<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
--------------------
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 30, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-26536
SMITH MICRO SOFTWARE, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
--------------------
<TABLE>
<S> <C>
DELAWARE 33-0029027
-------- ----------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR
ORGANIZATION) IDENTIFICATION NUMBER)
51 COLUMBIA, SUITE 200, ALISO VIEJO, CA 92656
--------------------------------------- -----
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (714) 362-5800
--------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK,
$.001 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES (X) NO ( )
As of July 31, 1996, there were 14,074,700 shares of Common Stock
outstanding.
<PAGE> 2
SMITH MICRO SOFTWARE, INC.
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
PART I. FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 1996 (UNAUDITED) AND DECEMBER 31, 1995 3
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 1996 AND JUNE 30, 1995 4
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTH PERIODS ENDED
JUNE 30, 1996 AND JUNE 30, 1995 5
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 6
MANAGEMENT'S DISCUSSION AND ANALYSIS 8
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 22
ITEM 2. CHANGES IN SECURITIES 22
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 22
ITEM 5. OTHER MATTERS 22
ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K 22
SIGNATURES 24
</TABLE>
<PAGE> 3
PART I - FINANCIAL INFORMATION
SMITH MICRO SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1996 1995
----------- ------------
(UNAUDITED)
<S> <C> <C>
CURRENT ASSETS
Cash & Cash Equivalents . . . . . . . . . . . . . . . . . . . . . . $16,079 $19,020
Accounts Receivable, net of allowances for doubtful accounts
and other adjustments of $1,041 (1996) and $518 (1995) 4,399 3,400
Income Tax Receivable. . . . . . . . . . . . . . . . . . . . . . . . 468 -
Deferred Tax Asset . . . . . . . . . . . . . . . . . . . . . . . . . 40 40
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 509 443
Prepaids and Other Assets . . . . . . . . . . . . . . . . . . . . . 306 207
------- -------
Total Current Assets . . . . . . . . . . . . . . . . . . . . . . 21,801 23,110
Equipment and Improvements, net . . . . . . . . . . . . . . . . . . 631 552
Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . . . 505 -
------- -------
1,136 552
------- -------
TOTAL ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . $22,937 $23,662
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . $ 851 $ 908
Accrued Liabilities . . . . . . . . . . . . . . . . . . . . . . . . 1,208 495
Income Tax Payable . . . . . . . . . . . . . . . . . . . . . . . . . - 79
Distributions Payable to Shareholders . . . . . . . . . . . . . . . - 1,935
------- -------
Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . 2,059 3,417
COMMITMENTS AND CONTINGENCIES . . . . . . . . . . . . . . . . . . . . . . - -
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.001 per share: authorized
5,000,000 shares; none issued and outstanding - -
Common stock, par value $.001 per share: authorized
20,000,000 shares; issued and outstanding 14,074,700
(1996) and 13,700,000 (1995) . . . . . . . . . . . . . . . . . . . 14 14
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . 21,250 18,146
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . (386) 2,085
------- -------
Total Stockholder's Equity . . . . . . . . . . . . . . . . . . . . 20,878 20,245
------- -------
TOTAL Liabilities and Stockholders' Equity . . . . . . . . . . . . . . . $22,937 $23,662
======= =======
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE> 4
SMITH MICRO SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
(UNAUDITED) (UNAUDITED)
1996 1995 1996 1995
------- ------ ------- --------
<S> <C> <C> <C> <C>
Net Revenues . . . . . . . . . . . $6,016 $4,528 $13,306 $8,023
Cost of Sales . . . . . . . . . . . 1,864 1,415 4,763 2,483
----- ----- ----- -----
Gross Margin . . . . . . . . . . . 4,152 3,113 8,543 5,540
Operating Expenses:
Sales & Marketing . . . . . . . . 675 588 1,283 1,009
Research & Development . . . . . 948 498 1,452 791
General & Administrative . . . . 937 674 1,741 1,313
--- --- ----- -----
Total Operating Expenses . . . . . 2,560 1,760 4,476 3,113
Operating Income before acquired
R&D expenses . . . . . . . . . . 1,592 1,353 4,067 2,427
Acquired Research & Development
expense . . . . . . . . . . . . . - - 5,169 -
Other Income, net . . . . . . . . . 262 12 469 22
--- ----- ---- ----
Income (Loss) Before Income Tax . . 1,854 1,365 (633) 2,449
Income Tax Expense . . . . . . . . 743 19 1,838 34
----- -- ----- --
Net Income (Loss) . . . . . . . . . $1,111 $1,346 ($2,471) $2,415
====== ====== ======== ======
PROFORMA INFORMATION
Pro Forma Income prior to acquired
Research & Development
expenses. . . . . . . . . . . . . $1,854(A) $1,365 $4,536(A) $2,449
Provision for Income Taxes . . . . 743 508(B) 1,838 901(B)
Pro Forma Net Income (Loss) . . . . 1,111 857 2,698 1,548
Pro Forma Net Income (Loss) per
Share prior to acquired R&D
expenses. . . . . . . . . . . . . 0.08 0.07 0.19 0.12
Net Income (Loss) before
Taxes . . . . . . . . . . . . . . $1,854 $1,365 ($633) $2,499
Provision for Income Taxes . . . . 743 508(B) 1,838 901(B)
Pro Forma Net Income (Loss) . . . . 1,111 857 (2,471) 1,548
Pro Forma Net Income per Share
prior to acquired R&D expenses. . 0.08 0.07 (0.18) 0.12
Weighted Average Shares Outstanding 14,327 12,500 14,046 12,500
</TABLE>
Note A: During the first quarter of 1996, Smith Micro acquired Performance
Computing, Inc. This resulted in a one-time pre-tax charge in the quarter of
$5.169 million. Proforma income data is presented to show the comparable
business operations exclusive of this one-time charge.
