS version of HotLine is similar in its overall purpose, but has a more limited set of features. CrossConnect(R) is a modem-sharing product for LANs. CrossConnect expands the capability of the modems on both Novell IPX and NetBIOS LANs by providing an integrated outbound software product for sharing modems connected anywhere on the LAN and by providing remote access on the LAN for users away from the office. The outbound function supports a mixed environment of DOS and Windows users on the same LAN. The inbound function allows users away from the office LAN to dial into the network environment and gain access to a node. After doing so, the remote user can use CrossConnect for outbound communications, accessing private or public telephone books, and communicating through a shared modem on the LAN to bulletin boards, on-line services or any host computer. This remote process occurs in the background, so that the personal computer with the shared modem will not be interrupted during the communication. FaxUSA is an xBase-compatible database. When used along with software products like HotFax, it enables users to locate the names and fax numbers of over 100,000 businesses across the United States. FaxUSA includes SIC codes and is updated annually to provide users with current information for their marketing, sales and other needs. National Directory Electronic Edition is an xBase-compatible database. When used along with software products like HotLine, it enables users to locate the names, telephone numbers and mailing addresses of over 100,000 businesses, spanning over 1,300 industry categories, across the United States. National Directory Electronic Edition includes SIC codes and provides current listings, updated annually, in all area codes. SALES AND MARKETING The Company sells its communication software products worldwide to OEM customers that bundle or pre-load the Company's software with their hardware products and to distributors and retailers that sell the product to end user customers. The Company has begun to focus on a third channel, the corporate/government marketplace. In January 1998, the Company acquired the network fax software technology of Mitek Systems, Inc. The acquired software is focused on the fax requirements of the enterprise customer. The software includes a LAN product that began shipping in 1998 and two applications under development that would enhance IP protocol distribution of fax documents. The Company is also developing video and fax products to address vertical markets to be distributed through channels established by corporate partners. OEM Sales The Company has OEM relationships with many of the major modem manufacturers worldwide. The Company's customers include 3Com (including U.S. Robotics Corporation and its Megahertz subsidiary), IBM, Taicom (Taiwan), Sirius Technologies (Australia), Sitre (Spain) and Boca Research. Each of these manufacturers bundles the Company's software products with its own hardware products. Approximately 22.4% and 13.3% of the Company's OEM revenues for the twelve months ended December 31, 1997 and 1996, respectively, were derived from OEM customers outside of the United States. Products translated into Japanese, German and French accounted 9 10 for approximately 2.3% and 9.2% of the Company's OEM revenues for the twelve months ended December 31, 1997 and 1996, respectively. Recent translations allow the Company to provide certain products in 15 foreign languages. The OEM modem market continues to evolve. Many personal computer manufacturers now bundle modems and communication software with their products. In some cases, personal computer manufacturers are pre-loading communication software onto hard drives. Moreover, modem chips are under development which will put modem functionality on the motherboard of the personal computer, eliminating the need for a separate modem. In light of these trends, the Company has expanded its OEM relationships with personal computer manufacturers. In addition, the Company has opened dialogues with many other non-modem manufacturers due to the development of high speed Internet access devices such as cable and xDSL modems and with developers of multi-port fax hardware devices as a result of its recent acquisition of technology assets from Mitek Systems, Inc. The cycle from the placement of an OEM order to shipping is very short. OEM customers generally operate under a just-in-time system and order software to be delivered as needed by their manufacturing operations. The Company generally ships its products as orders are received. As a result, the Company has relatively little backlog at any given time and does not consider backlog to be a significant indicator of future performance. Moreover, the Company does not generally produce software in advance of anticipated orders and therefore has insignificant amounts of inventory. As a result of the foregoing, revenues in any quarter are substantially dependent on orders booked in that quarter. During 1997, 1996 and 1995 the Company's three largest OEM customers and their affiliates, including 3Com, accounted for 56.9%, 62.9% and 66.8% of net revenues, respectively. In June 1997, 3Com Corporation ("3Com") acquired U.S. Robotics Corporation ("U.S. Robotics"), to date the Company's largest customer based on the percentage of revenues, as a wholly owned subsidiary. 3Com and its affiliates accounted for more than 10% of the Company's net revenues in 1997, 1996 and 1995. Motorola accounted for more than 10% of revenue in 1996. The Company's major customers could reduce their orders of the Company's products in favor of a competitor's product or for any other reason. The loss of any of the Company's major OEM customers would have a material adverse effect on the Company's business, results of operations and financial condition. In April 1996, the Company entered into an OEM agreement having an initial one year term with a wholly-owned subsidiary of U.S. Robotics (now a subsidiary of 3Com). The agreement superseded a previous agreement between the parties and automatically renews at the end of each one year term unless a party provides at least 60 days notice of its intent to terminate the agreement at the end of the then-current term. During 1997, the agreement automatically renewed according to its terms and certain other 3Com entities (hereinafter 3Com, its affiliates and their subsidiaries will be referred to as "3Com entities") were added as parties pursuant to new addenda to the agreement. Under the terms of the agreement, the Company granted certain pricing incentives to the 3Com entities in consideration for which the Company became the provider of fax, data, voice and telephony communications software for such 3Com entities. In addition, under the terms of the agreement, certain of the 3Com entities agreed to place Smith Micro retail products and commercials for such products on certain of their compact disks. The agreement does not require any 3Com entity to purchase any minimum quantity of Smith Micro products and may be terminated by a party thereto at any time for any reason upon 90 days' prior written notice. The Company sells directly to modem and personal computer manufacturers using an in-house sales staff based in Aliso Viejo, California. The Company recently established sales operations in Europe and Australia to expand international presence. The Company allows its OEM customers to return unused software. To date, however, such returns have been infrequent. Retail Sales While historically the Company has generated its revenues primarily from the OEM market, it also sells retail products that are designed to complement or upgrade its OEM products. Retail sales represented 5.2%, 16.5% and 6.0% of net revenues for 1997, 1996 and 1995, respectively. 10 11 The Company has a separate sales staff that handles retail sales and works closely with Smith Micro's retail distributors on the management of orders, inventory levels, sell-through to retailers, as well as promotions and marketing activities. Domestically, the Company's retail products are sold by independent distributors including Ingram Micro and Tech Data. In addition, the retail sales force is responsible for contacting major retail customers to generate demand for the Company's retail products in the retail distribution channel. During 1997, the Company began to develop retail outlets using the Internet by selling product through the Company's web site and electronic distributors. The delivery of retail products derived from Internet sales is direct to the customer through electronic download or shipment from the Company, depending on the customer's preference. The Company allows distributors and retailers to return products without charge or penalty. In addition, there are times when the Company updates products and requests the distributors of the products to replace inventory on the shelves with the new version in what is called a stock rotation. A component of the Company's revenue recognition policy is that the Company calculates an allowance for product returns based on its historical experience with product returns. If retail sales of the Company's products increase, the risk of product returns will increase. While the Company's revenue recognition policy contemplates this risk, it is possible that returns may occur in excess of the Company's previous experience, causing the Company to revise its estimates and increase the allowances for such returns. The Company employs direct mail programs to offer end-users upgrades to the Company's retail products. The Company advertises in selected computer end-user and re-seller publications and periodically introduces promotions and incentive offers such as special pricing for the purchase of upgrades. The Company also participates in major trade shows, professional conferences and personal computer user group events to reach its target markets. Corporate and Government Sales During 1997 the Company began selling to the corporate/government marketplace while building the infrastructure necessary to sell to these two customer bases. In January 1998, the Company acquired the network fax software technology of Mitek Systems, Inc. The acquired software is designed to address the fax requirements of the enterprise customer. The software includes a LAN product that began shipping in 1998 and two applications under development that would enhance IP protocol distribution of fax documents. The Company anticipates upgrading the LAN product with HotFaxShare during 1998. The Company intends to continue to focus its sales and marketing efforts for its video and fax technologies through direct sales and sales through value added resellers ("VARs") that specialize in selling to enterprise customers. Sales in this marketplace tend to be made in single volume orders, typically for site licenses, and are often accompanied by maintenance programs. The Company's pricing structure in this marketplace currently accommodates multi-level, volume purchase with discounts for larger single orders. The maintenance program provides technical support and automatic product upgrades under specifically defined terms. In addition, the Company is continuing with the development of vertical market products for the medical, insurance, and security industries among others. Vertical market products, such as telemedicine for the medical industry, will be distributed through channels established by VARs and other corporate partners. CUSTOMER SERVICE AND TECHNICAL SUPPORT The Company provides technical support and customer service by telephone, mail, fax, modem, its customer bulletin board service, an Internet web site and through a forum that it operates on CompuServe. Certain of the Company's OEM customers provide their own primary customer support functions and rely on the Company for back-up customer support, while support functions for other OEM customers are provided solely by the Company. PRODUCT DEVELOPMENT The software industry is characterized by frequent changes in technology and evolving user needs. The Company works closely with its current OEM customers to determine future user needs and to anticipate changes in technology. Modem functionality is determined by the capabilities of the modem chip and, accordingly, the 11 12 Company maintains close relationships with the major modem chip manufacturers and develops software in tandem with modem chip development. These highly interactive development approaches extend to modem manufacturers as well, where Smith Micro works with modem developers in an attempt to provide fully tested software when new modems are released. Engineering relationships with Rockwell, IBM, Cirrus Logic, Intel, Texas Instruments and others as well as with the Company's major OEM modem customers are central to the product development efforts of the Company. In addition, the Company participates in software product developer programs sponsored by Microsoft, Intel, IBM and Apple. The Company believes that it must be responsive to the specific customization requests of its OEM customers. With this need for flexibility in mind, the Company has completely redeveloped the code base from which its products are created. Its object-oriented C++ modular code base is designed to allow significant customization and enhancements of features within tight development schedules. As of December 31, 1997, the Company had a product development staff of 31 engineers and quality assurance and product testing specialists. The Company plans to add additional software engineers and product testing personnel in the future. MANUFACTURING The Company's software is sold in three forms. The software is sold in the form of a kit which includes disks or a CD-ROM and a manual. In addition, the Company permits certain of its OEM customers to duplicate their own disks or CD-ROMs and the Company controls that process through the use of serialized labels sold to those customers. This method of sale does not require the Company to provide a disk or manual. Also, the Company grants licenses to certain OEM customers that enable those customers to pre-load a copy of the Company's software onto a personal computer's hard drive. With the corporate sales program, the Company offers site licenses under which a corporate user is allowed to distribute copies of the software to users within the corporate sites. The Company relies on third party suppliers who provide the components used in its kitted products. These components include disks, CD-ROMs and printed manuals. Disk shortages have occurred in the past and there can be no assurance that shortages will not recur. If the Company cannot obtain a sufficient quantity of disks, CD-ROMs or other components, or cannot obtain disks, CD-ROMs or other components at prices at least comparable to prices paid currently, the Company's business, results of operations and financial condition could be adversely affected. Modem manufacturers purchase chips from a relatively limited number of chip manufacturers. Production problems or product quality problems experienced by a chip manufacturer could reduce modem sales or slow the growth of modem sales. Where the Company is selling kitted diskette product, it duplicates most of the required disks at its Aliso Viejo, California facility. This facility is capable of producing 50,000 duplicated disks in a single eight hour shift. Operations are primarily conducted on a single shift basis, although the Company operates a second shift from time to time to accommodate customer delivery requirements. The Company has outside production alternatives in the event of a disruption of its Aliso Viejo operations. The Company uses outside vendors for the printing of labels, manuals and packaging. Where the Company is selling kitted CD-ROM product, it relies on third party suppliers to provide CD-ROM components and CD-ROM replication. The equipment to replicate CD-ROMs is very costly making it unlikely that the Company will add this capability internally. This leaves the Company dependent on CD-ROM replication facilities for both the timing and pricing of the software produced in CD-ROM format. This could impair the Company's ability to deliver products to customers and any price increases could reduce gross margins which could have a material adverse effect on the Company's business, results of operations and financial condition. 12 13 COMPETITION The markets in which the Company operates are highly competitive and subject to rapid changes in technology. The strategic directions of major personal computer hardware manufacturers and operating system developers are also subject to changes. The Company competes with other software vendors for access to distribution channels, retail shelf space and the attention of customers. The Company also competes with other software companies in its efforts to acquire software technology developed by third parties and in attracting qualified personnel. These actions may result in increased price competition. The Company believes that the principal competitive factors affecting the market include product features and ease of use, willingness of the vendor to customize the product to fit customer-specific needs, product reputation, quality, performance, price, customer service and support, and the effectiveness of sales and marketing efforts. Although the Company believes that its products currently compete favorably with respect to such factors, there can be no assurance that the Company can maintain its competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Because there are relatively low barriers to entry in the software market and because rapidly changing technology is constantly creating new opportunities, the Company expects additional competition from other established and emerging software companies as fax and data applications merge with video and audio applications and the emerging cellular, wireless and telephony markets develop. The Company also believes that the market in which it competes has been characterized by the consolidation of established communication software suppliers and that this trend, which may lead to the creation of additional large and better-financed competitors, may continue. Increased competition could result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on the Company's business and results of operations. The Company competes primarily with Symantec, Cheyenne, White Pine and VDONet in the OEM market, and with Symantec, Global Village and Quarterdeck in the retail market for communication software products. Some of the Company's competitors have a retail emphasis and offer OEM products with a reduced set of features. The opportunity for retail upgrade sales may induce these and other competitors to make OEM products available at their own cost or even at a loss. Such a pricing strategy could have an adverse affect on the Company's business, results of operations and financial condition. Symantec and many of the Company's other current and prospective competitors have significantly greater financial, marketing, service, support, technical and other resources than the Company. Moreover, these companies may introduce additional products that are competitive with those of the Company, and there can be no assurance that the Company's products would compete effectively with such products. The Company believes that its ability to compete depends on elements both within and outside its control, including the success and timing of new product development and introduction by the Company and its competitors, product performance and price, distribution and customer support. There can be no assurance that the Company will be able to compete successfully with respect to these and other factors. The Company believes that the market for its software products has been and will continue to be characterized by significant price competition. A material reduction in the price of the Company's products could negatively affect the Company's profitability. Many of the Company's existing and potential OEM customers are major manufacturers of modems and have substantial technological capabilities. These customers may currently be developing, or may in the future develop, products that compete directly with the Company's products and may, therefore, discontinue purchases of the Company's products. The Company's future performance is substantially dependent upon the extent to which existing OEM customers elect to purchase communication software from the Company rather then design and develop their own software. In light of the fact that the Company's customers are not contractually obligated to purchase any of the Company's products, there can be no assurance that the Company's existing OEM customers will continue to rely, or expand their reliance, on the Company as an external source for communication software. 13 14 The Company also faces competition from Microsoft, which dominates the personal computer software industry. Due to its market dominance and the fact that it is the publisher of the most prevalent personal computer operating systems, DOS and Windows, Microsoft represents a significant competitive threat to all personal computer software vendors, including the Company. PROPRIETARY RIGHTS AND LICENSES Although the Company believes that its products do not infringe on the intellectual property rights of others, there can be no assurance that such a claim will not be asserted against the Company in the future. The failure of the Company to protect its proprietary information could have a material adverse effect on the Company's business, results of operations and financial condition. From time to time, the Company has received and may receive in the future communications from third parties asserting that trademarks used by the Company or features or content of certain of the Company's products infringe upon intellectual property rights held by such third parties. As the number of trademarks, patents, copyrights and other intellectual property rights in the Company's industry increases, and as the coverage of these patents and rights and the functionality of products in the market further overlap, the Company believes that products based on its technology may increasingly become the subject of infringement claims. Moreover, any of these proceedings could also result in an adverse decision as to the priority of the Company's inventions. Such results would materially adversely affect the Company, and may also require the Company to obtain one or more licenses from third parties. There can be no assurance that the Company would be able to obtain any such required licenses upon reasonable terms, if at all, and the failure by the Company to obtain such licenses could have a material adverse effect on its business, results of operations and financial condition. The Company's success is dependent upon its software code base, its programming methodologies and other intellectual properties. To protect its proprietary technology, the Company relies on a combination of trade secret, nondisclosure and copyright and trademark law which may afford only limited protection. Prior to becoming a publicly held entity, the Company did not require its employees to sign proprietary information and inventions agreements stipulating, among other things, software ownership rights. There can be no assurance that the steps taken by the Company will be adequate to deter misappropriation of its proprietary information, will prevent the successful assertion of an adverse claim to software utilized by the Company or that the Company will be able to detect unauthorized use and take effective steps to enforce its intellectual property rights. In selling its products, the Company relies primarily on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology. In addition, the Company licenses technology on a non-exclusive basis from several companies for inclusion in its products and anticipates that it will continue to do so in the future. The inability of the Company to continue to license these technologies or to license other necessary technologies for inclusion in its products, or substantial increases in royalty payments under these third party licenses could have a material adverse effect on its business, results of operations and financial condition. EMPLOYEES As of December 31, 1997, the Company had a total of 75 employees, of which 31 were engaged in engineering, 12 were in sales and marketing, 13 were in customer support, 12 were in finance and administration and 7 were in manufacturing. The Company utilizes temporary labor to assist during periods of increased manufacturing volume. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppages, and considers its relations with its employees to be good. 14 15 RISK FACTORS This Annual Report on Form 10-K contains forward looking statements which involve risks and uncertainties and the Company's actual results may materially differ from the results anticipated in those statements. Factors that might cause such a difference include, without limitation, those discussed in this section, in the Management's Discussion and Analysis of Financial Condition and Results of Operations section and elsewhere in this Annual Report on Form 10-K. All such factors should be considered in evaluating the Company and a decision to invest in the Company. Fluctuations in Quarterly Operating Results. Certain of the Company's significant customers and other modem manufacturers have announced in recent quarters that there was an increase of inventory in the channel and that the slower than expected rollout of V.90 standard 56K modems may reduce their rates of growth during subsequent quarters. The rate at which this inventory is moved out of the channel could have a significant impact on the Company's operating results in future quarters. The Company's operating results have in the past fluctuated, and may in the future fluctuate, from quarter to quarter as a result of a number of factors including, but not limited to, the size and timing of orders from, and shipments to, major customers; the ability to maintain or increase gross margins; the ability of the Company's customers to obtain financing for the purchase of the Company's products; changes in pricing policies or price reductions by the Company or its competitors; variations in the Company's sales channels or the mix of product sales; the timing of new product announcements and introductions by the Company or its competitors and customers; the availability and cost of supplies; the financial stability of major customers; market acceptance of new products, applications and product enhancements; the Company's ability to develop, introduce and market new products, applications and product enhancements; the Company's ability to control costs; possible delays in the shipment of new products; the Company's success in expanding its sales and marketing programs; deferrals of customer orders in anticipation of new products, applications, product enhancements or operating systems; changes in Company strategy; personnel changes; and general economic factors. The Company's software products are generally shipped as orders are received and accordingly, the Company has historically operated with little backlog. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. In addition, the Company's expense levels are based, in part, on its expectations as to future revenues. If revenue levels are below expectations, operating results are likely to be adversely affected. The Company's net income may be disproportionately affected by a reduction in revenues because of fixed costs related to generating its revenues. While the Company has not historically experienced seasonality in its sales, many of the Company's OEM customers experience seasonality in their sales, and the Company's sales may, in the future, be subject to seasonality particularly as its sales of retail products increase. Quarterly results in the future may be influenced by these or other factors and, accordingly, there may be significant variations in the Company's quarterly operating results. Further, the Company's historical operating results are not necessarily indicative of future performance for any particular period and there can be no assurance that the Company's recent revenue growth or its profitability will continue on a quarterly or annual basis. Due to all of the foregoing factors, it is possible that in some future quarter the Company's operating results may be below the expectations of public market analysts and investors. In such event, the price of the Company's Common Stock would likely be materially adversely affected. Reliance on 3Com Corporation. In June 1997, 3Com acquired U.S. Robotics, to date the Company's largest customer based on the percentage of revenues, as a wholly owned subsidiary. There can be no assurance that 3Com's acquisition of U.S. Robotics will not result in a change in U.S. Robotics' purchasing habits, a decrease in new orders by U.S. Robotics, delays in orders previously made by U.S. Robotics, or the loss of U.S. Robotics as a customer entirely. Sales to 3Com entities (primarily to U.S. Robotics and its subsidiaries) represented 43.1%, 46.4% and 52.1% of the Company's net revenues in 1997, 1996 and 1995, respectively. The Company expects that the 3Com entities, including U. S. Robotics and its subsidiaries, will continue to account for a significant portion of the Company's revenues in future periods. In April 1996, the Company entered into an OEM agreement having an initial one year term with a wholly-owned subsidiary of U.S. Robotics. The agreement superseded a previous agreement between the parties and automatically renews at the end of each one year term unless a party provides at least 60 days notice of its intent to terminate the agreement at the end of the then-current term. During 1997, the agreement automatically renewed according to its terms and certain other 3Com entities were added as parties pursuant to new 15 16 addenda to the agreement. Under the terms of the agreement, the Company granted certain pricing incentives to the 3Com entities in consideration for which the Company became the provider of fax, data, voice and telephony communications software for such 3Com entities. In addition, under the terms of the agreement, certain of the 3Com entities agreed to place Smith Micro retail products and commercials for such products on certain of their compact disks. The agreement does not require any 3Com entity to purchase any minimum quantity of Smith Micro products and may be terminated by a party at any time thereto for any reason upon 90 days prior written notice. As a result, there can be no assurance that the 3Com entities will continue to purchase the Company's products. While the Company believes that it has been the principal supplier of OEM communication software products to U.S. Robotics, there can be no assurance that U.S. Robotics and the other 3Com entities to which the Company sells products will not seek additional sources for such products in the future. Accordingly, there can be no assurance that sales to the 3Com entities will reach or exceed in any future period the historical levels of sales to U.S. Robotics. A substantial decrease or delay in sales to the 3Com entities would have a material adverse effect on the Company's business, results of operations and financial condition. Concentration of Customer Revenues. In addition to the 3Com entities, including U.S. Robotics, the Company has in the past derived, and expects in the future to derive, a significant portion of its revenues from a relatively small number of customers. The Company's three largest customers, including the 3Com entities, represented approximately 56.9%, 70.8% and 66.8% of the Company's net revenues during 1997, 1996 and 1995, respectively. The Company expects that it will continue to be dependent upon relatively large orders from major OEM customers for a significant portion of its revenues in future periods, although none of them is obligated to purchase any products. Accordingly, there can be no assurance that any sales to these entities, individually or as a group, will continue or, if continued, will reach or exceed historical levels in any future period. Any substantial decrease or delay in sales to one or more of these entities would have a material adverse effect on the Company's business, results of operations and financial condition. In addition, certain of the Company's OEM customers have in the past and may in the future acquire competitors or be acquired by competitors, causing further consolidation in the modem industry. Previous acquisitions in the modem industry have often caused the purchasing departments of the combined companies to reevaluate their purchasing decisions. There can be no assurance that such acquisitions will not result in a change in a current customer's purchasing habits, including a loss of the customer, a decrease in orders from that customer or a delay in orders previously made by the customer. Moreover, acquisitions involving existing OEM customers may cause the concentration of the Company's customer revenues to increase if the combined companies continue to purchase the Company's software products. Although the Company maintains allowances for doubtful accounts, the insolvency of one or more of the other major customers of the Company could substantially impair the Company's business, results of operations and financial condition. Product Concentration. The Company has in the past derived, and may in the future derive, a significant portion of its revenues from a relatively small number of products. The sale of QuickLink related products represented approximately 81.3%, 69.4% and 84.0% of the Company's net revenues during 1997, 1996 and 1995, respectively. The Company expects that revenues from these products will continue to account for a substantial portion of the Company's total revenues in the foreseeable future. Declines in the revenues from these software products, whether as a result of competition, technological change, price pressures or other factors, would have a material adverse effect on the Company's business, results of operations and financial condition. Further, life cycles of the Company's products are difficult to estimate due in large measure to the recent emergence of the Company's market, the effect of new products, applications or product enhancements, technological changes in the communication software industry in which the Company operates and future competition. The Company's future financial performance will depend in part on the successful development, introduction and market acceptance of new products, applications and product enhancements. There can be no assurance that the Company will continue to be successful in marketing its current products or any new products, applications or product enhancements. Technological Change. The communication software market for personal computers is characterized by rapid technological change, changing customer needs, frequent product introductions and evolving industry standards. The introduction of products incorporating new technologies and the emergence of new industry standards could render the Company's existing products obsolete and unmarketable. The Company's future success will depend upon 16 17 its ability to develop and introduce new software products (including new releases, applications and enhancements) on a timely basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of its customers. There can be no assurance that the Company will be successful in developing and marketing new products that respond to technological changes or evolving industry standards, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products, or that its new products will adequately meet the requirements of the marketplace and achieve market acceptance. If the Company is unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, the Company's business, results of operations and financial condition would be materially adversely affected. Microsoft is the leading developer of operating systems for personal computers. There can be no assurance that the Company will successfully develop new versions of its software products that will operate on future Microsoft operating systems, or that any such development, even if successful, will be completed concurrently with or prior to introductions by competitors of communication software products for those new operating systems. Any such failure or delay could affect the Company's competitive position or lead to product obsolescence in the future. While the Company ships software to a number of computer manufacturers, its primary OEM customers are modem manufacturers. The Company is aware that technology is being developed to enable the functions of the modem to be performed by a chip embedded into the computer. This development, if and when it comes to market, could impair the business of those of the Company's customers that rely on the existence of a separate modem component for their continued success. A downturn in the business of one or more of its principal customers could adversely affect the Company's business, results of operations and financial condition. In March 1997, modem manufacturers shipped the first 56K modems (modems which download information at speeds up to 56,000 bits per second) for retail sale. 56K modems were initially based on either one of two incompatible standards, the x2 standard adopted by 3Com or the K56flex standard adopted by Rockwell International and Lucent Technologies. This incompatibility, combined with the failure of the modem industry to adopt an industry-wide standard for such modems, caused some modem manufacturers to delay the launch of proprietary 56K modems and caused consumers to delay purchases of the new modems. The company believes that its business, results of operations and financial condition since the launch of the 56K modems have been directly and adversely affected by the incompatibly of the 56K modem standards and the resulting confusion created thereby in the marketplace. In February 1998, the ITU (international standards governing body) voted on a draft of a 56K modem standard, V.90, and plans to formally approve it during the next ITU meeting in September 1998. Both competing 56K modem groups have announced that they intend to support the V.90 standard by moving forward with all new modems and by providing downloadable flash memory upgrades for currently owned X2 and K56flex technology modems. The shipment of the V.90 compliant modems began in early 1998 and there can be no assurance that the Company will not continue to be adversely affected by the previous incompatibility issues or that other technological changes in the communications industry will not similarly affect the Company, its results of operations or financial condition. Competitive Threat from Microsoft and Other Operating Systems. The Company faces competition from Microsoft, which dominates the personal computer software industry. Due to its market dominance and the fact that it is the publisher of the most prevalent personal computer operating platforms, DOS and Windows, Microsoft represents a significant competitive threat to all personal computer software vendors, including the Company. In addition, Windows 95 and Windows NT, the latest Microsoft operating systems, include capabilities now provided by certain of the Company's OEM and retail software products, including the Company's principal product, QuickLink. If the communications capabilities of Windows 95, Windows NT or other operating systems are adopted by users, sales of the Company's products could decline. The Company is uncertain of the level of communication capabilities that will be included in Microsoft's pending release of Windows 98. The communication capabilities of Windows 98 may adversely affect the purchasing decisions of OEMs and end users with regards to the Company's communication software products. If so, sales of the Company's products could be adversely affected. 17 18 Competition. The markets in which the Company operates are highly competitive and subject to rapid changes in technology. The strategic directions of major personal computer hardware manufacturers and operating system developers are also subject to changes. The Company competes with other software vendors for access to distribution channels, retail shelf space and the attention of customers. The Company also competes with other software companies in its efforts to acquire software technology developed by third parties. These factors may result in increased price competition. Additionally, there can be no assurance that competitors will not develop or acquire products that are superior to the Company's products or that achieve greater market acceptance. The Company's retail products face significant competition. For example, HotFax MessageCenter and HotFax, the Company's principal retail products, compete directly with Symantec's WinFax Pro 8.0. Symantec is well established in the retail distribution channel. There can be no assurance that HotFax MessageCenter, HotFax, AudioVision, VideoLink Mail Pro, HotPage or any other of the Company's retail product lines will capture a significant share of the retail market for communication software. In addition, the Company's retail video conferencing product, AudioVision, competes in a new and rapidly changing software market. Some of the current competitors in the video conferencing retail software market are White Pine and VocalTech, and there can be no assurance that the Company will compete successfully with these and any future competitors in the retail video conferencing software market. In the OEM distribution channel, the Company has several competitors, among them Symantec, Cheyenne, White Pine and VDONet. Some of the Company's competitors have a retail emphasis and offer OEM products with a reduced set of features. The opportunity for retail upgrade sales may induce these and other competitors to make OEM products available at their own cost or even at a loss. Such a pricing strategy could have an adverse affect on the Company's business, results of operations and financial condition. Symantec currently makes certain complementary products that are sold separately. Symantec may be able to enhance its competitive position by bundling certain of these products to attract customers seeking integrated, cost-effective software applications. The Company also believes that the market in which it competes has been characterized by the consolidation of established communication software suppliers and that this trend, which may lead to the creation of additional large and well-financed competitors, may continue. In addition, other competitors have entered the market. Moreover, because there are low barriers to entry into the software market, the Company believes that competition will increase in the future. To remain competitive, the Company believes that it will need to make continuing investments in research and development and sales and marketing. There can be no assurance that the Company will have sufficient resources to make such investments, or that it will be successful in its research and development or sales and marketing efforts. Symantec and many of the Company's current and prospective competitors have significantly greater financial, marketing, service, support, technical and other resources than the Company. Moreover, these companies may introduce additional products that are competitive with those of the Company, and there can be no assurance that the Company's products would compete effectively with such products. The Company believes that its ability to compete depends on elements both within and outside its control, including the success and timing of new product development, product performance and price, distribution and customer support and introduction by the Company and its competitors of new products. There can be no assurance that the Company will be able to compete successfully with respect to these and other factors. The Company believes that the market for its software products has been and will continue to be characterized by significant price competition. A material reduction in the price of the Company's products could negatively affect the Company's profitability. Many of the Company's existing and potential OEM customers are major manufacturers of modems and have substantial technological capabilities. These customers may currently be developing, or may in the future develop, products that compete directly with the Company's products and may, therefore, discontinue purchases of the Company's products. The Company's future performance is substantially dependent upon the extent to which existing OEM customers elect to purchase communication software from the Company rather than design and develop their own software. In light of the fact that the Company's customers are not contractually obligated to purchase any of the Company's products, there can be no assurance that the Company's existing OEM customers will continue to rely, or expand their reliance, on the Company as an external source for communication software. 18 19 Dependence on New Product Offerings. The Company's future success will depend, in significant part, on its ability to successfully develop and introduce new software products and improved versions of existing software products on a timely basis and in a manner that will allow such products to achieve broad customer acceptance. There can be no assurance that new products will be introduced on a timely basis, if at all. If new products are delayed or do not achieve market acceptance, the Company's business, results of operations and financial condition will be materially adversely affected. In the past, the Company has experienced delays in purchases of its products by customers anticipating the launch of new products by the Company. There can be no assurance that material order deferrals in anticipation of new product introductions will not occur. There can also be no assurance that the Company will be successful in developing, introducing on a timely basis and marketing such software or that any such software will be accepted in the market. Retail Product Strategy Unproven. The Company's revenues have historically been generated almost entirely on the strength of its OEM sales. The Company has developed retail products with expanded functionality from its OEM products and expects to introduce other products in the retail distribution channel as well. The Company's ability to maintain distributor and retailer relationships is largely a function of volumes. If the Company does not meet certain minimum volume requirements, it will not be able to maintain its relationships. The Company continues to work on strengthening product recognition and distribution and there can be no assurance that the Company's retail marketing plan will succeed. Further, while retail products provide higher unit revenues than OEM products, retail distribution entails significantly higher costs. These costs include advertising, trade shows, public relations and the expenses related to the development and maintenance of a sales force dedicated to the retail distribution effort. Accordingly, there can be no assurance that retail sales will provide the margins that the Company has been able to achieve on its OEM sales or that distributor and retailer minimum volume requirements will be met. In implementing its retail sales strategy, the Company relies on distributors, retailers, internet distributors and value added resellers (collectively, "resellers") for the marketing and distribution of HotFax MessageCenter, HotFax, AudioVision, VideoLink Mail Pro, HotPage and its other retail products. The Company's agreements with resellers are not exclusive and in many cases may be terminated by either party without cause. Many of the Company's resellers carry product lines that are competitive with those of the Company. There can be no assurance that these resellers will give a high priority to the marketing of the Company's products or that resellers will continue to carry the Company's products. These resellers typically are allowed to return products without charge or penalty. A component of the Company's revenue recognition policy is that the Company calculates an allowance for product returns based on its historical experience. If retail sales of the Company's products increase, the risk of product returns will increase. While the Company's revenue recognition policy contemplates this risk, it is possible that returns may occur in excess of the Company's previous experience, causing the Company to revise its estimates and increase the allowances for such returns. Excessive or unanticipated returns could materially adversely affect the Company's business, results of operations and financial condition. The Company's results of operations could also be materially adversely affected by changes in reseller inventory strategies, which could occur rapidly, and in many cases, may not be related to end user demand. There can be no assurance that the Company will be successful in recruiting resellers to represent it. Any of these anticipated changes in the Company's distribution channels could materially adversely affect the Company's business, results of operations and financial condition. Corporate and Government Product and Marketing Strategy Unproven. The Company's revenues have historically been generated almost entirely on the strength of its OEM sales. Since the second quarter of 1997 the Company has been adding, and plans to continue to add, the infrastructure necessary to support a focus on the corporate and government markets. In January 1998, the Company acquired network fax software technology from Mitek Systems, Inc. as a part of its strategy to address this market. The corporate market includes vertical applications that are industry specific and require the investment of engineering resources. There can be no assurance that the additional infrastructure required in sales and marketing to the corporate and government markets, or the investment in engineering resources for applications specific to such markets, will yield significant sales growth for the Company or provide the margins the Company has achieved historically on its OEM sales. Potential for Undetected Errors. Software products as complex as those offered by the Company may contain undetected errors. The Company has in the past discovered software errors in certain of its products and has 19 20 experienced delayed or lost revenues during the period required to correct these errors. There can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found in new or existing products after commencement of commercial shipments, resulting in loss of or delay in market acceptance or the recall of such products, which could have a material adverse effect upon the Company's business, results of operations and financial condition. The Company provides customer support for most of its products. The Company is preparing to launch several new products. If these products are flawed or are more difficult to use than traditional Company products, customer support costs could rise and customer satisfaction levels could fall. Pre-Load and Royalty Based Software Market. The Company primarily sells its software in a form that includes a disk and a manual. Some of the Company's customers "pre-load" the Company's software onto a CD, diskette or the hard drive of a personal computer and pay a royalty based on units produced or shipped. These arrangements eliminate the need for a disk and may eliminate the need for a manual. The pre-load arrangements produce smaller unit revenues for the Company and eliminate the Company's ability to generate revenues from its production facilities. The Company believes these facilities contribute profits to the Company. Currently, the Company has the capability to produce its products in-house on 3 1/2-inch diskettes. The Company does not currently have the capability to produce CD-ROMs and the cost to develop such production capability may be prohibitive. As the size of software programs grow, CD-ROM is becoming a more prominent medium. The Company currently contracts CD-ROM production to specialized CD-ROM facilities. In the event of a shift of this kind, more of the Company's relationships would involve product pre-loads and CD-ROM production and the Company's business, results of operations and financial condition could be adversely affected. Acceptance of Video Related Products. The Company's video communication software sales volume has achieved only modest growth and has not become a significant part of net revenues. Video communication software products compete in a new and rapidly changing market and there can be no assurance that such products will receive or gain market acceptance. Lack of market acceptance of such products, or delays in or non-completion of the development of new video communication software products, could have an adverse impact on the Company's business, results of operations and financial condition. In addition, video communication software products compete against those of several competitors, including White Pine, Connectix, Intel, Microsoft, VocalTech and VDONet, some of whom have greater financial and other resources than the Company, and there can be no assurance that the Company will be able to compete successfully against these and any future competitors in the video conferencing software market. Dependence Upon Key Personnel. The Company's future performance depends in significant part upon the continued service of William Smith and Rhonda Smith, the Company's co-founders, and other key technical and senior management personnel. The Company is dependent on its ability to identify, hire, train, retain and motivate high quality personnel, especially highly skilled engineers involved in the ongoing research and development required to develop and enhance the Company's communication software products and introduce enhanced future applications. The industry is characterized by a high level of employee mobility and aggressive recruiting of skilled personnel. There can be no assurance that the Company's current employees will continue to work for the Company. Loss of services of key employees could have a material adverse effect on the Company's business, results of operations and financial condition. In addition, the Company may need to grant additional options and provide other forms of incentive compensation to attract and retain key personnel. Fluctuations in Gross Margins. The Company has experienced fluctuations in gross margins from quarter to quarter, primarily as a result of changes in the mix of retail and OEM sales. Other factors that can contribute to margin fluctuations are inventory obsolescence as a result of new retail product releases and return of retail product, price competition, expediting costs, and changes in OEM sales mix and the related variances in OEM product pricing. An erosion of the gross margins as a result of any of the aforementioned reasons or for any other reasons not contemplated by the Company at this time, could have a material adverse affect on the Company's operating results. Duplication of Software. The Company duplicates all of its diskette software at its Aliso Viejo, California facility. The Company believes that its internal duplication capability provides it with a competitive advantage since it 20 21 eliminates the profit margin required by outside duplication sources and enables a high degree of scheduling control. This concentration of production does, however, expose the Company to the risk that production could be disrupted by natural disaster or other events, such as the presence of a virus in the Company's duplicators. The Company believes that it could retain outside duplication alternatives quickly, but there is no assurance that it could do so or, if such arrangements could be made, that duplication could take place in an economical or timely manner. When CD-ROMs are required, the Company uses outside third parties for CD-ROM replication. The equipment to replicate CD-ROMs is very costly making it unlikely that the Company will add this capability internally. Because the Company is dependent on CD-ROM replication facilities for both the timing and pricing of the software produced in CD-ROM format, any adverse changes in the timing of such replication could impair the Company's ability to deliver products to customers and any price increases could reduce gross margins which, in each case, could have a material adverse effect on the Company's business, results of operations and financial condition. Reliance on Third Party