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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
[ ] 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.
DELAWARE | 33-0029027 | |
(STATE OR OTHER JURISDICTION OF | (I.R.S. EMPLOYER INCORPORATION OR | |
ORGANIZATION) | IDENTIFICATION NUMBER) |
51 COLUMBIA, SUITE 200, ALISO VIEJO, CA | 92656 | |
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) | (ZIP CODE) |
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (949) 362-5800
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 whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
YES [ ] NO [X]
As of November 9, 2004 there were 17,711,769 shares of Common Stock outstanding.
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SMITH MICRO SOFTWARE, INC.
FORM 10-Q
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PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SMITH MICRO SOFTWARE, INC.
September 30, | December 31, | |||||||
2004 | 2003 | |||||||
ASSETS | ||||||||
CURRENT ASSETS: | ||||||||
Cash and cash equivalents | $ | 5,737 | $ | 3,722 | ||||
Accounts receivable, net of allowances for doubtful accounts and other adjustments of $137 (2004) and $33 (2003) | 1,825 | 741 | ||||||
Inventories, net | 24 | 22 | ||||||
Prepaid expenses and other current assets | 66 | 204 | ||||||
Total current assets | 7,652 | 4,689 | ||||||
EQUIPMENT AND IMPROVEMENTS, net | 66 | 70 | ||||||
INTANGIBLE ASSETS, net | 7 | 40 | ||||||
GOODWILL | 1,715 | 1,715 | ||||||
OTHER ASSETS | 79 | 73 | ||||||
$ | 9,519 | $ | 6,587 | |||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
CURRENT LIABILITIES: | ||||||||
Accounts payable | $ | 750 | $ | 538 | ||||
Accrued liabilities | 797 | 459 | ||||||
Total current liabilities | 1,547 | 997 | ||||||
COMMITMENTS AND CONTINGENCIES | ||||||||
STOCKHOLDERS’ EQUITY: | ||||||||
Preferred stock, par value $0.001 per share; 5,000,000 shares authorized; none issued and outstanding | ||||||||
Common stock, par value $0.001 per share; 30,000,000 shares authorized; 17,414,000 and 17,011,000 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively | 17 | 17 | ||||||
Additional paid-in capital | 26,255 | 25,687 | ||||||
Accumulated deficit | (18,300 | ) | (20,114 | ) | ||||
Net stockholders’ equity | 7,972 | 5,590 | ||||||
$ | 9,519 | $ | 6,587 | |||||
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
NET REVENUES | ||||||||||||||||
Products | $ | 3,304 | $ | 1,283 | $ | 8,414 | $ | 4,938 | ||||||||
Services | 252 | 218 | 747 | 716 | ||||||||||||
Total Net Revenues | 3,556 | 1,501 | 9,161 | 5,654 | ||||||||||||
COST OF REVENUES | ||||||||||||||||
Products | 555 | 298 | 1,802 | 1,049 | ||||||||||||
Services | 118 | 71 | 293 | 240 | ||||||||||||
Total Cost of Revenues | 673 | 369 | 2,095 | 1,289 | ||||||||||||
GROSS PROFIT | 2,883 | 1,132 | 7,066 | 4,365 | ||||||||||||
OPERATING EXPENSES: | ||||||||||||||||
Selling and marketing | 375 | 364 | 1,165 | 1,307 | ||||||||||||
Research and development | 633 | 622 | 1,922 | 1,879 | ||||||||||||
General and administrative | 790 | 629 | 2,156 | 1,801 | ||||||||||||
Total operating expenses | 1,798 | 1,615 | 5,243 | 4,987 | ||||||||||||
OPERATING INCOME (LOSS) | 1,085 | (483 | ) | 1,823 | (622 | ) | ||||||||||
INTEREST INCOME | 14 | 11 | 28 | 27 | ||||||||||||
INCOME (LOSS) BEFORE INCOME TAXES | 1,099 | (472 | ) | 1,851 | (595 | ) | ||||||||||
INCOME TAX EXPENSE | 22 | 37 | 3 | |||||||||||||
NET INCOME (LOSS) | $ | 1,077 | $ | (472 | ) | $ | 1,814 | $ | (598 | ) | ||||||
NET INCOME (LOSS) PER SHARE, basic | $ | 0.06 | $ | (0.03 | ) | $ | 0.11 | $ | (0.04 | ) | ||||||
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING, basic | 17,254 | 16,610 | 17,117 | 16,364 | ||||||||||||
NET INCOME (LOSS) PER SHARE, diluted | $ | 0.06 | $ | (0.03 | ) | $ | 0.10 | $ | (0.04 | ) | ||||||
WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING, diluted | 18,617 | 16,610 | 18,265 | 16,364 | ||||||||||||
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
Nine Months | ||||||||
Ended September 30, | ||||||||
2004 | 2003 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net income (loss) | $ | 1,814 | $ | (598 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||
Depreciation and amortization | 130 | 346 | ||||||
Provision for doubtful accounts and other adjustments to accounts receivable | 112 | 122 | ||||||
Change in operating accounts: | ||||||||
Accounts receivable | (1,196 | ) | (52 | ) | ||||
Inventories | (2 | ) | 40 | |||||
Prepaid expenses and other assets | 85 | 108 | ||||||
Accounts payable and accrued liabilities | 550 | (104 | ) | |||||
Net cash provided by (used in) operating activities | 1,493 | (138 | ) | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Capital expenditures | (46 | ) | (25 | ) | ||||
Net cash used in investing activities | (46 | ) | (25 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Cash received from exercise of stock options | 568 | 862 | ||||||
Cash used in repurchase of common stock | — | (13 | ) | |||||
Net cash provided by financing activities | 568 | 849 | ||||||
NET INCREASE IN CASH AND CASH EQUIVALENTS | 2,015 | 686 | ||||||
CASH AND CASH EQUIVALENTS, beginning of period | 3,722 | 3,627 | ||||||
CASH AND CASH EQUIVALENTS, end of period | $ | 5,737 | $ | 4,313 | ||||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: | ||||||||
Cash paid for income taxes | $ | 30 | $ | 3 | ||||
SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business- Smith Micro Software, Inc. and subsidiaries (the “Company”) is a diversified developer and marketer of wireless communication and eBusiness software products and services. We manufacture, market and sell value-added wireless communication software products targeted to the original equipment manufacturers (“OEM”) market, particularly wireless service providers, mobile phone manufacturers and wireless PC card manufacturers, as well as direct to the consumer. We offer software products for Windows XP, Windows 2000, Windows NT, Windows 98, Windows CE, Pocket PC, Mac, Palm, Unix and Linux operating systems. We also offer professional consulting services that help clients implement web-based projects. An extension of our eBusiness activity includes the offering of fulfillment services for customer web stores.
Basis of Presentation- The accompanying unaudited interim consolidated financial statements reflect adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of the Company at September 30, 2004, the results of its operations for the three and nine month periods ended September 30, 2004 and 2003 and its cash flows for the nine month periods ended September 30, 2004 and 2003. Certain information and footnote disclosures normally included in the financial statements have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”), although the Company believes that the disclosures in the unaudited consolidated financial statements are adequate to ensure the information presented is not misleading. These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003. The results of operations of interim periods are not necessarily indicative of the operating results for the year.
Cash and Cash Equivalents- Cash and cash equivalents generally consist of cash, government securities and money market funds. These securities are all held in one financial institution. All have original maturity dates 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 estimated credit losses, and those losses have been within management’s expectations. Allowances for product returns are included in other adjustments to accounts receivable on the accompanying consolidated balance sheets. Product returns are estimated based on historical experience and have also been within management’s expectations.