Note B: Prior to the public offering of the Company's common stock, the Company
was taxed as an S Corporation for Federal and State tax purposes. Concurrent
with the public offering concluded in September, 1995, the Company began to be
taxed as a C Corporation. Pro Forma income data is presented to show the tax
provision as if the Company had been a C Corporation throughout all periods.
Pro Forma amounts for 1995 do not reflect a reduction in Founder's compensation
which was concurrent with the company going public.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE> 5
SMITH MICRO SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
(UNAUDITED)
-------- --------
1996 1995
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) . . . . . . . . . . . . . . ($2,471) $2,415
Adjustments to reconcile net income to net
cash provided by operating activities:
Writeoff of in process research and
development due to Performance Computing
Incorporated acquisition . . . . . . . . . . 5,169 -
Depreciation and Amortization . . . . . . . . 186 103
Provision for doubtful accounts and other
adjustments to accounts receivable . . . . 272 104
Change in Operating Accounts:
Accounts Receivable, net . . . . . . . . . (1,060) (693)
Income Tax Receivable . . . . . . . . . . . (468) -
Inventories . . . . . . . . . . . . . . . . (66) 41
Prepaid Expenses and Other Current . . . . (88) (6)
Accounts Payable . . . . . . . . . . . . . (165) 323
Accrued Liabilities . . . . . . . . . . . . (63) 396
Income Tax Payable . . . . . . . . . . . . (134) -
----- ------
Net Cash Provided (Used) by Operating
Activities . . . . . . . . . . . . . . . . 1,110 2,683
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of PCI . . . . . . . . . . . . . (2,100) -
Capital Expenditures . . . . . . . . . . . . (172) (156)
----- -----
Net Cash Provided (Used) by Investing
Activities . . . . . . . . . . . . . . . . (2,272) (156)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the Exercise of Stock Options 160
Repayment of Notes Payable to Founders . . . (1,935) (1,789)
------- -------
Net Cash Provided (Used) by Financing
Activities . . . . . . . . . . . . . . . . (1,775) (1,789)
======= =======
NET CHANGE IN CASH & CASH EQUIVALENTS . . . . ($2,941) $738
======== ====
CASH & CASH EQUIVALENTS, Beginning of Period $19,020 $632
CASH & CASH EQUIVALENTS, End of Period . . . $16,079 $1,370
======= ======
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . $ 41 $ 0
Income Taxes . . . . . . . . . . . . . . . . 2,195 36
===== ==
$2,236 $36
====== ===
Detail of businesses acquired in purchase
transactions:
Acquired in-process research and development
costs . . . . . . . . . . . . . . . . . . . $5,169 n/a
Fair value of assets acquired . . . . . . . . $796 n/a
Common Stock Issued in acquisition . . . . . $2,944 n/a
Cash paid for acquisition . . . . . . . . . . $2,100 n/a
Liabilities assumed or created . . . . . . . $921 n/a
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE> 6
SMITH MICRO SOFTWARE, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying unaudited financial
statements have been prepared by Smith Micro Software, Inc. (the "Company")
pursuant to Securities and Exchange Commission regulations. On March 14, 1996,
the Company acquired Performance Computing Incorporated (PCI), a video software
application provider. The periods presented in the financial statements
include PCI's operations from the date of acquisition (Note 4). In the opinion
of management, such information contains all adjustments, necessary for a fair
presentation of the results of such periods. The results of operations for the
interim periods are not necessarily indicative of the results to be expected
for the full year. These financial statements should be read in conjunction
with the audited financial statements included in the Company's report on Form
10-K for the year ended December 31, 1995.
Cash Equivalents - Cash equivalents are considered to be highly
liquid investments with initial maturities of 3 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.
Research and Development - Research and development costs are
expensed as incurred. The current accounting rule, Accounting for Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed, does not
materially affect the Company.
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, in accordance with Statement of
Position 91-1, Software Revenue Recognition. The Company generally allows its
retail distributors to exchange unsold products for other products and provides
inventory price protection in the event of price reductions by the Company.
Allowances for product returns and price protection are estimated based on
previous experience and are recorded as a reduction of revenue at the time
sales are recognized. The Company provides technical support and customer
services to its customers. The Company expenses such costs as incurred as such
costs have historically been insignificant.
Income Taxes - The Company accounts for income taxes under Statement
of Financial Accounting Standards No. 109, Accounting for Income Taxes ("SFAS
109"). This statement requires the recognition of deferred tax assets and
liabilities for 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 the 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 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 will be recorded when it is more likely than not that some portion or
all of the deferred tax asset will not be realized.
6
<PAGE> 7
Beginning November 1, 1992, the Company and its predecessor, Smith
Micro Software, Inc., a California corporation, 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. With the exception of Smith Micro
Software, Inc. of Colorado (which was taxed as a C corporation prior to its
merger with the Company), substantially all of the Company's earnings from
November 1, 1992 until the termination of the Company's S corporation status on
September 21, 1995 generally have been taxed, for federal and state income tax
purposes, directly to the Company's existing stockholders rather than to the
Company.
