1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED JUNE 30, 1998

[ ] 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: (949) 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, 1998, there were 14,074,698 shares of Common Stock
outstanding.

SMITH MICRO SOFTWARE, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 1998 (UNAUDITED)
AND DECEMBER 31, 1997 3

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE
AND SIX MONTHS ENDED JUNE 30, 1998 AND JUNE 30, 1997 4

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX
MONTHS ENDED JUNE 30, 1998 AND JUNE 30, 1997 5

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS 6

MANAGEMENT'S DISCUSSION AND ANALYSIS 8

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS 19

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 19

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 20

SIGNATURES 23

FORWARD LOOKING STATEMENTS

THE STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q THAT ARE NOT
STATEMENTS OF HISTORICAL FACT MAY BE FORWARD LOOKING STATEMENTS WITHIN THE A
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, SECTION 21E OF
THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, AND SECTION 27A OF THE
SECURITIES ACT OF 1933, AS AMENDED, AND ARE SUBJECT TO THE "SAFE HARBORS"
CREATED BY THESE SECTIONS. THESE FORWARD LOOKING STATEMENTS ARE SUBJECT TO A
NUMBER OF RISKS AND UNCERTAINTIES. THE FOLLOWING FACTORS, TOGETHER WITH THOSE
ADDITIONAL RISKS DISCUSSED IN THIS QUARTERLY REPORT ON FORM 10-Q (PARTICULARLY
IN "RISK FACTORS" COMMENCING ON PAGE 11), COULD CAUSE THE ACTUAL RESULTS OF THE
COMPANY TO MATERIALLY DIFFER FROM THOSE ANTICIPATED BY FORWARD LOOKING
STATEMENTS HEREIN SET FORTH: DEMAND FOR COMMUNICATION SOFTWARE; DEMAND FOR
MODEMS AND OTHER ELECTRONIC COMMUNICATION DEVICES; NATIONAL, REGIONAL AND
INTERNATIONAL ECONOMIC CONDITIONS AFFECTING THE SUPPLY OF AND DEMAND FOR
COMMUNICATION SOFTWARE, MODEMS OR OFFERINGS BY THE COMPANY; THE COMPANY'S
ABILITY TO COMPETE IN AND SELL ITS PRODUCTS THROUGH THE RETAIL CHANNEL AND
ORIGINAL EQUIPMENT MANUFACTURERS' (OEMS) DISTRIBUTION CHANNEL; THE COMPANY'S
ABILITY TO COMPETE AND SELL ITS PRODUCTS THROUGH THE CORPORATE AND GOVERNMENT
MARKETPLACE; DEMAND FOR THE COMPANY'S PRODUCTS; THE COMPANY'S ABILITY TO
MAINTAIN AND EXPAND ITS CUSTOMER 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 QUARTERLY REPORT ON FORM 10-Q SHOULD BE CONSIDERED IN THE LIGHT OF THESE
AND ANY OTHER FACTORS WHICH MIGHT CAUSE THE COMPANY'S FUTURE PERFORMANCE TO
MATERIALLY DIFFER FROM THAT ANTICIPATED BY THIS QUARTERLY REPORT ON FORM 10-Q.
THE COMPANY DISCLAIMS ANY OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY
REVISIONS TO THESE FORWARD LOOKING STATEMENTS WHICH MAY BE MADE TO REFLECT
EVENTS OR CIRCUMSTANCES OCCURRING SUBSEQUENT TO THE FILING OF THIS FORM 10-Q
WITH THE SECURITIES AND EXCHANGE COMMISSION ("SEC") OR OTHERWISE TO REVISE OR
UPDATE ANY ORAL OR WRITTEN FORWARD LOOKING STATEMENT THAT MAY BE MADE FROM TIME
TO TIME BY OR ON BEHALF OF THE COMPANY.

2
3

SMITH MICRO SOFTWARE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

June 30 December 31,
1998 1997
----------- ------------
(unaudited)

ASSETS

CURRENT ASSETS:
Cash and cash equivalents $14,236 $14,367
Accounts receivable, net of allowances for doubtful accounts
and other adjustments of $620 (1998) and $1,413 (1997) 3,710 3,808
Income taxes receivable 382 1,127
Deferred tax asset 467 467
Inventories 685 553
Prepaid expenses and other current assets 636 503
------- -------
Total current assets 20,116 20,825

EQUIPMENT AND IMPROVEMENTS, net 354 444

DEFERRED TAX ASSET 139 139

INTANGIBLE ASSETS, net 601 347
------- -------
$21,210 $21,755
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts payable $ 737 $ 877
Accrued liabilities 826 635
------- -------
Total current liabilities 1,563 1,512

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.001 per share;
5,000,000 shares authorized; none issued and
outstanding
Common stock, par value $0.001 per share;
20,000,000 shares authorized; 14,075,000 shares
issued and outstanding (1998 and 1997) 14 14
Additional paid-in capital 21,250 21,250
Accumulated deficit (1,617) (1,021)
------- -------
Total stockholders' equity 19,647 20,243
------- -------
$21,210 $21,755
======= =======

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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,
1998 1997 1998 1997
---- ---- ---- ----

NET REVENUES $ 1,656 $2,620 $ 4,922 $ 5,278

COST OF REVENUES 581 834 1,447 2,080
------- ------ ------- -------

GROSS PROFIT 1,075 1,786 3,475 3,198

OPERATING EXPENSES:
Selling and marketing 759 921 1,527 1,916
Research and development 839 851 1,625 1,733
General and administrative 840 936 1,676 2,472
------- ------ ------- -------

Total operating expenses 2,438 2,708 4,828 6,121
------- ------ ------- -------

OPERATING LOSS (1,363) (922) (1,353) (2,923)

INTEREST INCOME 183 180 363 360
------- ------ ------- -------

LOSS BEFORE INCOME TAXES (1,180) (742) (990) (2,563)

INCOME TAX BENEFIT (471) (260) (394) (897)
------- ------ ------- -------

NET LOSS $ (709) $ (482) $ (596) $(1,666)
======= ====== ======= =======

NET LOSS PER SHARE, basic and diluted $ (0.05) $(0.03) $ (0.04) $ (0.12)
======= ====== ======= =======

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.

SMITH MICRO SOFTWARE, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

For The Six Months
Ended June 30,
1998 1997
---- ----

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (596) $(1,666)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 338 387
Provision for doubtful accounts and other adjustments
to accounts receivable (793) 163
Change in operating accounts:
Accounts receivable 891 1,527
Income taxes receivable 745 (1,128)
Inventories (132) (75)
Prepaid expenses and other current assets (133) (6)
Accounts payable and accrued liabilities 51 (716)
------- -------

Net cash provided by (used in) operating activities 371 (1,514)

CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (44) (179)
Acquisition of technology (458)
------- -------
Net cash used in investing activities (502) (179)
------- -------

NET DECREASE IN CASH AND CASH EQUIVALENTS (131) (1,693)

CASH AND CASH EQUIVALENTS, beginning of period 14,367 14,487
------- -------

CASH AND CASH EQUIVALENTS, end of period $14,236 $12,794
======= =======

SEE NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.

