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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 JUNE 30, 1997
[ ] 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 July 31, 1997, there were 14,074,698 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 JUNE 30, 1997 (UNAUDITED)
AND DECEMBER 31, 1996 3
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE
AND SIX MONTHS ENDED JUNE 30, 1997 AND JUNE 30, 1996 4
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX
MONTHS ENDED JUNE 30, 1997 AND JUNE 30, 1996 5
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 7
MANAGEMENT'S DISCUSSION AND ANALYSIS 9
PART II OTHER INFORMATION
ITEM 1. EXHIBITS AND REPORTS ON FORM 8-K 25
SIGNATURES 27
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, together
with those additional risks discussed in this Form 10-Q (particularly in "Risk
Factors" commencing on page 13), 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, modems or offerings by the Company; the Company's ability to compete
in and sell its products through the retail channel and OEM distribution
channel; the Company's ability to compete and sell its products through the
corporate and government marketplaces; 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, EXCEPT SHARE AND PER SHARE DATA)
JUNE 30, DECEMBER 31,
1997 1996
----------- ------------
(UNAUDITED)
CURRENT ASSETS
Cash & Cash Equivalents $ 12,794 $ 14,487
Accounts Receivable, net of allowances for doubtful accounts
and other adjustments of $1,986 (1997) and $1,822 (1996) 4,326 6,017
Income Tax Receivable 1,648 520
Deferred Tax Asset 850 850
Inventories 636 561
Prepaids and Other Assets 421 415
-------- --------
Total Current Assets 20,675 22,850
Equipment and Improvements, net 563 548
Intangible Assets, net 486 709
-------- --------
1,049 1,257
-------- --------
TOTAL ASSETS $ 21,724 $ 24,107
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable $ 806 $ 892
Accrued Liabilities 593 1,223
-------- --------
Total Current Liabilities 1,399 2,115
DEFERRED TAX LIABILITY 162 162
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 14,074,698
(1997) and 14,074,698 (1996) 14 14
Additional paid-in capital 21,250 21,250
Retained Earnings (Deficit) (1,101) 566
-------- --------
Total Stockholder's Equity 20,163 21,830
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 21,724 $ 24,107
======== ========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------------- --------------------------
1997 1996 1997 1996
-------- -------- -------- --------
Net Revenues $ 2,620 $ 6,016 $ 5,278 $ 13,306
Cost of Revenues 834 1,864 2,080 4,763
-------- -------- -------- --------
Gross Profit 1,786 4,152 3,198 8,543
Operating Expenses:
Sales & Marketing 921 675 1,916 1,283
Research & Development 851 948 1,733 1,452
Acquired R & D Expenses 5,169
General & Administrative 936 937 2,472 1,741
-------- -------- -------- --------
Total Operating Expenses 2,708 2,560 6,121 9,645
Operating Income (Loss) (922) 1,592 (2,923) (1,102)
Other Income, net 180 262 360 469
-------- -------- -------- --------
Income (Loss) Before Income Tax (742) 1,854 (2,563) (633)
Income Tax Expense (Benefit) (260) 743 (897) 1,838
-------- -------- -------- --------
Net Income (Loss) $ (482) $ 1,111 $ (1,666) $ (2,471)
======== ======== ======== ========
Net Income (Loss) per share $ (0.03) $ 0.08 $ (0.12) $ (0.18)
======== ======== ======== ========
Weighted Average Shares Outstanding 14,074 14,327 14,074 14,046
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
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SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
1997 1996
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $(1,666) $(2,471)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Write-off of in process research and
development due to the acquisition of
Performance Computing Incorporated 123 5,169
Depreciation and Amortization 164 186
Provision for doubtful accounts and other
adjustments to accounts receivable 163 272
Change in Operating Accounts:
Accounts Receivable, net 1,527 (1,060)
Income Tax Receivable (1,128) (468)
Inventories (75) (66)
Prepaid Expenses and Other Current (6) (88)
Intangibles 100 --
Accounts Payable (86) (165)
Accrued Liabilities (630) 63
Income Tax Payable (134)
-------- --------
Net Cash Provided by (Used in) Operating
Activities (1,514) 1,110
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of PCI -- (2,100)
Capital Expenditures (179) (172)
-------- --------
Net Cash Used in Investing
Activities (179) (2,272)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the Exercise of Stock Options -- 160
Repayment of Notes Payable to Founders -- (1,935)
-------- --------
Net Cash Used in Financing
Activities -- (1,775)
-------- --------
NET CHANGE IN CASH & CASH EQUIVALENTS $ (1,693) $ (2,941)
CASH & CASH EQUIVALENTS, Beginning of Period $ 14,487 $ 19,020
-------- --------
CASH & CASH EQUIVALENTS, End of Period $ 12,794 $ 16,079
======== ========
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FOR THE SIX MONTHS
ENDED JUNE 30,
-----------------------
1997 1996
-------- ------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Interest -- $ 41
Income taxes 206 2,195
Detail of businesses acquired in purchase transactions:
Acquired in-process research and development $5,169
Fair value of assets acquired $ 796
Common Stock Issued in acquisition $2,944
Cash paid for acquisition $2,100
Liabilities assumed or created $ 921
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 consolidated
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. In the opinion of
management, such information contains all adjustments, necessary for a fair
presentation of the results of such periods. 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, 1996.
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.
Equipment and Improvements - Equipment and Improvements are stated at
cost. Depreciation is computed using the straight-line method based on the
estimated useful lives of the assets, generally ranging from three to seven
years. Leasehold improvements are amortized using the straight-line method over
the shorter of the estimated useful life of the asset or the lease term.