Inventories- Inventories consist principally of cables, CDs, boxes and manuals and are stated at the lower of cost (determined by the first-in, first-out method) or market. The Company regularly reviews its inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on management’s forecast of product demand and production requirements.
Equipment and Improvements- Equipment and improvements are stated at cost. Depreciation is computed using the straight-line method based on the estimated useful lives of the assets, generally ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.
Long Lived Assets —The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144,Accounting for Impairment or Disposal of Long-Lived Assets. This statement addresses financial accounting and reporting for the impairment of long-lived assets and for the disposal of long-lived assets. In accordance with SFAS No. 144, long-lived assets to be held are reviewed for events or changes in circumstances, which indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long-lived assets to determine whether or not an impairment to such value has occurred. The Company has determined that there was no impairment at September 30, 2004.
Goodwill- The Company adopted SFAS No. 142,Goodwill and Other Intangible Assets,effective January 1, 2002 and no impairment has been identified. As a result of the adoption, the Company is no longer required to amortize goodwill. Prior to the adoption of SFAS 142, goodwill was amortized over 7 years. In accordance with SFAS No. 142, the Company reviews the
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recoverability of the carrying value of goodwill at least annually or whenever events or circumstances indicate a potential impairment. The Company’s annual impairment testing date is December 31. Recoverability of goodwill is determined by comparing the fair value of the Company’s reporting units to the carrying value of the underlying net assets in the reporting units. If the fair value of a reporting unit is determined to be less than the carrying value of its net assets, goodwill is deemed impaired and an impairment loss is recognized to the extent that the carrying value of goodwill exceeds the difference between the fair value of the reporting unit and the fair value of its other assets and liabilities. The Company determined that it did not have any impairment of goodwill at September 30, 2004.
The carrying amount of the Company’s goodwill was $1,715,000 as of September 30, 2004 and December 31, 2003. The Company’s reporting units are equivalent to its operating segments. At September 30, 2004 and December 31, 2003, the amount of goodwill allocated to the products segment is $1,380,000 and the amount of goodwill allocated to the services segment is $335,000.
Other Intangible Assets- The following table sets forth the acquired intangible assets by major asset class:
September 30, 2004 | December 31, 2003 | |||||||||||||||||||||||||||
Useful | ||||||||||||||||||||||||||||
Life | Accumulated | Net Book | Accumulated | Net Book | ||||||||||||||||||||||||
(in thousands) | (Years) | Gross | Amortization | Value | Gross | Amortization | Value | |||||||||||||||||||||
Amortizing: | ||||||||||||||||||||||||||||
Purchased and Licensed Technology | 3 | $ | 2,260 | $ | (2,253 | ) | $ | 7 | $ | 2,260 | $ | (2,220 | ) | $ | 40 | |||||||||||||
Aggregate amortization expense on intangible assets was approximately $184,000 and $284,000 for the years ended December 31, 2003 and 2002, respectively. Amortization expense in 2004 will be $40,000 at which time all amortizing intangible assets that existed at December 31, 2003 will be fully amortized.
Revenue Recognition- Software revenue is recognized in accordance with the Statement of Position (SOP) 97-2,Software Revenue Recognition,as amended, when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectibility is probable. The Company recognizes revenues from sales of its software to OEM customers or end users as completed products are shipped and title passes or from royalties generated as authorized customers duplicate the Company’s software, if the other requirements of SOP 97-2 are met. If the requirements of SOP 97-2 are not met at the date of shipment, revenue is not recognized until these elements are known or resolved. Returns from OEM customers are limited to defective goods or goods shipped in error. Historically, OEM customer returns have been very nominal and have not exceeded the estimates and reserves.
The Company may permit retail customers to return or exchange product and may provide price protection on products unsold by a customer. As a result, revenue from resellers is recognized upon sell-through to the end customer, rather than upon shipment. Product sales directly to end-users are recognized upon delivery. End users have a thirty day right of return, but such returns are reasonably estimable and have historically been immaterial. The Company also provides technical support to its customers. Such costs have historically been insignificant.
Service revenues include sales of consulting services, web site hosting and fulfillment. Service revenues are recognized as services are provided or as milestones are delivered and accepted by customers.
Sales Incentives– Pursuant to the consensus of EITF 01-09,Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Product),effective January 1, 2002, the cost of sales incentives the Company offers without charge to customers that can be used in, or that are exercisable by a customer as a result of, a single exchange transaction is accounted for as a reduction of revenue.
Software Development Costs- Development costs incurred in the research and development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility has been established. The Company considers technological feasibility to be established when all planning, designing, coding and testing has been completed according to design specifications. After technological feasibility is established, any additional costs are capitalized. Through
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September 30, 2004, software has been substantially completed concurrently with the establishment of technological feasibility; and, accordingly, no costs have been capitalized to date.
Income Taxes- The Company accounts for income taxes under SFAS No. 109,Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in the Company’s financial statements or tax returns. The measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax bases of the Company’s assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the probability of being able to realize the future benefits indicated by such asset. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some portion or all of the deferred tax asset will not be realized.
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 and related interpretations.
SFAS No. 123, Accounting for Stock-Based Compensation,requires the disclosure of pro forma net income (loss) and income (loss) per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values.
The Company’s calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, 48 months following vesting (ranging from four to eight years); stock volatility, 127% and 123% for grants issued in 2004 and 2003, respectively; risk-free interest rates of 2.81% to 3.48% and 2.39% to 2.87% in the nine months ended September 30, 2004; 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 existing awards had been amortized to expense over the vesting period of the awards, pro forma net income (loss) would have been as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
(in thousands, except per share data) | (in thousands, except per share data) | |||||||||||||||
Net income (loss): | ||||||||||||||||
Net income (loss), as reported | $ | 1,077 | $ | (472 | ) | $ | 1,814 | $ | (598 | ) | ||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (138 | ) | (64 | ) | (235 | ) | (215 | ) | ||||||||
Pro forma net income (loss) | $ | 939 | $ | (536 | ) | $ | 1,579 | $ | (813 | ) | ||||||
Income (loss) per common share | ||||||||||||||||
Basic and diluted, as reported | $ | 0.06 | $ | (0.03 | ) | $ | 0.11 | $ | (0.04 | ) | ||||||
Basic and diluted, pro forma | $ | 0.05 | $ | (0.03 | ) | $ | 0.09 | $ | (0.05 | ) |
Net Income (Loss) per Share- Pursuant to SFAS No. 128,Earnings per Share,the Company is required to provide dual presentation of “basic” and “diluted” earnings (loss) per share (EPS). Basic EPS amounts are based upon the weighted average number of common shares outstanding. Diluted EPS amounts are based upon the weighted average number of common and potential common shares outstanding. Potential common shares for diluted EPS include stock options, using the treasury stock method, of 1,363,363 and 1,147,849 for the three and nine months ended September 30, 2004. Potential common
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shares are excluded from the calculation of diluted EPS in loss years, as the impact is antidilutive. Potential common shares of 1,267,000 and 1,079,000 have been excluded from diluted weighted average common shares for the three and nine month periods ended September 30, 2003, as the effect would be antidilutive.
Fulfillment Services- The Company currently holds approximately $500,000 of consigned inventory for a customer, which is used to fulfill internet orders. As the Company does not hold title to the inventory, it is not recorded in the accompanying consolidated balance sheet. In addition, the Company receives cash for internet fulfillment orders which is paid out to the fulfillment customer on a monthly basis. Such cash and the related payable are recorded on a net basis as the amounts are held for the benefit of this fulfillment customer.
Segment Information– The Company currently operates in two business segments: products and services. In addition, revenues are broken down into two markets, Wireless and OEM Sales and Internet and Direct Sales. The Company’s Internet Sales market includes Internet based software products as well as consulting, fulfillment and hosting revenue.