2. SUPPLEMENTAL PRO FORMA INFORMATION
Acquired Research and Development - On March 14, 1996, the Company
acquired the ongoing research and development activities of Performance
Computing, Inc. This resulted in a one-time pre-tax charge of $5.169 million
in the the first quarter of 1996. The proforma income data is shown to compare
the ongoing business operations exclusive of this one-time pre-tax charge.
Income Taxes - As described in Note 1, the Company has not been
subject to most federal and most state income taxes. On September 21, 1995,
the Company terminated its status as an S corporation and became subject to
federal and state income taxes. The pro forma information presented on the
statement of income reflect a provision for such income taxes as if the Company
had been taxed as a C corporation assuming effective tax rates that would have
been in effect for the periods indicated. 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.
Pro Forma Net Income Per Share - Pro forma net income per share is
based on the weighted average number of shares of common stock and common stock
equivalents (stock options) outstanding during the period. The dilutive effect
of such common stock equivalents is computed using the treasury stock method.
For purposes of such computation, 691,469 shares included for options issued
since May, 1995 at an average exercise price of $7.93 per share are treated as
outstanding for all periods presented.
3. INCOME TAXES
As discussed in Note 1, the Company and its predecessor, Smith Micro
Software, Inc., a California corporation, elected to be treated as an S
corporation for federal and California franchise tax purposes effective
November 1, 1992. Smith Micro Software of Colorado, Inc. was a C corporation
from inception to the time it was merged with the Company and recorded income
tax expense for both federal and state purposes during that time. On September
22, 1995, the date of the public offering of the Company's common stock, the
Company reverted to C corporation status. At that time, the Company recorded
a $122,800 deferred tax asset arising principally from cash to accrual timing
differences and non- deductible reserves. The difference between the effective
tax rate of the Company and the staturtory federal tax rate is primarily
attributable to income tax as an S corporation and the establishment of
deferred taxes.
4. ACQUISITION OF PERFORMANCE COMPUTING INCORPORATED
On March 14, 1996, the Company acquired all outstanding shares of
Performance Computing Incorporated for $5,965,053 in cash and stock. The
transaction was accounted for as a purchase and the Company obtained an
independent valuation of the net assets acquired. In accordance with FASB
Interpretation No. 4, the Company is required to write-off acquired in-process
research and development in the period in which the acquisition is consummated.
As a result, the company recorded a one-time pre-tax charge to earnings of
$5,169,000. In addition, the Company recorded an issuance of 350,000
additional common stock shares, acquired assets of $245,000, intangible assets
of $551,000 (consisting of covenants not to compete of $381,000, current
technology of $154,000 and goodwill of $16,000), assumed liabilities of
$321,000, and accrued anticipated obligations of $600,000 pursuant to the
acquisition.
7
<PAGE> 8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Smith Micro was founded in March 1982 to design and market financial
software. In the mid-1980s, the Company shifted its focus to communication
software for modem manufacturers. The Company shipped its first data
communication software product in 1985 and, since that time, the Company's
growth in revenues has been the result of the market acceptance of its OEM data
and fax communication software products.
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. To date, substantially all of
the Company's revenue has been derived from sales of the Company's QuickLink
data and fax OEM software products, and the Company expects that revenues from
its QuickLink products will continue to account for substantially all of the
Company's revenues for the foreseeable future. Any material reduction in
demand for the Company's QuickLink 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 and retail 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 3.7% and 2.3% of the Company's net revenues for
1994 and 1995, respectively.
From November 1, 1992 through September 21, 1995 (the closing date of
the Company's initial public offering), the Company elected to be treated as an
S corporation for federal income tax purposes. As a consequence, the Company
generally did not have, during this period, an income tax liability and the
Company's earnings have been treated as being distributed to the existing
stockholders for income tax reporting purposes. Until the initial public
offering of the Company's stock, William Smith and Rhonda Smith had been the
sole stockholders of the Company from its inception. They have drawn
compensation from the Company on an irregular basis from the Company, portions
of which were paid to satisfy tax liabilities arising from the allocation of
the Company's earnings to William Smith and Rhonda Smith as a result of the
Company's S Corporation status. The timing of the compensation has had the
effect of creating sizeable quarterly fluctuations in general and
administrative expenses and, consequently, the Company's historical operating
results.
A small number of customers have historically accounted for a
substantial portion of the Company's revenues. Sales to U.S. Robotics
(including, for 1995, sales to Megahertz which U.S. Robotics acquired in
February 1995), in particular, which became a customer in the fourth quarter of
1993, accounted for approximately 4.9%, 35.8%, 52.1% and 58.6% of the Company's
net revenues for the years ended 1993, 1994, 1995, and the six months ended June
30, 1996, respectively. During 1993, 1994 and 1995, the Company's three largest
customers, including U.S. Robotics, accounted for 37.6%, 56.7% and 66.8%,
respectively, of net revenues. For the six months ended June 30, 1996 the
Company's three largest customers, including U.S. Robotics, accounted for 74.8%
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 March 1996, the Company entered into a one-year OEM agreement with
U.S. Robotics Access Corp., one of several wholly-owned subsidiaries of U.S.
Robotics Corporation which agreement superseded the previous agreement between
the parties. This agreement was amended and restated in June of 1996 and runs
until April 1997. Under the terms of the new agreement, the Company granted
certain pricing incentives to U.S. Robotics Access Corp. in consideration for
which the Company became the exclusive provider of fax, data, voice and
telephony communications software for certain U.S. Robotics modems. In
addition, under the terms of the agreement, U.S. Robotics Access Corp.