Intangible Assets - Intangible assets relate primarily to goodwill,
existing technology and noncompete agreements, which are amortized over periods
ranging from three to five years.
Revenue Recognition - The Company recognizes revenues from sales of its
software as completed products are shipped and from royalties from customers who
are authorized to duplicate the Company's software as the individual duplication
rights are granted. The Company generally allows its retail distributors to
exchange unsold products for other products and provides inventory price
protection in the event of price reductions by the Company. Allowances for
product returns and price protection are estimated based on previous experience
and are recorded as a reduction of revenue at the time sales are recognized. The
Company provides technical support and customer services to its customers. Such
costs have historically been insignificant.
Income Taxes - The Company accounts for income taxes under Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. This
statement requires the recognition of deferred tax assets and liabilities for
the future consequences of events that have been recognized in the Company's
financial statements or tax returns. The measurement of the deferred items is
based on enacted tax laws. In the event the future consequences of differences
between financial reporting basis and the tax basis of
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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.
Software Development Costs - Development costs incurred in the research
and development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. The Company considers technological feasibility to be established
when all planning, designing, coding and testing has been completed according to
design specifications. After technological feasibility is established, any
additional costs are capitalized. Through December 31, 1996, software has been
substantially completed concurrently with the establishment of technological
feasibility; and, accordingly, no costs have been capitalized to date.
Fair Value of Financial Instruments - Pursuant to SFAS No. 107,
Disclosures about Fair Value of Financial Instruments, the Company is required
to estimate the fair value of all financial instruments included on its balance
sheet at December 31, 1996. The Company considers the carrying value of such
amounts in the financial statements to approximate their fair value due to (1)
the relatively short period of time between origination of the instruments and
their expected realization, (2) interest rates which approximate current market
rates, or (3) the overall immateriality of the amounts.
Stock-Based Compensation - The Company accounts for stock-based awards
to employees using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees.
Per Share Information - Net income (loss) per share is based on the
weighted average number of shares of common stock and common stock equivalents
(stock options) outstanding during the period. Common stock equivalents were
excluded from the computation in loss periods as the effect was anti-dilutive.
Use of Estimates - The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting years. Actual results could differ from those estimates.
2. NEW ACCOUNTING PRONOUNCEMENT
In February 1997, the Financial Accounting Standards board issued
Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per
Share", which is effective for financial statements for both interim and annual
periods ending after December 15, 1997. Early adoption of the statement is not
permitted. The Company has determined that the adoption of this statement would
not have had a material impact on the earnings per share calculation for the
periods presented.
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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 2.3% and 16.8% of the Company's net
revenues for 1995 and 1996, respectively. The increase in returns during 1996 is
primarily the result of the increased volume of business in the retail
distribution channel which has experienced a higher rate of returns than the OEM
channel.
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 36%, 52%, 46% and 42% of the Company's net
revenues for the years ended 1994, 1995, 1996, and the six months ended June 30,
1997, respectively. During 1994, 1995 and 1996, the Company's three largest
customers, including U.S. Robotics, accounted for approximately 57%, 67% and
71%, respectively, of net revenues. For the six months ended June 30, 1997 the
Company's three largest customers, including U.S. Robotics, accounted for
approximately 63% of net revenues. Any reduction, delay or change in orders from
such customers could have a material adverse affect on the Company's business,
results of operations and financial condition.
In April 1996, the Company entered into an OEM agreement having an
initial one year term with 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. 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. Under the terms of the 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. 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 either party
at any time for any reason upon 90 days written notice. As a result, there can
be no assurance that U.S. Robotics will continue to purchase the Company's
products. While the Company believes
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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 1996 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. In June 1997, 3Com Corp.
acquired U.S. Robotics, to date the Company's largest customer based on the
percentage of revenues, as a wholly-owned subsidiary. There can be no assurance
that 3Com's acquisition of U.S. Robotics will not result in a change of U.S.
Robotics' purchasing habits, a decrease in new orders by or delays in orders
previously made by U.S. Robotics, or the loss of U.S. Robotics as a customer
entirely.
The Company entered into an agreement having an initial one-year term
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 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 ("PCI"). In connection with the acquisition, all the outstanding
PCI shares were converted into the right to receive an aggregate of 350,000
shares of the Company's common stock, valued at $2,944,000, and $2,100,000 in
cash with an additional $800,000 payable to the seller group or at its direction
contingent on the achievement of certain milestones. The $800,000 additional
payment was accrued as part of the purchase price; all of the milestones have
subsequently been met and the entire amount was paid subsequent to the December
31, 1996 year-end. The Company also incurred direct costs of approximately
$111,000 related to the acquisition.
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The Company obtained an independent valuation of the net assets
acquired in the PCI purchase transaction which resulted in the allocation of the
purchase price to $996,000 of identified assets, $321,000 of liabilities and
$5,169,000 of in-process research and development. As the technological
feasibility of the in-process research and development had not been established
and such technology had no alternative future use, the acquired in-process
research and development was expensed in accordance with interpretation 4 of APB
Opinion No. 16.
The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Financial Statements and related notes thereto
included elsewhere. Historical results of operations, percentage relationships
and any trends that may be inferred from the discussion below are not
necessarily indicative of the operating results for any future period.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated, the
percentages of net revenues represented by each item in the Company's statement
of income. The proforma information for 1996, includes activity for Performance
Computing Incorporated since March 15, 1996.