The Company does not separately allocate operating expenses to these segments, nor does it allocate specific assets to these segments. Therefore, segment information reported includes only revenues and cost of revenues.
The following table shows the net revenues and cost of revenues generated by each segment:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
(in thousands) | (in thousands) | |||||||||||||||||||||||||||||||
Products | Services | Products | Services | Products | Services | Products | Services | |||||||||||||||||||||||||
Wireless & OEM Sales | $ | 3,095 | $ | — | $ | 1,003 | $ | — | $ | 7,670 | $ | — | $ | 3,688 | $ | — | ||||||||||||||||
Internet & Direct Sales | 209 | 252 | 280 | 218 | 744 | 747 | 1,250 | 716 | ||||||||||||||||||||||||
�� | ||||||||||||||||||||||||||||||||
Total Revenues | 3,304 | 252 | 1,283 | 218 | 8,414 | 747 | 4,938 | 716 | ||||||||||||||||||||||||
Cost of Revenues | 555 | 118 | 298 | 71 | 1,802 | 293 | 1,049 | 240 | ||||||||||||||||||||||||
Gross Profit | $ | 2,749 | $ | 134 | $ | 985 | $ | 147 | $ | 6,612 | $ | 454 | $ | 3,889 | $ | 476 | ||||||||||||||||
Sales to individual customers and their affiliates, which amounted to more than 10% of the Company’s net revenues for the three months ended September 30, 2004 and 2003, respectively, included two OEM customers at 58.9% and 12.5% in 2004 and three OEM customers at 27.2%, 20.6% and 12.5% in 2003. Sales to individual customers and their affiliates, which amounted to more than 10% of the Company’s net revenues for the nine months ended September 30, 2004 and 2003, respectively, included one OEM customer at 64.2% in 2004 and two OEM customers at 25.3% and 11.7% in 2003.
Use of Estimates- The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 periods. Actual results could differ from those estimates.
Comprehensive Income– Comprehensive income, as defined, includes all changes in equity (net assets) during a period from non-owner sources. For each of the periods ended September 30, 2004 and 2003, there was no difference between net income (loss), as reported, and comprehensive income (loss).
Reclassifications —Certain reclassifications have been made to the prior years’ consolidated financial statements to conform to the current year presentation.
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2. NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. The Company adopted the provisions of FIN 46 effective February 1, 2003 and such adoption did not have a material impact on its consolidated financial statements since the Company currently has no variable interest entities. In December 2003, the FASB issued FIN 46R with respect to variable interest entities created before January 31, 2003, which, among other things, revised the implementation date to the first fiscal year or interim period ending after March 15, 2004, with the exception of Special Purpose Entities (“SPE”). The consolidation requirements apply to all SPE’s in the first fiscal year or interim period ending after December 15, 2003. The Company adopted the provisions of FIN 46R effective December 31, 2003 and such adoption did not have a material impact on its consolidated financial statements since it currently has no SPE’s.
In May 2003, the FASB issued SFAS No.150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The Statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. FASB No.150 requires that those instruments be classified as liabilities in statements of financial position. The Statement is effective for financial instruments entered into or modified after May 31, 2003, otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. On June 15, 2003, the Company adopted SFAS No. 150 which had no material impact on the Company’s financial condition and results of operations.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains forward-looking statements regarding Smith Micro which include, but are not limited to, statements concerning projected revenues, expenses, gross profit and income, the competitive factors affecting our business, market acceptance of products, customer concentration, the success and timing of new product introductions, the protection of our intellectual property, and the need for additional capital. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and certain assumptions made by us. Words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “potential,” “believes,” “seeks,” “estimates,” “should,” “may,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. Such factors include, but are not limited to the following:
• | our ability to predict consumer needs, introduce new products, gain broad market acceptance for such products and ramp up manufacturing in a timely manner; |
• | the intensity of the competition and our ability to successfully compete; |
• | the pace at which the market for new products develop; |
• | the response of competitors, many of whom are bigger and better financed than us; |
• | our ability to successfully execute our business plan and control costs and expenses; |
• | our ability to protect our intellectual property and our ability to not infringe on the rights of others; |
• | our depressed market capitalization; and |
• | those additional factors which are listed under the section “Risk Factors” beginning on page 18. |
All forward looking statements included in this document are based on information available to us on the date hereof. We do not undertake any obligation to revise or update publicly any forward-looking statements for any reason.
OVERVIEW
Our business model is based primarily upon the design, production and sale of software and connectivity kits for use with wireless communication networks worldwide. Our products are utilized with major wireless networks throughout the world that support data communications through the use of cell phones or other wireless communication devices such as PC cards. Wireless network providers generally incorporate our products into their accessory products sold directly to individual consumers to offer wireless PC data connectivity to their wireless networks.
Our business is primarily dependent upon the demand for wireless communications and the corresponding requirements for software and connectivity kits to support this demand. During the last three years, demand for these types of products has fluctuated dramatically, and there has been a significant increase in price competition within our industry. These factors have led to swings in our revenues and contributed to the operating losses reported in our financial results.
We continue to invest in research and development of wireless software products, and we believe that we have one the industry’s leading wireless product lines in terms of performance and features. We believe that our “out-of-the-box” design technology further differentiates our products.
We also sell eBusiness and utility software and professional consulting services related to eBusiness applications.
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During 2004, we have maintained a sharp focus on our operating cost structure while ensuring that we maintain our operating flexibility to support future growth in the industry. We measure success by monitoring our net sales and gross margins and operating cash flow while striving to achieve profitability. We believe that there continues to be excellent growth opportunities within the wireless communications software marketplace and we continue to focus on positioning Smith Micro to benefit from these opportunities.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of total revenue.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||
Net Revenues: | ||||||||||||||||
Products | 92.9 | % | 85.5 | % | 91.9 | % | 87.3 | % | ||||||||
Services | 7.1 | % | 14.5 | % | 8.1 | % | 12.7 | % | ||||||||
Total net revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of revenues: | ||||||||||||||||
Products | 15.6 | % | 19.9 | % | 19.7 | % | 18.6 | % | ||||||||
Services | 3.3 | % | 4.7 | % | 3.2 | % | 4.2 | % | ||||||||
Total cost of revenues | 18.9 | % | 24.6 | % | 22.9 | % | 22.8 | % | ||||||||
Gross profit | 81.1 | % | 75.4 | % | 77.1 | % | 77.2 | % | ||||||||
Operating expenses: | ||||||||||||||||
Selling and marketing | 10.6 | % | 24.3 | % | 12.7 | % | 23.1 | % | ||||||||
Research and development | 17.8 | % | 41.4 | % | 21.0 | % | 33.2 | % | ||||||||
General and administrative | 22.2 | % | 41.9 | % | 23.5 | % | 31.9 | % | ||||||||
Total operating expenses | 50.6 | % | 107.6 | % | 57.2 | % | 88.2 | % | ||||||||
Operating income (loss) | 30.5 | % | -32.2 | % | 19.9 | % | -11.0 | % | ||||||||
Interest income | 0.4 | % | 0.7 | % | 0.3 | % | 0.5 | % | ||||||||
Income (loss) before income taxes | 30.9 | % | -31.5 | % | 20.2 | % | -10.5 | % | ||||||||
Income tax expense | 0.6 | % | 0.0 | % | 0.4 | % | 0.1 | % | ||||||||
Net income (loss) | 30.3 | % | -31.5 | % | 19.8 | % | -10.6 | % | ||||||||
Three and Nine Months Ended September 30, 2004 and 2003
Revenues
Total net revenues were $3.6 million and $1.5 million for the three months ended September 30, 2004 and 2003, respectively, representing an increase of $2.1 million, or 136.9% from 2003 to 2004. Sales to individual customers and their affiliates, which amounted to more than 10% of the Company’s net revenues for the three months ended September 30, 2004 and 2003, respectively, included two OEM customers at 58.9% and 12.5% in 2004 and three OEM customers at 27.2%, 20.6% and 12.5% in 2003. Total net revenues were $9.2 million and $5.7 million for the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $3.5 million, or 62.0% from 2003 to 2004. Sales to individual customers and their affiliates, which amounted to more than 10% of the Company’s net revenues for the nine months ended September 30, 2004 and 2003, respectively, included one OEM customer at 64.2% in 2004 and two OEM customers at 25.3% and 11.7% in 2003. If our sales to these customers are reduced, it could negatively affect our results of operations.
