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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 SEPTEMBER 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)
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: (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 October 31, 1996, there were 14,074,700 shares of Common Stock
outstanding.
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SMITH MICRO SOFTWARE, INC.
FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 1996 (UNAUDITED)
AND DECEMBER 31, 1995 3
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND SEPTEMBER 30, 1995 4
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE
MONTH PERIODS ENDED SEPTEMBER 30, 1996 AND SEPTEMBER 30, 1995 5
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 6
MANAGEMENT'S DISCUSSION AND ANALYSIS 10
PART II OTHER INFORMATION
ITEM 1. EXHIBITS AND REPORTS ON FORM 8-K 27
SIGNATURES 31
FORWARD LOOKING STATEMENTS
The statements contained in this Quarterly Report on Form 10-Q (the "Form
10-Q") which are not statements of historical fact may be forward looking
statements subject to a number of risks and uncertainties. The following
factors are amount those that could cause actual results of the Company to
materially differ from those anticipated by forward looking statements set
forth in this Form 10-Q: demand for communication software; demand for modems
and other electronic communication devices; national, regional and
international economic conditions affecting the supply of and demand for
communication software or offerings by the Company; the Company's ability to
compete in and sell its products through the retail channel and OEM
distribution channel; demand for the Company's products; the Company's ability
to maintain its customer base and to expand that base; and the Company's
ability to anticipate and adjust to technological shifts and changes in the
electronic communication software and hardware industries. All forward looking
statements contained in this Form 10-Q should be considered in light of these
and any other factors which might cause the Company's future performance to
materially differ from that anticipated by this Form 10-Q.
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PART I - FINANCIAL INFORMATION
SMITH MICRO SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1996 1995
---- ----
(UNAUDITED)
CURRENT ASSETS
Cash & Cash Equivalents $14,635 $19,020
Accounts Receivable, net of allowances for doubtful accounts
and other adjustments of $1,973 (1996) and $518 (1995) 5,422 3,400
Income Tax Receivable 938 -
Deferred Tax Asset 40 40
Inventory 537 443
Prepaids and Other Assets 291 207
--------- ---------
Total Current Assets 21,863 23,110
Equipment and Improvements, net 552 552
Intangible Assets 459 -
--------- ---------
1,011 552
--------- ---------
TOTAL ASSETS $22,874 $23,662
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable $ 542 $ 908
Accrued Liabilities 1,065 495
Income Tax Payable - 79
Distributions Payable to Shareholders - 1,935
--------- ---------
Total Current Liabilities 1,607 3,417
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Preferred stock, par value $.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 3 2,085
--------- ---------
Total Stockholder's Equity 21,267 20,245
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $22,874 $23,662
========= =========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
(UNAUDITED) (UNAUDITED)
----------- -----------
1996 1995 1996 1995
---- ---- ---- ----
Net Revenues $ 3,841 $ 5,054 $17,147 $13,077
Cost of Sales 778 1,704 5,541 4,187
------- ------- ------- -------
Gross Margin 3,063 3,350 11,606 8,890
Operating Expenses:
Sales & Marketing 574 458 1,857 1,468
Research & Development 957 409 2,409 1,201
General & Administrative 1,088 667 2,829 1,980
------- ------- ------- -------
Total Operating Expenses 2,619 1,534 7,095 4,649
Operating Income before acquired
R&D expenses 444 1,816 4,511 4,241
Acquired Research & Development
expense - - 5,169 -
Other Income, net 205 37 674 60
------- ------- ------- -------
Income Before Income Tax 649 1,853 16 4,301
Income Tax Expense 259 142 2,097 176
------- ------- ------- -------
Net Income (Loss) $ 390 $ 1,711 ($2,081) $ 4,125
======= ======= ======= =======
PROFORMA INFORMATION
Net Income before Taxes $ 649 $ 1,853 $ 16 $ 4,301
Pro Forma Provision for Income Taxes 259 741(1) 2,097 1,643(1)
Pro Forma Net Income (Loss) 390 1,112 (2,081) 2,658
Pro Forma Net Income (Loss) per share 0.03 0.09 (0.15) 0.21
Pro Forma Net Income prior to acquired
R&D expenses $ 390 $ 1,112 $ 3,088(2) $ 2,658
Pro Forma Net Income per Share
prior to acquired R&D expenses 0.03 0.09 .22 0.21
Weighted Average Shares Outstanding 14,085 12,678 14,049 12,678
Note 1: 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.
Note 2: 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.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
(UNAUDITED)
-----------
1996 1995
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) ($2,081) $4,125
Adjustments to reconcile net income to net
cash provided by operating activities:
Write-off of in process research and
development due to Performance Computing
Incorporated acquisition 5,169 -
Depreciation and Amortization 316 160
Provision for doubtful accounts and other
adjustments to accounts receivable 1,204 143
Deferred income taxes (123)
Change in Operating Accounts:
Accounts Receivable, net (3,016) (971)
Income Tax Receivable (938) -
Interest receivable (11)
Inventories (94) (8)
Prepaid Expenses and Other Current (73) (120)
Accounts Payable (475) 1,046
Accrued Liabilities (210) 499
Income Tax Payable (135) 230
Interest payable on distribution - 2
------- -------
Net Cash Provided (Used) by Operating
Activities (333) 4,972
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of PCI (2,100) -
Capital Expenditures (177) (248)
------- -------
Net Cash Provided (Used) by Investing
Activities (2,277) (156)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from stock offering - 18,148
Distributions to S Corporation stockholders - (3,839)
Proceeds from the Exercise of Stock Options 160 -
Repayment of Notes Payable to Founders (1,935) -
------- -------
Net Cash Provided (Used) by Financing
Activities (1,775) 14,309
------- -------
NET CHANGE IN CASH & CASH EQUIVALENTS ($4,385) $19,033
CASH & CASH EQUIVALENTS, Beginning of Period $19,020 $ 632
------- -------
CASH & CASH EQUIVALENTS, End of Period $14,635 $19,665
======= =======
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FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
(UNAUDITED)
-----------
1996 1995
---- ----
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
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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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
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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.
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
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.
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 first quarter of 1996. The proforma income data is shown to compare the
ongoing business operations exclusive of this one-time pre-tax charge.
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 statutory federal tax rate is primarily
attributable to income tax as an S Corporation and the establishment of
deferred taxes.
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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.
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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 data,
fax and video 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. The Company expects that
revenues from its QuickLink products will continue to account for a substantial
portion of the Company's revenues. The Company believes that the video and
retail based products will also represent a substantial portion of the
revenue in the future. Any material reduction in demand for the Company's
products would have a material adverse effect on the Company's business, results
of operations and financial condition. The Company has continued to expand its
business by introducing new products and its future success will depend in part
on the continued introduction of new and enhanced OEM 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 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 sizable 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 5%, 36%, 52% and 51% of the Company's net
revenues for the years ended 1993, 1994, 1995, and the nine months ended
September 30, 1996, respectively. During 1993, 1994 and 1995, the Company's
three largest customers, including U.S. Robotics, accounted for approximately
38%, 57% and 67%, respectively, of net revenues. For the nine months ended
September 30, 1996 the Company's three largest customers, including U.S.
Robotics, accounted for approximately 72% 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.
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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. 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.
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.
As the Company's retail sales have grown there has been an increase of
inventory held by distributors and retail stores. As inventory in the retail
channel builds it
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increases the Company's exposure to product returns. This exposure is
considered when the allowance is made for product returns. Substantial returns
of product from the retail channel could have a material adverse affect on
the Company's business, results of operations and financial condition.
On March 14, 1996, the Company acquired Performance Computing
Incorporated for $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.
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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.
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
1996 1995 1996 1995
---- ---- ---- ----
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of sales 20.3 33.7 32.3 32.0
------ ------ ------ ------
Gross profit 79.7 66.3 67.7 68.0
Operating expenses:
Sales and marketing 14.9 9.1 10.8 11.2
Research and development 24.9 8.1 14.0 9.2
General and Administrative 28.3 13.2 16.5 15.1
------ ------ ------ ------
Total operating expenses 68.1 30.4 41.4 35.6
Operating income 11.6 35.9 26.3 32.4
In-Process R&D Expense .- .- 30.1 .-
Other income (expense), net 5.3 .7 (3.9) .5
------ ------ ------ ------
Income before income tax expense 16.9 36.7 .1 32.9
Income tax expense 6.8 2.8 12.2 1.3
------ ------ ------ ------
Net income 10.1% 33.9% (12.1%) 31.5%
====== ====== ====== ======
NET REVENUES
Net revenues decreased 24%, from $5.1 million in the three months
ended September 30, 1995 to $3.8 million in the three month period ended
September 30, 1996. This decrease was primarily due to a broad based slowdown
in the Company's OEM business. Offsetting some of this decrease was the
continued expansion of the Company's retail business.
Net revenues increased 31%, or $4.0 million, from $13.1 million in the
nine months ended September 30, 1995 to $17.1 million in the nine month period
ended September 30, 1996. This increase in revenue represented a $2 million
increase in OEM sales, and a $2 million increase in retail sales. The
increased retail sales were driven primarily by the Company's POTS (Plain Old
Telephone Lines) based videoconferencing software product, Audiovision and the
fax software product, Hotfax, as well as a new product introduced in the most
recent quarter, HotFax Message Center, a fully integrated fax, data and voice
application supporting Windows, Windows 95 and Windows NT.
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.
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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 decreased $287 thousand from $3.4 million in the three months ended
September 30, 1995, to $3.1 million, in the three months ended September 30,
1996. As a percentage of net revenues, gross profits increased 13% from 66% in
the three months ended September 30, 1995, to 80% in the three months ended
September 30, 1996.
Gross profit increased 31% from $8.9 million in the nine months ended
September 30,1995, to $11.6 million, in the nine months ended September 30,
1996. As a percentage of net revenues, gross profits remained unchanged at 68%
during the nine months ended September 30, 1996. In the first quarter of
1996, the Company began supplying a substantial portion of its software to one
of its largest customers 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 in the second and
third quarters.
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 25% from
$458,000 in the three months ended September 30, 1995, to $574,000 in the three
months ended September 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
increased to 15% from 9% of net revenues, primarily due to the decline in
revenues.
Sales and marketing expenses increased 26% from $1,468,000 in the nine
months ended September 30, 1995, to $1,857,000 in the nine months ended
September 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 remained
unchanged at 11% of net 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 134% from $409,000 in the three months
ended September 30, 1995, to $957,000 in the three months ended September 30,
1996. This increase was primarily due to the addition of staff as a result of
the acquisition of Performance 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 25% from 8% of net revenues, as the Company
dedicated more resources to product development, and also as a result of the
decrease in revenues.
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Research and development expenses rose 101% from $1,201,000 in the
nine months ended September 30, 1995, to $2,409,000 in the nine months ended
September 30, 1996. This increase was primarily due to the addition of staff as
a result of the acquisition of Performance 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 14% from 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
63%, from $667,000 in the three months ended September 30, 1995, to $1,088,000
in the three months ended September 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 28% from 13% of net revenues, primarily due to the
decrease in revenues
General and administrative expenses rose 43%, from $1,980,000 in the
nine months ended September 30, 1995, to $2,829,000 in the nine months ended
September 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 16% from 15% of net
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
$259,000 in the quarter ended September 30, 1996 as compared to $142,000 in the
quarter ended September 30, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed its operations primarily
through cash generated from operations. Net cash used by operating activities
was $333,000 in the nine month period ended September 30, 1996 as compared to
$5.0 million provided by operations in the nine month period ended September
30, 1995. In the nine month period ended September 30, 1996, the increase in
receivable balances was the primary use of cash in operations. During the nine
month period ended September 30, 1996, the Company used $2.3 million in
investing activities, primarily for the acquisition of Performance Computing
Incorporated in the first quarter of 1996. During the nine months ended
September 30, 1996, $1.8 million was used in financing activities, which
primarily consisted of the retirement of a loan payable to the company's
founders.
At September 30, 1996, the Company had $14.6 million in cash and cash
equivalents and $20.2 million of working capital. The Company had $5.4 million
of accounts receivable, net of allowance for doubtful accounts and other
adjustments. The Company has no
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significant capital commitments and currently anticipates that growth in
capital expenditures will not vary significantly from recent periods.
RISK FACTORS
In addition to the other information contained in this Form 10-Q, the
following risk factors should be considered in evaluating the Company and a
decision to invest in the Company. This Form 10-Q contains forward looking
statements which involve risks and uncertainties and the Company's actual
results may materially differ from the results anticipated in those statements.
Factors that might cause such a difference include, without limitation, those
discussed in this section and elsewhere in this Form 10-Q.
Fluctuations in Quarterly Operating Results. Certain of the Company's
significant customers and other modem manufacturers have announced in recent
quarters that there was an increase of inventory in the channel 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.
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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 agreement was amended and restated in June of 1996 and runs until April
1997. 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 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.
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
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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 (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
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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.
Reliance on Retail Channel. As the Company's retail sales have grown
there has been an increase of inventory held by distributors and retail stores.
As inventory in the retail channel builds it increases the Company's exposure
to product returns. This exposure is considered when the allowance is made for
product returns. Substantial returns of product from the retail channel could
have a material adverse affect on the Company's business, results of
operations and financial condition.
The 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, Audiovision, HotPage or any other of the
retail product line 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.
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
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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
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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 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
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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 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.
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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, CD's 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 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
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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 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
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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 September 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 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
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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 September 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 September 30,
1996, in May 1996, options covering an additional 41,950 shares of Common Stock
became exercisable; in July 1996, options covering an additional 43,000 shares
became exercisable; in September 1996, options covering an additional 2,375
shares will became 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 September 30, 1996, under the Company's 1995 Stock
Option/Stock Issuance Plan.
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PART II -- OTHER INFORMATION
ITEM 1. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBIT
NO. TITLE METHOD OF FILING
--- ----- ----------------
3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1
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 No. 33-95096
the Registrant's Registration Statement
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
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EXHIBIT
NO. TITLE METHOD OF FILING
--- ----- ----------------
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 No. 33-95096
Corporation.
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 No. 33-95096
Corporation.
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
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
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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.
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EXHIBIT
NO. TITLE METHOD OF FILING
--- ----- ----------------
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
Performance Computing Incorporated and PCI 8-K filed with the Commission on March 28,
Video Products, Inc. dated as of March 14, 1996
1996.
10.21 Smith Micro Software, Inc. Amended and Filed Herewith (this exhibit is subject
Restated Software Licensing and to a request for confidential
Distribution treatement filed with the Securities
Agreement dated April 18, 1996 and Exchange Commission)
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
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(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.
November 13, 1996 By /s/ WILLIAM
W. SMITH, JR.
William W. Smith, Jr.
Chairman, President and Chief
Executive Officer
(Principal Executive Officer)
November 13, 1996 By /s/ ROBERT E. GRICE, JR.
Robert E. Grice, Jr.
Chief Financial Officer
(Principal Financial Officer)
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