8
<PAGE> 9
has agreed to place Smith Micro retail products and commercials for such
products on certain U.S. Robotics compact disks. The agreement renews
automatically at the end of each one year term unless either party provides at
least 60 days notice of its intention to terminate the agreement at the end of
the then-current term. Moreover, the agreement does not require U.S. Robotics
Access Corp. or any other U.S. Robotics-affiliated entity to purchase any
minimum quantity of Smith Micro products and may be terminated by U.S. Robotics
at any time for any reason upon 90 days written notice. As a result, there can
be no assurance that U.S. Robotics 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 (excluding Megahertz),
there can be no assurance that U.S. Robotics will not seek additional sources
for such products in the future. Accordingly, there can be no assurance that
sales to U.S. Robotics will reach or exceed historical levels in any future
period. A substantial decrease or delay in sales to U.S. Robotics would have a
material adverse effect on the Company's business, results of operations and
financial condition. Assuming the number of products sold to U.S. Robotics
Access Corp. were to remain at 1995 levels, in light of the pricing incentives
provided in the agreement, gross revenues from U.S. Robotics with respect to
products covered by the agreement could be adversely affected, although the
Company believes that net income attributable to such sales would not be
impacted negatively.
Based on indications from current Motorola orders, the Company
believes that Motorola could become a significant customer. The Company
entered into a one-year agreement with Motorola in January 1996 to
provide retail and OEM products to Motorola's PCMCIA Division and Information
Systems Group. This agreement is automatically renewable for consecutive
one-year terms, but either party may terminate the agreement at the end of the
then-current term by providing 60 days notice to the other party. Moreover, as
with the U.S. Robotics Access Corp. agreement, the Motorola agreement does not
require Motorola to purchase any minimum quantity of Smith Micro products and,
as a result, there can be no assurance that Motorola will order any additional
products or that it will develop into a substantial customer of the Company.
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.
On March 14, 1996, the Company acquired the ongoing research and
development efforts of Performance Computing Incorporated $5,965,053 in cash
and stock. The Company obtained an independent valuation of the net assets
acquired. In accordance with FASB Interpretation No. 4, the Company is
required to write-off in-process research and development in the period in
which the acquisition is consummated. In accounting for the acquisition, the
Company recorded a one-time pre-tax charge to earnings of $5,169,000 to account
for the in-process research and development. In addition, the Company recorded
in issuance of 350,000 additional Common Stock Shares, acquired assets of
$245,000, intangible assets of $551,000 (consisting of covenants not to compete
of $381,000, current technology of $154,000 and goodwill of $16,000), and
assumed liabilities of $321,000 as well as a milestone agreement initiated with
the acquisition of $600,000.
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.
9
<PAGE> 10
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, the
percentages of net revenues represented by each item in the Company's statement
of income. The proforma information for 1996, includes activity for
Performance Computing Incorporated since March 15, 1996.
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
----------------- -----------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0% 100.0%
Cost of sales . . . . . . . . . . . . . . . . . . 31.0 31.3 35.8 30.9
----- ----- ---- ----
Gross profit . . . . . . . . . . . . . . . . . . 69.0 68.7 64.2 69.1
Operating expenses:
Sales and marketing . . . . . . . . . . . . . 11.2 13.0 9.6 12.6
Research and development 15.8 11.0 10.9 9.9
General and Administrative . . . . . . . . . 15.6 14.9 13.1 16.4
---- ---- ---- ----
Total operating expenses . . . . . . . . . . . . 42.6 38.9 33.6 38.9
Operating income . . . . . . . . . . . . . . . . 26.5 29.8 30.6 30.2
In-Process R&D Expense . . . . . . . . . . . . . - - 38.8 -
Other income (expense), net . . . . . . . . . . . 4.4 .3 3.5 .3
--- -- --- --
Income before income tax expense . . . . . . . . 30.8 30.1 (4.7) 30.5
Income tax expense . . . . . . . . . . . . . . . 12.4 0.4 13.8 0.4
---- --- ---- ---
Net income . . . . . . . . . . . . . . . . . . . 18.5% 29.7% (18.5%) 30.1%
==== ==== ===== ====
</TABLE>
NET REVENUES
Net revenues increased 32.9%, or $1.5 million, from $4.5 million in
the three months ended June 30, 1995 to $6.0 million in the three month period
ended June 30, 1996. This increase in revenue was primarily attributable to an
increase in retail revenue. The retail business growth was primarily driven by
the introduction of the company's POTS based videoconferencing software
product, AudioVision.
Net revenues increased 65.8%, or $5.3 million, from $8.0 million in
the six months ended June 30, 1995 to $13.3 million in the six month period
ended June 30, 1996. This increase in revenue was attributable to growth in
the OEM business, primarily QuickLink, in the first quarter of 1996 and an
increase in retail revenue in the second quarter of 1996.
Certain of the Company's significant customers and other modem
manufacturers have recently announced that during the most recently completed
quarter there was an increase of inventory in the channel which may reduce
their rates of growth in subsequent quarters. The rate at which this inventory
moves out of the channel could have a significant impact on the Company's net
revenues and operating results in subsequent quarters.
GROSS PROFIT
Gross profit represents net revenues, less cost of sales, which
includes costs of materials, costs related to the operations of the Company's
duplicating facilities, freight charges and royalties to licensors. Gross
profit increased 33.4%, or $1.0 million, from $3.1 million in the three months
ended June 30, 1995, to $4.1 million, in the three months ended June 30, 1996.