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We currently operate in two business segments: products and services. In addition, revenues are broken down into two markets, Wireless and OEM Sales and Internet & Direct Sales. Our Internet Sales market includes Internet based software products as well as consulting, fulfillment and hosting revenue.
The following table shows the net revenues and cost of revenues generated by each segment:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
Products | Services | Products | Services | Products | Services | Products | Services | |||||||||||||||||||||||||
Wireless & OEM | $ | 3,095 | $ | — | $ | 1,003 | $ | — | $ | 7,670 | $ | — | $ | 3,688 | $ | — | ||||||||||||||||
Internet & Direct | 209 | 252 | 280 | 218 | 744 | 747 | 1,250 | 716 | ||||||||||||||||||||||||
Total Net Revenues | 3,304 | 252 | 1,283 | 218 | 8,414 | 747 | 4,938 | 716 | ||||||||||||||||||||||||
Cost of Revenues | 555 | 118 | 298 | 71 | 1,802 | 293 | 1,049 | 240 | ||||||||||||||||||||||||
Gross Profit | $ | 2,749 | $ | 134 | $ | 985 | $ | 147 | $ | 6,612 | $ | 454 | $ | 3,889 | $ | 476 | ||||||||||||||||
Products.Net product revenues were $3.3 million and $1.3 million in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $2.0 million, or 157.5%, from 2003 to 2004. Wireless & OEM sales increased $2.1 million, or 208.6%, due to the combination of increased data kit unit volume along with the additional revenue generated by the PC Card software that began shipping late in the second quarter of 2004. Data kits include our software on a CD/ROM packaged in a retail box along with a cable and quickstart guide. Internet & Direct Sales decreased $37,000 or 7.4% as a result of lower direct and web store sales and the move away from the retail channel. Product revenues accounted for 92.9% of total revenues in the three months ended September 30, 2004 compared with 85.5% of total revenues in the comparable period of 2003.
Net product revenues were $8.4 million and $4.9 million in the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $3.5 million, or 70.4%, from 2003 to 2004. Wireless & OEM sales increased $4.0 million, or 108.0%, due to the combination of increased data kit unit volume along with the additional revenue generated by the PC Card software that began shipping late in the second quarter of 2004. Data kits include our software on a CD/ROM packaged in a retail box along with a cable and quickstart guide. Internet & Direct Sales decreased $475,000 or 24.2% as a result of lower direct and web store sales and the move away from the retail channel. The first quarter of 2003 benefited from the release of a new MacIntosh product early in that quarter. Product revenues accounted for 91.9% of total revenues in the nine months ended September 30, 2004 compared with 87.3% of total revenues in the comparable period of 2003.
Services.Service revenues were $252,000 and $218,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $34,000 or 15.6%, from 2003 to 2004. Service revenue accounted for 7.1% of total revenues in the three months ended September 30, 2004 compared with 14.5% of total revenues in the comparable period of 2003.
Service revenues were $747,000 and $716,000 in the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $31,000, or 4.3%, from 2003 to 2004. Service revenue accounted for 8.2% of total revenues in the nine months ended September 30, 2004 compared with 12.7% of total revenues in the comparable period of 2003.
Cost of Revenues
Cost of Product Revenues. Cost of product revenues were $555,000 and $298,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $257,000, or 86.2%, from 2003 to 2004. Cost of product revenue as a percentage of product revenues was 16.8% and 23.2% for 2004 and 2003, respectively. The increase in the cost of product revenue is a direct result of increased sales during the period, and also reflects the variable cost of data connectivity kit components.
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Cost of product revenues were $1.8 million and $1.0 million in the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $753,000, or 71.8%, from 2003 to 2004. Cost of product revenue as a percentage of product revenues was 21.4% and 21.2% for 2004 and 2003, respectively. The increase in the cost of product revenue is a direct result of increased sales during the period, and also reflects the variable cost of data connectivity kit components.
Cost of Service Revenues.Cost of service revenues were $118,000 and $71,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $47,000 or 66.2%, from 2003 to 2004. Cost of service revenue as a percentage of service revenues was 46.8% and 32.6% for 2004 and 2003, respectively. Cost of service revenues includes the cost of our consulting personnel and the cost of hiring outside contractors to support our staff of consultants. The increase in the cost of consulting service revenues is primarily the result of fixed fee contracts during the period and the mix of consultants utilized.
Cost of service revenues were $293,000 and $240,000 in the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $53,000, or 22.1%, from 2003 to 2004. Cost of service revenue as a percentage of service revenues was 39.2% and 33.5% for 2004 and 2003, respectively. Cost of service revenues includes the cost of our consulting personnel and the cost of hiring outside contractors to support our staff of consultants.
Operating Expenses
The following table presents a breakdown of our operating expenses by functional category and as a percentage of total net revenues:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||||||||||||||||||
2004 | 2003 | 2004 | 2003 | |||||||||||||||||||||||||||||
Operating expenses: | ||||||||||||||||||||||||||||||||
Selling and marketing | $ | 375 | 10.6 | % | $ | 364 | 24.3 | % | $ | 1,165 | 12.7 | % | $ | 1,307 | 23.1 | % | ||||||||||||||||
Research and development | 633 | 17.8 | % | 622 | 41.4 | % | 1,922 | 21.0 | % | 1,879 | 33.2 | % | ||||||||||||||||||||
General and administrative | 790 | 22.2 | % | 629 | 41.9 | % | 2,156 | 23.5 | % | 1,801 | 31.9 | % | ||||||||||||||||||||
Total operating expenses | $ | 1,798 | 50.6 | % | $ | 1,615 | 107.6 | % | $ | 5,243 | 57.2 | % | $ | 4,987 | 88.2 | % | ||||||||||||||||
Selling and Marketing.Selling and marketing expenses were $375,000 and $364,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $11,000, or 3.0%, from 2003 to 2004. Our selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. As a percentage of revenues, selling and marketing expenses decreased to 10.6% for the three months ended September 30, 2004 from 24.3% in the three months ended September 30, 2003, primarily as a result of increased sales.
Selling and marketing expenses were $1.2 million and $1.3 million in the nine months ended September 30, 2004 and 2003, respectively, representing a decrease of $142,000, or 10.9%, from 2003 to 2004. Our selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. The decrease in our selling and marketing expenses was the result of the reduction in retail channel focus, including marketing and promotional activities, partially offset by the increase discussed above. As a percentage of revenues, selling and marketing expenses decreased to 12.7% for the nine months ended September 30, 2004 from 23.1% in the nine months ended September 30, 2003, primarily as a result of reduced expenses and increased sales.