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
------------------- -------------------
1997 1996 1997 1996
----- ----- ----- -----
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 31.8 31.0 39.4 35.8
----- ----- ----- -----
Gross profit 68.2 69.0 60.6 64.2
Operating expenses:
Sales and marketing 35.2 11.2 36.3 9.6
Research and development 32.5 15.8 32.9 10.9
Acquired research and development -- -- -- 38.8
General and Administrative 35.7 15.6 46.8 13.1
----- ----- ----- -----
Total operating expenses 103.4 42.6 116.0 72.5
Operating income (loss) -35.2 26.4 -55.4 -8.3
Other income, net 6.9 4.4 6.8 3.5
----- ----- ----- -----
Loss before income tax expense -28.3 30.8 -48.6 -4.8
Income tax expense -9.9 12.4 -17.0 13.8
----- ----- ----- -----
Net income (loss) -18.4% 18.5% -31.6 -18.6
===== ===== ===== =====
NET REVENUES
Net revenues decreased 56%, from $6.0 million in the three months ended
June 30, 1996 to $2.6 million in the three month period ended June 30, 1997.
This decrease was primarily due to the continued weakness in the Company's OEM
business as well as lower than expected increases in sell-through rates of the
Company's retail products.
Net revenues decreased 60%, from $13.3 million for the six months ended
June 30, 1996 to $5.3 million for the six months ended June 30, 1997. This
decrease was primarily due to the continued broad-based slowdown in the OEM
business as mentioned earlier, as well as the higher revenues obtained in the
first quarter of 1996 due to the CD business from the Company's largest
customer.
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GROSS PROFIT
Gross profit represents net revenues, less cost of revenues, which
includes costs of materials, costs related to the operations of the Company's
duplicating facilities, freight charges and royalties to licensors. Gross profit
decreased $2.4 million from $4.2 million in the three months ended June 30,
1996, to $1.8 million in the three months ended June 30, 1997. As a percentage
of net revenues, gross profits decreased 1% from 69% in the three months ended
June 30, 1996, to 68% in the three months ended June 30, 1997. Margins for the
Company decreased primarily due to the reduced mix of retail sales, as well as
the higher percentage of fixed overhead resulting from the lower sales volume.
Gross profit decreased 63%, from $8.5 million for the six months ended
June 30, 1996 to $3.2 million for the six months ended June 30, 1997. As a
percentage of net revenues, gross profits decreased 3.6% from 64.2% for the six
months ended June 30, 1996 to 60.6% for the six months ended June 30, 1997.
Margins for the Company decreased primarily due to the reduced mix of retail
sales and increased rate of retail returns reserves, as well as the higher
percentage of fixed overhead resulting from the lower sales volume
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 36% from
$675,000 in the three months ended June 30, 1996, to $921,000 in the three
months ended June 30, 1997. The increase in sales and marketing expenses is
primarily due to promotional campaigns in the retail channel as well as
additional personnel. As a percent of net revenues, sales and marketing expenses
increased to 35% from 11% of net revenues, primarily due to the decline in
revenues.
Sales and marketing expenses increased 49%, from $1.3 million for the
six months ended June 30, 1996 to $1.9 million for the six months ended June 30,
1997. The increase in sales and marketing expenses is primarily due to
promotional campaigns in the retail channel as well as additional personnel. As
a percent of net revenues, sales and marketing expenses increased to 36% from
10% of net revenues, primarily due to the decline in revenues.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist primarily of personnel and
supply costs required to conduct the Company's software development activities.
Research and development expenses decreased 10% from $948,000 in the three
months ended June 30, 1996, to $851,000 in the three months ended June 30, 1997.
This decrease is primarily due to lower headcount. As a percent of net revenues,
research and development expenses increased to 33% from 16% of net revenues,
primarily due to the decline in revenues.
Research and development expenses increased 19% from $1.5 million in
the six months ended June 30, 1996, to $1.7 million in the six months ended June
30, 1997. This increase is primarily due to the addition of staff late in the
first quarter of 1996 as a result of the acquisition of PCI. As a percent of net
revenues, research and development expenses increased to 33% from 10% of net
revenues, due to the decline in revenues and the increase
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related to the PCI acquisition mentioned previously. On March 14, 1996 the
Company acquired PCI. In accordance with Interpretation 4 of APB Opinion No. 16,
$5,169,000 of in-process research and development was expensed as of the date of
the acquisition.
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
remained stable, at $937,000 in the three months ended June 30, 1996, and
$936,000 in the three months ended June 30, 1997. As a percent of net revenues,
general and administrative expenses increased to 36% from 16% of net revenues,
primarily due to the decrease in revenues.
General and administrative expenses increased 42%, from $1.7 million in
the six months ended June 30, 1996, to $2.5 million in the six months ended June
30, 1997. This increase was primarily due to additional reserves for bad debt
provided during the three months ended March 31, 1997, due to the slower payment
patterns by retail channel customers. As a percent of net revenues, general and
administrative expenses increased to 47% from 13% of net revenues, primarily due
to the decrease in revenues.
INCOME TAXES
Income tax expense was $743,000 in the quarter ended June 30, 1996
based on pre-tax earnings of $1,854,000. During the quarter ended June 30, 1997,
the Company provided for a tax benefit of $260,000 based on a 35% estimated
effective tax rate.
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 $1.5 million in the six month period ended June 30, 1997 as compared to $1.1
million provided by operations in the six month period ended June 30, 1996. The
primary uses of cash during the six month period ended June 30, 1997 were the
operating loss, the increase in income tax receivable and the final PCI
milestone payment. During the six month period ended June 30, 1996, the Company
used $2.2 million in investing activities, primarily for the acquisition of PCI.