As a percentage of net revenues, gross profits increased 0.2% from 68.8% in the
three months ended June 30,1995, to 69.0% in the three months ended June 30,
1996.
Gross profit increased 54.2%, or $3.0 million, from $5.5 million in
the six months ended June 30,1995, to $8.5 million, in the six months ended June
30, 1996. As a percentage of net revenues, gross profits decreased 4.9% from
69.1% in the six months ended June 30, 1995, to 64.2% in the six months ended
June 30, 1996.
Gross profit as a percentage of net revenues decreased from 69.1% to
64.2% for the six month period ended June 30, 1996, compared to the same period
in the prior year. In the first quarter of 1996, the Company began supplying a
substantial portion of its software to its largest customer on CD ROM format,
which costs considerably more than the conventional diskette format, which was
the primary reason for lower margins in the first quarter. During the second
quarter of 1996, the Company changed the product format for this customer to a
royalty based arrangement, which along with increased retail sales, improved
the margins from the first quarter.
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SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of personnel costs,
advertising costs, sales commissions and trade show expenses. These expenses
vary considerably from quarter to quarter based on the timing of trade shows
and new product introductions. Sales and marketing expenses increased 14.8%,
or $87,000, from $588,000 in the three months ended June 30, 1995, to $675,000
in the three months ended June 30, 1996. The increase in sales and marketing
expenses is primarily due to additional personnel as well as promotional
campaigns in the retail channel. As a percent of net revenues, sales and
marketing expenses declined to 11.2% from 13.0% of net revenues, due to the
substantial growth in revenues.
Sales and marketing expenses increased 27.2%, or $274,000, from
$1,009,000 in the six months ended June 30, 1995, to $1,283,000 in the six
months ended June 30, 1996. The increase in sales and marketing expenses is
primarily due to additional personnel as well as promotional campaigns in the
retail channel. As a percent of net revenues, sales and marketing expenses
declined to 9.6% from 12.6% of net revenues, due to the substantial growth in
revenues.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist primarily of personnel and
supply costs required to conduct the Company's software development activities.
Research and development expenses rose 90.4%, or $450,000, from $498,000 in the
three months ended June 30, 1995, to $948,000 in the three months ended June
30, 1996. This increase was primarily due to the addition of staff as a result
of the acquisition of Perfomance Computing Inc., late in the first quarter of
1996 as well as addition of software engineers in the company's Texas,
Colorado, and California offices As a percent of net revenues, research and
development expenses increased to 15.8% from 11.0% of net revenues, as the
Company dedicated more resources to product development.
Research and development expenses rose 83.6%, or $661,000, from
$791,000 in the six months ended June 30, 1995, to $1,452,000 in the six months
ended June 30, 1996. This increase was primarily due to the addition of staff
as a result of the acquisition of Perfomance Computing Inc., late in the first
quarter of 1996 as well as addition of software engineers in the company's
Texas, Colorado, and California offices as the Company continues to dedicate
more resources to product development. As a percent of net revenues, research
and development expenses increased to 10.9% from 9.9% of net revenues, due to
the additional personnel.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses encompass expenses related to
general operations, which are not included as costs of sales, sales and
marketing or research and development. General and administrative expenses
rose 39.0%, from $674,000 in the three months ended June 30, 1995, to $937,000
in the three months ended June 30, 1996. The increase is primarily
attributable to general expenses related to the expansion of the Company's
facilities and the addition of administrative personnel to support the
Company's growth. As a percent of net revenues, general and administrative
expenses increased to 15.6% from 14.9% of net revenues.
General and administrative expenses rose 32.6%, from $1,313,000 in the
six months ended June 30, 1995, to $1,741,000 in the six months ended June 30,
1996. The increase is primarily attributable to general expenses related to
the expansion of the Company's facilities and the addition of administrative
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<PAGE> 12
personnel to support the Company's growth. As a percent of net revenues, general
and administrative expenses decreased to 13.1% from 16.4% of net revenues, due
to the substantial growth in revenues.
INCOME TAXES
Prior to its initial public offering on September 22, 1995, the
Company was treated as an S corporation for federal and certain state tax
purposes. Subsequent to the offering, the company is taxed as a C Corporation
at an effective tax rate of approximately 40%. As such, income tax expense was
$743,000 in the quarter ended June 30, 1996 as compared to $19,000 in the
quarter ended June 30, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through cash generated from operations. Net cash provided by operating
activities was $1.1 million in the six month periods ended June 30, 1996 as
compared to $2.7 million in the six month periods ended June 30, 1995. In the
six month period ended June 30, 1996, increased net cash provided by operating
activities was offset by an increase in Accounts Receivable and a decrease in
payable balances. During the six month period ended June 30, 1996, the Company
used $2.3 million in investing activities, primarily for the acquisition of the
ongoing research and development activities of Performance Computing
Incorporated in the first quarter of 1996. During the six months ended June 30,
1996, $1.7 million was used in financing activities. The balance used was
attributed to the retirement a loan payable to the company's founders,
partially offset by the proceeds from the exercise of employee stock options.
At June 30, 1996, the Company had $16.1 million in cash and cash
equivalents and $19.7million of working capital. The Company had $4.4 million
of accounts receivable, net of allowance for doubtful accounts and other
adjustments. The Company has no significant capital commitments and currently
anticipates that growth in capital expenditures will not vary significantly
from recent periods.