Research and Development.Research and development expenses were $633,000 and $622,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $11,000, or 1.8%, from 2003 to 2004. Our research and development expenses consist primarily of personnel and equipment costs required to conduct our software development efforts. We remain focused on the development and expansion of our technology, particularly our wireless, diagnostic, utility and Internet software technologies. The increase in our research and development expenses was primarily due to a small increase in headcount along with a refocus of engineering resources from consulting projects to product development. As a percentage of revenues, research and
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development expenses decreased to 17.8% for the three months ended September 30, 2004 from 41.4% in the three months ended September 30, 2003, primarily as a result of increased sales.
Research and development expenses were constant at $1.9 million in the nine months ended September 30, 2004 and 2003, respectively, with an increase of only $43,000, or 2.3%, from 2003 to 2004. Our research and development expenses consist primarily of personnel and equipment costs required to conduct our software development efforts. We remain focused on the development and expansion of our technology, particularly our wireless, diagnostic, utility and Internet software technologies. As a percentage of revenues, research and development expenses decreased to 21.0% for the nine months ended September 30, 2004 from 33.2% in the nine months ended September 30, 2003, primarily as a result of increased sales.
General and Administrative.General and administrative expenses were $790,000 and $629,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $161,000, or 25.6%, from 2003 to 2004. The increase in our general and administrative expenses is primarily due to increases in patent related legal expense and benefit costs. As a percentage of revenues, general and administrative expenses decreased to 22.2% for the three months ended September 30, 2004 from 41.9% in the three months ended September 30, 2003, primarily as a result of increased sales.
General and administrative expenses were $2.2 million and $1.8 million in the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $355,000, or 19.7%, from 2003 to 2004. The increase in our general and administrative expenses is primarily due to absence of the recovery of costs relating to the closure of the Oregon office that were present in the first quarter 2003, offset by increases in bad debt, benefit costs, professional services and other fixed costs. As a percentage of revenues, general and administrative expenses decreased to 23.5% for the nine months ended September 30, 2004 from 31.9% in the nine months ended September 30, 2003, primarily as a result of increased sales.
Interest Income.Interest income was $14,000 and $11,000 in the three months ended September 30, 2004 and 2003, respectively, representing an increase of $3,000 or 27.3% from 2003 to 2004. Interest income was $28,000 and $27,000 in the nine months ended September 30, 2004 and 2003, respectively, representing an increase of $1,000 or 3.7% from 2003 to 2004. Interest income is directly related to our average cash balance during the period and varies among periods. We have not changed our investment strategy during the periods being reported on, with our excess cash consistently being invested in short term marketable securities.
Provision for Income Taxes.The provision for income taxes was $22,000 and $0 in the three months ended September 30, 2004 and 2003, respectively. The provision for income taxes was $37,000 and $3,000 in the nine months ended September 30, 2004 and 2003, respectively. The provision for income taxes reported in 2004 relates to an accrual for alternative minimum taxes that may be owed on income. The income tax expense reported in 2003 relates to taxes owed on foreign sales and minimum state tax payments. The Company has a full valuation allowance on its net deferred tax assets.
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Liquidity and Capital Resources
Since our inception, we have financed operations primarily through cash generated from operations and from proceeds of $18.1 million generated by our initial public offering in 1995. Our principal sources of liquidity as of September 30, 2004 consisted primarily of cash and cash equivalents of $5.7 million.
Net cash provided by operating activities was $1.5 million in the nine months ended September 30, 2004 compared to $138,000 used in operations in the comparable period of 2003. The primary source of operating cash in 2004 was the increased net income and the increase in accounts payable and accrued liabilities, offset by the increase in accounts receivable. The primary operating use of cash during 2003 was the net loss and a reduction in accounts payable and accrued liabilities, which were partially offset by the collection of accounts receivable.
During the nine months ended September 30, 2004, we used $46,000 in investing activities compared to $25,000 in the same period of 2003. Our capital expenditures in both periods consisted of the purchase of computers and other office equipment.
We received $568,000 in cash from the exercise of employee stock options during the nine months ended September 30, 2004 compared to $862,000 during the comparable period of 2003, which was partially offset by $13,000 used to repurchase shares of our common stock.
At September 30, 2004, we had $5.7 million in cash and cash equivalents and $6.1 million of working capital. Our accounts receivable balance, net of allowance for doubtful accounts and other adjustments was $1.8 million at September 30, 2004. We have no significant capital commitments, and currently anticipate that capital expenditures will not vary significantly from recent periods. We believe that our existing cash, cash equivalents and investment balances and cash flow from operations will be sufficient to finance our working capital and capital expenditure requirements through at least the next 12 months. We may require additional funds to support our working capital requirements or for other purposes and may seek to raise additional funds through public or private equity or debt financing or from other sources. If additional financing is needed, we cannot assure you that such financing will be available to us at commercially reasonable terms or at all.
Our corporate headquarters, which includes our principal administrative, sales and marketing, customer support and research and development facilities, is located in Aliso Viejo, California. We have leased this space through May, 2009. We also have an operating lease for our facility in Lee’s Summit, Missouri that expires in June 2005.
As of September 30, 2004, we had no debt and no long term liabilities. The following table summarizes our contractual obligations as of September 30, 2004 (in thousands):
Payments due by period | ||||||||||||||||||||
Less than | More than | |||||||||||||||||||
Contractual obligations: | Total | 1 year | 1 - 3 Years | 3-5 Years | 5 Years | |||||||||||||||
Operating lease obligation | $ | 1,815 | $ | 360 | $ | 759 | $ | 696 | $ | 0 | ||||||||||
Purchase obligations | 159 | 159 | 0 | 0 | 0 | |||||||||||||||
Total | $ | 1,974 | $ | 519 | $ | 759 | $ | 696 | $ | 0 | ||||||||||
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of results of operations, financial condition and liquidity are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments 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 period. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may materially differ from these estimates under different assumptions or conditions. On an on-going basis, we review our estimates to ensure that the estimates appropriately reflect changes in our business or new information as it becomes available.
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We believe the following critical accounting policies affect our more significant estimates and assumptions used in the preparation of our consolidated financial statements:
Revenue Recognition- Software revenue is recognized in accordance with the Statement of Position (“SOP”) 97-2,Software Revenue Recognition,as amended, when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable, and collectibility is probable. We recognize revenues from sales of our software to OEM customers or end users as: completed products are shipped and title passes; or from royalties generated as authorized customers duplicate our software, if the other requirements of SOP 97-2 are met. If the requirements of SOP 97-2 are not met at the date of shipment, revenue is not recognized until these elements are known or resolved. Returns from OEM customers are limited to defective goods or goods shipped in error. Historically, OEM customer returns have not exceeded the very nominal estimates and reserves.
We may permit reseller customers to return or exchange product and may provide price protection on products unsold by a customer. As a result, revenue from resellers is recognized upon sell-through to the end customer, rather than upon shipment. Product sales directly to end-users are recognized upon delivery. End users have a thirty day right of return, but such returns are reasonably estimable and have historically been immaterial. We also provide technical support to our customers. Such costs have historically been insignificant.
Service revenues include sales of consulting services, website hosting and fulfillment. We recognize service revenues as services are provided or as milestones are delivered and accepted by our customers.
Accounts Receivable– We sell our products worldwide. We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history, the customer’s current credit worthiness and various other factors, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers. We estimate credit losses and maintain a bad debt reserve based upon these estimates. While such credit losses have historically been within our estimated reserves, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If not, this could have an adverse effect on our consolidated financial statements.