At June 30, 1997, the Company had $12.8 million in cash and cash
equivalents and $19.3 million of working capital. The Company had $4.3 million
of accounts receivable, net of allowance for doubtful accounts and other
adjustments. The Company has no significant capital commitments and currently
anticipates that growth in capital expenditures will not vary significantly from
recent periods.
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.
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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
to maintain or increase gross margins; the ability of the Company's customers to
obtain financing for the purchase of the Company's products; changes in pricing
policies or price reductions by the Company or its competitors; variations in
the Company's sales channels or the mix of product sales; the timing of new
product announcements and introductions by the Company or its competitors and
customers; the availability and cost of supplies; the financial stability of
major customers; market acceptance of new products, applications and product
enhancements; the Company's ability to develop, introduce and market new
products, applications and product enhancements; the Company's ability to
control costs; possible delays in the shipment of new products; the Company's
success in expanding its sales and marketing programs; deferrals of customer
orders in anticipation of new products, applications, product enhancements or
operating systems; changes in Company strategy; personnel changes; and general
economic factors. The Company's software products are generally shipped as
orders are received and accordingly, the Company has historically operated with
little backlog. As a result, sales in any quarter are dependent on orders booked
and shipped in that quarter and are not predictable with any degree of
certainty. In addition, the Company's expense levels are based, in part, on its
expectations as to future revenues. If revenue levels are below expectations,
operating results are likely to be adversely affected. The Company's net income
may be disproportionately affected by a reduction in revenues because of fixed
costs related to generating its revenues. While the Company has not historically
experienced seasonality in its sales, many of the Company's OEM customers
experience seasonality in their sales, and the Company's sales may, in the
future, be subject to seasonality particularly as its sales of retail products
increase. Quarterly results in the future may be influenced by these or other
factors and, accordingly, there may be significant variations in the Company's
quarterly operating results. Further, the Company's historical operating results
are not necessarily indicative of future performance for any particular period
and there can be no assurance that the Company's recent revenue growth or its
profitability will continue on a quarterly or annual basis. Due to all of the
foregoing factors, it is possible that in some future quarter the Company's
operating results may be below the expectations of public market analysts and
investors. In such event, the price of the Company's Common Stock would likely
be materially adversely affected.
Reliance on U.S. Robotics and 3Com Corp. In June 1997, 3Com Corp.
acquired U.S. Robotics, to date the Company's largest customer based on the
percentage of revenues, as a wholly owned subsidiary. There can be no assurance
that 3Com's acquisition of U.S. Robotics will not result in a change of U.S.
Robotics' purchasing habits, a decrease in new orders by or delays in orders
previously made by U.S. Robotics, or the loss of U.S. Robotics as a customer
entirely.
In 1994, 1995, 1996 and the six months ended June 30, 1997, U.S.
Robotics (including, with respect to 1995, Megahertz, which U.S. Robotics
acquired in February 1995), represented 35.8%, 52.1%, 46.4% and 42.0%
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 April 1996, the Company entered into an OEM agreement with U.S.
Robotics Access Corp., one of several wholly-owned subsidiaries of U.S. Robotics
Corporation. This OEM
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agreement superseded the previous agreement between the parties. This agreement
was amended and restated in June 1996 and initially ran until April 1997 and was
automatically renewed for a one year term. The agreement renews automatically at
the end of each one year term for an additional 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. Under the terms of the 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. In addition, as discussed above, 3Com has acquired U.S. Robotics.
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 1996 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. 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 1996 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 57%, 67%, 71% and 68% of the Company's net revenues in
1994, 1995, 1996 and the six months ended June 30, 1997 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%, 9.8% and 3.8% of the Company's net
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revenues for 1994, 1995 and 1996, respectively. Previous acquisitions in the
modem industry have often caused the purchasing departments of the combined
companies to reevaluate their purchasing decisions. Finally, in June 1997, 3Com
acquired U.S. Robotics as a wholly-owned subsidiary. There can be no assurance
that such acquisitions will not result in a change in a current customer's
purchasing habits, including a loss of the customer, a decrease in orders from
that customer or a delay in orders previously made by the customer. Moreover,
acquisitions involving existing OEM customers may cause the concentration of the
Company's customer revenues to increase if the combined companies continue to
purchase the Company's software products. Although the Company maintains
allowances for doubtful accounts, the insolvency of one or more of the other
major customers of the Company could substantially impair the Company's
business, results of operations and financial condition.
Product Concentration. The Company has in the past derived, and may in
the future derive, a significant portion of its revenues from a relatively small
number of products. In 1995, 1996 and the six months ended June 30, 1997,
approximately 84%, 64% and 79% respectively, of the Company's net revenues were
derived from the sale of various versions of QuickLink II Fax, and 10%, 7% and
4% respectively, 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.
The decline in the percentages of QuickLink II Fax sales during 1996 was
primarily due to increased retail sales. 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.
Microsoft is the leading developer of operating systems for personal
computers. There can be no assurance that the Company will successfully develop
new versions of its software products that will operate on future Microsoft
operating systems, or that any such
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development, even if successful, will be completed concurrently with or prior to
introductions by competitors of communication software products for those new
operating systems. Any such failure or delay could affect the Company's
competitive position or lead to product obsolescence in the future.
While the Company ships software to a number of computer manufacturers,
its primary OEM customers are modem manufacturers. The Company is aware that
technology is being developed to enable the functions of the modem to be
performed by a chip embedded into the computer. This development, if and when it
comes to market, could impair the business of those of the Company's customers
that rely on the existence of a separate modem component for their continued
success. A downturn in the business of one or more of its principal customers
could adversely affect the Company's business, results of operations and
financial condition.
Competitive Threat from Microsoft and Other Operating Systems. The
Company faces competition from Microsoft, which dominates the personal computer
software industry. Due to its market dominance and the fact that it is the
publisher of the most prevalent personal computer operating platforms, DOS and
Windows, Microsoft represents a significant competitive threat to all personal
computer software vendors, including the Company. In addition, Windows 95 and
Windows NT, the latest Microsoft operating systems, include capabilities now
provided by certain of the Company's OEM and retail software products, including
the Company's principal product, QuickLink II Fax. Other operating systems, such
as OS/2, offer communications capabilities as well. If the communications
capabilities of Windows 95, Windows NT or other operating systems are adopted by
users, sales of the Company's products could decline.
Competition. The markets in which the Company operates are highly
competitive and subject to rapid changes in technology. The strategic directions
of major personal computer hardware manufacturers and operating system
developers are also subject to changes. The Company competes with other software
vendors for access to distribution channels, retail shelf space and the
attention of customers. The Company also competes with other software companies
in its efforts to acquire software technology developed by third parties. These
factors may result in increased price competition. Additionally, there can be no
assurance that competitors will not develop or acquire products that are
superior to the Company's products or that achieve greater market acceptance.
The Company's retail products face significant competition. In the
retail market, HotFax, the Company's principal retail product competes directly
with Symantec/Delrina's WinFax Pro 7.5. 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 addition,
the Company's newly released retail video conferencing product, AudioVision,
competes in a new and rapidly changing software market. Some of the current
competitors in the video conferencing software market are White Pine, Connectix,
and VDONet, and there can be no assurance that the Company will compete
successfully with these and any future competitors in the retail video
conferencing software market. In the OEM distribution channel, the Company has
several strong competitors, among them Symantec/Delrina, Global Village, White
Pine and VDONet. Some of the Company's competitors have a retail emphasis and
offer OEM products with a reduced set of features. The opportunity for retail
upgrade sales may induce these and other competitors to make OEM products
available at their own cost or even at a loss. Such a pricing strategy could
have an adverse affect on the Company's business, results of operations and
financial condition.
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Symantec/Delrina currently make certain products that are complementary
with products sold by each other. The combined entity may be able to enhance its
competitive position by bundling certain of these products to attract customers
seeking integrated, cost-effective software applications. The Company also
believes that the market in which it competes has been characterized by the
consolidation of established communication software suppliers and that this
trend, which may lead to the creation of additional large and well-financed
competitors, may continue. In addition, other competitors have entered the
market. Moreover, because there are low barriers to entry into the software
market, the Company believes that competition will increase in the future. To
remain competitive, the Company believes that it will need to make continuing
investments in research and development and sales and marketing. There can be no
assurance that the Company will have sufficient resources to make such
investments, or that it will be successful in its research and development or
sales and marketing efforts.
Symantec/Delrina and many of the Company's current and prospective
competitors have significantly greater financial, marketing, service, support,
technical and other resources than the Company. Moreover, these companies may
introduce additional products that are competitive with those of the Company,
and there can be no assurance that the Company's products would compete
effectively with such products. The Company believes that its ability to compete
depends on elements both within and outside its control, including the success
and timing of new product development, product performance and price,
distribution and customer support and introduction by the Company and its
competitors of new products. There can be no assurance that the Company will be
able to compete successfully with respect to these and other factors. The
Company believes that the market for its software products has been and will
continue to be characterized by significant price competition. A material
reduction in the price of the Company's products could negatively affect the
Company's profitability.
Many of the Company's existing and potential OEM customers are major
manufacturers of modems and have substantial technological capabilities. These
customers may currently be developing, or may in the future develop, products
that compete directly with the Company's products and may, therefore,
discontinue purchases of the Company's products. The Company's future
performance is substantially dependent upon the extent to which existing OEM
customers elect to purchase communication software from the Company rather than
design and develop their own software. In light of the fact that the Company's
customers are not contractually obligated to purchase any of the Company's
products, there can be no assurance that the Company's existing OEM customers
will continue to rely, or expand their reliance, on the Company as an external
source for communication software.
Dependence on New Product Offerings. The Company's future success will
depend, in significant part, on its ability to successfully develop and
introduce new software products and improved versions of existing software
products on a timely basis and in a manner that will allow such products to
achieve broad customer acceptance. There can be no assurance that new products
will be introduced on a timely basis, if at all. If new products are delayed or
do not achieve market acceptance, the Company's business, results of operations
and financial condition will be materially adversely affected. In the past, the
Company has 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.
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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 has developed retail products with expanded functionality from its OEM
products and expects to introduce other products in the retail distribution
channel as well. The Company's ability to maintain distributor and retailer
relationships is largely a function of volumes. If the Company does not meet
certain minimum volume requirements, it will not be able to maintain its
relationships. 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 relies on
distributors, retailers and value added resellers (collectively, "resellers")
for the marketing and distribution of HotFax, HotFax MessageCenter, HotPage,
AudioVision and its other retail products. The Company's agreements with
resellers are not exclusive and in many cases may be terminated by either party
without cause. Many of the Company's resellers carry product lines that are
competitive with those of the Company. There can be no assurance that these
resellers will give a high priority to the marketing of the Company's products
or that resellers will continue to carry the Company's products. These resellers
typically are allowed to return products without charge or penalty. A component
of the Company's revenue recognition policy is that the Company calculates an
allowance for product returns based on its historical experience. If retail
sales of the Company's products increase, the risk of product returns will
increase. While the Company's revenue recognition policy contemplates this risk,
it is possible that returns may occur in excess of the Company's previous
experience, causing the Company to revise its estimates and increase the
allowances for such returns. Excessive or unanticipated returns could materially
adversely affect the Company's business, results of operations and financial
condition. The Company's results of operations could also be materially
adversely affected by changes in reseller inventory strategies, which could
occur rapidly, and in many cases, may not be related to end user demand. There
can be no assurance that the Company will be successful in recruiting resellers
to represent it. Any of these anticipated changes in the Company's distribution
channels could materially adversely affect the Company's business, results of
operations and financial condition.
Corporate and Government Product and Marketing Strategy Unproven. The
Company's revenues have increased during the past five years almost entirely on
the strength of its OEM sales, and more recently, retail sales. During the
second quarter of 1997 the Company has been adding, and plans to continue to
add, the infrastructure necessary to support a focus on the corporate and
government markets. The corporate market includes vertical applications that are
industry specific and require the investment of engineering resources. There can
be no assurance that the additional infrastructure required in sales and
marketing to the corporate and government markets, or the investment in
engineering resources for applications specific to such markets, will yield
significant sales growth for the Company or provide the margins the Company has
achieved historically on its OEM sales.
Potential for Undetected Errors. Software products as complex as those
offered by the Company may contain undetected errors. The Company has in the
past discovered software errors in certain of its products and has experienced
delayed or lost revenues during the period required to correct these errors.
There can be no assurance that, despite testing by
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the Company and by current and potential customers, errors will not be found in
new or existing products after commencement of commercial shipments, resulting
in loss of or delay in market acceptance or the recall of such products, which
could have a material adverse effect upon the Company's business, results of
operations and financial condition. The Company provides customer support for
most of its products. The Company is preparing to launch several new products.
If these products are flawed or are more difficult to use than traditional
Company products, customer support costs could rise and customer satisfaction
levels could fall.
Pre-Load and Royalty Based Software Market. The Company primarily sells
its software in a form that includes a disk and a manual. Some of its customers
"pre-load" the Company's software onto a hard disk or pay a royalty based on
units produced or shipped. These arrangements eliminate the need for a disk and
may eliminate the need for a manual. The pre-load arrangements produce smaller
unit revenues for the Company and eliminate the Company's ability to generate
revenues from its production facilities. The Company believes these facilities
contribute profits to the Company. Currently, the Company has the capability to
produce its products in-house on 3 1/2-inch diskettes. The Company does not
currently have the capability to produce CD-ROMs and the cost to develop such
production capability may be prohibitive. As the size of software programs grow,
CD-ROM is becoming a more prominent medium. The Company currently contracts
CD-ROM production to specialized CD-Rom facilities. In the event of a shift of
this kind, more of the Company's relationships would involve product pre-loads
and CD-ROM production and the Company's business, results of operations and
financial condition could be adversely affected.
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.
Acquisition of Performance Computing Incorporated. The Company acquired
PCI in March 1996. The Company's future financial results will depend in part on
its ability to successfully integrate PCI's business with its own, and there can
be no assurance that the Company will be able to successfully coordinate its
business activities with those of PCI. Furthermore, there can be no assurance
that the Company will be successful in integrating PCI products with those of
the Company or that the results of PCI's operations will not have an adverse
effect upon the Company's operating results.
The Company has sold only a limited amount of PCI products to date. PCI
products compete in a new and rapidly changing market and there can be no
assurance that such products will receive or gain market acceptance. Lack of
market acceptance of such products, or delays in or non-completion of the
development of new PCI products, could have an adverse impact on the Company's
business, results of operations and financial condition. In addition, PCI
products compete against those of several competitors, including White Pine,
Connectix, Intel and VDONet, some of whom have greater financial and other
resources than the Company, and there can be no assurance that the Company will
be
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able to compete successfully against these and any future competitors in the
video conferencing software market.
Fluctuations in Gross Margins. The Company has recently experienced
fluctuations in gross margins, primarily as a result of changes in the mix of
retail and OEM sales. Other factors that can contribute to margin fluctuations
are inventory obsolescence as a result of new retail product releases and return
of retail product, price competition, expediting costs, and changes in OEM sales
mix and the related variances in OEM product pricing. An erosion of the gross
margins as a result of any of the aforementioned reasons or for any other
reasons not contemplated by the Company at this time, could have a material
adverse affect on the Company's operating results.
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.
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. When CD-ROMs are required, the Company uses outside
third parties for CD-ROM replication. The equipment to replicate CD-ROMs is very
costly making it unlikely that the Company will add this capability internally.
Because the Company is dependent on CD-ROM replication facilities for both the
timing and pricing of the software produced in CD-ROM format, any adverse
changes in the timing of such replication could impair the Company's ability to
deliver products to customers and any price increases could reduce gross margins
which, in each case, could have a material adverse effect on the Company's
business, results of operations and financial condition.
Reliance on Third Party Suppliers; Shortage of Modem Chips. The Company
relies on third party suppliers who provide the components used in its kitted
products. These components include disks, CDs and printed manuals. Disk
shortages have occurred in the past and there can be no assurance that shortages
will not recur. If the Company cannot obtain a sufficient quantity of disks or
other components, or cannot obtain disks or other components at prices at least
comparable to prices paid currently, the Company's business, results of
operations and financial condition could be adversely affected.
Modem manufacturers purchase chips from a relatively limited number of
chip manufacturers. Production problems or product quality problems experienced
by a chip manufacturer could reduce modem sales or slow the growth of modem
sales. Chip manufacturers have a limited capacity to produce chips. This
capacity cannot be quickly expanded and the capital investment to expand
capacity is high. If chip suppliers are unable to meet demand,
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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 six months ended June
30, 1997 net revenues generated outside the U.S. decreased 38.0% to $1.0
million. As a percentage of total net revenues, international sales increased to
19.8% during 1997 from 12.7% for the six months ended June 30, 1996. For the
twelve months ended December 31, 1996 net revenues generated outside the U.S.
grew 6.6% to $3.2 million. As a percentage of total net revenues, international
sales decreased to 14.4% during 1996 from 16.6% for the twelve months ended
December 31, 1995. International business is subject to risks in addition to
those inherent in the Company's United States business including substantially
different regulatory requirements in different jurisdictions, varying technical
standards, tariffs and trade barriers, political and economic instability,
reduced protection for intellectual property rights in certain countries,
difficulties in staffing and maintaining foreign operations, difficulties in
managing distributors, potentially adverse tax consequences, foreign currency
exchange fluctuations, the burden of complying with a wide variety of complex
foreign laws and treaties and the possibility of difficulties in collecting
accounts receivable. There can be no assurance that the Company will be able to
continue to generate significant international sales. While the Company does not
currently accept payment in foreign currencies and invoices all of its sales in
U.S. dollars, there can be no assurance that the Company will be able to
continue this policy if it is able to grow international sales. If the Company
begins to receive payment in foreign currencies, it is likely to be subjected to
the risks of foreign currency losses due to fluctuations in foreign currency
exchange rates. In addition, in the event the Company is successful in doing
business outside of the United States, the Company may also face economic,
political and foreign currency situations that are substantially more volatile
than those commonly experienced in the United States. There can be no assurance
that any of these factors will not have a material adverse effect on the
Company's business, results of operations and financial condition.
Intellectual Property Rights. The Company's success is dependent upon
its software code base, its programming methodologies and other intellectual
properties. To protect its proprietary technology, the Company relies on a
combination of trade secret, nondisclosure and copyright and trademark law which
may afford only limited protection. The Company owns United States trademark
registrations for certain of its trademarks, including QUICKLINK GOLD, but has
not yet obtained registrations for all of its trademarks in the United States or
other countries, such as for the mark QUICKLINK II FAX. Until recently, the
Company did not require its employees to sign proprietary information and
inventions agreements stipulating, among other things, software ownership
rights. In addition, the Company has recently started the patent application
process for a number of technologies that could provide additional protection
for existing products and products under development. There can be no assurance
that the steps taken by the Company will be adequate to deter misappropriation
of its proprietary information, 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
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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. The Company has also received correspondence from another third party
asserting that the Company's video conferencing products violate certain patents
that they hold. No litigation has been initiated by this party and the Company
is attempting to resolve all such assertions.
As the number of trademarks, patents, copyrights and other intellectual
property rights in the Company's industry increases, and as the coverage of
these patents and rights and the functionality of products in the market further
overlap, the Company believes that products based on its technology may
increasingly become the subject of infringement claims. Such claims could
materially adversely affect the Company, and may also require the Company to
obtain one or more licenses from third parties. There can be no assurance that
the Company would be able to obtain any such required licenses upon reasonable
terms, if at all, and the failure by the Company to obtain such licenses could
have a material adverse effect on its business, results of operations and
financial condition. In addition, the Company licenses technology on a
non-exclusive basis from several companies for inclusion in its products and
anticipates that it will continue to do so in the future. The inability of the
Company to continue to license these technologies or to license other necessary
technologies for inclusion in its products, or substantial increases in royalty
payments under these third party licenses, could have a material adverse effect
on its business, results of operations and financial condition.
Litigation in the software development industry has increasingly been
used as a competitive tactic both by established companies seeking to protect
their existing position in the market and by emerging companies attempting to
gain access to the market. If the Company is forced to defend itself against a
claim, whether or not meritorious, the Company could be forced to incur
substantial expense and diversion of management attention, and may encounter
market confusion and reluctance of customers to purchase the Company's software
products.
Concentration of Ownership. As of June 30, 1997, William Smith and
Rhonda Smith beneficially owned, as community property, approximately 69.5% of
the outstanding shares of the Company. William Smith and Rhonda Smith are
married to one another and, acting together, will have the ability to elect the
Company's directors and determine the outcome of any corporate action requiring
stockholder approval, irrespective of how other stockholders of the Company may
vote. This concentration of ownership may have the effect of delaying or
preventing a change in control of the Company.
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Potential Effect of Anti-Takeover Provisions. The Company's Certificate
of Incorporation and Bylaws contain provisions that may discourage or prevent
certain types of transactions involving an actual or potential change in control
of the Company, including transactions in which the stockholders might otherwise
receive a premium for their shares over then current market prices, and may
limit the ability of the stockholders to approve transactions that they may deem
to be in their best interest. In addition, the Board of Directors has the
authority to fix the rights and preferences of shares of the Company's Preferred
Stock and to issue such shares, which may have the effect of delaying or
preventing a change in control of the Company, without action by the Company's
stockholders. Certain provisions of Delaware law applicable to the Company,
including Section 203 of the Delaware General Corporation Law, could also have
the effect of delaying, deferring or preventing a change of control of the
Company. It is possible that the provisions in the Company's Certificate of
Incorporation and Bylaws, the ability of the Board of Directors to issue the
Company's Preferred Stock, and Section 203 of the Delaware General Corporation
Law may have the effect of delaying, deferring or preventing a change of control
of the Company without further action by the stockholders, may discourage bids
for the Company's Common Stock at a premium over the market price of the Common
Stock and may adversely affect the market price of the Common Stock and the
voting and other rights of the holders of Common Stock.