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<PAGE> 13
RISK FACTORS
Fluctuations in Quarterly Operating Results. Certain of the Company's
significant customers and other modem manufacturers have recently announced that
during the most recently completed quarter there was an increase of inventory in
the channel which 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 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; 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 U.S. Robotics. In 1993, 1994 and 1995, U.S. Robotics
(including, with respect to 1995, Megahertz, which U.S. Robotics acquired in
February 1995), represented 4.9%, 35.8% and 52.1%, respectively, of the
Company's net revenues. The Company expects that U.S. Robotics, which became
a customer in the fourth quarter of 1993, will continue to account for a
significant portion of the Company's revenues in future periods. In March
1996, the Company entered into a new one-year OEM agreement with U.S. Robotics
Access Corp., one of several wholly-owned subsidiaries of U.S. Robotics
Corporation. This OEM agreement superseded the previous agreement between the
parties. Under the terms of the new agreement, the Company granted certain
pricing incentives to U.S. Robotics Access Corp. in consideration for which the
Company became the exclusive provider of fax, data, voice and telephony
communications software for certain U.S. Robotics modems. In addition, under
the terms of the agreement, U.S. Robotics Access Corp. has agreed to place
Smith Micro retail products and commercials for such products on certain U.S.
Robotics compact disks. The agreement renews automatically at the end of each
one year term unless either party provides at least 60 days notice of its
intention to terminate the agreement at the end of the then-current term.
Moreover, the agreement does not require U.S. Robotics Access Corp. or any
other U.S. Robotics-affiliated entity to purchase any minimum quantity of Smith
Micro products and moreover may be terminated by either party at any time for
any reason upon 90 days written notice. As a result, there can be no assurance
that U.S. Robotics 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 (excluding Megahertz), there can be no
assurance that U.S. Robotics will not seek additional sources for such products
in the future. Accordingly, there can be no assurance that sales to U.S.
Robotics will reach or exceed
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<PAGE> 14
historical levels in any future period. A substantial decrease or delay in
sales to U.S. Robotics would have a material adverse effect on the Company's
business, results of operations and financial condition. Assuming the number
of products sold to U.S. Robotics Access Corp. were to remain at 1995 levels,
in light of the pricing incentives provided in the agreement, gross revenues
from U.S. Robotics with respect to products covered by the agreement could be
adversely affected, although the Company believes that net income attributable
to such sales would not be impacted negatively.
Concentration of Customer Revenues. In addition to its reliance on
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. Approximately 37.6%, 56.7% and 66.8% of the Company's net
revenues in 1993, 1994 and 1995, respectively, were derived from sales of
products to the Company's three largest customers, including U.S. Robotics. The
Company expects that it will continue to be dependent upon relatively large
orders from these customers and a limited number of other 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. Hayes
Microcomputer Products ("Hayes"), one of the Company's significant OEM
customers, previously acquired Practical Peripherals, another OEM customer of
the Company. Hayes (including Practical Peripherals) accounted for 15.4% and
9.8% of the Company's net revenues for 1994 and 1995, respectively. 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 adequate 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. In 1995, 83.9% of the Company's net revenues were
derived from the sale of various versions of QuickLink II Fax and 9.6% of the
Company's net revenues were derived from MacComCenter, which is the QuickLink
II Fax equivalent for the Macintosh market. 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 its ability to
develop and introduce new software products
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<PAGE> 15
(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.
There can be no assurance that the Company will successfully develop
new versions of its software products that will operate on Windows 95, or that
any such development, even if successful, will be completed concurrently with
or prior to introductions by competitors of communication software products for
Windows 95. 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.
Competitive Threat from Microsoft Windows 95 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, the new Microsoft operating system, includes capabilities
now provided by certain of the Company's OEM and retail software products,
including the Company's principal product, QuickLink II Fax. Other operating
systems, such as OS/2, offer communications capabilities as well. If the
communications capabilities of Windows 95 or other operating systems are
adopted by users, sales of the Company's products could decline.
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 expects that its new retail products will face significant
competition. In the retail market, HotFax, the Company's principal retail
product competes directly with Symantec/Delrina's WinFax Pro 7.0.
Symantec/Delrina is well established in the retail distribution channel. There
can be no assurance that HotFax will capture a significant share of the retail
market for communication software. In the OEM distribution channel, the
Company has several strong competitors, among them Symantec/Delrina and Global
Village. 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.
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<PAGE> 16
Symantec/Delrina currently make certain products that are
complementary with products sold by each other. The combined entity 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/Delrina 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.
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. As a result of its acquisition of PCI, the
Company expects to begin offering a personal computer-based video conferencing
product to its OEM customers in the near future. There can be no assurance
that this and other 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 also 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
increased during the past five years almost entirely on the strength of its OEM
sales. The Company is developing retail products with expanded functionality
from its OEM products, and the Company expects to introduce other products in
the retail distribution channel as well, including a retail video conferencing
product with enhanced features. The 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
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relationships. With unproven products and its distribution system at early
stages, 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 expects to rely
on distributors, retailers and value added resellers (collectively,
"resellers") for the marketing and distribution of HotFax for Windows and
Windows 95 and its other retail products. The Company's agreements with
resellers are not expected to be 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.
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
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 Software Market. The Company primarily sells its software in
a form that includes a disk and a manual. Some of its customers "pre-load" the
Company's software onto a hard disk. This arrangement eliminates the need for
a disk and may eliminate the need for a manual. These 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 produces its products 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. In the event of a shift of this
kind, more of the Company's relationships would involve product pre-loads and
the Company's business, results of operations and financial condition could be
adversely affected.
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
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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.
Management of Growth. The Company has recently experienced a period
of significantly expanding operations and headcount, which has placed, and will
continue to place, a significant strain on the Company's limited personnel and
other resources. One of the Company's executive officers commenced employment
with the Company in March 1996. The Company's ability to manage any future
increases in the scope of its operations or headcount, should they occur, will
depend on significant expansion of its manufacturing, research and development,
marketing and sales, management and financial and administrative capabilities.
The failure of the Company's management to effectively manage any expansion in
its business could have a material adverse effect on the Company's business,
results of operations and financial condition.
Acquisition-Related Risks. The recent acquisition of PCI by the
Company will present it with numerous challenges, including difficulties in the
assimilation of the operations, technologies, products and personnel of the
acquired company and managing separate geographic operations. The process of
integrating PCI's business into the Company's operations may result in
unforeseen operating difficulties and expenditures and may absorb significant
management attention that would otherwise be available for the ongoing
development of the Company's business. If the Company's management does not
respond to these challenges effectively, the Company's business, results of
operations and financial condition could be adversely affected. Moreover,
there can be no assurance that the anticipated benefits of the acquisition will
be realized. In particular, Smith Micro's interest in PCI is based primarily
on the Company's evaluation of the market potential for PCI's new personal
computer-based, video conferencing products which have yet to be proven in the
marketplace. Delays in or non-completion of the development of these new
products, or lack of market acceptance of such products, could have an adverse
impact on the Company's business, results of operations and financial condition
and result in a failure to realize anticipated benefits of the acquisition.
Duplication of Software. The Company duplicates nearly all of its
software at its Aliso Viejo, California facility. The Company believes that
its internal duplication capability provides it with a competitive advantage
since it 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.
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 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. The Company believes
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<PAGE> 19
that chip suppliers currently lack sufficient capacity to meet the demand for
certain chips used by modem manufacturers, including the Company's OEM
customers. If this shortage continues, it could adversely affect sales of the
Company's OEM communication software.
International Sales. The Company presently operates in foreign
markets and intends to expand its international presence. For the twelve
months ended December 31, 1995, the Company generated 16.6% of its net revenues
outside of the United States, up from 12.7% for the twelve months ended
December 31, 1994, of these amounts, 4.8% and 5.5%, respectively, were
attributable to sales to modem manufacturers located in Taiwan. 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, but has not yet obtained registrations for all of its trademarks in the
United States or other countries, such as for the mark QUICKLINK II FAX. Until
recently, 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.
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 that features, content, or trademarks of certain of the Company's
products infringe upon intellectual property rights held by such third parties.
For example, the Company has received correspondence from a third party
asserting that the use by the Company of the mark QUICKLINK in the United
States and Canada constitutes trademark infringement and unfair competition.
The Company believes that it has meritorious defenses to the claims asserted,
particularly in
19
<PAGE> 20
light of the length of time the Company has continuously used its
QUICKLINK-based marks. While no litigation has been initiated by this party,
the Company is attempting to resolve all such assertions. Should there be a
successful challenge to the Company's use of the QUICKLINK mark or any other
mark, the Company could incur significant expenses in connection with changing
the name and experience a loss of goodwill related to its QUICKLINK product
line. 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.
Concentration of Ownership. As of June 30, 1996, William Smith and
Rhonda Smith beneficially own, as community property, approximately 69.6% 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
20
<PAGE> 21
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. Sales of substantial amounts of
Common Stock in the public market could adversely affect the market price of
the Common Stock. At June 30, 1996, the Company had 14,074,700 shares of Common
Stock outstanding. Of this amount, the 9,790,000 shares held by William Smith
and Rhonda Smith will be available for sale in the public market (subject to
the volume and other applicable restrictions of Rule 144) following the
expiration of a two year lock-up agreement with the Representatives of the
Underwriters of the initial public offering consummated on September 1995.
However, this lock-up agreement does not preclude William Smith and Rhonda
Smith from selling shares in an underwritten offering meeting certain
parameters commencing no sooner than 180 days after September 19, 1995. In
February 1996, options covering 2,500 shares of Common Stock became
exercisable. In addition, based on options outstanding as of June 30, 1996, in
May 1996, options covering an additional 41,950 shares of Common Stock became
exercisable; commencing July 1996, options covering an additional 43,000 shares
became exercisable; commencing September 1996, options covering an additional
2,375 shares will become exercisable; commencing January 1997, options covering
an additional 5,061 shares will become exercisable; commencing February 1997,
options covering an additional 7,500 shares will become exercisable; and
commencing March 1997, options covering an additional 58,606 shares will become
exercisable. Thereafter, options covering approximately 14,406 shares will
become exercisable each month until approximately March 2001, based on options
outstanding as of June 30, 1996, under the Company's 1995 Stock Option/Stock
Issuance Plan.
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<PAGE> 22
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On December 14, 1995, Norbert Hanus, a stockholder of the Company, filed
suit in the United States District Court for the Central District (Southern
Division) of California (the "District Court") against the Company, and
William Smith, Rhonda Smith, Thomas Campbell, Frank Kavanaugh, and Charles
Spear, each of whom is a current or former officer or director of the
Company. The lawsuit alleged violations of the federal securities laws and
purported to seek damages on behalf of stockholders who purchased the
Company's Common Stock during the period from September 19, 1995 through
December 11, 1995. Each defendant denied all such allegations.