Goodwill– We have adopted SFAS No. 142,Goodwill and Other Intangible Assets,effective January 1, 2002 and no impairment has been identified. As a result of the adoption, we are no longer required to amortize goodwill. Prior to the adoption of SFAS 142, goodwill was amortized over 7 years. In accordance with SFAS No. 142, we review the recoverability of the carrying value of goodwill at least annually or whenever events or circumstances indicate a potential impairment. Our annual impairment testing date is December 31. Recoverability of goodwill is determined by comparing the estimated fair value of our reporting units to the carrying value of the underlying net assets in the reporting units. If the estimated fair value of a reporting unit is determined to be less than the carrying value of its net assets, goodwill is deemed impaired and an impairment loss is recognized to the extent that the carrying value of goodwill exceeds the difference between the estimated fair value of the reporting unit and the fair value of its other assets and liabilities. We determined that we did not have any impairment of goodwill at September 30, 2004. Estimates of reporting unit fair value are based upon market capitalization and therefore are volatile being sensitive to market fluctuations. To the extent that our market capitalization decreases significantly or the allocation of value to our reporting units changes, we could be required to write off some or all of our goodwill.
Deferred Income Taxes- We account for income taxes under SFAS No. 109,Accounting for Income Taxes. This statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that have been recognized in our 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 our 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. We currently have a full valuation allowance on our deferred tax assets. To the extent that it becomes more likely than not that we will recover such assets, we would be required to reverse some or all of the valuation allowance.
Stock-Based Compensation –We account for employee stock-based compensation under the “intrinsic value” method prescribed in APB No. 25,Accounting for Stock Issued to Employees,as opposed to the “fair value” method prescribed by SFAS No. 123,Accounting for Stock-Based Compensation.Pursuant to the provisions of APB No. 25, we generally do not record an expense for the value of stock-based awards to employees. If proposals currently under consideration by various accounting standards organizations are adopted, such as the Financial Accounting Standards Board Proposed Statement of Financial Accounting Standard,“Share-Based Payment, an amendment of FASB Statements No. 123 and 95”, we may be required to treat the value of stock-based awards granted to employees as compensation expense in the future, which could have a material adverse effect on our reported
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operating results and could negatively affect the price of our Common Stock. If these proposals are adopted, we could decide to reduce the number of stock-based awards granted to employees in the future, which could adversely impact our ability to attract qualified candidates or retain existing employees without increasing their cash compensation and, therefore, have a material adverse effect on our business, results of operations and financial condition.
RISK FACTORS
Our future operating results are highly uncertain. Before deciding to invest in our common stock or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC, including our Annual Report onForm 10-K for the year ended December 31, 2003 and our subsequent reports on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, that could seriously harm our business, financial condition or results of operations. In that event, the market price for our common stock could decline and you may lose all or part of your investment.
Our quarterly operating results may fluctuate and cause the price of our common stock to fall.
Our quarterly revenues and operating results have fluctuated significantly in the past and may continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, our stock price may decline. Fluctuations in our operating results may be due to a number of factors, including the following:
• | the volume of our product sales and pricing concessions on volume sales; |
• | the size and timing of orders from and shipments to our major customers; |
• | the size and timing of any return product requests for our products; |
• | our ability to maintain or increase gross margins; |
• | general economic and market conditions; |
• | variations in our sales channels or the mix of our product sales; |
• | the gain or loss of a key customer; |
• | our ability to specify, develop, complete, introduce, market and transition to volume production new products and technologies in a timely manner; |
• | the availability and pricing of competing products and technologies and the resulting effect on sales and pricing of our products; |
• | the effect of new and emerging technologies; |
• | deferrals of orders by our customers in anticipation of new products, applications, product enhancements or operating systems; and |
• | the continued success of our cost-cutting measures. |
A large portion of our operating expenses, including rent, depreciation and amortization is fixed and difficult to reduce or change. Accordingly, if our total revenue does not meet our expectations, we may not be able to adjust our expenses quickly enough to compensate for the shortfall in revenue. In that event, our business, financial condition and results of operations would be materially and adversely affected.
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Due to all of the foregoing factors, and the other risks discussed in this report, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of future performance.
We depend upon a small number of customers for a significant portion of our revenues.
In the past we have derived a substantial portion of our revenues from sales to a small number of customers and expect to continue to do so in the future. The agreements we have with these entities do not require them to purchase any minimum quantity of our products and may be terminated by the entity or us at any time for any reason upon minimal prior written notice. Accordingly, we cannot be certain that these customers will continue to place large orders for our products in the future, or purchase our products at all. Our three largest OEM customers accounted for 77.0% and 46.5% in the nine months ended September 30, 2004 and 2003, respectively.
Our customers may acquire products from our competitors or develop their own products that compete directly with ours. Any substantial decrease or delay in our sales to one or more of these entities in any quarter would have an adverse effect on our results of operations. In addition, certain of our customers have in the past and may in the future acquire competitors or be acquired by competitors, causing further industry consolidation. In the past, such acquisitions have caused the purchasing departments of the combined companies to reevaluate their purchasing decisions. If one of our major customers engages in an acquisition in the future, it could change its current purchasing habits. In that event, we could lose the customer, or experience a decrease in orders from that customer or a delay in orders previously made by that customer. Further, although we maintain allowances for doubtful accounts, the insolvency of one or more of our major customers could result in a substantial decrease in our revenues.
Our business, financial condition and operating results could be adversely affected as a result of legal, business and economic risks specific to international operations.
Approximately 4.7% and 18.0% of our revenues in the nine months ended September 30, 2004 and 2003, respectively, were derived from sales to customers outside the United States. We also frequently ship products to our domestic customers’ international manufacturing divisions and subcontractors. In the future, we may expand these international business activities. International operations are subject to many inherent risks, including:
• | general political, social and economic instability; |
• | trade restrictions; |
• | the imposition of governmental controls; |
• | exposure to different legal standards, particularly with respect to intellectual property; |
• | burdens of complying with a variety of foreign laws; |
• | import and export license requirements and restrictions of the United States and each other country in which we operate; |
• | unexpected changes in regulatory requirements; |
• | foreign technical standards; |
• | changes in tariffs; |
• | difficulties in staffing and managing international operations; |
• | difficulties in collecting receivables from foreign entities; and |
• | potentially adverse tax consequences. |
These conditions may increase our cost of doing business. Moreover, as our customers are adversely affected by these conditions, our business with them may be disrupted and our results of operations could be adversely affected.
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Although we have begun reporting backlog, our ability to predict our revenues and operating results is extremely limited.
We have historically operated with little backlog because we have generally shipped our software products and recognized revenue shortly after we received orders because our production cycle has traditionally been very short. As a result, our sales in any quarter were generally dependent on orders that were booked and shipped in that quarter. As our wireless business has evolved, production cycle time for items such as data kits has increased to the point that orders received towards the end of a quarter may not ship until the subsequent quarter. Additionally, customers may issue purchase orders that have extended delivery dates that may cause the shipment to fall in a subsequent quarter. These situations make it difficult for us to predict what our revenues and operating results will be in any quarter. Therefore, the level of backlog is not necessarily indicative of trends in our business. As of September 30, 2004, we have a backlog of approximately $2.0 million.
Competition within our product markets is intense and includes numerous established competitors, which could negatively affect our revenues.
We operate in markets that are extremely competitive and subject to rapid changes in technology. Specifically, Microsoft Corporation poses a significant competitive threat to us because Microsoft operating systems may include some capabilities now provided by certain of our OEM and retail software products. If users are satisfied relying on the capabilities of the Windows-based systems or other operating systems, or other vendors products, sales of our products are likely to decline. In addition, because there are low barriers to entry into the software market, we expect significant competition from both established and emerging software companies in the future. Furthermore, many of our existing and potential OEM customers may acquire or develop products that compete directly with our products.