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. ("Smith
Micro" or the "Company") pursuant to Securities and Exchange Commission
regulations. The accompanying unaudited consolidated financial statements
reflect the operating results and financial position of Smith Micro Software,
Inc. and its wholly-owned subsidiary. All significant intercompany amounts have
been eliminated in consolidation. 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 three and six months
ended June 30, 1998 are not necessarily indicative of the results to be
expected for the full year ended December 31, 1998. The accompanying unaudited
consolidated 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, 1997 as footnotes and certain financial
presentations are condensed or omitted from generally accepted accounting
principles presentation requirements, pursuant to SEC rules and regulations.

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,
purchased technology and noncompete agreements, which are amortized over periods
ranging from three to five years. The Company assesses the recoverability of
intangible assets at each balance sheet date by determining whether the
amortization of the balance over its remaining useful life can be recovered
through projected undiscounted future operating cash flows.

Revenue Recognition - The Company recognizes revenues from sales of its
software as completed products are shipped and from royalties generated as
authorized customers duplicate the Company's software. 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
service to its customers. Such costs have historically been insignificant.

The Company has adopted Statement of Position (SOP) 97-2, Software
Revenue Recognition, issued by the American Institute of Certified Public
Accountants which supersedes SOP 91-1. SOP 97-2 provides guidance on when
revenue should be recognized and in what amounts for licensing, selling, leasing
or otherwise marketing computer software. The adoption of SOP 97-2 had no
material impact on the Company's recognition of revenue.

Software Development Costs - Development costs incurred in the research
and development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility has been
established. The Company considers technological feasibility to be established
when all planning, designing, coding and testing has been completed according to
design specifications. After technological feasibility is established, any
additional costs are capitalized. Through June 30, 1998, software has been
substantially completed concurrently with the establishment of technological
feasibility; and, accordingly, no costs have been capitalized to date.

Income Taxes - The Company accounts for income taxes under Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. This
statement requires the recognition of deferred tax assets and liabilities for
the future

consequences of events that have been recognized in the Company's financial
statements or tax returns. The measurement of the deferred items is based on
enacted tax laws. In the event the future consequences of differences between
financial reporting bases and the tax bases of the Company's assets and
liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation
of the probability of being able to realize the future benefits indicated by
such asset. A valuation allowance related to a deferred tax asset is recorded
when it is more likely than not that some portion or all of the deferred tax
asset will not be realized.

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 June 30, 1998. 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.

Net Income (Loss) Per Share - The Company has adopted SFAS No. 128,
Earnings per Share (EPS), which replaces the presentation of "primary" earnings
per share with "basic" earnings per share and the presentation of "fully
diluted" earnings per share with "diluted" earnings per share. All previously
reported EPS amounts have been restated based on the provisions of the new
standard. Basic EPS amounts are based upon the weighted average number of common
shares outstanding. Diluted EPS amounts are based upon the weighted average
number of common and common equivalent shares outstanding. Common equivalent
shares include stock options using the treasury stock method. Common equivalent
shares are excluded from the calculation of diluted EPS in loss periods, as the
impact is antidilutive. There was no difference between basic and diluted EPS
for each period presented. The number of shares used in computing EPS is as
follows:

For the Three Months For the Six Months
Ended June 30, Ended June 30,
---------------------------- ----------------------------
1998 1997 1998 1997
------------- ------------ ------------ -------------

Weighted average number of shares outstanding,
basic and diluted 14,075,000 14,075,000 14,075,000 14,075,000
========== ========== ========== ==========

Use of Estimates - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting years. Actual results could differ from those estimates.

Comprehensive Income - The Company has adopted SFAS No. 130, Reporting
Comprehensive Income. This statement establishes standards for the reporting of
comprehensive income and its components. Comprehensive income, as defined,
includes all changes in equity (net assets) during a period from nonowner
sources. For each of the three and six month periods ending June 30, 1998 and
1997, there was no difference between net income, as reported, and comprehensive
income.

Reclassifications - Certain reclassifications have been made to the 1997
financial statements to conform to the 1998 presentation.

2. NEW ACCOUNTING PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, Disclosures About Segments of an Enterprise and Related Information. This
statement establishes standards for the way companies report information about
operating segments in annual financial statements. It also establishes standards
for related disclosure about products and services, geographic areas and major
customers. The disclosures prescribed by SFAS No. 131 are effective for the year
ended December 31, 1998 but not required for interim periods in the year of
adoption.

3. ACQUISITION OF TECHNOLOGY

During 1998, the Company acquired certain fax technology assets from
Mitek Systems, Inc. for $458,000 in cash. The fax software acquired provides fax
functionality over Local Area Networks ("LANs"), the Internet and intranets.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

GENERAL

Smith Micro, founded in 1982, develops and sells personal computer
communication software. The Company's communication software products include
fax, video conferencing, video email, telephony and data transmission products.
The Company shipped its first data communication software product in 1985 and,
since that time, the Company's revenues have been primarily the result of the
market acceptance of its OEM fax and data communication software products. The
Company began providing video communication products in 1996 to both OEM and
retail customers. In January 1998, the Company purchased certain fax software
assets of Mitek Systems, Inc. to provide LAN, Internet and intranet fax
transmission solutions designed for the corporate market.

The Company recognizes revenues from sales of its software as completed
products are shipped and from royalties generated as authorized customers
duplicate the Company's software. Any material reduction in demand for the
Company's products would have a material adverse effect on the Company's
business, results of operations and financial condition. The Company continues
to introduce new products and its future success will depend in part on the
continued introduction of new and enhanced OEM, retail and corporate products
that achieve market acceptance. Revenues are net of estimated returns and other
adjustments at the time the products are shipped. The Company has allowed its
customers to return unused software, constituting 22.8%, 26.8% and 16.8% of the
Company's net revenues for the six months ended June 30, 1998 and for the years
1997 and 1996, respectively.

A small number of customers have historically accounted for a
substantial portion of the Company's revenues. In June 1997, 3Com Corporation
("3Com") acquired U.S. Robotics Corporation ("U.S. Robotics"), to date the
Company's largest customer based on the percentage of revenues, as a wholly
owned subsidiary. Sales to 3Com (primarily U.S Robotics and its subsidiaries),
accounted for approximately 31.4%, 43.4% and 46.4% of net revenue for the six
months ended June 30, 1998 and the years 1997 and 1996, respectively. During the
six months ended June 30, 1998 and the years 1997 and 1996, the Company's three
largest OEM customers, including 3Com, accounted for 44.3%, 56.9% and 62.9%,
respectively, of net revenues. Any reduction, delay or change in orders from
such customers could have a material adverse effect on the Company's business,
results of operations and financial condition.