Possible Volatility of Stock Price. The trading price of the Common
Stock is likely to be subject to significant fluctuations in response to
variations in quarterly operating results, the gain or loss of significant
orders, changes in management, announcements of technological innovations or new
products by the Company, its customers or its competitors, legislative or
regulatory changes, general trends in the industry and other events or factors.
In addition, the stock market has experienced extreme price and volume
fluctuations which have particularly affected the market price for many high
technology companies similar to Smith Micro, and which have often been unrelated
to the operating performance of these companies. These broad market fluctuations
may adversely affect the market price of the Company's Common Stock. Further,
factors such as announcements of new contracts or product offerings by the
Company or its competitors and market conditions for stocks similar to that of
the Company could have significant impact on the market price of the Common
Stock.
Shares Eligible for Future Sale. No prediction can be made as to the
effect, if any, that future sales of Company Common Stock or the availability of
such Common Stock for future sales will have on the market price of the
Company's Common Stock. As of June 30, 1997, the Company had 14,074,698 shares
of Common Stock outstanding. Of this amount, the 9,781,670 shares held by
William Smith and Rhonda Smith will be available for sale in the public market
(subject to the volume and other applicable restrictions of Rule 144) following
the expiration in September 1997 of a two year lock-up agreement with certain
representatives of the underwriters of the Company's initial public offering
which consummated in September 1995. 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. Sales of a substantial number of shares of Common Stock by William
Smith, Rhonda Smith or any other person, either individually or when aggregated
with sales by other persons, could adversely affect the market price of the
Common Stock.
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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 the Registrant's Registration Statement
No. 33-95096
10.4 Form of 1995 Stock Option Agreement under Incorporated by reference to Exhibit 10.4
1995 Stock Option /Stock Issuance Plan. to the Registrant's Registration Statement
No. 33-95096
10.5 Form of 1995 Stock Purchase Agreement Incorporated by reference to Exhibit 10.5
under 1995 Stock Issuance Plan. to the Registrant's Registration Statement
No. 33-95096
10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6
September 30, 1991, by and between the to the Registrant's Registration Statement
Company and Crandell Development 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
10.11 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
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EXHIBIT
NO. TITLE METHOD OF FILING
--- ----- ----------------
10.12 Software Distribution Agreement dated May Incorporated by reference to Exhibit 10.12
8, 1995, by and between the Company and to the Registrant's Registration Statement
International Business Machines Corporation. No. 33-95096
10.13 Office Building Lease, dated June 10, Incorporated by reference to Exhibit 10.13
1992, by and between the Company and to the Registrant's Registration Statement
Developers Venture Capital Corporation. No. 33-95096
10.14 Amendment No. 1 To Office Building Lease, Incorporated by reference to Exhibit 10.14
dated July 9, 1993, by and between the to the Registrant's Registration Statement
Company and Pioneer Bank. No. 33-95096
10.15 Amendment No. 2 To Office Building Lease, Incorporated by reference to Exhibit 10.15
dated August 15, 1994, by and between the to the Registrant's Registration Statement
Company and T&C Development. No. 33-95096
10.16 Fourth Addendum to Office Building Lease, Incorporated by reference to Exhibit 10.16
dated April 21, 1995, by and between the to the Registrant's Registration Statement
Company and T&C Development. No. 33-95096
10.17 Form of Promissory Note related to Incorporated by reference to Exhibit 10.17
S Corporation Distribution. to the Registrant's Registration Statement
No. 33-95096
10.18 Smith Micro Software, Inc. Amended and Restated Incorporated by reference to Exhibit 10.21
Software Licensing and Distribution Agreement, to the Registrant's Quarterly Report on Form
dated April 18, 1996 by and between the Company 10-Q for the quarter ended September 30, 1996
and U.S. Robitics Access Corp.
10.19 Office Building Lease, dated March 1, Incorporated by reference to Exhibit 10.19
1994, by and between Performance Computing to the Registrant's Annual Report on Form
Incorporated and Petula Associates, 10-K for the fiscal year ended December 31, 1995
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 Amendment No. 1, dated as of March 10, 1997 Incorporated by reference to Exhibit 10.21
to Agreement and Plan of Merger by and to the Registrant's Annual Report on Form 10-K
between Smith Micro Software, Inc., for the fiscal year ended December 31, 1996
Performance Computing Incorporated and PCI
Video Products, Inc. dated as of March 14, 1996
20.1 1996 Investment Profile Incorporated by reference
to Exhibit 20.1 to the
Registrant's Quarterly Report on Form 10-Q for
the quarter ended March 31, 1997
21.1 Subsidiaries of Registrant. Incorporated by reference to Exhibit 21.1
to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995
27.0 Financial Data Schedule. Filed Herewith
(B) REPORTS ON FORM 8-K
No Current reports on Form 8-K were filed during the quarter ended June
30, 1997.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SMITH MICRO SOFTWARE, INC.
August 12, 1997 By /s/ WILLIAM W. SMITH, JR.
------------------------------
William W. Smith, Jr.
Chairman of the Board,
President and Chief Executive
Officer (Principal Executive
Officer)
August 12, 1997 By /s/ ROBERT E. GRICE, JR.
------------------------------
Robert E. Grice, Jr.
Chief Financial Officer
(Principal Financial Officer)
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