Microsoft and many of our other current and prospective competitors have significantly greater financial, marketing, service, support, technical and other resources than we do. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products. There is also a substantial risk that announcements of competing products by large competitors such as Microsoft or other vendors could result in the cancellation of orders by customers in anticipation of the introduction of such new products. In addition, some of our competitors currently make complementary products that are sold separately. Such competitors could decide to enhance their competitive position by bundling their products to attract customers seeking integrated, cost-effective software applications. Some competitors have a retail emphasis and offer OEM products with a reduced set of features. The opportunity for retail upgrade sales may induce these and other competitors to make OEM products available at their own cost or even at a loss. We also expect competition to increase as a result of software industry consolidations, which may lead to the creation of additional large and well-financed competitors. Increased competition is likely to result in price reductions, fewer customer orders, reduced margins and loss of market share.
If the adoption of new technologies and services grows more slowly than anticipated in our product planning and development, our future sales and profits may be negatively affected.
If the adoption of new technologies and services does not grow or grows more slowly than anticipated in our product planning and development, demand for certain of our products and services will be reduced. For example, our new QuickLink Mobile Wi-Fi product provides notebook users with the ability to roam between wireless wide area networks (“WWAN”) and Wi-Fi hot spots. Another product, QuickLink Wi-Fi, allows users to seek out and select available hot spots in their area. Therefore, future sales and any future profits from this and related products are substantially dependent upon the widespread acceptance and use of Wi-Fi as an effective medium of communication by consumers and businesses.
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Our products may contain undetected software errors, which could negatively affect our revenues.
Our software products are complex and may contain undetected errors. In the past, we have discovered software errors in certain of our products and have experienced delayed or lost revenues during the period it took to correct these errors. Although we and our OEM customers test our products, it is possible that errors may be found in our new or existing products after we have commenced commercial shipment of those products. These undetected errors could result in adverse publicity, loss of revenues, delay in market acceptance of our products or claims against us by customers.
Acquisitions of companies or technologies may disrupt our business and divert management attention and cause our current operations to suffer.
We have in the past made and we expect to continue to consider acquisitions of complementary companies, products or technologies. If we make any additional acquisitions, we will be required to assimilate the operations, products and personnel of the acquired businesses and train, retain and motivate key personnel from the acquired businesses. We may be unable to maintain uniform standards, controls, procedures and policies if we fail in these efforts. Similarly, acquisitions may cause disruptions in our operations and divert management’s attention from our company’s day-to-day operations, which could impair our relationships with our current employees, customers and strategic partners. Acquisitions may also subject us to liabilities and risks that are not known or identifiable at the time of the acquisition.
We may also have to incur debt or issue equity securities in order to finance future acquisitions. The issuance of equity securities for any acquisition could be substantially dilutive to our existing stockholders. In addition, we expect our profitability could be adversely affected because of acquisition-related accounting costs and write offs. In consummating acquisitions, we are also subject to risks of entering geographic and business markets in which we have had limited or no prior experience. If we are unable to fully integrate acquired businesses, products or technologies within existing operations, we may not receive the intended benefits of acquisitions.
Technology and customer needs change rapidly in our market, which could render our products obsolete and negatively affect our revenues.
Our future success will depend on our ability to anticipate and adapt to changes in technology and industry standards. We will also need to continue to develop and introduce new and enhanced products to meet our customers’ changing demands, keep up with evolving industry standards, including changes in the Microsoft operating systems with which our products are designed to be compatible, and to promote those products successfully. The communications and utilities software markets in which we operate are characterized by rapid technological change, changing customer needs, frequent new product introductions, evolving industry standards and short product life cycles. Any of these factors could render our existing products obsolete and unmarketable. In addition, new products and product enhancements can require long development and testing periods as a result of the complexities inherent in today’s computing environments and the performance demanded by customers. If our software markets do not develop as we anticipate, or our products do not gain widespread acceptance in these markets or if we are unable to develop new versions of our software products that can operate on future operating systems, our business, financial condition and results of operations could be materially and adversely affected.
Delays or failure in deliveries from our component suppliers could cause our net revenues to decline and harm our results of operations.
We rely on third party suppliers to provide us with services and components for our product kits. These components include: CDs; cables; printed manuals; and boxes. We do not have long-term supply arrangements with any vendor to obtain these necessary services and components for our products. If we are unable to purchase components from these suppliers or if the CD replication services that we use do not deliver our requirements on schedule, we may not be able to deliver products to our customers on a timely
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basis or enter into new orders because of a shortage in components. Any delays that we experience in delivering our products to customers could impair our customer relationships and adversely impact our reputation and our business. In addition, if our third party suppliers raise their prices for components or services, our gross margins would be reduced.
We may be unable to adequately protect our intellectual property and other proprietary rights, which could negatively impact our revenues.
Our success is dependent upon our software code base, our programming methodologies and other intellectual properties and proprietary rights. In order to protect our proprietary technology, we rely on a combination of trade secret, nondisclosure and copyright and trademark law. We currently own United States trademark registrations for certain of our trademarks and United States patents for certain of our technologies, however, these measures afford us only limited protection. Furthermore, we rely primarily on “shrink wrap” licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. Accordingly, it is possible that third parties may copy or otherwise obtain our rights without our authorization. It is also possible that third parties may independently develop technologies similar to ours. It may be difficult for us to detect unauthorized use of our intellectual property and proprietary rights.
We may be subject to claims of intellectual property infringement as the number of trademarks, patents, copyrights and other intellectual property rights asserted by companies in our industry grows and the coverage of these patents and other rights and the functionality of software products increasingly overlap. From time to time, we have received communications from third parties asserting that our trade name or features, content, or trademarks of certain of our products infringe upon intellectual property rights held by such third parties. We have also received correspondence from third parties separately asserting that our fax products may infringe on certain patents held by each of the parties. Although we are not aware that any of our products infringe on the proprietary rights of others, third parties may claim infringement by us with respect to our current or future products. Infringement claims, whether with or without merit, could result in time-consuming and costly litigation, divert the attention of our management, cause product shipment delays or require us to enter into royalty or licensing agreements with third parties. If we are required to enter into royalty or licensing agreements, they may not be on terms that are acceptable to us. Unfavorable royalty or licensing agreements could seriously impair our ability to market our products.
Our stock price is highly volatile. Accordingly, you may not be able to resell your shares of common stock at or above the price you paid for them.
The market price of our common stock has fluctuated substantially in the past and is likely to continue to be highly volatile and subject to wide fluctuations. These fluctuations have occurred and may continue to occur in response to various factors, many of which we cannot control, including:
• | quarter-to-quarter variations in our operating results; |
• | announcements of technological innovations or new products by our competitors, customers or us; |
• | market conditions within our retail and OEM software markets; |
• | general global economic and political instability; |
• | changes in earnings estimates or investment recommendations by analysts; |
• | changes in investor perceptions; or |
• | changes in expectations relating to our products, plans and strategic position or those of our competitors or customers. |
In addition, the market prices of securities of high technology companies have been especially volatile. This volatility has significantly affected the market prices of securities of many technology companies. Accordingly, you may not be able to resell your
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shares of common stock at or above the price you paid. In the past, companies that have experienced volatility in the market price of their securities have been the subjects of securities class action litigation. If we were the object of a securities class action litigation, it could result in substantial losses and divert management’s attention and resources from other matters.
If we are unable to comply with NASDAQ’s continued listing requirements, our common stock could be delisted.