Suppliers; Shortage of Modem Chips. The Company relies on third party suppliers who provide the components used in its kitted products. These components include disks, CDs and printed manuals. Disk shortages have occurred in the past and there can be no assurance that shortages will not recur. If the Company cannot obtain a sufficient quantity of disks or other components, or cannot obtain disks or other components at prices at least comparable to prices paid currently, the Company's business, results of operations and financial condition could be adversely affected. Modem manufacturers purchase chips from a relatively limited number of chip manufacturers. Production problems or product quality problems experienced by a chip manufacturer could reduce modem sales or slow the growth of modem sales. Chip manufacturers have a limited capacity to produce chips. This capacity cannot be quickly expanded and the capital investment to expand capacity is high. If chip suppliers are unable to meet demand, the growth of modem sales will slow. International Sales. The Company presently operates in foreign markets and intends to expand its international presence. As a percentage of total net revenues, international net revenues increased to 24.3% during the twelve months ended December 31, 1997 from 14.4% for the twelve months ended December 31, 1996. Net revenues generated outside the United States remained constant at approximately $2.9 million for the twelve months ended December 31, 1997 and 1996. International business is subject to risks in addition to those inherent in the Company's United States business including substantially different regulatory requirements in different jurisdictions, varying technical standards, tariffs and trade barriers, political and economic instability, reduced protection for intellectual property rights in certain countries, difficulties in staffing and maintaining foreign operations, difficulties in managing distributors, potentially adverse tax consequences, foreign currency exchange fluctuations, the burden of complying with a wide variety of complex foreign laws and treaties and the possibility of difficulties in collecting accounts receivable. There can be no assurance that the Company will be able to continue to generate significant international sales. While the Company does not currently accept payment in foreign currencies and invoices all of its sales in U.S. dollars, there can be no assurance that the Company will be able to continue this policy if it is able to grow international sales. If the Company begins to receive payment in foreign currencies, it is likely to be subjected to the risks of foreign currency losses due to fluctuations in foreign currency exchange rates. In addition, in the event the Company is successful in doing business outside of the United States, the Company may also face economic, political and foreign currency situations that are substantially more volatile than those commonly experienced in the United States. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, results of operations and financial condition. Intellectual Property Rights. The Company's success is dependent upon its software code base, its programming methodologies and other intellectual properties. To protect its proprietary technology, the Company relies on a combination of trade secret, nondisclosure and copyright and trademark law which may afford only limited protection. The Company owns United States trademark registrations for certain of its trademarks, including QuickLink Gold, HotFax, HotPage, HotLine, HotDesk and CrossConnect but has not yet obtained registrations for all of its trademarks in the United States or other countries, such as for the mark QuickLink. Prior to becoming a publicly held entity, the Company did not require its employees to sign proprietary information and inventions agreements stipulating, among other things, software ownership rights. In addition, the Company has recently 21 22 started the patent application process for a number of technologies that could provide additional protection for existing products and products under development. There can be no assurance that the steps taken by the Company will be adequate to deter misappropriation of its proprietary information or will prevent the successful assertion of an adverse claim to software utilized by the Company or that the Company will be able to detect unauthorized use and take effective steps to enforce its intellectual property rights. In selling its products, the Company relies primarily on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to as great an extent as do the laws of the United States. There can be no assurance that the Company's means of protecting its proprietary rights will be adequate or that the Company's competitors will not independently develop similar technology. Further, although the Company believes that its services and products do not infringe on the intellectual property rights of others, there can be no assurance that such a claim will not be asserted against the Company in the future. The failure of the Company to protect its proprietary information could have a material adverse effect on the Company's business, results of operations and financial condition. From time to time, the Company has received and may receive in the future communications from third parties asserting that the Company's trade name or features, content, or trademarks of certain of the Company's products infringe upon intellectual property rights held by such third parties. Should there be a successful challenge to the Company's use of any of its trademarks, the Company could incur significant expenses in connection therewith and experience a loss of goodwill related thereto. The Company has received correspondence from third parties separately asserting that the Company's fax products may be violative of certain patents held by each of the parties. No litigation has been initiated by these parties and the Company is attempting to resolve all such assertions. As the number of trademarks, patents, copyrights and other intellectual property rights in the Company's industry increases, and as the coverage of these patents and rights and the functionality of products in the market further overlap, the Company believes that products based on its technology may increasingly become the subject of infringement claims. Such claims could materially adversely affect the Company, and may also require the Company to obtain one or more licenses from third parties. There can be no assurance that the Company would be able to obtain any such required licenses upon reasonable terms, if at all, and the failure by the Company to obtain such licenses could have a material adverse effect on its business, results of operations and financial condition. In addition, the Company licenses technology on a non-exclusive basis from several companies for inclusion in its products and anticipates that it will continue to do so in the future. The inability of the Company to continue to license these technologies or to license other necessary technologies for inclusion in its products, or substantial increases in royalty payments under these third party licenses, could have a material adverse effect on its business, results of operations and financial condition. Litigation in the software development industry has increasingly been used as a competitive tactic both by established companies seeking to protect their existing position in the market and by emerging companies attempting to gain access to the market. If the Company is forced to defend itself against a claim, whether or not meritorious, the Company could be forced to incur substantial expense and diversion of management attention, and may encounter market confusion and reluctance of customers to purchase the Company's software products. Year 2000 Compliance. Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used in many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the computer industry concerning the potential effects associated with such compliance. The Company currently offers software products that are designed to be Year 2000 compliant. However, there can be no assurance that such products do not contain undetected errors or defects associated with Year 2000 date functions. 22 23 The Company has received confirmation from vendors of certain purchased software used for internal operations that current releases or upgrades are designed to be Year 2000 compliant, if installed. The Company is in the process of determining whether to upgrade the current system or purchase a new system that is designed to be Year 2000 compliant. The Company anticipates that all internally used software will be designed to be Year 2000 compliant prior to operational requirements for Year 2000 data. The Company currently believes that becoming Year 2000 compliant will not have a significant impact on the financial position or results of operations of the Company. Although the Company is not aware of any material operational issues or costs associated with preparing its software products or internal information systems for the year 2000, there can be no assurances that the Company will not experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in the technology used in its internal systems, which are composed predominantly of third party software and hardware. Concentration of Ownership. As of March 24, 1998, William Smith and Rhonda Smith beneficially owned, as community property, approximately 69.5% of the outstanding shares of the Company. William Smith and Rhonda Smith are married to one another and, acting together, will have the ability to elect the Company's directors and determine the outcome of any corporate action requiring stockholder approval, irrespective of how other stockholders of the Company may vote. This concentration of ownership may have the effect of delaying or preventing a change in control of the Company. Potential Effect of Anti-Takeover Provisions. The Company's Certificate of Incorporation and Bylaws contain provisions that may discourage or prevent certain types of transactions involving an actual or potential change in control of the Company, including transactions in which the stockholders might otherwise receive a premium for their shares over then current market prices, and may limit the ability of the stockholders to approve transactions that they may deem to be in their best interest. In addition, the Board of Directors has the authority to fix the rights and preferences of shares of the Company's Preferred Stock and to issue such shares, which may have the effect of delaying or preventing a change in control of the Company, without action by the Company's stockholders. Certain provisions of Delaware law applicable to the Company, including Section 203 of the Delaware General Corporation Law, could also have the effect of delaying, deferring or preventing a change of control of the Company. It is possible that the provisions in the Company's Certificate of Incorporation and Bylaws, the ability of the Board of Directors to issue the Company's Preferred Stock, and Section 203 of the Delaware General Corporation Law may have the effect of delaying, deferring or preventing a change of control of the Company without further action by the stockholders, may discourage bids for the Company's Common Stock at a premium over the market price of the Common Stock and may adversely affect the market price of the Common Stock and the voting and other rights of the holders of Common Stock. Possible Volatility of Stock Price. The trading price of the Common Stock is likely to be subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant orders, changes in management, announcements of technological innovations or new products by the Company, its customers or its competitors, legislative or regulatory changes, general trends in the industry and other events or factors. In addition, the stock market has experienced extreme price and volume fluctuations which have particularly affected the market price for many high technology companies similar to Smith Micro, and which have often been unrelated to the operating performance of these companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. Further, factors such as announcements of new contracts or product offerings by the Company or its competitors and market conditions for stocks similar to that of the Company could have significant impact on the market price of the Common Stock. Shares Eligible for Future Sale. No prediction can be made as to the effect, if any, that future sales of Company Common Stock or the availability of such Common Stock for future sales will have on the market price of the Company's Common Stock. As of March 24, 1998, the Company had 14,074,698 shares of Common Stock outstanding. Of this amount, the 9,781,670 shares held by William Smith and Rhonda Smith became available for sale in the public market (subject to the volume and other applicable restrictions of Rule 144) following the 23 24 expiration in September 1997 of a two year lock-up agreement with certain representatives of the underwriters of the Company's initial public offering which consummated in September 1995. Sales of a substantial number of shares of Common Stock by William Smith, Rhonda Smith or any other person, either individually or when aggregated with sales by other persons, could adversely affect the market price of the Common Stock. ITEM 2. PROPERTIES The Company's principal administrative, sales and marketing, customer support and research and development facility is located in approximately 33,000 square feet of space in Aliso Viejo, California. This facility is leased by the Company through March 31, 2003. The Company also leases a facility of approximately 3,600 square feet in Beaverton, Oregon pursuant to a lease which extends through February 28, 2000, a facility of approximately 1,500 square feet in Boulder, Colorado pursuant to a lease which extends through May 31, 1998, a facility of approximately 1,500 square feet in Calgary, Alberta pursuant to a lease that extends through July 31, 1999 and a facility of approximately 900 square feet in Plano, Texas, pursuant to a lease which extends through June 30, 1998. The Company believes that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed. ITEM 3. LEGAL PROCEEDINGS The Company and its PCI Video Products, Inc. subsidiary ("PCI Video") have been named parties to a lawsuit, Virtual Ambiance, Inc. v. Video Conferencing Communications. Inc., et al., filed August 11, 1997 in the Superior Court of the State of California for the County of Orange, Case No. 782856. The complaint alleges causes of action against the Company and PCI Video for negligent misrepresentation, fraud, declaratory relief, breach of covenant of good faith and fair dealing, and civil conspiracy, involves a dispute over the licensing of video conferencing software, and seeks consequential and punitive damages against all defendants. The Company and PCI Video demurred to the complaint, and the court on March 24, 1998 dismissed the causes of action for declaratory relief and breach of the covenant of good faith and fair dealing, and ordered the plaintiff to amend its remaining causes of action to conform with state pleading requirements. Accordingly, the Company and PCI Video have not answered the complaint. The Company and PCI Video believe the claims against them lack any merit and have no factual basis. The Company and PCI Video are vigorously defending the case and intend to continue to do so. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of stockholders during the quarter ended December 31, 1997. 24 25 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION The Company's Common Stock is traded on the Nasdaq National Market under the symbol "SMSI." The high and low closing sale prices for the Company's Common Stock as reported by Nasdaq are set forth below for the periods indicated.
High Low --------- -------- YEAR ENDED DECEMBER 31, 1997: First Quarter $ 5 1/2 $ 2 7/8 Second Quarter 4 1/2 2 Third Quarter 3 1/2 1 7/8 Fourth Quarter 3 7/8 1 5/8 YEAR ENDED DECEMBER 31, 1996: First Quarter 9 3/4 5 1/2 Second Quarter 16 7/8 8 3/8 Third Quarter 12 1/4 5 1/8 Fourth Quarter 6 1/4 4 3/4 YEAR ENDED DECEMBER 31, 1995: Third Quarter (from September 19, 1995) 14 1/2 9 7/8 Fourth Quarter 13 1/2 5 1/4
On March 24, 1998, the closing sale price for the Company's Common Stock as reported by Nasdaq was $3.50. HOLDERS As of March 24, 1998, there were 85 holders of record of the Company's Common Stock. DIVIDENDS The Company has never paid any cash dividends on its Common Stock and has no current plans to do so. 25 26 USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING The effective date of the Company's first registration statement (the "Registration Statement") filed on Form S-1 (Registration No. 33-95096) under the Securities Act of 1993, as amended, was September 18, 1995. The class of securities registered was Common Stock. The offering commenced on September 19, 1995 and all securities were sold in the offering. The managing underwriters for the offering were Hambrecht & Quist LLC and Oppenheimer & Co., Inc. Pursuant to the Registration Statement, the Company sold 1,700,000 shares of its Common Stock for an aggregate offering price of $20,400,000, and certain selling stockholders sold 2,210,000 shares of the Common Stock of the Company for an aggregate offering price of $26,520,000. The Company incurred expenses of $2,262,000 of which $1,428,000 represented underwriting discounts and commissions and $834,000 represented other expenses. All such expenses were direct or indirect payments to others. The net offering proceeds to the Company after total expenses were $18,138,000. As of December 31, 1997, of the net proceeds from the offering, $4,188,000 was used to repay amounts due under a promissory note issued by the Company to certain of its stockholders as a part of a distribution of retained earnings in connection with the Company's prior S corporation status, $3,011,000 was used in the Company's acquisition of Performance Computing Incorporated which was consummated in March 1996 and the remainder has been invested in U. S. Government obligations and corporate bonds. The use of the proceeds from the offering does not represent a material change in the use of the proceeds described in the prospectus which is part of the Registration Statement. 26 27 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data with respect to the Company's consolidated statements of operations for the years ended and consolidated balance sheets as of December 31, 1997, 1996, 1995 and 1994 are derived from the audited Consolidated Financial Statements of the Company. The following information should be read in conjunction with the Consolidated Financial Statements of the Company and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.
YEAR ENDED DECEMBER 31, -------------------------------------------- 1997 1996 1995 1994 -------- -------- -------- ------- (in thousands, except per share data) STATEMENT OF OPERATIONS DATA: Net revenues $11,684 $22,091 $18,012 $10,372 Cost of revenues 3,853 6,795 5,887 3,128 ------- ------- ------- ------- Gross profit 7,831 15,296 12,125 7,244 Operating expenses: Selling and marketing 3,525 2,939 1,995 1,559 Research and development 3,266 3,324 1,621 1,126 General and administrative 4,191 3,796 2,555 1,956 Acquired in-process research and development 5,169 ------- ------- ------- ------- Total operating expenses 10,982 15,228 6,171 4,641 ------- ------- ------- ------- Operating income (loss) (3,151) 68 5,954 2,603 Interest income 725 849 308 13 ------- ------- ------- ------- Income (loss) before income taxes (2,426) 917 6,262 2,616 Income tax expense (benefit) (1) (839) 2,436 810 49 ------- ------- ------- ------- Net income (loss) $(1,587) $(1,519) $ 5,452 $ 2,567 ======= ======= ======= ======= Net loss per share, basic and dilutive $ (0.11) $ (0.11) ======= ======= Pro forma net income (1) $ 3,757 ======= Pro forma net income per share, basic and dilutive (1) $ 0.30 ======= Weighted average shares used in computation 14,075 13,992 12,627 ======= ======= =======
AS OF DECEMBER 31, -------------------------------------------- 1997 1996 1995 1994 ------- ------- ------- ------ Balance Sheet Data: Total assets $21,755 $24,107 $23,662 $3,240 Total liabilities 1,512 2,277 3,417 608 Retained earnings (accumulated deficit) (1,021) 566 2,085 2,610 Total stockholders' equity 20,243 21,830 20,245 2,632
(1) Prior to the effective date of the initial public offering, the Company was treated as an S corporation pursuant to the Internal Revenue Code. Subsequent to the effective date of the initial public offering, the Company's tax status reverted to that of a C corporation. The pro forma information presented on the statement of operations data reflect a provision for income taxes in 1995 as if the Company had been taxed as a C corporation for the entire year, assuming effective tax rates that would have been in effect at such time. The principal difference between the effective pro forma tax rate and the statutory federal tax rate relates to state taxes and research and development tax credits. 27 28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Smith Micro, founded in 1982, develops and sells personal computer communication software. The Company's communication software products include fax, video conferencing, video email, telephony and data transmission products. The Company shipped its first data communication software product in 1985 and, since that time, the Company's revenues have been primarily the result of the market acceptance of its OEM fax and data communication software products. The Company began providing video communication products in 1996 to both OEM and retail customers. In January 1998, the Company purchased certain fax software assets of Mitek Systems, Inc. to provide LAN, Internet and intranet fax transmission solutions designed for the corporate market. The Company recognizes revenues from sales of its software as completed products are shipped and from royalties from customers who are authorized to duplicate the Company's software. Any material reduction in demand for the Company's products would have a material adverse effect on the Company's business, results of operations and financial condition. The Company has continued to expand its business by introducing new products and its future success will depend in part on the continued introduction of new and enhanced OEM, retail and corporate products that achieve market acceptance. Revenues are net of estimated returns and other adjustments at the time the products are shipped. The Company has allowed its customers to return unused software, constituting 26.8%, 16.8% and 2.3% of the Company's net revenues for 1997, 1996 and 1995, respectively. Returns include stock rotation for new versions of retail product releases that were 14.6%, 6.8% and 0.0% of the Company's net revenues for 1997, 1996 and 1995, respectively. A small number of customers have historically accounted for a substantial portion of the Company's revenues. In June 1997, 3Com Corporation ("3Com") acquired U.S. Robotics Corporation ("U.S. Robotics"), to date the Company's largest customer based on the percentage of revenues, as a wholly owned subsidiary. Sales to 3Com (primarily U.S Robotics and its subsidiaries), accounted for approximately 43.1%, 46.4% and 52.1% in 1997, 1996, and 1995, respectively. During 1997, 1996, and 1995, the Company's three largest OEM customers, including 3Com, accounted for 56.9%, 62.9% and 66.8%, respectively, of net revenues. Any reduction, delay or change in orders from such customers could have a material adverse affect on the Company's business, results of operations and financial condition. In April 1996, the Company entered into an OEM agreement having an initial one year term with a wholly-owned subsidiary of U.S. Robotics (now a subsidiary of 3Com). The agreement superseded a previous agreement between the parties and automatically renews at the end of each one year term unless a party provides at least 60 days notice of its intent to terminate the agreement at the end of the then-current term. During 1997, the agreement automatically renewed according to its terms and certain other 3Com entities (hereinafter 3Com, its affiliates and their subsidiaries will be referred to as "3Com" entities) were added as parties pursuant to new addenda to the agreement. Under the terms of the agreement, the Company granted certain pricing incentives to the 3Com entities in consideration for which the Company became the provider of fax, data, voice and telephony communications software for such 3Com entities. In addition, under the terms of the agreement, certain of the 3Com entities agreed to place Smith Micro retail products and commercials for such products on certain of their compact disks. The agreement does not require any 3Com entity to purchase any minimum quantity of Smith Micro products and may be terminated by a party thereto at any time for any reason upon 90 days prior written notice. While the Company believes that it has been the principal supplier of OEM communication software products to U.S. Robotics, there can be no assurance that the 3Com entities, including U.S. Robotics, will not seek additional sources for such products in the future. Accordingly, there can be no assurance that sales to the U.S. Robotics and the other 3Com entities to which the Company sells products in any future period will reach or exceed the historical levels of sales to U.S. Robotics. A substantial decrease or delay in sales to the 3Com entities would have a material adverse effect on the Company's business, results of operations and financial condition. 28 29 The OEM product ordering cycle beginning from placement of an order to shipping is very short. OEM customers generally operate under a just-in-time system and order software to be delivered as needed by their manufacturing operations. The Company's products are generally shipped as orders are received and, accordingly, the Company has historically operated with little backlog, and does not consider backlog to be a significant indication of future performance. As a result, sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. Moreover, the Company does not generally produce software in advance of orders and therefore has not maintained a material amount of inventory. Inventory in the retail channel exposes the Company to product returns. This exposure is considered when the allowance is made for product returns. Substantial returns of product from the retail channel could have a material adverse affect on the Company's business, results of operations and financial condition. The following discussion should be read in conjunction with, and is qualified in its entirety by, the Financial Statements and related notes thereto included elsewhere. Historical results of operations, percentage relationships and any trends that may be inferred from the discussion below are not necessarily indicative of the operating results for any future period. RESULTS OF OPERATIONS The following table sets forth for the periods indicated, the percentages of net revenues represented by each item in the Company's statement of income.
YEAR ENDED DECEMBER 31, ----------------------------------------------- 1997 1996 1995 1994 --------- --------- --------- --------- Net revenues 100.0% 100.0% 100.0% 100.0% Cost of revenues 33.0% 30.8% 32.7% 30.2% --------- --------- --------- --------- Gross profit 67.0% 69.2% 67.3% 69.8% Operating expenses: Selling and marketing 30.2% 13.3% 11.1% 15.0% Research and development 27.9% 15.0% 9.0% 10.8% General and administrative 35.9% 17.2% 14.2% 18.9% Acquired in-process research and development 23.4% --------- --------- --------- --------- Total operating expenses 94.0% 68.9% 34.3% 44.7% --------- --------- --------- --------- Operating income (loss) -27.0% 0.3% 33.0% 25.1% Interest income 6.2% 3.8% 1.7% 0.1% --------- --------- --------- --------- Income (loss) before income taxes -20.8% 4.1% 34.7% 25.2% Income tax expense (benefit) -7.2% 11.0% 4.5% 0.5% --------- --------- --------- -------- Net income (loss) -13.6% -6.9% 30.2% 24.7% ========= ========= ========= =========
1997 COMPARED TO 1996 Net Revenues Net revenues decreased 47.1% to $11.7 million for 1997 from $22.1 million for 1996. This decrease consisted of a 40.7% and 82.2% decrease in OEM and retail sales, respectively, in 1997 compared with 1996. The OEM decrease was the result of a combination of decreased unit volume that the Company believes was primarily driven by the lack of a 56K modem standard during 1997 and an increased percentage of net revenues resulting from royalty agreements. These reasons for the decrease were reflected in the decrease in revenue from 3Com and Motorola of 50.5% and 77.0%, respectively. The decrease in retail sales was primarily driven by slower than 29 30 anticipated sales of the video communication software product lines that the Company believes continues to be impacted by the consumer's lack of acceptance of current video technology and pricing. Gross Profit Gross profit represents net revenues, less cost of sales, which includes cost of materials, costs related to the operations of the Company's duplication facilities, freight charges and royalties to licensors. Gross profit decreased 48.8% to $7.8 million in 1997 from $15.3 million in 1996 and gross profit as a percentage of net revenues decreased to 67.0% in 1997 compared to 69.2% in 1996. An increased percentage of revenue from royalty agreements, cost control measures and increased manufacturing efficiencies helped the Company achieve only a slight decrease in gross profit percentage despite the 47.1% decrease in sales. Gross profits as a percentage of net revenues decreased primarily due to the decrease in net revenue, an increase in inventory write-offs resulting from releases of new version retail product releases during 1997 and an increase in royalty expenses primarily related to video products shipped. Operating Expenses Selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. Selling and marketing expenses increased 19.9% to $3.5 million in 1997 from $2.9 million in 1996. As a percent of net revenues, sales and marketing increased to 30.2% in 1997 from 13.3% in 1996. Sales and marketing expenditures increased primarily due to promotional campaigns in the retail channel during the first half of the year combined with an increase in personnel. Research and development expenses consist primarily of personnel and equipment costs required to conduct the Company's software development efforts. Research and development expenses remained constant at $3.3 million in 1997 compared to 1996. As a percentage of net revenues, research and development expenditures increased to 27.9% in 1997 from 15.0% in 1996. An increase in the amortization of purchased technologies related to video communication software was offset by a decrease in all other research and development expense categories. To date, the Company has not capitalized any software development expenses, since the Company's development efforts have been completed concurrently with the establishment of technological feasibility. However, significant new products developed in the future may require the capitalization of certain software development expenses. General and administrative expenses include expenses related to the general operations of the Company. General and administrative expenses increased 10.4% to $4.2 million in 1997 from $3.8 million in 1996. As a percentage of net revenues, general and administrative expenditures increased to 35.9% in 1997 from 17.2% in 1996. The Company's cost control efforts reduced general and administrative expenses in most categories, particularly salaries and benefits, however, this reduction was offset by an increase in bad debt reserves. Bad debt reserves were increased due to slower payment patterns from customers that were largely influenced by slower than anticipated sales of retail video communication software products. Income Taxes During 1997, the Company's income tax benefit was 34.6% of the loss before income taxes. Income tax benefit was $839,000 in 1997 and the income tax expense was $2.4 million in 1996. The effective tax rate during 1996 differed from the statutory federal rate of 35.0% principally because of nondeductible acquired in-process research and development costs of $1.8 million and state taxes. 30 31 1996 COMPARED TO 1995 Net Revenues Net revenues increased 22.6% to $22.1 million for 1996 from $18.0 million for 1995. This increase was due to increased retail and OEM sales. Net revenues from retail sales increased approximately 212% to $3.4 million in 1996 from $1.1 million in 1995. As a consequence, retail sales grew as a percentage of net revenues to 15.8% for 1996 from 5.8% for 1995. In addition, net revenues from sales to U.S. Robotics increased approximately 9% to $10.2 million in 1996 from $9.4 million in 1995. However, as a percentage of net revenues, sales to U.S. Robotics decreased to 46.4% during 1996 from 52.1% during 1995. Sales to Motorola increased 220% to $2.8 million in 1996 from $.9 million in 1995. Gross Profit Gross profit represents net revenues, less cost of sales, which includes cost of materials, costs related to the operations of the Company's duplication facilities, freight charges and royalties to licensors. Gross profit increased 26.2% to $15.3 million in 1996 from $12.1 million in 1995 and increased as a percentage of net revenues to 69.2% from 67.3% over the same periods. The increase in gross margins as a percentage of net revenues for 1996 was primarily due to the fact that retail sales as a percent of net revenues increased and, in addition, during 1996 the Company made arrangements with several of it's large OEM customers to charge for products on a royalty schedule instead of producing kitted products for them. Operating Expenses Selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. Sales and marketing expenses increased 47.3% to $2.9 million in 1996 from $2.0 million in 1995. As a percent of net revenues, sales and marketing increased to 13.3% in 1996 from 11.1% in 1995. Sales and marketing expenditures increased due to additional personnel, increased presence in trade shows, increased channel marketing programs, and increased print advertising campaigns. Additional channel marketing programs have been necessary as the company expands in the retail channel. Research and development expenses consist primarily of personnel and equipment costs required to conduct the Company's software development efforts. Research and development expenses increased 105% to $3.3 million in 1996 from $1.6 million for 1995. As a percentage of net revenues, research and development expenditures also increased to 15.0% in 1996 from 9.0% in 1995. This increase is attributed primarily to the additional personnel related to the acquisition of Performance Computing Incorporated in the first quarter of 1996. General and administrative expenses include expenses related to the general operations of the Company. General and administrative expenses increased 48.6% to $3.8 million in 1996 from $2.6 million in 1995. As a percentage of net revenues, general and administrative expenditures increased to 17.2% in 1996 from 14.2% in 1995. The increase in expenditures is due to the additional personnel in technical support, accounting and administrative functions who were added throughout the year. Income Taxes Prior to the Company's initial public offering in September 1995, the Company had been treated as an S corporation for federal and certain state income tax purposes. Income tax expense was $2.4 million and $810,000 for 1996 and 1995, respectively. Concurrent with the closing of the public offering, the Company recorded a deferred tax asset of $122,800 to reflect the deferred taxes of the Company as a C corporation. The pro forma net income for 1995 reflects a provision for income taxes assuming effective tax rates in effect for each period presented. This effective tax rate differs from the statutory federal rate of 34.0% principally because of state taxes and research and development credits. 31 32 LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company has financed its operations primarily through cash generated from operations. Net cash provided by operating activities was $102,000 and $4.5 million for 1997 and 1995, respectively. Net cash used in operations in 1996 was $288,000. The increase in cash provided by operations in 1997 was primarily due to a decrease in accounts receivable that was offset by a net loss for the year. The decrease in cash provided from operations in 1996 was primarily the result of increased accounts receivable and income taxes receivable, and increased operating costs, primarily in research and development expenditures. Net cash provided by operating activities for 1995 consisted primarily of net income and an increase in accrued liabilities, offset by an increase in accounts receivable. Cash used in investing activities was $222,000, $2.5 million and $384,000 for 1997, 1996 and 1995, respectively. Cash used in investing activities during 1997 and 1995 consisted primarily of the acquisition of property and equipment including the purchase of computers and production equipment with a similar amount spent in 1996. During 1996, however, the primary use of cash for investing activities related to the purchase of Performance Computing Incorporated in the first quarter of 1996. During 1997, the Company did not use or generate cash from financing activities. Net cash used in financing activities during 1996 was $1.8 million was primarily for the repayment of notes to founders. For 1995, net cash provided by financing activities was $14.3 million. This was related to the Company's initial public offering and was partially offset by distributions to the S corporation stockholders. At December 31, 1997, the Company had $14.4 million in cash and cash equivalents and $19.3 million of working capital. The Company had $3.8 million in accounts receivable, net of allowance for doubtful accounts and other adjustments. The Company currently anticipates that capital expenditures will not vary significantly from recent years. During early 1998, the Company used $420,000 in cash to acquire certain fax software providing fax over LANs, the Internet and intranets and related assets from Mitek Systems, Inc. The Company has no other significant capital commitments. YEAR 2000 COMPLIANCE Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, in less than two years, computer systems and/or software used in many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the computer industry concerning the potential effects associated with such compliance. The Company currently offers software products that are designed to be Year 2000 compliant. However, there can be no assurance that such products do not contain undetected errors or defects associated with Year 2000 date functions. The Company has received confirmation from vendors of certain purchased software used for internal operations that current releases or upgrades are designed to be Year 2000 compliant, if installed. The Company is in the process of determining whether to upgrade the current system or purchase a new system that is designed to be Year 2000 compliant. The Company anticipates that all internally used software will be designed to be Year 2000 compliant prior to operational requirements for Year 2000 data. The Company currently believes that becoming Year 2000 compliant will not have a significant impact on the financial position or results of operations of the Company. Although the Company is not aware of any material operational issues or costs associated with preparing its software products or internal information systems for the year 2000, there can be no assurances that the Company will not experience serious unanticipated negative consequences 32 33 and/or material costs caused by undetected errors or defects in the technology used in its internal systems, which are composed predominantly of third party software and hardware. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Company's consolidated financial statements and schedule, as listed under Item 14, appear in a separate section of this Annual Report on Form 10-K beginning on page F-1 and S-1, respectively. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE During the three years prior to the date of the most recent financial statements and the subsequent interim period, the Company has not had a change in its independent auditors nor have there been any disagreements between the Company and its independent auditors. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The sections titled "Executive Officers of the Company," "Directors and Nominees" and "Compliance with Section 16(a) of the Exchange Act" appearing in the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference ITEM 11. EXECUTIVE COMPENSATION The section titled "Executive Compensation and Related Information" appearing in the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The section titled "Principal Stockholders" appearing in the Company's Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. 33 34 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS The Company's financial statements appear in a separate section of this Annual Report on Form 10-K beginning on the pages referenced below:
PAGE Independent Auditors' Report....................................................................F-1 Consolidated Balance Sheets as of December 31, 1997 and 1996....................................F-2 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1997...........................................................F-3 Consolidated Statements of Stockholders Equity for each of the three years in the period ended December 31, 1997..................................................F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1997...............................................................F-5 Notes to Consolidated Financial Statements for each of the three years in the period ended December 31, 1997........................................................F-7
(2) FINANCIAL STATEMENT SCHEDULE The Company's financial statement schedule appears in a separate section of this Annual Report on Form 10-K on the pages referenced below. All other schedules have been omitted as they are not applicable, not required or the information is included in the consolidated financial statements or the notes thereto.
PAGE Independent Auditors' Report....................................................................S-1 Schedule II - Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 1997............................................................S-2
(3) EXHIBITS
Exhibit No. Title Method of Filing - -------- ----------------------------------- ------------------------------------------- 3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1 Incorporation of the Company to the Registrant's Registration Statement No. 33-95096 3.2 Amended and Restated Bylaws of the Incorporated by reference to Exhibit 3.2 Company. to the Registrant's Registration Statement No. 33-95096 4.1 Specimen certificate representing Incorporated by reference to Exhibit 4.1 shares of Common Stock of the to the Registrant's Registration Statement Company. No. 33-95096 10.1 Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement No. 33-95096 10.2 1995 Stock Option/Stock Issuance Incorporated by reference to Exhibit 10.2 Plan. to the Registrant's Registration Statement No. 33-95096
34 35
10.3 Form of Notice of Grant of Stock Incorporated by reference to Exhibit 10.3 Option under 1995 Stock Option/Stock to the Registrant's Registration Statement Issuance Plan. No. 33-95096 10.4 Form of 1995 Stock Option Agreement Incorporated by reference to Exhibit 10.4 under 1995 Stock Option /Stock to the Registrant's Registration Statement Issuance Plan. No. 33-95096 10.5 Form of 1995 Stock Purchase Incorporated by reference to Exhibit 10.5 Agreement under 1995 Stock to the Registrant's Registration Statement Option/Stock Issuance Plan. No. 33-95096 10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6 September 30, 1991, by and between to the Registrant's Registration Statement the Company and Crandell Development No. 33-95096 Corporation. 10.7 Application Program Interface Retail Incorporated by reference to Exhibit 10.7 License Agreement July 28, 1992 by to the Registrant's Registration Statement and between the Company and Rockwell No. 33-95096 International Corporation. 10.8 Application Program Interface Incorporated by reference to Exhibit 10.8 License Agreement July 28, 1992 by to the Registrant's Registration Statement and between the Company and Rockwell No. 33-95096 International Corporation. 10.9 Rockwell High Speed Interface Incorporated by reference to Exhibit 10.9 License Agreement dated June 2, to the Registrant's Registration Statement 1994, by and between the Company and No. 33-95096 Rockwell International Corporation. 10.10 Letter Agreement dated February 22, Incorporated by reference to Exhibit 10.10 1994, by and between the Company and to the Registrant's Registration Statement Rockwell International Corporation. No. 33-95096 10.11 Letter Agreement dated April 22, Incorporated by reference to Exhibit 10.11 1993, by and between the Company and to the Registrant's Registration Statement Rockwell International Corporation. No. 33-95096 10.12 Software Distribution Agreement Incorporated by reference to Exhibit 10.12 dated May 8, 1995, by and between to the Registrant's Registration Statement the Company and International No. 33-95096 Business Machines Corporation. 10.13 Office Building Lease, dated June Incorporated by reference to Exhibit 10.13 10, 1992, by and between the Company to the Registrant's Registration Statement and Developers Venture Capital No. 33-95096 Corporation. 10.14 Amendment No. 1 To Office Building Incorporated by reference to Exhibit 10.14 Lease, dated July 9, 1993, by and to the Registrant's Registration Statement between the Company and Pioneer Bank. No. 33-95096 10.15 Amendment No. 2 To Office Building Incorporated by reference to Exhibit 10.15 Lease, dated August 15, 1994, by and to the Registrant's Registration Statement between the Company and T&C No. 33-95096 Development.
35 36
10.16 Fourth Addendum to Office Building Incorporated by reference to Exhibit 10.16 Lease, dated April 21, 1995, by and to the Registrant's Registration Statement between the Company and T&C No. 33-95096 Development. 10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17 Corporation Distribution. to the Registrant's Registration Statement No. 33-95096 10.18 Smith Micro Software, Inc. Amended Incorporated by reference to Exhibit 10.21 and Restated Software Licensing and to the Registrant's Quarterly Report on Distribution Agreement, dated April Form 10-Q for the quarter ended September 18, 1996, by and between the Company 30, 1996 and U.S. Robotics Access Corp. 10.19 Office Building Lease, dated March Incorporated by reference to Exhibit 10.19 1, 1994, by and between Performance to the Registrant's Annual Report on Form Computing Incorporated and Petula 10-K for the fiscal year ended December Associates, Ltd./KC Woodside. 3l, 1995 10.20 Agreement and Plan of Merger by and Incorporated by reference to Exhibit 2 to between Smith Micro Software, Inc., the Registrant's Current Report on Form Performance Computing Incorporated 8-K filed with the Commission on March 28, and PCI Video Products, Inc. dated 1996 as of March 14, 1996. 10.21 Amendment No. 1, dated as of March Incorporated by reference to Exhibit 10.21 10, 1997, to Agreement and Plan of to the Registrant's Annual Report on Form Merger by and between Smith Micro 10-K for the fiscal year ended December Software, Inc., Performance 31, 1996 Computing Incorporated and PCI Video Products, Inc. dated as of March 14, 1996. 10.22 Amendment No. 6 to Office Building Filed Herewith Lease, dated February 19, 1998, by and between the Company and World Outreach Center. 23.1 Independent Auditors' Consent. Filed Herewith 27 Financial Data Schedule. Filed Herewith
(b) EXHIBITS ON FORM 8-K No Current Reports on Form 8-K were filed during the quarter ended December 31, 1997. 36 37 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SMITH MICRO SOFTWARE, INC. Date: March 27, 1998 By: /s/ William W. Smith, Jr. -------------------------------- William W. Smith, Jr. Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ William W. Smith, Jr. Chairman of the Board, March 27, 1998 - ----------------------------- President and Chief Executive Officer William W. Smith, Jr. (principal executive officer) /s/ Rhonda L. Smith Executive Vice President, Chief March 27, 1998 - ----------------------------- Operating Officer, Secretary, Rhonda L. Smith Treasurer and Director /s/ Robert W. Scheussler Senior Vice President, Chief March 27, 1998 - ----------------------------- Technical Officer, and Director Robert W. Scheussler /s/ Mark W. Nelson Vice President of Finance and Chief March 27, 1998 - ----------------------------- Financial Officer (principal Mark W. Nelson financial and accounting officer) /s/ Thomas G. Campbell Director March 27, 1998 - ----------------------------- Thomas G. Campbell /s/ F. Terry Eger Director March 27, 1998 - ----------------------------- F. Terry Eger
37 38 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Smith Micro Software, Inc.: We have audited the accompanying consolidated balance sheets of Smith Micro Software, Inc. and subsidiary (the Company) as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Smith Micro Software, Inc. and subsidiary as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California February 13, 1998 F-1 39 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1996 - ------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1997 1996 ASSETS CURRENT ASSETS: Cash and cash equivalents $14,367 $14,487 Accounts receivable, net of allowances for doubtful accounts and other adjustments of $1,413 (1997) and $1,822 (1996) 3,808 6,017 Income taxes receivable 1,127 520 Deferred tax asset (Note 5) 467 850 Inventories 553 561 Prepaid expenses and other current assets 503 415 ------- ------- Total current assets 20,825 22,850 EQUIPMENT AND IMPROVEMENTS, net (Note 3) 444 548 DEFERRED TAX ASSET (Note 5) 139 INTANGIBLE ASSETS, net (Note 10) 347 709 ------- ------- $21,755 $24,107 ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 877 $ 892 Accrued liabilities (Note 4) 635 1,223 ------- ------- Total current liabilities 1,512 2,115 DEFERRED TAX LIABILITY (Note 5) 162 COMMITMENTS AND CONTINGENCIES (Note 6) STOCKHOLDERS' EQUITY (Note 9): Preferred stock, par value $0.001 per share; 5,000,000 shares authorized; none issued and outstanding Common stock, par value $0.001 per share; 20,000,000 shares authorized; 14,075,000 shares issued and outstanding (1997 and 1996) 14 14 Additional paid-in capital 21,250 21,250 Retained earnings (accumulated deficit) (1,021) 566 ------- ------- Total stockholders' equity 20,243 21,830 ------- ------- $21,755 $24,107 ======= =======
See notes to consolidated financial statements. F-2 40 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 - -------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, -------------------------------------- 1997 1996 1995 NET REVENUES (Note 7) $11,684 $22,091 $18,012 COST OF REVENUES 3,853 6,795 5,887 ------- ------- ------- GROSS PROFIT 7,831 15,296 12,125 OPERATING EXPENSES: Selling and marketing 3,525 2,939 1,995 Research and development 3,266 3,324 1,621 General and administrative 4,191 3,796 2,555 Acquired in-process research and development (Note 10) 5,169 ------- ------- ------- Total operating expenses 10,982 15,228 6,171 ------- ------- ------- OPERATING INCOME (LOSS) (3,151) 68 5,954 INTEREST INCOME 725 849 308 ------- ------- ------- INCOME (LOSS) BEFORE INCOME TAXES (2,426) 917 6,262 INCOME TAX EXPENSE (BENEFIT) (Note 5) (839) 2,436 810 ------- ------- ------- NET INCOME (LOSS) $(1,587) $(1,519) $ 5,452 ======= ======= ======= NET LOSS PER SHARE, basic and dilutive $ (0.11) $ (0.11) ======= ======= PRO FORMA INFORMATION (unaudited) (Note 2): Historical income before income tax expense $ 6,262 Pro forma income tax expense 2,505 ------- PRO FORMA NET INCOME $ 3,757 ======= PRO FORMA NET INCOME PER SHARE, basic and dilutive $ 0.30 =======
See notes to consolidated financial statements. F-3 41 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 - -------------------------------------------------------------------------------- (IN THOUSANDS)
RETAINED COMMON STOCK ADDITIONAL EARNINGS -------------------- PAID-IN (ACCUMULATED SHARES AMOUNT CAPITAL DEFICIT) TOTAL BALANCE, January 1, 1995 12,000 $12 $ 10 $ 2,610 $ 2,632 Distributions to stockholders (5,977) (5,977) Issuance of common stock 1,700 2 18,136 18,138 Net income 5,452 5,452 ------ --- ------- ------- ------- BALANCE, December 31, 1995 13,700 14 18,146 2,085 20,245 Issuance of common stock in acquisition 350 2,944 2,944 Exercise of common stock options 25 160 160 Net loss (1,519) (1,519) ------ --- ------- ------- ------- BALANCE, December 31, 1996 14,075 14 21,250 566 21,830 Net loss (1,587) (1,587) ------ --- ------- ------- ------- BALANCE, December 31, 1997 14,075 $14 $21,250 $(1,021) $20,243 ====== === ======= ======= =======
See notes to consolidated financial statements. F-4 42 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 - ------------------------------------------------------------------------------- (IN THOUSANDS)
YEAR ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(1,587) $(1,519) $5,452 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Depreciation and amortization 688 452 218 Write-off of in-process research and development 5,169 Provision for doubtful accounts and other adjustments to accounts receivable (409) 1,304 122 Deferred income taxes 82 (648) (40) Change in operating accounts, net of amounts acquired: Accounts receivable 2,618 (3,723) (1,755) Income taxes receivable (607) (599) 79 Inventories 8 (118) (225) Prepaid expenses and other current assets (88) (197) (172) Accounts payable and accrued liabilities (603) (409) 795 ------- ------ ------- Net cash provided by (used in) operating activities 102 (288) 4,474 CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (222) (259) (384) Acquisition of Performance Computing, Inc. (2,211) ------- ------ ------- Net cash used in investing activities (222) (2,470) (384) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 160 18,138 Distributions to stockholders (3,840) Repayment of notes payable to founders (1,935) ------- ------ ------- Net cash (used in) provided by financing activities (1,775) 14,298 ------- ------ ------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (120) (4,533) 18,388 CASH AND CASH EQUIVALENTS, beginning of year 14,487 19,020 632 ------- ------- ------- CASH AND CASH EQUIVALENTS, end of year $14,367 $14,487 $19,020 ======= ======= =======
See notes to consolidated financial statements. F-5 43 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1996 1995 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION - Cash paid during the year for income taxes $206 $1,142 $771 ==== ====== ====
During 1996, the Company acquired a business in a transaction summarized as follows:
Acquired in-process research and development $5,169 Fair value of assets acquired 1,107 Value of common stock issued in transaction (2,944) Liabilities assumed or created (1,121) ------ Cash paid, net of cash acquired $2,211 ======
In conjunction with the initial public offering, the Company made S corporation distributions to its existing stockholders equal to all the previously undistributed S corporation earnings through the termination of the Company's S corporation status. The distribution of $2,137,000 was made in the form of two automobiles with a net book value of $202,000 and a promissory note payable of $1,935,000. The note payable was fully repaid in 1996. See notes to consolidated financial statements. F-6 44 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 - ------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business - Smith Micro Software, Inc. and subsidiary (the Company) develops, manufactures and distributes personal computer software to enable data, fax, voice and video teleconferencing communications using modems and IP devices. A substantial majority of the Company's sales are directly to modem and personal computer manufacturers under OEM agreements. The Company also sells its products through independent distributors and retail channels. The Company completed an initial public offering of its common stock on September 18, 1995. Basis of Presentation - The accompanying consolidated financial statements reflect the operating results and financial position of Smith Micro Software, Inc. and its wholly-owned subsidiary, PCI Video Products, Inc. (PCI), (previously Performance Computing, Inc.) acquired in March 1996 (Note 10). All significant intercompany amounts have been eliminated in consolidation. Cash Equivalents - Cash equivalents are considered to be highly-liquid investments with initial maturities of three months or less. Accounts Receivable - The Company sells its products worldwide. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses, and those losses have been within management's expectations. Allowances for product returns and price protection are included in other adjustments to accounts receivable on the accompanying balance sheets. Inventories - Inventories consist principally of manuals and diskettes and are stated at the lower of cost (determined by the first-in, first-out method) or market. Equipment and Improvements - Equipment and improvements are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets, generally ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term. Intangible Assets - Intangible assets relate primarily to goodwill, existing technology and noncompete agreements, which are amortized over periods ranging from three to five years. The Company assesses the recoverability of intangible assets at each balance sheet date by determining whether the amortization of the balance over its remaining useful life can be recovered through projected undiscounted future operating cash flows. Revenue Recognition - The Company recognizes revenues from sales of its software as completed products are shipped and from royalties from customers who are authorized to duplicate the Company's software as the individual duplication rights are granted. The Company generally allows F-7 45 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- its retail distributors to exchange unsold products for other products and provides inventory price protection in the event of price reductions by the Company. Allowances for product returns and price protection are estimated based on previous experience and are recorded as a reduction of revenue at the time sales are recognized. The Company provides technical support and customer services to its customers. Such costs have historically been insignificant. Income Taxes - The Company accounts for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company's financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax bases of the Company's assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Prior to the effective date of its initial public offering, the Company had elected to be treated as an S corporation under Subchapter S of the Internal Revenue Code of 1986, as amended, and comparable state tax laws. As a result of the termination of S corporation status in conjunction with the initial public offering, the Company became subject to federal and state income taxes at statutory C corporation rates, changed from a cash to accrual tax reporting basis and recorded a deferred tax asset of $123,000 to reflect the deferred tax items accruing to the Company as of the termination date (Note 5). Software Development Costs - Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. The Company considers technological feasibility to be established when all planning, designing, coding and testing has been completed according to design specifications. After technological feasibility is established, any additional costs are capitalized. Through December 31, 1997, software has been substantially completed concurrently with the establishment of technological feasibility; and, accordingly, no costs have been capitalized to date. Fair Value of Financial Instruments - Pursuant to SFAS No. 107, Disclosures about Fair Value of Financial Instruments, the Company is required to estimate the fair value of all financial instruments included on its balance sheet at December 31, 1997. The Company considers the carrying value of such amounts in the financial statements to approximate their fair value due to (1) the relatively short period of time between origination of the instruments and their expected realization, (2) interest rates which approximate current market rates, or (3) the overall immateriality of the amounts. F-8 46 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- Stock-Based Compensation - The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Net Income (Loss) Per Share - The Company has adopted SFAS No. 128, Earnings per Share (EPS), which replaces the presentation of "primary" earnings per share with "basic" earnings per share and the presentation of "fully diluted" earnings per share with "diluted" earnings per share. All previously reported EPS amounts have been restated based on the provisions of the new standard. Basic EPS amounts are based upon the weighted average number of common shares outstanding. Diluted EPS amounts are based upon the weighted average number of common and common equivalent shares outstanding. Common equivalent shares include stock options using the treasury stock method. Common equivalent shares are excluded from the calculation of diluted EPS in loss years, as the impact is antidilutive. There was no difference between basic and diluted EPS for each period presented. The number of shares used in computing EPS is as follows:
1997 1996 1995 Weighted average number of shares outstanding 14,075,000 13,992,000 12,484,000 Common stock equivalents 143,000 ---------- ---------- ---------- 14,075,000 13,992,000 12,627,000 =========== ========== ==========
Use of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting years. Actual results could differ from those estimates. Reclassification - Certain reclassifications have been made to the 1996 and 1995 financial statements to conform to the 1997 presentation. New Accounting Pronouncements - In June 1997, the Financial Accounting Standard Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income. This statement establishes standards for the reporting of comprehensive income and its components in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income, as defined, includes all changes in equity (net assets) during a period from nonowner sources. Examples of items to be included in comprehensive income, which are excluded from net income, include foreign currency translation adjustments and unrealized gain/loss on available-for-sale securities. The disclosures prescribed by SFAS No. 130 are effective beginning with the first quarter of calendar 1998. F-9 47 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- In June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. This statement establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosure about products and services, geographic areas and major customers. The Company has not yet determined the impact, if any, of adopting this new standard. The disclosures prescribed by SFAS No. 131 are effective for calendar 1998. In October 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which supersedes SOP 91-1. SOP 97-2 provides guidance on when revenue should be recognized and in what amounts for licensing, selling, leasing or otherwise marketing computer software. The provisions of SOP 97-2 that impact the Company are effective for financial statements for fiscal years beginning after December 15, 1997. The Company will adopt SOP 97-2 in fiscal 1998 and has not yet determined its impact. 2. UNAUDITED PRO FORMA INFORMATION Prior to the effective date of the initial public offering, the Company was treated as an S corporation pursuant to the Internal Revenue Code. Subsequent to the effective date of the initial public offering, the Company's tax status reverted back to that of a C corporation. The pro forma information presented on the statements of operations reflect a provision for income taxes as if the Company had been taxed as a C corporation for the entire year, assuming effective tax rates that would have been in effect at such time. The principal difference between the effective pro forma tax rate and the statutory federal tax rate relates to state taxes and research and development tax credits. F-10 48 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- 3. EQUIPMENT AND IMPROVEMENTS Equipment and improvements consist of the following (in thousands):
DECEMBER 31, ------------------- 1997 1996 Machinery and equipment $ 880 $1,057 Leasehold improvements 137 130 Office furniture and fixtures 239 232 ------ ------ 1,256 1,419 Less accumulated depreciation and amortization (812) (871) ------ ------ $ 444 $ 548 ====== ======
4. ACCRUED LIABILITIES Accrued liabilities consists of the following (in thousands):
DECEMBER 31, ------------------ 1997 1996 Salaries and benefits $463 $ 371 Cooperative advertising rebate 131 PCI acquisition costs (Note 11) 800 Other 41 52 ---- ------ $635 $1,223 ==== ======
F-11 49 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- 5. INCOME TAXES A summary of income tax expense (benefit) is as follows (in thousands):
YEAR ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 Current: Federal $(920) $2,471 $660 State (1) 613 190 ----- ------ ---- (921) 3,084 850 Deferred: Federal 202 (552) (30) State (120) (96) (10) ----- ------ ---- 82 (648) (40) ----- ------ ---- $(839) $2,436 $810 ===== ====== ====
A reconciliation of the effective tax rate from the federal statutory tax rate is as follows:
DECEMBER 31, -------------------------- 1997 1996 1995 Federal statutory rate (35)% 35% 35% State tax, net of federal benefit (3) 37 2 Nondeductible expense related to acquired intangibles 4 197 Re-establishment of deferred taxes due to change in tax status (2) Reduction on tax rate due to S corporation status (23) Other (1) (3) 1 ---- ---- --- (35)% 266% 13% ==== ==== ===
F-12 50 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- The major components of the Company's net deferred tax asset consist of the following (in thousands):
DECEMBER 31, ---------------- 1997 1996 Various reserves $ 632 $ 801 Nondeductible accruals 97 55 Accrual to cash adjustment (163) (281) State taxes (65) 174 Prepaid expenses (76) (61) Credit carryforwards 81 Net operating loss carryforwards 94 Other 6 ----- ----- $ 606 $ 688 ===== =====
6. COMMITMENTS AND CONTINGENCIES Leases - The Company has noncancelable operating leases for its building facilities. Future minimum rental commitments under leases with terms of one year or more consist of the following (in thousands):
Year ending December 31: 1998 $ 612 1999 618 2000 562 2001 566 2002 583 Thereafter 147 ------ $3,088 ======