The OEM product ordering cycle beginning from placement of an order to
shipping is very short. OEM customers generally operate under a just-in-time
system and order software to be delivered as needed by their manufacturing
operations. The Company's products are generally shipped as orders are received
and, accordingly, the Company has historically operated with little backlog, and
does not consider backlog to be a significant indication of future performance.
As a result, sales in any quarter are dependent on orders booked and shipped in
that quarter and are not predictable with any degree of certainty. Moreover, the
Company does not generally produce software in advance of orders and therefore
has not maintained a material amount of inventory.

Inventory in the retail channel exposes the Company to product returns.
This exposure is considered when the allowance is made for product returns.
Substantial returns of product from the retail channel could have a material
adverse effect on the Company's business, results of operations and financial
condition.

The following discussion should be read in conjunction with, and is
qualified in its entirety by, the Financial Statements and related notes thereto
included elsewhere. Historical results of operations, percentage relationships
and any trends that may be inferred from the discussion below are not
necessarily indicative of the operating results for any future period.

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated, the
percentages of net revenues represented by each item in the Company's statement
of income.

For The Three Months For The Six Months
Ended June 30, Ended June 30,
---------------------- ----------------------
1998 1997 1998 1997
--------- --------- --------- ---------

Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 35.1% 31.8% 29.4% 39.4%
----- ----- ----- -----
Gross profit 64.9% 68.2% 70.6% 60.6%
Operating expenses:
Selling and marketing 45.8% 35.2% 31.0% 36.3%
Research and development 50.7% 32.5% 33.0% 32.9%
General and administrative 50.7% 35.7% 34.1% 46.8%
----- ----- ----- -----
Total operating expenses 147.2% 103.4% 98.1% 116.0%
----- ----- ----- -----
Operating income (loss) -82.3% -35.2% -27.5% -55.4%
Interest income 11.1% 6.9% 7.4% 6.8%
----- ----- ----- -----
Income (loss) before income taxes -71.2% -28.3% -20.1% -48.6%
Income tax expense (benefit) -28.4% -9.9% -8.0% -17.0%
----- ----- ----- -----
Net income (loss) -42.8% -18.4% -12.1% -31.6%
===== ===== ===== =====

NET REVENUES

Net revenues decreased 36.8% to $1.7 million in the three months ended
June 30, 1998 from $2.6 million in the three months ended June 30, 1997. The
decrease in revenue was the direct result of reduced demand by the company's
largest OEM analog modem customers, including 3Com. Sales to 3Com decreased
58.6% for the three months ended June 30, 1998 compared to June 30, 1997. The
company believes the reduction in orders placed by the Company's largest
customers was due to decreased sales in the analog modem market generally and
the efforts of certain customers to control inventory levels.

Net revenues decreased 6.7% to $4.9 million in the six months ended June
30, 1998 from $5.3 million in the six months ended June 30, 1997. The decrease
in revenue was the result of the reduced demand by the company's largest OEM
analog modem customers as noted above. Sales to 3Com decreased 30.5% for the six
months ended June 30, 1998 compared to June 30, 1997. This reduction was
partially offset by increased net revenue generated by video related product
sales to OEM customers.

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 39.8% to $1.1 million in the three months ended June 30, 1998 from
$1.8 million in the three months ended June 30, 1997. As a percentage of net
revenues, gross profits decreased to 64.9% in the three months ended June 30,
1998 from 68.2% in the three months ended June 30, 1997. The reduction in gross
profit and gross profit percentage was directly attributed to the 36.8%
reduction in net revenues, partially offset by the company's flexible
manufacturing process and improved controls over manufacturing expenses.

Gross profit increased 8.7% to $3.5 million in the six months ended June
30, 1998 from $3.2 million in the six months ended June 30, 1997. As a
percentage of net revenues, gross profits increased to 70.6% in the six months
ended June 30, 1998 from 60.6% in the six months ended June 30, 1997. The
increase in gross profit and gross profit percentage was attributable to higher
sales allowances in 1997 and the company's flexible manufacturing process and
improved controls over manufacturing expenses.

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 decreased 17.6% to
$759,000 in the three months ended June 30, 1998 from $921,000 in the three
months ended June 30, 1997. The decrease in sales and marketing expenses is
primarily due to reduced marketing expenditures within the retail channel. As a
percent of net revenues, sales and marketing expenses increased to 45.8% of net
revenues in the three months ended June 30, 1998 from 35.2% in the three months
ended June 30, 1997.

Sales and marketing expenses decreased 20.3% to $1.5 million in the six
months ended June 30, 1998 from $1.9 million in the six months ended June 30,
1997. The decrease in sales and marketing expenses is primarily due to reduced
marketing expenditures within the retail channel. As a percentage of net
revenues, sales and marketing expenses decreased to 31.0% in the six months
ended June 30, 1998 from 36.3% in the six months ended June 30, 1997.

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 1.4% to $839,000 in the three months
ended June 30, 1998 from $851,000 in the three months ended June 30, 1997.
Research and development expenses remain relatively constant as the Company
works to develop new products. As a percent of net revenues, research and
development expenses increased to 50.7% for the three months ended June 30, 1998
from 32.5% for the three months ended June 30, 1997.

Research and development expenses decreased 6.2% to $1.6 million in the
six months ended June 30, 1998 from $1.7 million in the six months ended June
30, 1997. Research and development expenses remain relatively constant as the
Company works to develop new products. As a percentage of net revenues, research
and development expenses increased to 33.0% in the six months ended June 30,
1998 from 32.8% in the six months ended June 30, 1997.

GENERAL AND ADMINISTRATIVE EXPENSES

General and administrative expenses encompass expenses related to
general operations that are not included as costs of sales, sales and marketing
or research and development. General and administrative expenses decreased 10.3%
to $840,000 in the three months ended June 30, 1998 from $936,000 in the three
months ended June 30, 1997. The decrease is primarily due to cost control
measures. As a percent of net revenues, general and administrative expenses
increased to 50.7% of net revenues in the three months ended June 30, 1998 from
35.7% in the three months ended June 30, 1997.

General and administrative expenses decreased 32.2% to $1.7 million in
the six months ended June 30, 1998 from $2.5 million in the six months ended
June 30, 1997. They decrease his primarily due to the higher allowance for bad
debt in 1997 and cost control measures during 1998. As a percentage of net
revenues, general and administrative expenses decreased to 34.1% in the six
months ended June 30, 1998 from 46.8% in the six months ended June 30, 1997.

INCOME TAXES

The income tax benefit was $471,000 for the three months ended June 30,
1998 based on a loss before income taxes of $1.2 million compared to an income
tax benefit of $260,000 for the three months ended June 30, 1997 based on a loss
before income taxes of $742,000.

LIQUIDITY AND CAPITAL RESOURCES

Since its inception, the Company has financed its operations primarily
through cash generated from operations. Net cash provided by operating
activities was $371,000 in the six months ended June 30, 1998 as compared to
$1.5 million used in operations in

the six months ended June 30, 1997. The primary sources of cash during the six
months ended June 30, 1998 were due to a reduction in accounts receivable and
the collection of income tax refunds that were offset by the net loss.

During the six months ended June 30, 1998, the Company used $502,000 in
investing activities, consisting primarily of the $458,000 acquisition of the
fax technology assets of Mitek Systems, Inc.

At June 30, 1998, the Company had $14.2 million in cash and cash
equivalents and $18.6 million of working capital. The Company had $3.7 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.

YEAR 2000 COMPLIANCE

Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. These date code
fields will need to accept four digit entries to distinguish 21st century dates
from 20th century dates. As a result, in less than two years, computer systems
and/or software used in many companies may need to be upgraded to comply with
such "Year 2000" requirements. Significant uncertainty exists in the computer
industry concerning the potential effects associated with such compliance.

The Company currently offers software products that are designed to be
Year 2000 compliant. However, there can be no assurance that such products do
not contain undetected errors or defects associated with Year 2000 date
functions.

The Company has received confirmation from vendors of certain purchased
software used for internal operations that current releases or upgrades are
designed to be Year 2000 compliant, if installed. The Company is in the process
of determining whether to upgrade the current system or purchase a new system
that is designed to be Year 2000 compliant. The Company anticipates that all
internally used software will be designed to be Year 2000 compliant prior to
operational requirements for Year 2000 data.

The Company currently believes that becoming Year 2000 compliant will
not have a significant impact on the financial position or results of operations
of the Company. Although the Company is not aware of any material operational
issues or costs associated with preparing its software products or internal
information systems for the year 2000, there can be no assurances that the
Company will not experience serious unanticipated negative consequences and/or
material costs caused by undetected errors or defects in the technology used in
its internal systems, which are composed predominantly of third party software
and hardware.

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 that 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 and that the
slower than expected rollout of V.90 standard 56K modems may reduce their rates
of growth during subsequent quarters. The rate at which this inventory is moved
out of the channel and the rate of the market's acceptance of the V.90 standard
56K modem 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

12
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. These or other factors may influence
quarterly results in the future 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. Due to all of the foregoing factors, it
is possible that in some future quarter the Company's operating results may be
below the expectations of public market analysts and investors. In such event,
the price of the Company's Common Stock would likely be materially adversely
affected.

Reliance on 3Com Corporation. In June 1997, 3Com acquired U.S. Robotics,
to date the Company's largest customer based on the percentage of revenues, as a
wholly owned subsidiary. There can be no assurance that 3Com's acquisition of
U.S. Robotics will not result in a change in U.S. Robotics' purchasing habits, a
decrease in new orders by U.S. Robotics, inventory levels maintained by U.S.
Robotics, or the loss of U.S. Robotics as a customer entirely.

Sales to 3Com (primarily U.S Robotics and its subsidiaries), accounted
for approximately 31.4%, 43.4% and 46.4% for the six months ended June 30, 1998
and the years 1997 and 1996, respectively. The Company expects that the 3Com
entities will continue to account for a significant portion of the Company's
revenues in future periods. In April 1996, the Company entered into an OEM
agreement having an initial one-year term with a wholly-owned subsidiary of U.S.
Robotics, which agreement superseded a previous agreement between the parties.
The agreement automatically renews at the end of each one year term unless a
party provides at least 60 days notice of its intent to terminate the agreement
at the end of the then-current term. During 1998, the agreement automatically
renewed according to its terms and during 1997 certain other 3Com entities were
added as parties pursuant to new addenda to the agreement. Under the terms of
the agreement, the Company granted certain pricing incentives to the 3Com
entities in consideration for which the Company became the provider of fax,
data, voice and telephony communications software for such 3Com entities. In
addition, under the terms of the agreement, certain of the 3Com entities agreed
to place Smith Micro retail products and commercials for such products on
certain of their compact disks. The agreement does not require any 3Com entity
to purchase any minimum quantity of Smith Micro products and may be terminated
by a party at any time thereto for any reason upon 90 days prior written notice.
As a result, there can be no assurance that the 3Com entities will continue to
purchase the Company's products.

While the Company believes that it has been the principal supplier of
OEM communication software products to U.S. Robotics, there can be no assurance
that U.S. Robotics and the other 3Com entities to which the Company sells
products will not seek additional sources for such products in the future.
Accordingly, there can be no assurance that sales to the 3Com entities will
reach or exceed in any future period the historical levels of sales to U.S.
Robotics. A substantial decrease or delay in sales to the 3Com entities would
have a material adverse effect on the Company's business, results of operations
and financial condition.

Concentration of Customer Revenues. In addition to the 3Com entities,
including U.S. Robotics, the Company has in the past derived, and expects in the
future to derive, a significant portion of its revenues from a relatively small
number of customers. Net revenue from the Company's three largest customers,
including the 3Com entities, represented approximately 44.3%, 56.9% and 70.8%
for the six months ended June 30, 1998 and the years 1997 and 1996,
respectively. The Company expects that it will continue to be dependent upon
relatively large orders from major OEM customers for a significant portion of
its revenues in future periods, although none of them is obligated to purchase
any products. Accordingly, there can be no assurance that any sales to these
entities, individually or as a group, will continue or, if continued, will reach
or exceed historical levels in any future period. Any substantial decrease or
delay in sales to one or more of these entities would have a material adverse
effect on the Company's business, results of operations and financial condition.
In addition, certain of the Company's OEM customers have in the past and may in
the future acquire competitors or be acquired by competitors, causing further
consolidation in the modem industry. Previous acquisitions in the modem industry
have often caused the purchasing departments of the combined companies to
reevaluate their purchasing decisions. There can be no assurance that such
acquisitions will not result in a change in a current customer's purchasing
habits, including a loss of the customer, a decrease in orders from that
customer or a delay in orders previously made by the customer. Moreover,
acquisitions involving existing OEM customers may cause the concentration of the
Company's customer revenues to increase if the combined companies continue to
purchase the Company's software products. Although the Company maintains
allowances for doubtful accounts, the insolvency of one or more of the other
major customers of the Company could substantially impair the Company's
business, results of operations and financial condition.

Product Concentration. The Company has in the past derived, and may in
the future derive, a significant portion of its revenues from a relatively small
number of products. The sale of QuickLink related products represented
approximately 68.4%, 81.3% and 69.4%

12
13

of the Company's net revenues in the six months ended June 30, 1998 and during
the years 1997 and 1996 respectively. The Company expects that revenues from
these products will continue to account for a substantial portion of the
Company's total revenues in the foreseeable future. Declines in 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 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.

In March 1997, modem manufacturers shipped the first 56K modems for
retail sale. 56K modems were initially based on either one of two incompatible
standards, the x2 standard adopted by 3Com or the K56flex standard adopted by
Rockwell International and Lucent Technologies. This incompatibility, combined
with the failure of the modem industry to adopt an industry-wide standard for
such modems, caused some modem manufacturers to delay the launch of proprietary
56K modems and caused consumers to delay purchases of the new modems. The
company believes that its business, results of operations and financial
condition since the launch of the 56K modems have been directly and adversely
affected by the incompatibly of the 56K modem technology and the resulting
confusion created thereby in the marketplace. In February 1998, the ITU
(international standards governing body) voted on a draft of a 56K modem
standard, V.90, and the Company believes the ITU plans to formally approve it
during the next ITU meeting in September 1998. Both competing 56K modem groups
support the proposed V.90 standard by providing downloadable flash memory
upgrades for currently owned X2 and K56flex technology modems and shipping V.90
compliant modems. There can be no assurance that the Company will not continue
to be adversely affected by the previous incompatibility issues or the rate of
the market's acceptance of this new technology. Additionally there can be no
assurance that other technological changes in the communications industry will
not similarly affect the Company, its results of operations or financial
condition.

Competitive Threat from Microsoft and Other Operating Systems. The
Company faces competition from Microsoft, which dominates the personal computer
software industry. Due to its market dominance and the fact that it is the
publisher of the most prevalent personal computer operating platforms, DOS and
Windows, Microsoft represents a significant competitive threat to all personal
computer software vendors, including the Company. In addition, Windows 98,
Windows 95 and Windows NT, the latest Microsoft operating systems, include
capabilities now provided by certain of the Company's OEM and retail software
products, including the Company's principal product, QuickLink. If the
communications capabilities of Windows 98, 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. For example,
HotFax MessageCenter and HotFax, the Company's principal retail products,
compete directly with Symantec's WinFax Pro. Symantec is well established in the
retail distribution channel. There can be no assurance that HotFax
MessageCenter, HotFax, AudioVision, VideoLink Mail Pro, HotPage, HotFax Share or
any of the Company's other retail product lines will capture a significant share
of the retail market for communication software. In addition, the Company's
retail video conferencing product, AudioVision, competes in a new and rapidly
changing software market. Some of the current competitors in the video
conferencing retail software market are White Pine and VocalTech, and there can
be no assurance that the Company will compete successfully with these and any
future competitors in the retail video conferencing software market. In the OEM
distribution channel, the Company has several competitors, among them Symantec,
Cheyenne, Intel, Microsoft, White Pine, VocalTech 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 effect on the
Company's business, results of operations and financial condition.

Symantec currently makes certain complementary products that are sold
separately. Symantec may be able to enhance its competitive position by bundling
certain of these products to attract customers seeking integrated,
cost-effective software applications. The Company also believes that the market
in which it competes has been characterized by the consolidation of established
communication software suppliers and that this trend, which may lead to the
creation of additional large and well-financed competitors, may continue. In
addition, other competitors have entered the market. Moreover, because there are
low barriers to entry into the software market, the Company believes that
competition will increase in the future. To remain competitive, the Company
believes that it will need to make continuing investments in research and
development and sales and marketing. There can be no assurance that the Company
will have sufficient resources to make such investments, or that it will be
successful in its research and development or sales and marketing efforts.

Symantec and many of the Company's current and prospective competitors
have significantly greater financial, marketing, service, support, technical and
other resources than the Company. Moreover, these companies may introduce
additional products that are competitive with those of the Company, and there
can be no assurance that the Company's products would compete effectively with
such products. The Company believes that its ability to compete depends on
elements both within and outside its control, including the success and timing
of new product development, product performance and price, distribution and
customer support and introduction by the Company and its competitors of new
products. There can be no assurance that the Company will be able to compete
successfully with respect to these and other factors. The Company believes that
the market for its software products has been and will continue to be
characterized by significant price competition. A material reduction in the
price of the Company's products could negatively affect the Company's
profitability.

Many of the Company's existing and potential OEM customers are major
manufacturers of modems and have substantial technological capabilities. These
customers may currently be developing, or may in the future develop, products
that compete directly with the Company's products and may, therefore,
discontinue purchases of the Company's products. The Company's future
performance is substantially dependent upon the extent to which existing OEM
customers elect to purchase communication software from the Company rather than
design and develop their own software. In light of the fact that the Company's
customers are not contractually obligated to purchase any of the Company's
products, there can be no assurance that the Company's existing OEM customers
will continue to rely, or expand their reliance, on the Company as an external
source for communication software.

Dependence on New Product Offerings. The Company's future success will
depend, in significant part, on its ability to successfully develop and
introduce new software products and improved versions of existing software
products on a timely basis and in a manner that will allow such products to
achieve broad customer acceptance. There can be no assurance that new products
will be introduced on a timely basis, if at all. If new products are delayed or
do not achieve market acceptance, the Company's business, results of operations
and financial condition will be materially adversely affected. In the past, the
Company has experienced delays in purchases of its products by customers
anticipating the launch of new products by the Company. There can be no
assurance that material order deferrals in anticipation of new product
introductions will not occur. There can also be no assurance that the Company
will be successful in developing, introducing on a timely basis and marketing
such software or that any such software will be accepted in the market.

Retail Product Strategy Unproven. The Company's revenues have
historically been generated almost entirely on the strength of its OEM sales.
The Company has developed retail products with expanded functionality from its
OEM products and expects to introduce other products in the retail distribution
channel as well. The Company's ability to maintain distributor and retailer
relationships is largely

a function of sales volume. If the Company does not meet certain minimum volume
requirements, it will not be able to maintain its relationships. The Company
continues to work on strengthening product recognition and distribution and
there can be no assurance that the Company's retail marketing plan will succeed.
Further, while retail products provide higher unit revenues than OEM products,
retail distribution entails significantly higher costs. These costs include
advertising, trade shows, public relations and the expenses related to the
development and maintenance of a sales force dedicated to the retail
distribution effort. Accordingly, there can be no assurance that retail sales
will provide the margins that the Company has been able to achieve on its OEM
sales or that distributor and retailer minimum volume requirements will be met.

In implementing its retail sales strategy, the Company relies on
distributors, retailers, Internet distributors and value added resellers
(collectively, "VARs") for the marketing and distribution of HotFax
MessageCenter, HotFax, AudioVision, VideoLink Mail Pro, HotPage and HotFax Share
and its other retail products. The Company's agreements with retailers and VARs
are not exclusive and in many cases may be terminated by either party without
cause. Many of the Company's retailers and VARs carry product lines that are
competitive with those of the Company. There can be no assurance that these
retailers and VARs will give a high priority to the marketing of the Company's
products or that retailers and VARs will continue to carry the Company's
products. These retailers and VARs 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 VARs and retailers to represent it. Any of these
anticipated changes in the Company's distribution channels could materially
adversely affect the Company's business, results of operations and financial
condition.

Corporate and Government Product and Marketing Strategy Unproven. The
Company's revenues have historically been generated almost entirely on the
strength of its OEM sales. Since the second quarter of 1997 the Company has been
adding, and plans to continue to add, the infrastructure necessary to support a
focus on the corporate and government markets. In January 1998, the Company
acquired network fax software technology from Mitek Systems, Inc. as a part of
its strategy to address this market. The corporate market includes vertical
applications that are industry specific and require the investment of
engineering resources. There can be no assurance that the additional
infrastructure required in sales and marketing to the corporate and government
markets, or the investment in engineering resources for applications specific to
such markets, will yield significant sales growth for the Company or provide the
margins the Company has achieved historically on its OEM sales.

Potential for Undetected Errors. Software products as complex as those
offered by the Company may contain undetected errors. The Company has in the
past discovered software errors in certain of its products and has experienced
delayed or lost revenues during the period required to correct these errors.
There can be no assurance that, despite testing by the Company and by current
and potential customers, errors will not be found in new or existing products
after commencement of commercial shipments, resulting in loss of or delay in
market acceptance or the recall of such products, which could have a material
adverse effect upon the Company's business, results of operations and financial
condition. The Company provides customer support for most of its products. The
Company is preparing to launch several new products. If these products are
flawed or are more difficult to use than traditional Company products, customer
support costs could rise and customer satisfaction levels could fall.

Pre-Load and Royalty Based Software Market. The Company primarily sells
its software in a form that includes a disk and a manual. Some of the Company's
customers "pre-load" the Company's software onto a CD, diskette or the hard
drive of a personal computer and pay a royalty based on units produced or
shipped. These arrangements eliminate the need for a disk and may eliminate the
need for a manual. The pre-load arrangements produce smaller unit revenues for
the Company and eliminate the Company's ability to generate revenues from its
production facilities. The Company believes these facilities contribute profits
to the Company. Currently, the Company has the capability to produce its
products in-house on 3 1/2-inch diskettes. The Company does not currently have
the capability to produce CD-ROMs and the cost to develop such production
capability may be prohibitive. As the size of software programs grow, CD-ROM is
becoming a more prominent medium. The Company currently contracts CD-ROM
production to specialized CD-ROM facilities. In the event of a shift of this
kind, more of the Company's relationships would involve product pre-loads and
CD-ROM production, which could have a material adverse effect on the Company's
operating results.

Acceptance of Video Related Products. The Company's video communication
software sales volume has achieved only modest growth and has not become a
significant part of net revenues. Video communication software products compete
in a new and rapidly changing market and there can be no assurance that such
products will receive or gain market acceptance. Lack of market

acceptance of such products, or delays in or non-completion of the development
of new video communication software products, could have an adverse impact on
the Company's business, results of operations and financial condition. In
addition, video communication software products compete against those of several
competitors, including White Pine, Connectix, Intel, Microsoft, VocalTech and
VDONet, some of whom have greater financial and other resources than the
Company, and there can be no assurance that the Company will be able to compete
successfully against these and any future competitors in the video conferencing
software market.

Dependence Upon Key Personnel. The Company's future performance depends
in significant part upon the continued service of senior management and other
key technical personnel. The Company is dependent on its ability to identify,
hire, train, retain and motivate high quality personnel, especially highly
skilled engineers involved in the ongoing research and development required to
develop and enhance the Company's communication software products and introduce
enhanced future applications. The industry is characterized by a high level of
employee mobility and aggressive recruiting of skilled personnel. There can be
no assurance that the Company's current employees will continue to work for the
Company. Loss of services of key employees could have a material adverse effect
on the Company's business, results of operations and financial condition. In
addition, the Company may need to grant additional options and provide other
forms of incentive compensation to attract and retain key personnel.

Fluctuations in Gross Margins. The Company has experienced fluctuations
in gross margins from quarter to quarter, primarily as a result of significant
changes in sales volume as well as 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 effect
on the Company's operating results.

Duplication of Software. The Company duplicates all of its diskette
software at its Aliso Viejo, California facility. The Company believes that its
internal duplication capability provides it with a competitive advantage since
it eliminates the profit margin required by outside duplication sources and
enables a high degree of scheduling control. This concentration of production
does, however, expose the Company to the risk that production could be disrupted
by natural disaster or other events, such as the presence of a virus in the
Company's duplicators. The Company believes that it could retain outside
duplication alternatives quickly, but there is no assurance that it could do so
or, if such arrangements could be made, that duplication could take place in an
economical or timely manner. When CD-ROMs are required, the Company uses outside
third parties for CD-ROM replication. The equipment to replicate CD-ROMs is very
costly making it unlikely that the Company will add this capability internally.
Because the Company is dependent on CD-ROM replication facilities for both the
timing and pricing of the software produced in CD-ROM format, any adverse
changes in the timing of such replication could impair the Company's ability to
deliver products to customers and any price increases could reduce gross margins
which, in each case, could have a material adverse effect on the Company's
business, results of operations and financial condition.

Reliance on Third Party Suppliers; Shortage of Modem Chips. The Company
relies on third party suppliers who provide the components used in its kitted
products. These components include disks, CDs and printed manuals. Disk
shortages have occurred in the past and there can be no assurance that shortages
will not recur. If the Company cannot obtain a sufficient quantity of disks or
other components, or cannot obtain disks or other components at prices at least
comparable to prices paid currently, the Company's business, results of
operations and financial condition could be adversely affected.

Modem manufacturers purchase chips from a relatively limited number of
chip manufacturers. Production problems or product quality problems experienced
by a chip manufacturer could reduce modem sales or slow the growth of modem
sales. Chip manufacturers have a limited capacity to produce chips. This
capacity cannot be quickly expanded and the capital investment to expand
capacity is high. If chip suppliers are unable to meet demand, the growth of
modem sales will slow.

International Sales. The Company presently operates in foreign markets
and intends to expand its international presence. International revenues
represented 19.2%, 24.3% and 14.4% of the Company's net revenues in the six
months ended June 30, 1998 and in the years 1997 and 1996, respectively.
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 that
may afford only limited protection. The Company owns United States trademark
registrations for certain of its trademarks, including QuickLink Gold, HotFax,
HotPage, HotLine, HotDesk and CrossConnect but has not yet obtained
registrations for all of its trademarks in the United States or other countries.
After becoming a publicly held entity, the Company began to 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 or
will prevent the successful assertion of an adverse claim to software utilized
by the Company or that the Company will be able to detect unauthorized use and
take effective steps to enforce its intellectual property rights. In selling its
products, the Company relies primarily on "shrink wrap" licenses that are not
signed by licensees and, therefore, may be unenforceable under the laws of
certain jurisdictions. In addition, the laws of some foreign countries do not
protect the Company's proprietary rights to as great an extent as do the laws of
the United States. There can be no assurance that the Company's means of
protecting its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology. Further, although
the Company believes that its services and products do not infringe on the
intellectual property rights of others, there can be no assurance that such a
claim will not be asserted against the Company in the future. The failure of the
Company to protect its proprietary information could have a material adverse
effect on the Company's business, results of operations and financial condition.