On or about May 2, 1996, the Hanus plaintiff and defendants stipulated to
the plaintiff's voluntary dismissal, without prejudice, of the
above-referenced action and lodged a proposed Stipulation and Order of
Dismissal to this effect with the District Court. On May 6, 1996, the
District Court accepted the parties' stipulation and entered and filed the
Stipulation and Order of Dismissal, dismissing the action in its entirety
without prejudice as to all defendants. The defendants did not make any
payment to or otherwise compensate, directly or indirectly, the plaintiff
in connection with the dismissal of the action.
ITEM 2. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
EXHIBIT
NO. TITLE METHOD OF FILING
------- ------------------------------------------ ------------------------------------------
<S> <C> <C>
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 Company. to the Registrant's Registration Statement
No. 33-95096
10.1 Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1
to the Registrant's Registration Statement
No. 33-95096
10.2 1995 Stock Option/Stock Issuance Plan. Incorporated by reference to Exhibit 10.2
to the Registrant's Registration Statement
No. 33-95096
10.3 Form of Notice of Grant of Stock Option Incorporated by reference to Exhibit 10.3
under 1995 Stock Option/Stock Issuance Plan. to the Registrant's Registration Statement
No. 33-95096
10.4 Form of 1995 Stock Option Agreement under Incorporated by reference to Exhibit 10.4
1995 Stock Option /Stock Issuance Plan. to the Registrant's Registration Statement
No. 33-95096
10.5 Form of 1995 Stock Purchase Agreement Incorporated by reference to Exhibit 10.5
under 1995 Stock Issuance Plan. to the Registrant's Registration Statement
No. 33-95096
10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6
September 30, 1991, by and between the to the Registrant's Registration Statement
Company and Crandell Development Corporation. No. 33-95096
10.7 Application Program Interface Retail Incorporated by reference to Exhibit 10.7
License Agreement July 28, 1992 by and to the Registrant's Registration Statement
between the Company and Rockwell No. 33-95096
International Corporation.
10.8 Application Program Interface License Incorporated by reference to Exhibit 10.8
Agreement July 28, 1992 by and between the to the Registrant's Registration Statement
Company and Rockwell International Corporation. No. 33-95096
10.9 Rockwell High Speed Interface License Incorporated by reference to Exhibit 10.9
Agreement dated June 2, 1994, by and to the Registrant's Registration Statement
between the Company and Rockwell No. 33-95096
</TABLE>
22
<PAGE> 23
<TABLE>
<S> <C> <C>
International Corporation.
10.10 Letter Agreement dated February 22, 1994, Incorporated by reference to Exhibit 10.10
by and between the Company and Rockwell to the Registrant's Registration Statement
International Corporation. No. 33-95096
10.111 Letter Agreement dated April 22, 1993, by Incorporated by reference to Exhibit 10.11
and between the Company and Rockwell to the Registrant's Registration Statement
International Corporation. No. 33-95096
10.12 Software Distribution Agreement dated May Incorporated by reference to Exhibit 10.12
8, 1995, by and between the Company and to the Registrant's Registration Statement
International Business Machines Corporation. No. 33-95096
10.13 Office Building Lease, dated June 10, Incorporated by reference to Exhibit 10.13
1992, by and between the Company and to the Registrant's Registration Statement
Developers Venture Capital Corporation. No. 33-95096
10.14 Amendment No. 1 To Office Building Lease, Incorporated by reference to Exhibit 10.14
dated July 9, 1993, by and between the to the Registrant's Registration Statement
Company and Pioneer Bank. No. 33-95096
10.15 Amendment No. 2 To Office Building Lease, Incorporated by reference to Exhibit 10.15
dated August 15, 1994, by and between the to the Registrant's Registration Statement
Company and T&C Development . No. 33-95096
10.16 Fourth Addendum to Office Building Lease, Incorporated by reference to Exhibit 10.16
dated April 21, 1995, by and between the to the Registrant's Registration Statement
Company and T&C Development. No. 33-95096
10.17 Form of Promissory Note related to Incorporated by reference to Exhibit 10.17
S Corporation Distribution. to the Registrant's Registration Statement
No. 33-95096
10.18 Smith Micro Software, Inc. Authorized OEM Incorporated by reference to Exhibit 10.18
Agreement, dated July 1, 1995, by and to the Registrant's Registration Statement
between the Company and U.S. Robotics No. 33-95096
Access Corp.
10.19 Office Building Lease, dated March 1, Incorporated by reference to Exhibit 10.19
1994, by and between Performance Computing to the Registrant's Form 10K filled with
Incorporated and Petula Associates, the Commission on April 1, 1996.
Ltd./KC Woodside.
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 8-K
Performance Computing Incorporated and PCI filed with the Commission on March 28, 1996
Video Products, Inc. dated as of March 14, 1996.
21.1 Subsidiaries of Registrant. Incorporated by reference to Exhibit 21.1
to the Registrant's Form 10K filed with
the Commission on April 1, 1996.
27 Financial Data Schedule. Filed Herewith
</TABLE>
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<PAGE> 24
(B) REPORTS ON FORM 8-K
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SMITH MICRO SOFTWARE, INC.
August 14, 1996 By /s/ WILLIAM W. SMITH, JR.
-------------------------------------
William W. Smith, Jr.
Chairman, President and Chief
Executive Officer
(Principal Executive Officer)
August 14, 1996 By /s/ ROBERT E. GRICE, JR.
-------------------------------------
Robert E. Grice, Jr.
Chief Financial Officer
(Principal Financial Officer)
24
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