Total rent expense was $539,000, $492,000 and $302,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Litigation - The Company is subject to litigation in the normal course of business, none of which management believes will have a material adverse effect on the Company's financial condition or results of operations as of December 31, 1997. F-13 51 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- 7. MAJOR CUSTOMERS AND EXPORT SALES Sales to individual customers or customers under common control which amounted to more than 10% of the Company's net revenues in the year indicated were as follows:
DECEMBER 31, ------------------------------ 1997 1996 1995 Customer: 1 - (OEM) 43.1% 46.4% 52.1% 2 - (OEM) 12.6 3 - (Retail) 11.8 ---- ---- ---- 43.1% 70.8% 52.1% ==== ==== ====
The Company has historically derived a significant portion of its revenues from a relatively small number of customers. A decision by a significant customer to substantially decrease or delay purchases from the Company or the Company's inability to collect receivables from these customers could have a material adverse effect on the Company's financial condition and results of operations. The Company also has international sales representing 24.3%, 14.4% and 16.6% of its net revenues for the years ended December 31, 1997, 1996 and 1995, respectively. All export sales have been denominated in U.S. dollars. 8. PROFIT SHARING During 1996 and 1995, the Company sponsored a profit sharing plan (the Profit Sharing Plan) for the benefit of all employees meeting certain age and service requirements. The Company made discretionary annual contributions to the Profit Sharing Plan amounting to approximately $68,000 and $100,000 for the years ended December 31, 1996, and 1995, respectively. During 1996, the Company converted the Profit Sharing Plan to a 401(k) plan, in which the Company matches the employee contribution at a rate of 20%, subject to a vesting schedule. Total employer contributions amounted to $49,000 for the year ended December 31, 1997. F-14 52 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- 9. STOCK-BASED COMPENSATION In 1995, the Company adopted the 1995 Stock Option/Stock Issuance Plan (the Plan). The Plan provides for issuance of, or options to be granted for the purchase of, an aggregate of 1,000,000 shares of common stock. Under the terms of the Plan, incentive and nonqualified options may be granted at an exercise price not less than 100% and 85%, respectively, of the fair market value on the grant date, with terms of up to 10 years, and with vesting to be determined by the Board of Directors. During 1997, the Company canceled 381,000 options held by certain employees and simultaneously issued 381,000 options to the same employees with a vesting period of two or three years depending upon the grant date of the options canceled. Stock option activity under the Plan is as follows:
WEIGHTED NUMBER AVERAGE OF SHARES EXERCISE PRICE OUTSTANDING, January 1, 1995 -- $ -- Granted (weighted average fair value of $2.55) 508,000 8.06 Canceled (57,000) 7.85 -------- OUTSTANDING, December 31, 1995 (0 exercisable) 451,000 8.08 Granted (weighted average fair value of $4.28 ) 335,000 7.70 Exercised (25,000) 6.40 Canceled (134,000) 8.64 -------- OUTSTANDING, December 31, 1996 (138,000 exercisable) 627,000 7.85 Granted (weighted average fair value of $2.12) 746,000 2.89 Canceled (565,000) 7.21 -------- OUTSTANDING, December 31, 1997 808,000 $3.72 ========
F-15 53 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- Additional information regarding options outstanding as of December 31, 1997 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------- ----------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED RANGE OF REMAINING AVERAGE AVERAGE EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE $2.88 - $3.13 683,000 9.6 $ 2.89 75,000 $2.88 $5.50 - $7.25 62,000 8.0 $ 6.07 54,000 $6.99 $9.07 - $14.00 63,000 7.8 $10.38 35,000 $11.28 ------- ------- 808,000 9.3 $ 3.72 164,000 $6.01 ======= =======
At December 31, 1997, 167,000 shares were available for future grants under the Stock Option Plan. Additional Stock Plan Information - As discussed in Note 1, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with APB Opinion No. 25 and its related interpretations. No compensation expense has been recognized in the financial statements for employee stock arrangements as all grants have been made at the fair market value of the underlying shares at the date of grant. SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net income (loss) and earnings per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, 48 months following vesting; stock volatility, 86% for grants issued in 1997, 50% for grants issued in 1996 and 0% prior to the Company's initial public offering in September 1995; risk-free interest rates, 5.9%, 6.0% and 6.2% in 1997, 1996 and 1995, respectively; and no dividends during the expected term. The Company's calculations are based on a single-option valuation approach, and forfeitures or cancellations are recognized as they occur. If the computed fair values of the 1997, 1996 and 1995 awards had been amortized to expense over the vesting period of the awards, pro forma net income (loss) would have been $(1,818,000), or $(.13) per share, in 1997, $(1,846,000), or $(.13) per share, in 1996 and $3,652,000, or $.29 per share, in 1995. F-16 54 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 (CONTINUED) - -------------------------------------------------------------------------------- 10. ACQUISITION On March 14, 1996, the Company completed its acquisition of PCI, an audio/video software solutions provider. In connection with the acquisition, all of the outstanding PCI shares were converted into the right to receive an aggregate of 350,000 shares of the Company's common stock, valued at $2,944,000, and $2,100,000 in cash with an additional $800,000 payable to the seller group contingent on the achievement of certain milestones. Such amount was accrued as part of the purchase price; all of the milestones were subsequently met and the entire amount was paid during 1997. The Company also incurred direct costs of approximately $111,000 related to the acquisition. The Company obtained an independent valuation of the net assets acquired in the purchase transaction which resulted in the allocation of the purchase price to $1,107,000 of identified assets, $321,000 of liabilities and $5,169,000 of in-process research and development. As the technological feasibility of the in-process research and development had not been established and such technology had no alternative future use, the acquired in-process research and development was expensed. In order to secure certain indemnification obligations of the sellers in the transaction, 60,000 of the shares of common stock issued are being held in an escrow account. The shares in escrow are being kept as security for future claims through March 14, 1998, or until such time as certain matters are fully resolved. The acquisition was accounted for using the purchase method of accounting, and PCI's operating results have been included in the accompanying consolidated statements of operations from the date of acquisition. The following unaudited pro forma information presents the consolidated results of operations for the year ended December 31, 1995 had the acquisition been consummated as of the beginning of 1995. Similar amounts for 1996 are not presented as the pro forma impact was insignificant. The pro forma information is not necessarily indicative of the results of operations that would have occurred nor of future results of the combined enterprise.
Pro forma net revenues $20,079,000 Pro forma net income $5,361,000 Pro forma net income per share $0.28
F-17 55 INDEPENDENT AUDITORS' REPORT To the Stockholders of Smith Micro Software, Inc.: We have audited the consolidated financial statements of Smith Micro Software, Inc. as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, and have issued our report thereon dated February 13, 1998, included elsewhere in this Annual Report on Form 10-K. Our audits also included the financial statement schedule listed in Item 14a(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole presents fairly, in all material respects, the information set forth therein. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California February 13, 1998 S-1 56 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1997 - -------------------------------------------------------------------------------- (IN THOUSANDS)
ADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING OF COSTS AND END OF PERIOD EXPENSES DEDUCTIONS PERIOD Allowance for doubtful accounts: 1997 $ 277 $ 589 $(268) $ 598 1996 210 561 (494) 277 1995 246 22 (58) 210 Allowance for other adjustments (1): 1997 1,545 1,746 (2,476) 815 1996 308 2,195 (958) 1,545 1995 150 573 (415) 308
(1) Other adjustments relate principally to sales returns. S-2 57
INDEX TO EXHIBITS Exhibit No. Title Method of Filing - -------- ----------------------------------- ------------------------------------------- 3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1 Incorporation of the Company to the Registrant's Registration Statement No. 33-95096 3.2 Amended and Restated Bylaws of the Incorporated by reference to Exhibit 3.2 Company. to the Registrant's Registration Statement No. 33-95096 4.1 Specimen certificate representing Incorporated by reference to Exhibit 4.1 shares of Common Stock of the to the Registrant's Registration Statement Company. No. 33-95096 10.1 Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1 to the Registrant's Registration Statement No. 33-95096 10.2 1995 Stock Option/Stock Issuance Incorporated by reference to Exhibit 10.2 Plan. to the Registrant's Registration Statement No. 33-95096 10.3 Form of Notice of Grant of Stock Incorporated by reference to Exhibit 10.3 Option under 1995 Stock Option/Stock to the Registrant's Registration Statement Issuance Plan. No. 33-95096 10.4 Form of 1995 Stock Option Agreement Incorporated by reference to Exhibit 10.4 under 1995 Stock Option /Stock to the Registrant's Registration Statement Issuance Plan. No. 33-95096 10.5 Form of 1995 Stock Purchase Incorporated by reference to Exhibit 10.5 Agreement under 1995 Stock to the Registrant's Registration Statement Option/Stock Issuance Plan. No. 33-95096 10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6 September 30, 1991, by and between to the Registrant's Registration Statement the Company and Crandell Development No. 33-95096 Corporation. 10.7 Application Program Interface Retail Incorporated by reference to Exhibit 10.7 License Agreement July 28, 1992 by to the Registrant's Registration Statement and between the Company and Rockwell No. 33-95096 International Corporation. 10.8 Application Program Interface Incorporated by reference to Exhibit 10.8 License Agreement July 28, 1992 by to the Registrant's Registration Statement and between the Company and Rockwell No. 33-95096 International Corporation. 10.9 Rockwell High Speed Interface Incorporated by reference to Exhibit 10.9 License Agreement dated June 2, to the Registrant's Registration Statement 1994, by and between the Company and No. 33-95096 Rockwell International Corporation. 10.10 Letter Agreement dated February 22, Incorporated by reference to Exhibit 10.10 1994, by and between the Company and to the Registrant's Registration Statement Rockwell International Corporation. No. 33-95096 10.11 Letter Agreement dated April 22, Incorporated by reference to Exhibit 10.11 1993, by and between the Company and to the Registrant's Registration Statement Rockwell International Corporation. No. 33-95096
58
Exhibit No. Title Method of Filing - -------- ----------------------------------- ------------------------------------------- 10.12 Software Distribution Agreement Incorporated by reference to Exhibit 10.12 dated May 8, 1995, by and between to the Registrant's Registration Statement the Company and International No. 33-95096 Business Machines Corporation. 10.13 Office Building Lease, dated June Incorporated by reference to Exhibit 10.13 10, 1992, by and between the Company to the Registrant's Registration Statement and Developers Venture Capital No. 33-95096 Corporation. 10.14 Amendment No. 1 To Office Building Incorporated by reference to Exhibit 10.14 Lease, dated July 9, 1993, by and to the Registrant's Registration Statement between the Company and Pioneer Bank. No. 33-95096 10.15 Amendment No. 2 To Office Building Incorporated by reference to Exhibit 10.15 Lease, dated August 15, 1994, by and to the Registrant's Registration Statement between the Company and T&C No. 33-95096 Development. 10.16 Fourth Addendum to Office Building Incorporated by reference to Exhibit 10.16 Lease, dated April 21, 1995, by and to the Registrant's Registration Statement between the Company and T&C No. 33-95096 Development. 10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17 Corporation Distribution. to the Registrant's Registration Statement No. 33-95096 10.18 Smith Micro Software, Inc. Amended Incorporated by reference to Exhibit 10.21 and Restated Software Licensing and to the Registrant's Quarterly Report on Distribution Agreement, dated April Form 10-Q for the quarter ended September 18, 1996, by and between the Company 30, 1996 and U.S. Robotics Access Corp. 10.19 Office Building Lease, dated March Incorporated by reference to Exhibit 10.19 1, 1994, by and between Performance to the Registrant's Annual Report on Form Computing Incorporated and Petula 10-K for the fiscal year ended December Associates, Ltd./KC Woodside. 3l, 1995 10.20 Agreement and Plan of Merger by and Incorporated by reference to Exhibit 2 to between Smith Micro Software, Inc., the Registrant's Current Report on Form Performance Computing Incorporated 8-K filed with the Commission on March 28, and PCI Video Products, Inc. dated 1996 as of March 14, 1996. 10.21 Amendment No. 1, dated as of March Incorporated by reference to Exhibit 10.21 10, 1997, to Agreement and Plan of to the Registrant's Annual Report on Form Merger by and between Smith Micro 10-K for the fiscal year ended December Software, Inc., Performance 31, 1996 Computing Incorporated and PCI Video Products, Inc. dated as of March 14, 1996. 10.22 Amendment No. 6 to Office Building Filed Herewith Lease, dated February 19, 1998, by and between the Company and World Outreach Center.
59
Exhibit No. Title Method of Filing - -------- ----------------------------------- ------------------------------------------- 23.1 Independent Auditors' Consent. Filed Herewith 27 Financial Data Schedule. Filed Herewith
EX-10.22 2 AMENDMENT NO. 6 TO OFFICE BUILDING LEASE 1 EXHIBIT 10.22 SIXTH AMENDMENT TO LEASE ------------------------ World Outreach Center (Landlord") and Smith Micro Software, Inc. ("Tenant"), hereby express their mutual desire and intent to extend the term of the lease and amend the following clauses for the lease at 51 Columbia, Suite 200, Aliso Viejo, California dated June 10, 1992 and modified previous in the "Amendment No. 1 to Office Building Lease", "Amendment #2 to Office Building Lease", Fourth Addendum to lease", and "Fifth Addendum to Lease", as of this 19th day of February 1998, 2. a. Base Rent: (See Rental Schedule) g. Expiration Date: The Lease shall expire March 31, 2003 FIRST ADDENDUM TO LEASE:
10. RENTAL SCHEDULE MONTHLY RENT --------------- ------------ 4/1/1998 - 3/31/1999 $43,513.61 4/1/1999 - 3/31/2000 $44,819.02 4/1/2000 - 3/31/2001 $46,163.59 4/1/2001 - 3/31-2002 $47,548.50 4/1/2002 - 3/31-2003 $48,974.95
All other terms and conditions of the above described lease and Amendments/Addendums shall remain in full force and effect. AGREED AND ACCEPTED "LANDLORD" "TENANT" BY: /s/ Peter C. Ireland BY: /s/ Mark Nelson DATE: March 6, 1998 DATE: March 15, 1998 EX-23.1 3 INDEPENDENT AUDITORS' CONSENT 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-02418 of Smith Micro Software, Inc. on Form S-8 of our report dated February 13, 1998, appearing in this Annual Report on Form 10-K of Smith Micro Software, Inc. for the year ended December 31, 1997. /s/ DELOITTE & TOUCHE LLP Costa Mesa, California March 27, 1998 EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 14,367 0 3,808 1,413 553 20,825 444 812 21,755 1,512 0 0 0 14 21,250 21,755 11,684 11,684 3,853 3,853 10,982 0 0 (2,426) (839) (1,587) 0 0 0 (1,587) (0.11) (0.11)
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