From time to time, the Company has received and may receive in the
future communications from third parties asserting that the Company's trade name
or features, content, or trademarks of certain of the Company's products
infringe upon intellectual property rights held by such third parties. Should
there be a successful challenge to the Company's use of any of its trademarks,
the Company could incur significant expenses in connection therewith and
experience a loss of goodwill related thereto.

The Company has received correspondence from third parties separately
asserting that the Company's fax products may infringe on certain patents held
by each of the parties. These parties have initiated no litigation and the
Company is attempting to resolve all such assertions.

As the number of trademarks, patents, copyrights and other intellectual
property rights in the Company's industry increases, and as the coverage of
these patents and rights and the functionality of products in the market further
overlap, the Company believes that products based on its technology may
increasingly become the subject of infringement claims. Such claims could
materially adversely affect the Company, and may also require the Company to
obtain one or more licenses from third parties. There can be no assurance that
the Company would be able to obtain any such required licenses upon reasonable
terms, if at all, and the failure by the Company to obtain such licenses could
have a material adverse effect on its business, results of operations and
financial condition. In addition, the Company licenses technology on a
non-exclusive basis from several companies for inclusion in its products and
anticipates that it will continue to do so in the future. The inability of the
Company to continue to license these technologies or to license other necessary
technologies for inclusion in its products, or substantial increases in royalty
payments under these third party licenses, could have a material adverse effect
on its business, results of operations and financial condition.

Litigation in the software development industry has increasingly been
used as a competitive tactic both by established companies seeking to protect
their existing position in the market and by emerging companies attempting to
gain access to the market. If the Company is forced to defend itself against a
claim, whether or not meritorious, the Company could be forced to incur
substantial expense and diversion of management attention, and may encounter
market confusion and reluctance of customers to purchase the Company's software
products.

Year 2000 Compliance. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used in many companies may need
to be upgraded to

comply with such "Year 2000" requirements. Significant uncertainty exists in the
computer industry concerning the potential effects associated with such
compliance.

Concentration of Ownership. As of June 30, 1998, William Smith and
Rhonda Smith beneficially owned approximately 69.5% of the outstanding shares of
the Company. William Smith and Rhonda Smith are married to one another and,
acting together, will have the ability to elect the Company's directors and
determine the outcome of any corporate action requiring stockholder approval,
irrespective of how other stockholders of the Company may vote. This
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.

Potential Effect of Anti-Takeover Provisions. The Company's Certificate
of Incorporation and Bylaws contain provisions that may discourage or prevent
certain types of transactions involving an actual or potential change in control
of the Company, including transactions in which the stockholders might otherwise
receive a premium for their shares over then current market prices, and may
limit the ability of the stockholders to approve transactions that they may deem
to be in their best interest. In addition, the Board of Directors has the
authority to fix the rights and preferences of shares of the Company's Preferred
Stock and to issue such shares, which may have the effect of delaying or
preventing a change in control of the Company, without action by the Company's
stockholders. Certain provisions of Delaware law applicable to the Company,
including Section 203 of the Delaware General Corporation Law, could also have
the effect of delaying, deferring or preventing a change of control of the
Company. It is possible that the provisions in the Company's Certificate of
Incorporation and Bylaws, the ability of the Board of Directors to issue the
Company's Preferred Stock, and Section 203 of the Delaware General Corporation
Law may have the effect of delaying, deferring or preventing a change of control
of the Company without further action by the stockholders, may discourage bids
for the Company's Common Stock at a premium over the market price of the Common
Stock and may adversely affect the market price of the Common Stock and the
voting and other rights of the holders of Common Stock.

Possible Volatility of Stock Price. The trading price of the Common
Stock is likely to be subject to significant fluctuations in response to
variations in quarterly operating results, the gain or loss of significant
orders, changes in management, announcements of technological innovations or new
products by the Company, its customers or its competitors, legislative or
regulatory changes, general trends in the industry and other events or factors.
In addition, the stock market has experienced extreme price and volume
fluctuations which have particularly affected the market price for many high
technology companies similar to Smith Micro, and which have often been unrelated
to the operating performance of these companies. These broad market fluctuations
may adversely affect the market price of the Company's Common Stock. Further,
factors such as announcements of new contracts or product offerings by the
Company or its competitors and market conditions for stocks similar to that of
the Company could have significant impact on the market price of the Common
Stock.

Shares Eligible for Future Sale. No prediction can be made as to the
effect, if any, that future sales of Company Common Stock or the availability of
such Common Stock for future sales will have on the market price of the
Company's Common Stock. As of June 30, 1998, the Company had 14,074,698 shares
of Common Stock outstanding. Of this amount, the 9,781,670 shares held by
William Smith and Rhonda Smith became available for sale in the public market
(subject to the volume and other applicable restrictions of Rule 144) in
September 1997 following the expiration of a two year lock-up agreement with
certain representatives of the underwriters of the Company's initial public
offering which consummated in September 1995. Sales of a substantial number of
shares of Common Stock by William Smith, Rhonda Smith or any other person,
either individually or when aggregated with sales by other persons, could
adversely affect the market price of the Common Stock.

PART II -- OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company and its PCI Video Products, Inc. subsidiary ("PCI Video")
have been named parties to a lawsuit, Virtual Ambiance, Inc. v. Video
Conferencing Communications. Inc., et al., filed August 11, 1997 in the Superior
Court of the State of California for the County of Orange, Case No. 782856. The
complaint alleges causes of action against the Company and PCI Video for
negligent misrepresentation, fraud, declaratory relief, breach of covenant of
good faith and fair dealing, and civil conspiracy, involves a dispute over the
licensing of video conferencing software, and seeks consequential and punitive
damages against all defendants. The Company and PCI Video demurred to the
complaint, and the court on March 24, 1998 dismissed the causes of action for
declaratory relief and breach of the covenant of good faith and fair dealing,
and ordered the plaintiff to amend its remaining causes of action to conform
with state pleading requirements. After Virtual Ambiance, Inc. filed an amended
complaint, the Company and PCI Video answered the amended complaint on May 21,
1998. The Company and PCI Video are currently engaged in discovery. The Company
and PCI Video believe the claims against them lack any merit and have no
factual basis. The Company and PCI Video are vigorously defending the case
and intend to continue to do so.

ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS

The effective date of the Company's first registration statement (the
"Registration Statement") filed on Form S-1 (Registration No. 33-95096) under
the Securities Act of 1993, as amended, was September 18, 1995. The class of
securities registered was Common Stock. The offering commenced on September 19,
1995 and all securities were sold in the offering. The managing underwriters for
the offering were Hambrecht & Quist LLC and Oppenheimer & Co., Inc.

Pursuant to the Registration Statement, the Company sold 1,700,000
shares of its Common Stock for an aggregate offering price of $20,400,000, and
certain selling shareholders sold 2,210,000 shares of the Common Stock of the
Company for an aggregate offering price of $26,520,000.

The Company incurred expenses of $2,262,000 of which $1,428,000
represented underwriting discounts and commissions and $834,000 represented
other expenses. All such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after total expenses was $18,138,000.

Of the net proceeds from the offering, $4,188,000 were used to repay
amounts due under a promissory note issued by the Company to certain of its
stockholders as part of a distribution of retained earnings in connection with
the Company's prior S corporation status, $3,011,000 was used in the Company's
acquisition of Performance Computing Incorporated which was consummated in March
1996, $458,000 was used in the acquisition of assets from Mitek Systems, Inc.
and the remainder has been invested in U.S. Government obligations and corporate
bonds. The use of the proceeds from the offering does not represent a material
change in the use of the proceeds described in the prospectus that is part of
the Registration Statement.

ITEM 6. 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 to the Registrant's Registration Statement
Company. No. 33-95096

10.1 Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.1
to the Registrant's Registration Statement
No. 33-95096

10.2 1995 Stock Option/Stock Issuance Incorporated by reference to Exhibit 10.2
Plan. to the Registrant's Registration Statement
No. 33-95096

10.3 Form of Notice of Grant of Stock Incorporated by reference to Exhibit 10.3
Option under 1995 Stock Option/Stock to the Registrant's Registration Statement
Issuance Plan. No. 33-95096

10.4 Form of 1995 Stock Option Agreement Incorporated by reference to Exhibit 10.4
under 1995 Stock Option /Stock to the Registrant's Registration Statement
Issuance Plan. No. 33-95096

10.5 Form of 1995 Stock Purchase Incorporated by reference to Exhibit 10.5
Agreement under 1995 Stock to the Registrant's Registration Statement
Option/Stock Issuance Plan. No. 33-95096

10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6
September 30, 1991, by and between to the Registrant's Registration Statement
the Company and Crandell Development No. 33-95096
Corporation.

10.7 Application Program Interface Retail Incorporated by reference to Exhibit 10.7
License Agreement July 28, 1992 by to the Registrant's Registration Statement
and between the Company and Rockwell No. 33-95096
International Corporation.

10.8 Application Program Interface Incorporated by reference to Exhibit 10.8
License Agreement July 28, 1992 by to the Registrant's Registration Statement
and between the Company and Rockwell No. 33-95096
International Corporation.

10.9 Rockwell High Speed Interface Incorporated by reference to Exhibit 10.9
License Agreement dated June 2, to the Registrant's Registration Statement
1994, by and between the Company and No. 33-95096
Rockwell International Corporation.

10.10 Letter Agreement dated February 22, Incorporated by reference to Exhibit 10.10
1994, by and between the Company and to the Registrant's Registration Statement
Rockwell International Corporation. No. 33-95096

10.11 Letter Agreement dated April 22, Incorporated by reference to Exhibit 10.11
1993, by and between the Company and to the Registrant's Registration Statement
Rockwell International Corporation. No. 33-95096

Exhibit
No. Title Method of Filing
------- ----- ----------------

10.12 Software Distribution Agreement Incorporated by reference to Exhibit 10.12
dated May 8, 1995, by and between to the Registrant's Registration Statement
the Company and International No. 33-95096
Business Machines Corporation.

10.13 Office Building Lease, dated June Incorporated by reference to Exhibit 10.13
10, 1992, by and between the Company to the Registrant's Registration Statement
and Developers Venture Capital No. 33-95096
Corporation.

10.14 Amendment No. 1 To Office Building Incorporated by reference to Exhibit 10.14
Lease, dated July 9, 1993, by and to the Registrant's Registration Statement
between the Company and Pioneer Bank. No. 33-95096

10.15 Amendment No. 2 To Office Building Incorporated by reference to Exhibit 10.15
Lease, dated August 15, 1994, by and to the Registrant's Registration Statement
between the Company and T&C No. 33-95096
Development.

10.16 Fourth Addendum to Office Building Incorporated by reference to Exhibit 10.16
Lease, dated April 21, 1995, by and to the Registrant's Registration Statement
between the Company and T&C No.33-95096
Development.

10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17
Corporation Distribution. to the Registrant's Registration Statement
No. 33-95096

10.18 Smith Micro Software, Inc. Amended Incorporated by reference to Exhibit 10.21
and Restated Software Licensing and to the Registrant's Quarterly Report on
Distribution Agreement, dated April Form 10-Q for the quarter ended September
18, 1996, by and between the Company 30, 1996
and U.S. Robotics Access Corp.

10.19 Office Building Lease, dated March Incorporated by reference to Exhibit 10.19
1, 1994, by and between Performance to the Registrant's Annual Report on Form
Computing Incorporated and Petula 10-K for the fiscal year ended December
Associates, Ltd./KC Woodside. 3l, 1995

10.20 Agreement and Plan of Merger by and Incorporated by reference to Exhibit 2 to
between Smith Micro Software, Inc., the Registrant's Current Report on Form
Performance Computing Incorporated 8-K filed with the Commission on March 28,
and PCI Video Products, Inc. dated 1996
as of March 14, 1996.

10.21 Amendment No. 1, dated as of March Incorporated by reference to Exhibit 10.21
10, 1997, to Agreement and Plan of to the Registrant's Annual Report on Form
Merger by and between Smith Micro 10-K for the fiscal year ended December
Software, Inc., Performance 31, 1996
Computing Incorporated and PCI Video
Products, Inc. dated as of March 14,
1996.

10.22 Amendment No. 6 to Office Building Incorporated by reference to Exhibit 10.22
Lease, dated February 19, 1998, by to the Registrant's Annual Report on Form
and between the Company and World 10-K for the fiscal year ended December
Outreach Center. 31, 1997

Exhibit
No. Title Method of Filing
------- ----- ----------------

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 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, 1998.

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, 1998 By /s/ WILLIAM W. SMITH, JR.
William W. Smith, Jr.
Chairman of the Board, President and
Chief Executive Officer
(Principal Executive Officer)

August 12, 1998 By /s/ MARK W. NELSON
Mark W. Nelson
Chief Financial Officer
(Principal Financial Officer)

EXHIBIT INDEX
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