In June 2002, our common stock failed to meet the minimum bid price of $1.00 per share for 30 consecutive days, which caused our stock price to fail to meet one of the minimum standards required by Nasdaq for continued listing as a Nasdaq National Market security. Accordingly, in mid-2002, we voluntarily transferred from the Nasdaq National Market to the Nasdaq SmallCap Market thereby allowing us additional time to comply with the core initial listing standards of the Nasdaq SmallCap Market. In April 2003, our stock began trading at prices in excess of $1.00 and in early May we received official notification from the Nasdaq that we had regained compliance with the continued listing requirements of the Nasdaq SmallCap Market. If however, our stock cannot maintain trading at prices over $1.00, we may again become subject to the delisting process.
There can be no assurance that we will satisfy all requirements for continued listing of our common stock on the Nasdaq SmallCap Market. If we are unable to meet the continued listing requirements in the future, our common stock will be subject to delisting, which may have a material adverse effect on the price of our common stock and the levels of liquidity currently available to our stockholders.
If we are unable to retain key personnel, the loss of their services could materially and adversely affect our business, financial condition and results of operations.
Our future performance depends in significant part upon the continued service of our senior management and other key technical and consulting personnel. We do not have employment agreements with our key employees that govern the length of their service. The loss of the services of our key employees would materially and adversely affect our business, financial condition and results of operations. Our future success also depends on our ability to continue to attract, retain and motivate qualified personnel, particularly highly skilled engineers involved in the ongoing research and development required to develop and enhance our communication software products as well those in our highly specialized consulting business. Competition for these employees remains high and employee retention is a common problem in our industry. Our inability to attract and retain the highly trained technical personnel that are essential to our product development, consulting services, marketing, service and support teams may limit the rate at which we can generate revenue, develop new products or product enhancements and generally would have an adverse effect on our business, financial condition and results of operations. Additionally, retaining key employees during restructuring efforts is critical to our company’s success.
We may need to raise additional capital in the future through the issuance of additional equity, or convertible debt securities or by borrowing money, in order to meet our capital needs. Additional funds may not be available on terms acceptable to us to allow us to meet our capital needs.
We believe that the cash, cash equivalents and investments on hand and the cash we expect to generate from operations will be sufficient to meet our capital needs for at least the next twelve months. However, it is possible that we may need or choose to obtain additional financing to fund our activities. We could raise these funds by selling more stock to the public or to selected investors, or by borrowing money. We may not be able to obtain additional funds on favorable terms, or at all. If adequate funds are not available, we may be required to curtail our operations or other business activities significantly or to obtain funds through arrangements with strategic partners or others that may require us to relinquish right to certain technologies or potential markets. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing stockholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock. We currently have no established line of credit or other business borrowing facility in place.
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It is possible that our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including:
• | the market acceptance of our products; |
• | the levels of promotion and advertising that will be required to launch our products and achieve and maintain a competitive position in the marketplace; |
• | our business, product, capital expenditure and research and development plans and product and technology roadmaps; |
• | the levels of inventory and accounts receivable that we maintain; |
• | capital improvements to new and existing facilities; |
• | technological advances; |
• | our competitors’ response to our products; and |
• | our relationships with suppliers and customers. |
In addition, we may require additional capital to accommodate planned growth, hiring, infrastructure and facility needs or to consummate acquisitions of other businesses, products or technologies.
Our officers and directors could control matters submitted to our stockholders and affect the outcome of any vote.
As of November 9, 2004, William W. Smith Jr., the President, Chief Executive Officer and Chairman of the Board of our company, and Rhonda L. Smith beneficially owned approximately 47.0% of our outstanding shares of common stock. Acting together, they would have the ability to elect our directors and determine the outcome of any corporate action requiring stockholder approval, including a sale of the company, irrespective of how other stockholders may vote. This concentration of ownership may discourage a potential acquirer from making an offer to buy our company, which, in turn, could adversely affect the market price of our common stock.
Sales of substantial numbers of our common stock could adversely impact the price of our stock.
As of November 9, 2004 we had 17,711,769 shares of common stock outstanding. Of this amount, the combined 8,329,230 shares held by William W. Smith, Jr. and Rhonda L. Smith are available for sale in the public market (subject to the volume and other applicable restrictions of Rule 144). Overall, our trading volume fluctuates widely and at times is relatively limited. Certain of our officers and directors, may implement 10b-5(1) selling plans in the future. Sales of a substantial number of shares of our common stock by William W. Smith, Jr., Rhonda L. Smith or any other person, including through any directed selling plan, either individually or when aggregated with sales by other persons, could adversely affect the market price of our common stock.
Provisions of our charter and bylaws and Delaware law could make a takeover of our company difficult.
Our certificate of incorporation and bylaws contain provisions that may discourage or prevent a third party from acquiring us, even if doing so would be beneficial to our stockholders. For instance, our certificate of incorporation authorizes the board of directors to fix the rights and preferences of shares of any series of preferred stock, without action by our stockholders. As a result, the board can authorize and issue shares of preferred stock, which could delay or prevent a change of control because the rights given to the holders of such preferred stock may prohibit a merger, reorganization, sale or other extraordinary corporate transaction. In addition, we are organized under the laws of the State of Delaware and certain provisions of Delaware law may have the effect of delaying or preventing a change in our control.
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We may be subject to additional risks.
The risks and uncertainties described above are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also adversely affect of business operations.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued FIN No. 46,Consolidation of Variable Interest Entities. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. We adopted the provisions of FIN 46 effective February 1, 2003 and such adoption did not have a material impact on our consolidated financial statements since we currently have no variable interest entities. In December 2003, the FASB issued FIN 46R with respect to variable interest entities created before January 31, 2003, which among other things, revised the implementation date to the first fiscal year or interim period ending after March 15, 2004, with the exception of Special Purpose Entities (“SPE”). The consolidation requirements apply to all SPE’s in the first fiscal year or interim period ending after December 15, 2003. We adopted the provisions of FIN 46R effective December 31, 2003 and such adoption did not have a material impact on our consolidated financial statements since we currently have no SPE’s.
In May 2003, the FASB issued SFAS No.150,Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The Statement improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. FASB No.150 requires that those instruments be classified as liabilities in statements of financial position. The Statement is effective for financial instruments entered into or modified after May 31, 2003, otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. On June 15, 2003, we adopted SFAS No. 150 which had no material impact on our financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Smith Micro’s financial instruments include cash and cash equivalents. At September 30, 2004, the carrying values of our financial instruments approximated fair values based on current market prices and rates.
It is our policy not to enter into derivative financial instruments. We do not currently have any significant foreign currency exposure, as we do not transact business in foreign currencies. As such, we do not have significant currency exposure at September 30, 2004.
ITEM 4. CONTROLS AND PROCEDURES
a) | Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in timely alerting them to the material information relating to us (or our consolidated subsidiaries) required to be included in the reports we file or submit under the Exchange Act. |
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b) | Changes in internal control over financial reporting. During the most recent fiscal quarter covered by this report, there has been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. |
PART II – OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None. |
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None. |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None. |
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None. |
ITEM 5. OTHER INFORMATION
None. |
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Exhibit No. | Exhibit Description | |
31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.1 | Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
(B) REPORTS ON FORM 8-K
On July 21, 2004, the Company filed a current report on Form 8-K in connection with the earnings release for its fiscal quarter ended June 30, 2004.
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SIGNATURES
Pursuant to the requirements 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. | ||
November 15, 2004 | By /s/ William W. Smith, Jr. | |
William W. Smith, Jr. | ||
Chairman of the Board, President and | ||
Chief Executive Officer | ||
(Principal Executive Officer) | ||
November 15, 2004 | By /s/ Robert W. Scheussler | |
Robert W. Scheussler | ||
Chief Operating Officer and | ||
Chief Financial Officer | ||
(Principal Financial Officer) |
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EXHIBIT INDEX
Exhibit No. | Exhibit Description | |||
31.1 | Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |||
31.2 | Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |||
32.1 | Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |