-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FjTAl+Icmeh0kYi5kGlQmmtL+d7UqULYvEh1Zr+hlBMskL/ySxO0GNsKDr5EDBtM 8GbfW4Ms6KGJ8AMQuP75Qg== 0000892569-99-000863.txt : 19990402 0000892569-99-000863.hdr.sgml : 19990402 ACCESSION NUMBER: 0000892569-99-000863 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMITH MICRO SOFTWARE INC CENTRAL INDEX KEY: 0000948708 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 330029027 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26536 FILM NUMBER: 99581338 BUSINESS ADDRESS: STREET 1: 51 COLUMBIA STREET 2: STE 200 CITY: ALISO VIEJO STATE: CA ZIP: 92656 BUSINESS PHONE: 7143625800 MAIL ADDRESS: STREET 1: 51 COLUMBIA STREET 2: STE 200 CITY: ALISO VIEJO STATE: CA ZIP: 92656 10-K 1 FORM 10-K FISCAL YEAR END DECEMBER 31, 1998 1 =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K --------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ 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 COMMON STOCK, $.001 PAR VALUE NASDAQ NATIONAL MARKET (Title of each class) (Name of each exchange on which registered) --------------------- 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 ( ) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]. The Registrant does not have different classes of Common Stock. As of March 23, 1999, the aggregate market value of the Common Stock of the Registrant held by non-affiliates was $11,290,199, based upon the closing sale price of such stock on that date. For purposes of such calculation, only executive officers, board members, and beneficial owners of more than 10% of the Company's outstanding Common Stock are deemed to be affiliates. As of March 23, 1999, there were 14,074,698 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the Annual Meeting of Stockholders currently expected to be held on May 26, 1999, as filed with the Securities Exchange Act of 1934, as amended, are incorporated by reference in Part III of this Report. =============================================================================== 2 SMITH MICRO SOFTWARE, INC. 1998 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
PAGE ---- PART I Item 1. BUSINESS.......................................................................... 3 Item 2. PROPERTIES........................................................................ 22 Item 3. LEGAL PROCEEDINGS................................................................. 22 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS................................ 22 PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS......... 23 Item 6. SELECTED FINANCIAL DATA........................................................... 25 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................................................... 26 Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK........................ 31 Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................... 31 Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................................................ 31 PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS.................................................. 32 Item 11. EXECUTIVE COMPENSATION............................................................ 32 Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................... 32 Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................... 32 PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K................... 33
------------------------- THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 PROVIDES A "SAFE HARBOR" FOR FORWARD-LOOKING STATEMENTS. THE STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE NOT STATEMENTS OF HISTORICAL FACT MAY BE FORWARD LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO A NUMBER OF RISKS AND UNCERTAINTIES THAT COULD CAUSE THE ACTUAL RESULTS OF THE COMPANY TO MATERIALLY DIFFER FROM THOSE ANTICIPATED. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS THAT SPEAK ONLY AS THE DATE HEREOF. THE COMPANY DISCLAIMS ANY OBLIGATION TO PUBLICLY RELEASE THE RESULTS OF ANY REVISIONS TO THESE FORWARD LOOKING STATEMENTS THAT MAY BE MADE TO REFLECT EVENTS OR CIRCUMSTANCES OCCURRING SUBSEQUENT TO THE FILING OF THIS FORM 10-K WITH THE SECURITIES AND EXCHANGE COMMISSION 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. READERS ARE ALSO URGED TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY THE COMPANY THAT DESCRIBE CERTAIN FACTORS WHICH AFFECT THE COMPANY'S BUSINESS, INCLUDING THE "RISK FACTORS" COMMENCING ON PAGE 14 OF THIS ANNUAL REPORT AND IN "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." 2 3 PART I ITEM 1. BUSINESS GENERAL Smith Micro Software, Inc. develops and sells communications software for personal and business use. Our objective is to enhance human interaction by giving users the ability to communicate through multimedia technologies over analog and digital platforms. Smith Micro's products enable personal communication through telephony, fax, multimedia email, data, paging, video security and video conferencing. Recently, we have been developing new products that leverage off of our core technologies to address the consumer's use of the Internet and corporate intranets. We intend to leverage our experience and position with original equipment manufacturers, commonly referred to as OEMs, to deploy these new product releases. Additionally, we are expanding our customer base to include manufacturers that produce devices that take advantage of the high bandwidth Internet connectivity such as cable and xDSL modems. Our corporate products are designed to provide cost effective and efficient methods of communicating that take advantage of corporate local and wide area networks, including the Internet or intranet. We began as a provider of fax and data communication software and continue to be a leading provider to modem manufacturers (based upon units included with analog modems sold through resellers and retailers in the United States.) Smith Micro was incorporated in California in November 1983 and reincorporated in Delaware in July 1995. INDUSTRY BACKGROUND Businesses and consumers are using the Internet to communicate, transact business, share information and access vast information resources. The increasing demand for Internet access is driving the adoption of new technology that enhances the Internet experience. These advances are found in multimedia personal computers and Internet access devices such as analog modems, cable modems, xDSL modems and network interface cards and software solutions. A research group, International Data Corporation, suggests that the number of worldwide Web users will grow dramatically in the future. Web users will increase from 87 million in 1997 to approximately 502 million worldwide by the year 2003. In 1997, 17% of web users made purchases over the Internet, a figure that is projected to be 36% in 2003. In addition, the dollar amount of transactions over the Internet is expected to increase from $15 billion in 1997 to an approximation of $1.3 trillion in 2003. Manufacturers of connectivity devices such as analog modems, cable modems, xDSL modems and network interface cards enable personal computer communication using direct connections, or connections over the Internet, intranets, Local Area Networks and Wide Area Networks. By adopting new technology, these manufacturers have been able to deliver products with higher transmission speeds and increased functionality. The rapid pace of these changes, the need to support a variety of operating systems, including Windows 95, Windows 98, Windows NT, Windows 3.x and Macintosh, and the desire to differentiate products, present a significant communication software challenge. These manufacturers generally focus on hardware and do not find it cost effective to develop software internally to meet the evolving needs of communication software for multiple platforms. Instead, these manufacturers typically bundle software from outside providers with their hardware. Demand for personal computer communication software products is generated by three distinct sources: original equipment manufacturer customers, retail end-user consumers and corporate/government customers, who purchase large quantities of user licenses for installations over large networks. OEMs, consisting primarily of modem, Internet access device, camera, video capture card and personal computer manufacturers, purchase software and bundle or pre-load it with their products. This software provides basic functionality and effectively serves the needs of most users. Users with more complex communication requirements typically seek software with more features in the retail market. 3 4 As communication hardware device manufacturers develop and adopt emerging technology, thereby expanding the functionality of communication devices, communication software must be continually enhanced to provide integrated, easy to use solutions to enable this functionality to be utilized. Emerging telephony applications can provide full duplex speakerphones, complex voicemail functions, and an enhanced level of information management capabilities to the home and small office. In addition, video conferencing, which traditionally has been available only to high-end corporate board rooms at a cost of thousands of dollars, has reached the desktop, with solutions that are affordable for the home and small office. Most recently, communication hardware device manufacturers have introduced devices such as cable and xDSL modems that enable high speed Internet access. These devices improve the functionality and efficiency of voice, fax, data and video transmissions over the Internet or intranets. The functionality of communication software must continue to evolve to keep pace with consumer expectations, future hardware functions and the rapidly changing competitive environment. SMITH MICRO STRATEGY AND PRODUCTS Smith Micro offers software products for Windows 98, Windows 95, Windows NT, Windows 3.x and Macintosh operating systems. We believe that our strong engineering focus and our relationships with analog modem, cable modem, xDSL modem, camera, video capture card, personal computer and chip manufacturers enable us to develop communication software in anticipation of changes in product design and to customize our OEM software to meet specific customer requirements. To address the complexity of personal computer communication, we have consistently developed products that are intuitive and easy to use. We believe that our experience in providing products to the OEM market, where software is required to enable new hardware devices to be put into service quickly and relatively effortlessly, provides us with a significant competitive advantage. Our strategy is to build upon the easy-to-use reputation of our OEM software products to encourage new users to migrate to our retail products as they require higher levels of functionality. In order to serve the market's evolving demands for connectivity, we intend to offer solutions beyond our core fax and data communication software. We offer products that support Internet telephony, video conferencing, video email, video security, paging and Internet chat. In the emerging fields of personal computer-based wireless and cellular communication, our software for PC Cards is currently being shipped by 3Com Corporation, Best Data, Viking Components and IBM, among others. In addition, modems capable of supporting full duplex speakerphone and other telephony applications are beginning to gain market acceptance and we have developed software to support these emerging technologies. Smith Micro has traditionally focused on the OEM and, more recently, the corporate/government and retail channels. Our OEM fax, data and video products are bundled with the analog modems, cable modems, xDSL modems, cameras, video capture cards and personal computers of many of the world's leading manufacturers or providers of such products. In addition, we currently offer a line of easy-to-use, retail communication software products that are designed to address the needs of the expanding base of personal computer users. Our retail software products are sold to distributors, retail stores, Internet stores and our Web site. We intend to broaden our retail product line and expand the functionality of these products as well as our OEM products with additional introductions of products designed for the Windows 98, Windows 95, Windows NT and Macintosh operating systems. We also offer Internet telephony and video teleconferencing products to our OEM and retail channel customers. We have also focused significant attention on our third channel, the corporate/government marketplace. During 1998, we acquired the network fax software technology of Mitek Systems, Inc. and completed the development of an IP fax gateway module. The IP fax gateway module allows companies to save on long distance charges using existing intranets or wide area networks, commonly known as WANs. The fax server passes the fax to the company's server that will have the lowest toll charge required to deliver the fax to its desired recipient. We are currently developing additional Internet functionality that would further enhance IP protocol distribution (over the Internet and intranet) of fax documents. 4 5 We believe that a key competitive feature of our products is the ability to switch seamlessly among fax, video conferencing, telephony, and data functions without interruption to the user. Our principal products automatically recognize whether an incoming call is a voice call, fax transmission or data transmission. In addition, a user can send fax, data, telephonic, or video conferencing transmissions without exiting one application and entering another. OEM Products The following chart lists the our current OEM products that are designed to work on Windows 95, Windows 98, Windows NT, Windows 3.x and/or the Macintosh operating systems:
PRODUCT NAME FUNCTIONALITY (PLATFORM) LANGUAGES ------------ ------------------------ --------- QuickLink(R) Data and fax (Windows) English and 15 other languages QuickLink(R) MessageCenter Data, fax and voicemail (Windows) English and 9 other languages conexs.com(TM) User authorized Internet phone, chat and video English phone (Windows) Internet CommSuite(TM) Telephony, multi-media email, video English teleconferencing, video security, chat and fax via the Internet (Windows) VideoLink(TM) Video conferencing (Windows) English VideoLink(TM)Mail Multi-media email (Windows) English and 15 other languages QuickLink(R) Page Paging (Windows) English MacComCenter(TM) Data and fax (Macintosh) English and Japanese MacComCenter(TM) with voice Data, fax and voice (Macintosh) English and Japanese
QuickLink provides integrated data communication and fax capabilities that allow users to send, receive and manage all fax activities in the foreground or background. In addition, this product enables fax broadcasting to an unlimited number of locations and the data communication functionality allows users to transfer files between computers. QuickLink MessageCenter provides integrated data communication, fax and computer telephony functions, including voicemail and full duplex speakerphone capabilities (when supported by the proper modem) in one package. QuickLink MessageCenter's features include multiple mailboxes and remote retrieval of voicemail. In addition, sending and receiving faxes from within any Windows application as well as data communication upload and downloads can take place entirely in the background, allowing users to continue to work in other applications. Users can call and request fax documents with the fax-on-demand feature by using the touch-tone keypad on their fax machine. Special features allow mailboxes to be individually configured, initiate a pager notification each time a voice message or fax is received and, through alphanumeric pagers, notify users of the number of faxes, voicemail and memos in the mailbox. 5 6 conexs.com is a service offering real-time person-to-person communications over the Internet. The conexs.com service identifies users via their legitimate email address that then becomes their "telephone number" and allows them to hold an Internet phone or chat session with another individual. If the user is video enabled, they can then hold a video phone conversation. The use of the user's email address as the telephone number provides for a level of authentication that allows the user to build a list of individuals that can call you as well as building in call blocking of unauthorized or unsolicited callers. conexs.com supports the International Telecommunications Union, commonly referred to as the ITU, H.323 standard for interoperability for the Internet and intranets. Internet CommSuite offers a comprehensive set of person-to-person Internet communication tools in one easy-to-use interface. Internet CommSuite lets users throughout the world communicate over the Internet using its phone, video phone, multimedia e-mail, fax or chat capabilities. This product was optimized for the newer broadband technologies such as cable modem, xDSL modems and network interface devices, however, it also functions with analog modems. Internet CommSuite is ITU H.323 compliant. VideoLink is a family of video conferencing products that enables video and audio communication over the Internet or between two locations using a standard analog modem connection that uses plain old telephone service, commonly known as POTS, or an integrated services digital network, commonly known as an ISDN. Our VideoLink 323 product supports the ITU H.323 standard and our VideoLink 324 supports the ITU H.324 standard for interoperability over POTS or Plain Old Telephone Service. VideoLink Mail is an application that allows the recording of a video and audio message that can be saved in a highly compressed format as a self extracting file. The file can be sent via an email attachment over the Internet. The recipient can then play the message just by double clicking on the attachment. QuickLink Page is paging software that works in conjunction with Microsoft Exchange, Messaging or Outlook in Windows 95, Windows 98 and Windows NT and as a stand-alone application that will allow users to send messages to numeric or alphanumeric pagers. With Microsoft Exchange, any incoming e-mail that is placed into the in-box can be sent to an alphanumeric pager. Filters are built in so that the user can define certain parameters under which HotPage will send the message. The user can also compose a message and send it directly to an alphanumeric pager. MacComCenter provides integrated data communication and fax capabilities that allow users to send, receive and manage all fax activities in the foreground or background for the Macintosh. This product enables fax broadcasting to multiple locations and its data communication functionality allows users to transfer files between computers. MacComCenter with voice adds telephony to the functionality included in MacComCenter that will support multiple mailboxes, each configurable to receive voice, fax and data into a specific mailbox. We have incorporated many of the features found in our QuickLink MessageCenter product into MacComCenter with voice. 6 7 Retail, Corporate and VAR Products The following chart lists our current retail, corporate and VAR products that are designed to work on Windows 95, Windows 98, Windows NT, Windows 3.x and/or the Macintosh operating systems:
PRODUCT NAME FUNCTIONALITY (PLATFORM) LANGUAGES ------------ ------------------------ --------- HotFax(R) Data and fax (Windows) English HotFax(R) MessageCenter Data, fax and voice (Windows) English, German, Italian and Spanish HotFaxShare(TM) Fax over a LAN (Server: Windows; Client: Windows English and German and Macintosh) The IP Fax Gateway module routes faxes across a WAN to a company's server that can take advantage of lower toll charges Internet CommSuite(TM) Telephony, multi-media email, video English teleconferencing, video security, chat and fax via the Internet (Windows) MacComCenter(TM) Plus Data, fax and voice (Macintosh) English and Japanese HotPage(R) Paging software (Windows) English VideoLink(TM) Mail Video and audio messaging (Windows) English
HotFax(R) is our integrated data and fax retail product. HotFax for Windows 3.x, Windows 95, Windows 98 and Windows NT provides the mobile user with a fax host for the remote retrieval of faxes and the unattended upload and broadcast of faxes at a scheduled time. It also provides users with the ability to modify faxes with graphics intact, use a personal computer as a data host and to share data like a bulletin board service, create custom cover pages with imported graphics and preview faxes, including cover pages. HotFax(R) MessageCenter is a fully integrated data, fax and voice mail application. This product includes all of the features of HotFax for Windows 3.x, Windows 95,Windows 98 and Windows NT. It also allows the user to configure multiple mailboxes that will accept voice, fax or data messages. The product installs as a Windows 95, Windows 98, Windows NT or Windows 3.x application. The application can send a pager notification each time a voice message or fax is received. If configured for an alphanumeric pager, the notification will specifically identify the number of faxes, voice mail and memos in the mailbox. HotFaxShare is a fax solution that handles fax creation, transmission and incoming fax routing for companies with high fax volume or with several computer users connected to a LAN. This product is an open platform solution and is independent of the type and size of the LAN. Faxes can be sent from any network workstation effortlessly from Windows 95, Windows 98, Windows NT, Windows 3.x or Macintosh applications. Individual and broadcast faxes can be sent immediately or scheduled for later transmission. The product can support up to 24 channels (fax lines). With the IP Fax Gateway option, faxes can be routed over the corporate intranet or over the Internet to another HotFaxShare server that is closer to the destination which therefore reduces or eliminates long distance telephone company charges. Internet CommSuite offers a comprehensive set of person-to-person Internet communication tools in one easy-to-use interface. Internet CommSuite lets users throughout the world communicate over the Internet using its phone, video phone, multimedia e-mail, fax or chat capabilities. This product was optimized for the newer 7 8 broadband technologies such as cable modem, xDSL modems and network interface devices, however, it also functions with analog modems. Internet CommSuite is ITU H.323 compliant. MacComCenter Plus with Voice is configured as our retail Macintosh data, fax and telephony communication software product. It allows the user to configure multiple mailboxes that will accept voice, fax or data messages. It includes OCR for converting incoming transmissions into text files and gives users the ability to send true WYSIWYG faxes from an application that has print capabilities. Users are also able to create custom cover pages with imported graphics, preview entire faxes, including cover pages, retrieve faxes from a remote location, and share data similar to a bulletin board service with a data host. HotPage(R) is paging software that works in conjunction with Microsoft Exchange, Messaging or Outlook in Windows 95, Windows 98 and Windows NT and as a stand-alone application that will allow users to send messages to numeric or alphanumeric pagers. With Microsoft Exchange, any incoming e-mail that is placed into the in-box can be sent to an alphanumeric pager. Filters are built in so that the user can define certain parameters under which HotPage will send the message. The user can also compose a message and send it directly to an alphanumeric pager. VideoLink Mail is an application that allows the recording of a video and audio message that can be saved in a highly compressed format as a self extracting file. The file can be sent via an email attachment over the Internet. The recipient can then play the message just by double clicking on the attachment. SALES AND MARKETING We sell our communication software products worldwide to OEM customers, who bundle or pre-load our software with their hardware products, to distributors and retailers, who sell the product to end user customers, and to the corporate/government marketplace. We develop video and fax products to address vertical markets, such as telemedicine to be distributed through channels established by corporate partners. In addition, we are developing "conexs.com," a product that will provide Internet telephony services and messaging services that will hold faxes and audio and video messages during times that the user is not logged in to the Internet. This product will also offer security features like caller authentication and call blocking. OEM Sales Our OEM market continues to evolve as we continue to offer new communications products and OEMs adopt new technologies and change their software bundling techniques. Historically, our OEM customer base consisted primarily of analog modem manufacturers. However, in light of these recent trends, we have expanded our OEM customer base to include personal computer, camera, cable modem and xDSL modem manufacturers, Internet service providers and content providers. Our OEM customers include 3Com (including U.S. Robotics Corporation and its Megahertz subsidiary), Brother Industries Ltd., Compaq Computer Corporation, Hewlett Packard Company, Gateway (Japan), Philips Consumer Electronics B.V. (Netherlands), IBM, Taicom (Taiwan), Sirius Technologies (Australia), Sitre (Spain) and Best Data. Each of these manufacturers bundles or pre-loads Smith Micro's software products with its own hardware products. As a percent of our net revenues, traditional analog modem manufacturers generated revenues of approximately 43.3% for 1998, 79.6% for 1997 and 68.6% for 1996. OEM customers outside of the United States made up approximately 20.6% of our revenues for 1998, 22.4% for 1997 and 13.3% for 1996. We have translated our products into as many as 18 languages to allow our OEM customers the flexibility of offering multi-language products that meet the needs of their worldwide markets. The cycle from the placement of an OEM 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. We generally ship our products as we receive orders. Additionally, an increasing percentage of our OEM revenue is derived from royalties accrued by customers that are authorized to replicate our software products on a CD or to pre-load our software on a personal computer. As a result of these two factors, we have relatively little backlog at 8 9 any given time and we do not consider backlog to be a significant indicator of future performance. Moreover, we generally do not produce software in advance of anticipated orders and therefore have insignificant amounts of inventory. As a result of the foregoing, our revenues in any quarter are substantially dependent on orders booked in that quarter. Our three largest OEM customers, including 3Com Corporation, and their affiliates accounted for 35.1% of our net revenues in 1998, 56.9% in 1997 and 62.9% in 1996. In June 1997, 3Com acquired U.S. Robotics Corporation, which has been our largest customer to date based on percentage of revenues. Sales to 3Com and its affiliates accounted for more than 10% of our net revenues in 1998, 1997 and 1996. Sales to Motorola also accounted for more than 10% of our net revenues in 1996. Our major customers could reduce their orders of our products in favor of a competitor's product or for any other reason. The loss of any of our major OEM customers, decisions by a significant OEM customer to substantially decrease purchases or our inability to collect receivables from these customers could have an adverse effect on our business, financial condition and results of operations. In April 1996, we entered into an OEM agreement having an initial one-year term with a wholly-owned subsidiary of U.S. Robotics. The agreement superseded a previous agreement between us and 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 (we refer to 3Com, its affiliates and their subsidiaries as 3Com entities in this Annual Report). Under the terms of the agreement, we granted certain pricing incentives to the 3Com entities in consideration for which we became the provider of fax, data, and 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. In December 1998, we entered into an additional OEM agreement with 3Com that covers purchases by the 3Com entities for upgraded versions of certain products covered by prior OEM agreements. These agreements do not require any 3Com entity to purchase any minimum quantity of our products and may be terminated by a party thereto at any time for any reason upon 60 days' prior written notice. We sell directly to OEM customers using our in-house sales staff based in Aliso Viejo, California, the United Kingdom and Australia. We allow our OEM customers to return unused software. To date, however, such returns have been infrequent. Retail Sales While historically we have generated our revenue primarily from the OEM market, we also sell retail products that are designed to complement or upgrade our OEM products. As a percentage of our net revenues, retail sales represented 26.4% of 1998, 5.2% of 1997 and 16.5% of 1996. Smith Micro has a separate sales staff that handles retail sales and we work closely with our retail distributors on the management of orders, inventory levels, sell-through to retailers, as well as promotions and marketing activities. Domestically, our retail products are sold by independent distributors including Ingram Micro and Tech Data. In addition, our retail sales force is responsible for contacting major retail customers to generate demand for our retail products in the retail distribution channel. We continue to develop Internet retail outlets by selling product through our web site and electronic distributors. End user customers can receive delivery of our Internet retail products through electronic download or via shipment of a retail package. Smith Micro allows distributors and retailers to return products without charge or penalty. In addition, there are times when we update products and request the distributors of our products to replace inventory on the shelves with the new version in what is called a stock rotation. A component of our revenue recognition policy is that we calculate an allowance for product returns based on our historical experience with product returns. If retail sales of our products increase, the risk of product returns will increase. While our revenue recognition policy 9 10 contemplates this risk, it is possible that returns may occur in excess of our previous experience, causing us to revise our estimates and increase the allowances for such returns. We employ direct mail programs to offer end-users upgrades from our OEM products to our retail products. We advertise in selected computer end-user and re-seller publications and periodically introduce promotions and incentive offers such as special pricing for the purchase of upgrades. We also participate in major trade shows, professional conferences and personal computer user group events to reach our target markets. Corporate and Government Sales During 1997 Smith Micro began selling to the corporate/government marketplace while building the infrastructure necessary to sell to these two customer bases. In January 1998, we acquired the network fax software technology of Mitek Systems, Inc. Through this acquisition, we acquired software that is designed to address the fax requirements of the corporate customer. During 1998 we developed the acquired network fax product into the currently shipping product, HotFaxShare and we released a newly developed IP Gateway module. We continue to develop IP protocol functionality. We intend to continue to focus our sales and marketing efforts for our video and fax technologies through direct sales and sales through value added resellers, commonly known as VARs, that specialize in selling to corporate customers. Sales in this marketplace tend to be made in single volume orders, typically for site licenses, and are often accompanied by maintenance programs. Our pricing structure in this marketplace currently accommodates multi-level, volume purchase with discounts for larger single orders. Our maintenance program provides technical support and automatic product upgrades under specifically defined terms. In addition, we are continuing to develop vertical market products for the medical, insurance, and security industries among others. During 1998, we began working with Eastman Kodak to develop video technology for the healthcare industry. Vertical market products, such as telemedicine for the medical industry, will be distributed through channels established by VARs and other corporate partners. CUSTOMER SERVICE AND TECHNICAL SUPPORT Smith Micro provides technical support and customer service through our Internet web site, by telephone, by mail and via fax. Certain of our OEM customers provide their own primary customer support functions and rely on us for back-up customer support, while other OEM customers rely solely on us to provide support functions. PRODUCT DEVELOPMENT The software industry is characterized by frequent changes in technology and evolving user needs. We work closely with our current OEM customers to help us determine future user needs and anticipate changes in technology. Software functionality depends upon the capabilities of the hardware, accordingly, we maintain relationships with hardware and chip manufacturers and we develop our software in tandem with their development. Our engineering relationships with chip manufacturers such as Conexant, IBM, Cirrus Logic, Intel, Texas Instruments, Analog Devices, 8 x 8, Brooktree, Broadcom and others, as well as with our major OEM hardware customers, are central to our product development efforts. In addition, we participate in software product developer programs sponsored by Microsoft, Intel, IBM and Apple. We believe that we must be responsive to the specific customization requests of our OEM and corporate customers. With this need for flexibility in mind, our object-oriented C++ modular code base is designed to allow significant customization and enhancements of features within tight development schedules. As of December 31, 1998, we had a product development staff of 29 engineers and quality assurance and product testing specialists. We plan to add additional software engineers and product testing personnel in the future. 10 11 MANUFACTURING Smith Micro software is sold in three forms. First, our software is sold in the form of an OEM kit or retail package that includes disks or a CD-ROM, a manual and certain other documentation or marketing material. Second, we permit certain of our OEM customers to duplicate their own disks or CD-ROMs and pay a usage based royalty. This method of sale does not require us to provide a disk or manual. Finally, we grant licenses to certain OEM customers that enable those customers to pre-load a copy of our software onto a personal computer's hard drive. With the corporate sales program, we offers site licenses under which a corporate user is allowed to distribute copies of the software to users within the corporate sites. We rely on third party suppliers who provide the components for our software product kits. These components include disks, CD-ROMs and printed manuals. Disk shortages have occurred in the past and may recur in the future. If we cannot obtain a sufficient quantity of disks, CD-ROMs or other components, or cannot obtain disks, CD-ROMs or other components at prices at least comparable to the prices we currently pay, our 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. We rely on third party suppliers to provide CD-ROM components and CD-ROM replication for the CD-ROMs that are placed in many of our product kits. The equipment to replicate CD-ROMs is very costly making it unlikely that we will add this capability internally. This leaves us dependent on CD-ROM replication facilities for both the timing and pricing of our software produced in CD-ROM format. This could impair our ability to deliver products to our customers. In addition, any price increases that we experience could reduce gross margins, which would have an adverse effect on our business, results of operations and financial condition. We duplicate most of the diskettes that are placed in certain of our OEM product kits at our Aliso Viejo, California facility. This facility is capable of producing 50,000 duplicated disks in a single eight hour shift. Operations are primarily conducted on a single shift basis, although we operate a second shift from time to time to accommodate customer delivery requirements. We have outside production alternatives in the event of a disruption of our Aliso Viejo operations. We use outside vendors for the printing of labels, manuals and packaging. COMPETITION The markets in which we operate 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 change. Smith Micro competes with other software vendors for access to distribution channels, retail shelf space and the attention of customers. We also compete with other software companies in our efforts to acquire software technology developed by third parties and in attracting qualified personnel. We believe that the principal competitive factors affecting the communication software market include product features and ease of use, willingness of the vendor to customize the product to fit customer-specific needs, product reputation, product quality, product performance, price, customer service and support and the effectiveness of sales and marketing efforts. Although we believe that our products currently compete favorably with respect to these factors, there can be no assurance that we can maintain our competitive position against current and potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Because there are relatively low barriers to entry in the communication software market and because rapidly changing technology is constantly creating new opportunities in this market, we expect new competitors to enter the market. We also believe that competition from established and emerging software companies will continue 11 12 to intensify as fax and data applications merge with video and audio applications and the emerging cellular, wireless and Internet telephony markets develop. The market in which we compete has been characterized by the consolidation of established communication software suppliers and we believe that this trend, which may lead to the creation of additional large and better-financed competitors, may continue. Increased competition could result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business and results of operations. Our software products compete primarily with Symantec, Cheyenne, White Pine, Intel, Microsoft, VocalTec and Right Fax, among others for communication software products. Some of our 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 our business, results of operations and financial condition. Many of our other current and prospective competitors have significantly greater financial, marketing, service, support, technical and other resources than Smith Micro. Moreover, these companies may introduce additional products that are competitive with ours, and our products may not compete effectively with such products. We believe that our ability to compete depends on elements both within and outside of our control, including the success and timing of new product development and introduction, product performance, price, distribution and customer support. We may not be able to compete successfully with respect to these and other factors. We believe that the market for our software products has been and will continue to be characterized by significant price competition. A material reduction in the price of our products could negatively affect our profitability. Many of our existing and potential OEM customers have substantial technological capabilities. These customers may currently be developing, or may in the future develop, products that compete directly with our products. In such event, these customers may discontinue purchases of our products. Our future performance is substantially dependent upon the extent to which existing OEM customers elect to purchase communication software from us rather then design and develop their own software. In light of the fact that our customers are not contractually obligated to purchase any of our products, they may cease to rely, or fail to expand their reliance, on us as an external source for communication software in the future. We also face 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 systems, Windows, Microsoft represents a significant competitive threat to all personal computer software vendors, including Smith Micro. PROPRIETARY RIGHTS AND LICENSES Although we believe that our products do not infringe on the intellectual property rights of others, such a claim may be asserted against us in the future. If we fail to protect our proprietary information, our business, results of operations and financial condition could be materially and adversely affected. From time to time, we have received and may receive in the future communications from third parties asserting that trademarks used by us or features or content of certain of our products infringe upon intellectual property rights held by such third parties. As the number of trademarks, patents, copyrights and other intellectual property rights in our industry increases, and as the coverage of these patents and rights and the functionality of products in the market further overlap, we believe that our products, with their existing technology, may increasingly become the subject of infringement claims. Moreover, any of these proceedings could also result in an adverse decision as to the priority of our inventions. Such results would materially and adversely affect us, and may also require us to obtain one or more licenses from third parties. We may not be able to obtain any such required licenses upon reasonable terms, if at all, and the failure by us to obtain such licenses could have an adverse effect on our business, results of operations and financial condition. 12 13 Our success is dependent upon our software code base, our programming methodologies and other intellectual properties. To protect our proprietary technology, we rely on a combination of trade secret, nondisclosure and patent, copyright and trademark law that may afford only limited protection. We apply for various patents and trademarks to protect intellectual property. Prior to becoming a publicly held entity, we did not require our employees to sign proprietary information and inventions agreements stipulating, among other things, software ownership rights. The steps that we have taken to protect our proprietary technology may not be adequate to deter misappropriation of our proprietary information or prevent the successful assertion of an adverse claim to software utilized by us. In addition, we may not be able to detect unauthorized use of our intellectual property rights or take effective steps to enforce those rights. In selling our products, we primarily rely 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 our proprietary rights to as great an extent as do the laws of the United States. The means we use to protect our proprietary rights may not be adequate. Moreover, our competitors may independently develop similar technology to ours. We also license technology on a non-exclusive basis from several companies for inclusion in our products and anticipate that we will continue to do so in the future. If we are unable to continue to license these technologies or to license other necessary technologies for inclusion in our products, or if we experience substantial increases in royalty payments under these third party licenses, our business, results of operations and financial condition could be materially and adversely affected. EMPLOYEES As of December 31, 1998, Smith Micro had a total of 79 employees, of which 29 were engaged in engineering, 17 were in sales and marketing, 13 were in customer support, 13 were in finance and administration and 7 were in manufacturing. We utilize temporary labor to assist during periods of increased manufacturing volume. None of our employees is represented by a labor union. We have not experienced any work stoppages, and consider our relations with our employees to be good. 13 14 RISK FACTORS This Annual Report on Form 10-K 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, in the Management's Discussion and Analysis of Financial Condition and Results of Operations section and elsewhere in this Annual Report on Form 10-K. All such factors should be considered in evaluating Smith Micro and a decision to invest in the company. Our Quarterly Operating Results are Subject to Significant Fluctuations that Could Adversely Impact Our Stock Price. Our quarterly operating results have fluctuated significantly in the past and may continue to vary from quarter to quarter due to a number of factors. Many of these factors are not in our control. These factors include: o the size and timing of orders from, and shipments to, our major customers; o our ability to maintain or increase gross margins; o changes in pricing policies or price reductions by us or our competitors; o variations in the our sales channels or the mix of our product sales; o the timing of new product announcements and introductions by us, our competitors or customers; o the availability and cost of supplies; o the financial stability of our major customers; o the market acceptance of our new products, applications and product enhancements; o our ability to develop, introduce and market new products, applications and product enhancements; o possible delays that we may face in the shipment of new products; o our success in expanding our sales and marketing programs; o deferrals of orders by our customers in anticipation of new products, applications, product enhancements or operating systems; o changes in our strategy; and o personnel changes. While we historically have not experienced significant fluctuations in our sales from season to season, we may face greater seasonality in our sales in the future. Many of our OEM customers experience seasonality in their sales, which may affect their buying patterns from us. In addition, as we increase our sales of retail products, we expect to experience greater seasonality in our sales. Due to all of the foregoing factors, and the other risks discussed in this section, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance. It is possible that in some future periods our results of operations may be below the expectations of public market analysts and investors. In that event, the price of our Common Stock would likely decline. Because We Currently Operate With Little Backlog, Our Revenues in Each Quarter are Substantially Dependent on Orders Booked and Shipped in that Quarter. We operate with little backlog because we generally ship our software products as we receive orders and because our royalty revenue is based upon our customers' actual usage in a given period. Accordingly, we recognize revenue shortly after orders are received or royalty reports are generated. As a result, our sales in any quarter are dependent on orders that we book and ship in that quarter. This makes it difficult for us to predict what our revenues and operating results will be in any quarter. If orders in the first month or two of a quarter fall short of expectations, it is likely that we will not meet our revenue targets for that quarter. If this happens, our quarterly operating results would be adversely affected. An Unexpected Shortfall in Revenue May Adversely and Disproportionately Affect Our Business Because Our Expenses are Largely Fixed. Our expense levels are based, in part, on our expectations of our future revenues and a significant portion of our expenses is fixed. As a result, we may not be able to adjust our spending rapidly enough to compensate for an unexpected shortfall in revenue. Therefore, if revenue levels fall below our 14 15 expectations, our operating results and net income are likely to be adversely and disproportionately affected. We Depend on 3Com Corporation for a Significant Portion of our Revenues. In the past we have derived a substantial portion of our revenues from sales to 3Com Corporation, primarily to its wholly-owned subsidiary, U.S. Robotics, and subsidiaries of U.S. Robotics. These 3Com entities represented 24.7% of our net revenues in 1998, 43.4% of our net revenues in 1997 and 46.4% of our net revenues in 1996. The OEM agreements we have with these 3Com entities do not require a 3Com entity to purchase any minimum quantity of our products and may be terminated by a 3Com entity or us at any time for any reason upon 60 days prior written notice. As a result, we cannot be certain that the 3Com entities will continue to purchase our products in substantial quantities, or at all. While we believe that we have been the principal supplier of OEM fax, voice and data communications software products to the U.S. Robotics product line, 3Com may seek additional sources for such products in the future. Accordingly, our sales to the 3Com entities in the future may not reach or exceed our historical levels of sales to U.S. Robotics. A substantial decrease or delay in sales to the 3Com entities would have an adverse effect on our business, results of operations and financial condition. We Depend Upon a Small Number of OEM Customers. Sales to our three largest OEM customers, including 3Com Corporation, accounted for approximately 35.1% of our net revenues in 1998, 56.9% of our net revenues in 1997 and 62.9% of our net revenues in 1996. We expect that we will continue to be dependent upon relatively large orders from our major OEM customers for a significant portion of our revenues in future periods. However, none of these customers is obligated to purchase any of our products. Accordingly, we cannot be certain that these customers will continue to place large orders for our products in the future, or purchase our products at all. Our customers may acquire products from our competitors or develop their own products that compete directly with ours. Any substantial decrease or delay in our sales to one or more of these entities would have an adverse effect on our business, results of operations and financial condition. In addition, certain of our OEM customers have in the past and may in the future acquire competitors or be acquired by competitors, causing further industry consolidation. In the past, such acquisitions have caused the purchasing departments of the combined companies to reevaluate their purchasing decisions. If one of our major OEM customers engages in an acquisition in the future, it could change its current purchasing habits. In that event, we could lose the customer, experience a decrease in orders from that customer or a delay in orders previously made by that customer. Moreover, if one of our existing OEM customers acquires another existing OEM customer, the concentration of our revenues from the combined companies could increase if the combined companies continue to purchase our software products. Although we maintain allowances for doubtful accounts, the insolvency of one or more of our major customers could substantially impair our business, results of operations and financial condition. Our Operating Results Have Been Substantially Dependent upon One Family of Products Sold to Original Equipment Manufacturers . In the past we have derived a significant portion of our revenues from a relatively small number of products and will likely continue to do so in the future. Sales of our QuickLink related products represented approximately 58.8% of our net revenues in 1998, 81.3% of our net revenues in 1997 and 69.4% of our net revenues in 1996. We expect that revenues from these products will continue to account for a substantial portion of our total revenues in the foreseeable future. If our revenues from these software products decline, whether as a result of competition, technological change, price pressures or other factors, our business, results of operations and financial condition could be seriously impaired. Our Efforts to Develop a Market for Our Retail Software Products Require Substantial Investments that May Adversely Affect Our Operating Margins. We are continuing our efforts to develop a market for our retail communication software products. We recently added Internet CommSuite to our existing line of retail software products that includes HotFax MessageCenter, HotFax, VideoLink Mail, MacComCenter HotPage and HotFaxShare. Sales of our retail products represented approximately 26.4% of our net revenues in 1998, 5.2% of our net revenues in 1997 and 16.5% of our net revenues in 1996. In order to strengthen our product recognition and build distribution channels for our retail products, we will have to make significant investments in advertising, trade shows, public relations, distributor relationships and a dedicated sales force. Accordingly, our retail sales may not provide us with the same contribution margin to operating income that we have historically achieved on our OEM sales. 15 16 We May Not be Able to Develop and Maintain Relationships with Distributors and Retailers to Sell Our Retail Software Products. We rely on distributors, retailers, Internet distributors and value added resellers, commonly known as VARs, to market and distribute our retail software products. We may not be successful in recruiting VARs and retailers to represent us. Our ability to maintain distributor and retailer relationships is largely a function of our sales volume. If we do not meet certain minimum volume requirements, we may not be able to maintain our relationships with our current distributors and retailers. Our agreements with retailers and VARs are not exclusive and in many cases may be terminated by either party without cause. Many of our retailers and VARs carry product lines that are competitive with our retail software products. These retailers and VARs may not give a high priority to the marketing of our products or may not continue to carry our products. In addition, our retailers and VARs may change their inventory strategies, with little or no warning to us. In many cases, such changes in inventory strategy may not be related to end user demand. If this happens, our business, results of operations and financial condition may be adversely affected. Our Risk of Product Returns Will Increase as Our Retail Sales Increase. We typically allow the retailers and VARs who sell our retail software products to return our products without charge or penalty. As part of our revenue recognition policy, we calculate an allowance for product returns based on our historical experience. If retail sales of our products increase, our risk of product returns will increase. While our revenue recognition policy contemplates this risk, it is possible that returns may occur in excess of our previous experience. If this happens, we would have to revise our estimates and increase our allowances for such returns. Excessive or unanticipated returns could adversely affect our business, results of operations and financial condition. Rapid Technological Change Could Render Our Products Obsolete. The communication software market in which we operate is characterized by rapid technological change, changing customer needs, frequent product introductions and evolving industry standards. These factors make it difficult for us to estimate the life cycles of our products. Our future success will depend upon our 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 our customers. We may experience difficulties that could delay or prevent our development, introduction and marketing of new products. If we are unable to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, or technological or other reasons, our business, results of operations and financial condition would be adversely affected. Microsoft is the leading developer of operating systems for personal computers. We may not be able to successfully develop new versions of our software products that will operate on future Microsoft operating systems. Even if we are able to develop such new versions, we may not be able to do so concurrently with or prior to introductions by our competitors of communication software products for those new operating systems. Any such failure or delay could affect our competitive position or lead to obsolescence of our products in the future. Microsoft Poses a Significant Competitive Threat to Us. We face competition from Microsoft, which is the publisher of the most prevalent personal computing operating platforms, Windows, Windows NT and DOS. Due to its market dominance, Microsoft represents a significant competitive threat to all personal computer software vendors, including us. The latest Microsoft operating systems, Windows 98, Windows 95 and Windows NT, include capabilities now provided by certain of our OEM and retail software products, including our principal product, QuickLink. If the communications capabilities of Windows 98, Windows 95, Windows NT or other operating systems are adopted by users, sales of our products could decline. We Face Significant Competition from Other Companies. We operate in markets that are highly competitive and subject to rapid changes in technology. We compete with other software vendors for access to distribution channels, retail shelf space and the attention of customers. We also compete with other software companies in our efforts to acquire software technology developed by third parties. Competitive pressures could reduce our market share or require us to reduce the prices of our products, either of which could have an adverse effect on our business, results of operations and financial condition. 16 17 We face significant competition from software vendors in the retail market. Our principal fax related retail products, HotFax MessageCenter and HotFax, compete directly with Symantec's WinFax Pro. Our new Internet communications software products, Internet CommSuite and conexs.com, compete with product offerings by Microsoft, Intel, White Pine, VDONet and VocalTech, among others. In addition, because there are low barriers to entry into the software market, we expect significant competition from other established and emerging software companies in the future. Furthermore, many of our existing and potential OEM customers may acquire or develop products that compete directly with our products. Many of our current and prospective competitors have significantly greater financial, marketing, service, support, technical and other resources than we do. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the promotion and sale of their products. There is also a substantial risk that announcements of competing products by large competitors such as Microsoft and Symantec could result in the cancellation of orders by retailers, distributors or other customers in anticipation of the introduction of such new products. In addition, some or our competitors, such as Symantec, currently make complementary products that are sold separately. Such competitors could decide to enhance their competitive position by bundling their products to attract customers seeking integrated, cost-effective software applications. Some competitors have a retail emphasis and offer OEM products with a reduced set of features. The opportunity for retail upgrade sales may induce these and other competitors to make OEM products available at their own cost or even at a loss. We also expect competition to increase as a result of software industry consolidations, which may lead to the creation of additional large and well-financed competitors. Increased competition is likely to result in price reductions, fewer customer orders, reduced margins and loss of market share, any of which could adversely affect our business, results of operations and financial condition. We believe that our ability to compete depends on elements both within and outside of our control, including: o the success and timing of new product development; o product performance; o price; o distribution; and o customer support. We cannot be certain that we will be able to compete successfully with respect to these and other factors or that the competitive pressures that we face will not adversely affect our business, results of operations and financial condition. Our Future Success Will Depend on Our Ability to Develop and Introduce New Product Offerings. Our future success will depend, in significant part, on our ability to successfully develop and introduce new software products and improved versions of our existing software products on a timely basis and in a manner that will allow such products to achieve broad customer acceptance. We cannot be certain that we will be able to develop and introduce new products on a timely basis, if at all, or that any new products that we do develop will be accepted in the market. If new products are delayed or do not achieve market acceptance, our business, results of operations and financial condition will be adversely affected. In the past, we have experienced delays in purchases of our products by customers anticipating the launch of new products by us. Accordingly, it is possible that our customers may defer material orders in the future in anticipation of new product introductions. If this happens, our business, results of operations and financial condition may be adversely affected. Our Efforts to Sell Our Products in the Corporate and Government Marketplaces May Not be Successful and May Adversely Affect Our Operating Margins. In the past, we have generated our revenues almost entirely from OEM sales. We began selling to the corporate/government marketplace while building the infrastructure necessary to sell to these two customer bases in 1997. In January 1998, we acquired the network fax software technology of Mitek Systems, Inc. Through this acquisition, we acquired software that is designed to address the fax requirements of the corporate/government customer. During 1998 we developed the acquired network fax product into the 17 18 currently shipping product, HotFaxShare and we released a newly developed IP Gateway module. Although we continue to invest resources in the research and development of products for the corporate and government markets, and in building the additional infrastructure required to market and sell products in these markets, we cannot be certain that our efforts will yield any significant sales growth. In addition, because we have had to make substantial investments to develop, market and sell products for these markets, sales of such products may not provide the operating margins historically achieved by us for OEM sales. Our Products May Contain Undetected Software Errors. Our software products are complex and may contain undetected errors. In the past, we have discovered software errors in certain of our products and have experienced delayed or lost revenues during the period it took to correct these errors. Although we test our products along with our current and potential OEM customers, it is possible that errors may be found in our new or existing products after we have commenced commercial shipment of those products. These undetected errors, could result in adverse publicity, loss of revenues, delay in market acceptance of our products or claims against us by customers, all of which could seriously impair our business, results of operations and financial condition. Our Customers May Continue to Switch to the Pre-Loaded or CD-ROM Versions of Our Products, Which May Adversely Affect Our Operating Results. We primarily sell our software in a kit that includes a disk or CD-ROM and a manual. However, some of our customers "pre-load" our software onto a CD, diskette or the hard drive of a personal computer and pay us a royalty based on units produced or shipped. These arrangements eliminate the need for us to provide a disk or CD-ROM and may eliminate the need for a manual. The pre-load arrangements produce smaller unit revenues for us and eliminate our ability to generate revenues from our production facilities. We believe that our production facilities contribute profits to our operations. Currently, we have the capability to produce our products in-house on 3 1/2-inch diskettes. However, we do not currently have the capability to produce CD-ROMs internally and the cost to develop such production capability may be prohibitive. As the size of software programs grows, CD-ROM is becoming a more prominent medium. We currently contract CD-ROM production to specialized CD-ROM facilities. If more of our customers request product pre-loads and CD-ROM versions of our products, our operating results could be adversely affected. Our Future Success Will Depend on the Level of Market Acceptance of Our Internet Communications Products and Video Related Products. We continue to focus significant resources on the development and introduction of Internet and video communications products. Such products compete in new and rapidly changing markets and we cannot be certain that our products will receive or gain market acceptance. Our Internet communications software product was released in September 1998. This software product includes a number of Internet communications tools such as telephony, fax, multimedia e-mail, video conferencing, video security and others. Our initial sales of this product were made to retail channels and do not include significant orders from OEM customers. We introduced our first video communications software in 1996. Since that time, our sales volume for such product has achieved only modest growth and has not become a significant part of net revenues. Lack of market acceptance for our Internet or video communications products or other similar products could have an adverse impact on our business, results of operations and financial condition. In addition, we may experience delays in or non-completion of the development of new Internet or video communications software products, which could adversely affect our competitive position in these markets. Our Internet and video communications software products compete against those of several competitors, including White Pine, Logitech, Intel, Microsoft, VocalTech and VDONet, some of whom have greater financial and other resources than we do. We cannot be certain that we will be able to compete successfully against these and any future competitors in the Internet communications or video conferencing software markets. 18 19 Our Planned Expansion of Our International Business Activities May Make Us More Susceptible to Global Economic Factors, Foreign Business Practices and Currency Fluctuations. We presently operate in foreign markets and intend to expand our international presence. International net revenues represented 22.8% of our total net revenues in 1998, 24.3% of our total net revenues in 1997 and 14.4% of our total net revenues in 1996. We may not be able to continue to generate significant international sales. Our international business activities are subject to a number of risks, including: o difficulties in managing distributors; o difficulties in staffing and maintaining foreign operations; o foreign currency exchange fluctuations; o the possibility of difficulties in collecting accounts receivable. o varying technical standards; o substantially different regulatory requirements in different jurisdictions; o tariffs and trade barriers; o political and economic instability; o reduced protection for our intellectual property rights in certain countries; o potentially adverse tax consequences; o burdens associated with complying with a wide variety of complex foreign laws and treaties; and While we currently do not accept payment in foreign currencies and invoice all of our sales in U.S. dollars, we may not be able to continue this policy if we are able to grow international sales. If we begin to receive payment in foreign currencies, we are likely to be subjected to the risks of foreign currency losses due to fluctuations in foreign currency exchange rates. In addition, if we are successful in growing our business outside of the United States, we may also face economic, political and foreign currency situations that are substantially more volatile than those commonly experienced in the United States. If this happens, our business, results of operations and financial condition could be adversely affected. We Must Continue to Hire and Retain Key Personnel in an Intensely Competitive Labor Market. Our future performance depends in significant part upon the continued service of our senior management and other key technical personnel. We are dependent on our 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 our communication software products and introduce enhanced future applications. The software industry is characterized by a high level of employee mobility and an aggressive approach to the recruiting of skilled personnel. Our inability to attract and retain the highly trained technical personnel that are essential to our product development, marketing and service and support teams may limit the rate at which we can generate revenue and develop new products or product enhancements. This could have an adverse effect on our business, results of operations and financial condition. In order to attract and retain key personnel, we may need to grant additional options and provide other forms of incentive compensation. Because We Rely on Third Party Suppliers, We Have Limited Control Over Component Costs and Product Delivery Schedules. We rely on third party suppliers to provide us with the components for our product kits. These components include disks, CDs and printed manuals. We also rely on third parties for CD-ROM replication. In the past, we have experienced disk shortages and may experience such shortages in the future. If we cannot obtain a sufficient quantity of disks or other components we may not be able to deliver products to our customers on a timely basis. Similarly, if the CD-ROM replication facilities that we use do not deliver our requirements on schedule, we may not be able to deliver products in a CD-ROM format to our customers on a timely basis. Any delays that we experience in delivering our products to customers could impair our customer relationships and adversely impact our business. In addition, if our third party suppliers raise their prices for disks or other components or CD-ROM replication services, our gross margins would be reduced. If this happens, our business, results of operations and financial condition would be adversely affected. We Duplicate All of Our Disks at One Facility and May Not be Able to Find Alternate Arrangements in an Economic or Timely Manner in the Event of a Disruption at That Facility. We duplicate all of our diskette software 19 20 at our Aliso Viejo, California facility. As a result, if our production at this facility is disrupted by natural disaster or another event, such as the presence of a virus in our duplicators, we cannot be certain that we could find an alternative arrangement in timely manner. Even if we are able to find an alternate duplication facility or a third party to duplicate our diskette software for us, we cannot be certain that we would be able to obtain such alternatives at commercially reasonable prices. We May be Unable to Adequately Protect Our Intellectual Property and Other Proprietary Rights. Our success is dependent upon our software code base, our programming methodologies and other intellectual properties. In order to protect our proprietary technology, we rely on a combination of trade secret, nondisclosure and copyright and trademark law. However, these measures afford us only limited protection. We currently own United States trademark registrations for certain of our trademarks, but we have not yet obtained registrations for all of our trademarks in the United States or other countries. In addition, prior to becoming a publicly held entity, we did not require our employees to sign proprietary information and inventions agreements stipulating to our software ownership rights. We only recently started the patent application process for a number of technologies relating to our existing products and products under development. Furthermore, we rely primarily on "shrink wrap" licenses that are not signed by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions. Accordingly, despite the precautions we have taken to protect our intellectual property and proprietary rights, it is possible that third parties may copy or otherwise obtain our rights without our authorization. It is also possible that third parties may independently develop technologies similar to ours. It may be difficult for us to detect unauthorized use of our intellectual property and proprietary rights. We may be subject to claims of intellectual property infringement as the number of trademarks, patents, copyrights and other intellectual property rights asserted by companies in our industry grows and the coverage of these patents and other rights and the functionality of software products increasingly overlap. From time to time, we have received communications from third parties asserting that our trade name or features, content, or trademarks of certain of our products infringe upon intellectual property rights held by such third parties. We have also received correspondence from third parties separately asserting that our fax products may infringe on certain patents held by each of the parties. Although we are not aware that any of our products infringe on the proprietary rights of others, third parties may claim infringement by us with respect to our current or future products. Infringement claims, whether with or without merit, could result in time-consuming and costly litigation, divert the attention of our management, cause product shipment delays or require us to enter into royalty or licensing agreements with third parties. If we are required to enter into royalty or licensing agreements, they may not be on terms that are acceptable to us. Unfavorable royalty or licensing agreements could seriously impair our business, results of operations and financial condition. Our Business May be Adversely Affected by Unexpected Year 2000 Problems. Many currently installed computer systems and software applications are coded to accept only two digit entries to identify the year in the date code field, without considering the impact of the change in the century. As a result, in less than one year, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. We believe that Year 2000 issues could encompass our own software products, internal systems used to operate and monitor our business and our third party vendors and customers. We currently offer software products that are designed to be Year 2000 compliant. Our software products do not utilize dates in their primary functions. We have evaluated our software products and their interaction with hardware, such as fax machines, and possible software applications, such as word processors, and believe that Year 2000 problems will not effect the functionality of its software products. However, it is possible that our products, or the hardware or software applications used by a customer, may contain undetected errors or defects associated with Year 2000 date functions. We believe that we have identified substantially all of the major internal systems and software applications that are important to the operation and monitoring of our business. We have obtained confirmation from vendors of certain purchased systems and software applications used in our internal operations that current releases or upgrades, if installed, are designed to be Year 2000 compliant. We have recently completed the installation of such upgrades to our current systems. We have recently completed the installation of such upgrades 20 21 to our current systems. We believe that with the upgrades, modifications and conversions we have made to date, the Year 2000 issue will not have a material impact on our internal systems. However, it is possible that the systems and software applications used for our internal operations contain undetected errors or defects associated with Year 2000 date functions. We are currently in the process of evaluating our critical external relationships, including relationships with both third party vendors and customers, to determine the extent to which we may be vulnerable to the failure of such third parties to resolve their own Year 2000 issues. We are gathering information through direct communication with third parties, SEC filings, information provided by the third parties' corporate web sites and product marketing documentation. Third parties being evaluated include, among others, software duplication vendors, freight companies, payroll service providers and our largest customers. Where practicable, we will assess and attempt to mitigate our risks with respect to failure of these entities to be Year 2000 ready. The effect, if any, on our results of operations from the failure of such parties to be Year 2000 ready is not reasonably estimable. Although we are not aware of any material operational issues or costs associated with preparing our products or internal information systems for the Year 2000, it is possible that we may experience serious unanticipated negative consequences and/or material costs caused by undetected errors or defects in the technology used in our internal systems, which are composed predominantly of third party software and hardware. If we are not completely successful in mitigating our internal and external Year 2000 risks, we could experience a system failure or disruptions in our operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Any of these problems, if they occur, would have an adverse effect on our business, results of operations and financial condition. Our Officers and Directors Could Control Matters Submitted to Our Stockholders. As of March 23, 1999, William Smith, the President, Chief Executive Officer and Chairman of the Board of the company, and Rhonda Smith, the Secretary, Treasurer and Vice-Chairman of the Board of our company, beneficially owned approximately 69.3% 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 our directors and determine the outcome of any corporate action requiring stockholder approval, including a merger or business combination, irrespective of how you may vote. This concentration of ownership may discourage a potential acquirer from making an offer to buy our company, which, in turn, could adversely affect the market price of our common stock. Provisions of Our Charter and Bylaws and Delaware Law Could Make a Takeover of Our Company Difficult. Our certificate of incorporation and bylaws contain provisions that may discourage or prevent a third party from acquiring us, even if doing so would be beneficial to our stockholders. For instance, our certificate of incorporation authorizes the board of directors to fix the rights and preferences of shares of any series of preferred stock, without action by our stockholders. As a result, the board can authorize and issue shares of preferred stock, which could delay or prevent a change of control because the rights given to the holders of such preferred stock may prohibit a merger, reorganization, sale or other extraordinary corporate transaction. In addition, we are organized under the laws of the State of Delaware and certain provisions of Delaware law may have the effect of delaying or preventing a change in our control. The Price of Our Stock Has Been Volatile and Could Continue to Fluctuate Substantially. The market price of our common stock has been volatile and could fluctuate substantially in response to a variety of factors that are out of our control, in addition to our financial performance. Furthermore, stock prices for many high technology companies, including our own fluctuate widely for reasons that may be unrelated to the operating performance. Future Sales of Our Common Stock Could Cause the Price of Our Shares to Decline. As of March 23, 1999, we had 14,074,698 shares of Common Stock outstanding. Of this amount, the 9,758,670 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 our initial public offering, which consummated in September 1995. Sales of a substantial number of shares of our common stock by William Smith, Rhonda Smith or any other 21 22 person, either individually or when aggregated with sales by other persons, could adversely affect the market price of our common stock. ITEM 2. PROPERTIES Our principal administrative, sales and marketing, customer support and research and development facility is located in approximately 33,000 square feet of space in Aliso Viejo, California. We have leased this facility through March 31, 2003. We also lease a facility of approximately 3,600 square feet in Beaverton, Oregon pursuant to a lease which extends through February 28, 2000, a facility of approximately 1,500 square feet in Boulder, Colorado pursuant to a lease which extends through May 31, 1999, a facility of approximately 1,500 square feet in Calgary, Alberta pursuant to a lease that extends through July 31, 1999 and a facility of approximately 900 square feet in Plano, Texas, pursuant to a lease which extends through June 30, 1999. We believe that suitable additional or alternative space will be available in the future on commercially reasonable terms as needed. ITEM 3. LEGAL PROCEEDINGS Smith Micro 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. In October 1998, Smith Micro and PCI Video successfully obtained a terminating sanction against Virtual Ambiance, resulting in immediate dismissal of the lawsuit with prejudice. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of stockholders during the quarter ended December 31, 1998. 22 23 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION Smith Micro's common stock is traded on the Nasdaq National Market under the symbol "SMSI." The high and low closing sale prices for our common stock as reported by Nasdaq are set forth below for the periods indicated.
High Low -------- ------- YEAR ENDED DECEMBER 31, 1998: First Quarter $ 5 9/16 $1 9/16 Second Quarter 4 7/16 2 1/4 Third Quarter 2 3/4 1 1/4 Fourth Quarter 4 3/8 1 7/16 YEAR ENDED DECEMBER 31, 1997: First Quarter 5 1/2 2 7/8 Second Quarter 4 1/2 2 Third Quarter 3 1/2 1 7/8 Fourth Quarter 3 7/8 1 5/8 YEAR ENDED DECEMBER 31, 1996: First Quarter 9 3/4 5 1/2 Second Quarter 16 7/8 8 3/8 Third Quarter 12 1/4 5 1/8 Fourth Quarter 6 1/4 4 3/4
On March 23, 1999, the closing sale price for our common stock as reported by Nasdaq was $2.63. HOLDERS As of March 23, 1999, there were 95 holders of record of our common stock. DIVIDENDS We have never paid any cash dividends on our common stock and we have no current plans to do so. 23 24 USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING The effective date of Smith Micro's first 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, we sold 1,700,000 shares of common stock for an aggregate offering price of $20,400,000, and certain of our stockholders sold 2,210,000 shares of our common stock for an aggregate offering price of $26,520,000. We 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 us after total expenses were $18,138,000. As of December 31, 1998, we had used the net proceeds from the offering as follows: $4,188,000 to repay amounts due under a promissory note issued by us to certain of our stockholders as a part of a distribution of retained earnings in connection with our prior S corporation status, $3,011,000 for our acquisition of Performance Computing Incorporated, which was consummated in March 1996, $458,000 for our acquisition of technology assets from Mitek Systems, Inc., which was consummated in January 1998 and $190,000 for other acquisitions of technology assets during 1998. We have invested the remainder of the net proceeds from the offering 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. 24 25 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data with respect to Smith Micro's consolidated statements of operations for the years ended and consolidated balance sheets as of December 31, 1998, 1997, 1996 and 1995 are derived from the audited Consolidated Financial Statements of Smith Micro Software Inc.. The following information should be read in conjunction with the Consolidated Financial Statements of the company and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.
Year Ended December 31, ----------------------------------------------- 1998 1997 1996 1995 -------- -------- -------- -------- (in thousands, except per share data) Statement of Operations Data: Net revenues $ 9,547 $ 11,684 $ 22,091 $ 18,012 Cost of revenues 2,898 3,853 6,795 5,887 -------- -------- -------- -------- Gross profit 6,649 7,831 15,296 12,125 Operating expenses: Selling and marketing 3,779 3,525 2,939 1,995 Research and development 3,262 3,266 3,324 1,621 General and administrative 3,443 4,191 3,796 2,555 Acquired in-process research and development 5,169 -------- -------- -------- -------- Total operating expenses 10,484 10,982 15,228 6,171 -------- -------- -------- -------- Operating income (loss) (3,835) (3,151) 68 5,954 Interest income 725 725 849 308 -------- -------- -------- -------- Income (loss) before income taxes (3,110) (2,426) 917 6,262 Income tax expense (benefit) (1) (1,112) (839) 2,436 810 -------- -------- -------- -------- Net income (loss) $ (1,998) $ (1,587) $ (1,519) $ 5,452 ======== ======== ======== ======== Net loss per share, basic and dilutive $ (0.14) $ (0.11) $ (0.11) ======== ======== ======== Pro forma net income (1) $ 3,757 ======== Pro forma net income per share, basic and dilutive (1) $ 0.30 ======== Weighted average shares used in computation 14,075 14,075 13,992 12,627 ======== ======== ======== ========
As of December 31, ----------------------------------------------- 1998 1997 1996 1995 -------- -------- -------- -------- (in thousands, except per share data) Balance Sheet Data: Total assets $ 20,803 $ 21,755 $ 24,107 $ 23,662 Total liabilities 2,558 1,512 2,277 3,417 Retained earnings (accumulated deficit) (3,019) (1,021) 566 2,085 Total stockholders' equity 18,245 20,243 21,830 20,245
- ---------- (1) Prior to the effective date of the initial public offering, the company was treated as an S corporation pursuant to the Internal Revenue Code. Subsequent to the effective date of the initial public offering, the company's tax status reverted to that of a C corporation. The pro forma information presented on the statement of operations data reflect a provision for income taxes in 1995 as if the company had been taxed as a C corporation for the entire year, assuming effective tax rates that would have been in effect at such time. The principal difference between the effective pro forma tax rate and the statutory federal tax rate relates to state taxes and research and development tax credits. 25 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Smith Micro Software, Inc. develops and sells communications software for personal and business use. Our objective is to enhance human interaction by giving users the ability to communicate through multimedia technologies over analog and digital platforms. Smith Micro's products enable personal communication through telephony, fax, multimedia email, data, paging, video security and video conferencing. Recently, we have been developing new products that leverage off our core technologies to address the consumer's use of the Internet and corporate intranets. We intend to leverage our experience and position with the original equipment manufacturers to deploy these new product releases. Additionally, we are expanding our customer base to include manufacturers that produce devices that take advantage of the high bandwidth Internet connectivity such as cable and xDSL modems. The Company's corporate products are designed to provide cost effective and efficient methods of communicating that take advantage of corporate local and wide area networks, including the Internet or intranet. We shipped our first data communication software product in 1985 and, since that time, we have generated revenues primarily from the market acceptance of our OEM fax and data communication software products. We began providing video communication products in 1996 to both OEM and retail customers. In January 1998, we purchased certain fax software assets of Mitek Systems, Inc. to provide LAN, Internet and intranet fax transmission solutions designed for the corporate market. In September 1998, we shipped our first Internet communications software product. This multi-purpose product provides for integrated telephony, multimedia e-mail, video security, fax, video conferencing and text based chat functionality over the Internet and other IP protocol services such as LANs and WANs. Designed to take advantage of high bandwidth technology, this product functions over a variety of IP connectivity hardware including xDSL modems, cable modems, network interface devices and analog modems. We recognize revenues from sales of our software as completed products are shipped and from royalties generated as authorized customers duplicate our software. Any material reduction in demand for our products would have an adverse effect on our business, results of operations and financial condition. We continue to introduce new products; and our 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. We have allowed our customers to return unused software and to rotate stock for new versions of retail releases. As a percentage of our net revenues, returns constituted 5.1% in 1998, 26.8% in 1997 and 16.8% in 1996. As a percentage of our net revenues, returns for stock rotation were 0.6% in 1998, 14.6% in 1997 and 6.8% in 1996. A small number of our customers have historically accounted for a substantial portion of our revenues. In June 1997, 3Com Corporation acquired our largest customer to date, U.S. Robotics Corporation. Sales to 3Com, primarily U.S Robotics and its subsidiaries, accounted for approximately 24.7% of our net revenues in 1998, 43.4% of our net revenues in 1997 and 46.4% of our net revenues in 1996. Our three largest OEM customers, including 3Com, accounted for the following portions of our net revenues: 35.1% in 1998, 56.9% in 1997 and 62.9% in 1996. Any reduction, delay or change in orders from such customers could have an adverse effect on our business, results of operations and financial condition. The OEM product ordering cycle beginning from placement of an order to shipment 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. We generally ship our products as we receive orders; and, accordingly, we have historically operated with little backlog. We do not consider backlog to be a significant indication of future performance. As a result, our sales in any quarter are dependent on orders booked and shipped in that quarter and are not predictable with any degree of certainty. Moreover, we generally do not produce software in advance of orders and, therefore, have not maintained a material amount of software inventory. 26 27 Inventory in the retail channel exposes us to product returns. We consider this exposure when we establish allowances for product returns. Substantial returns of product from the retail channel could have an adverse effect on our 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 in this Annual Report. Historical results of operations, percentage relationships and any trends that may be inferred from the discussion below are not necessarily indicative of our 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 our statement of income.
Year Ended December 31, --------------------------------------- 1998 1997 1996 1995 ----- ----- ----- ----- Net revenues 100.0% 100.0% 100.0% 100.0% Cost of revenues 30.4% 33.0% 30.8% 32.7% ----- ----- ----- ----- Gross profit 69.6% 67.0% 69.2% 67.3% Operating expenses: Selling and marketing 39.5% 30.2% 13.3% 11.1% Research and development 34.2% 27.9% 15.0% 9.0% General and administrative 36.1% 35.9% 17.2% 14.2% Acquired in-process research and development 23.4% ----- ----- ----- ----- Total operating expenses 109.8% 94.0% 68.9% 34.3% ----- ----- ----- ----- Operating income (loss) -40.2% -27.0% 0.3% 33.0% Interest income 7.6% 6.2% 3.8% 1.7% ----- ----- ----- ----- Income (loss) before income taxes -32.6% -20.8% 4.1% 34.7% Income tax expense (benefit) -11.7% -7.2% 11.0% 4.5% ----- ----- ----- ----- Net income (loss) -20.9% -13.6% -6.9% 30.2% ===== ===== ===== =====
1998 COMPARED TO 1997 Net Revenues Our net revenues decreased 18.3% to $9.5 million for 1998 from $11.7 million for 1997. This decrease in our revenue was the result of a decrease in sales to our largest OEM analog modem customers, including 3Com. The decrease in sales resulted from a combination of factors, including changes in product mix resulting from the analog modem industry's acceptance of the V.90, 56K modem standard, reduced demand of certain fax products and pricing pressures within the analog modem industry. In response to these factors, our revenues from sales to 3Com in 1998 decreased 53.4% when compared to 1997. This decrease in our revenues from analog modem manufacturers was partially offset by an increase in revenues from other OEM customers, including PC manufacturers, and increased retail revenues. During 1998, net retail revenues increased approximately 313% over 1997 net retail revenues. Gross Profit Gross profit represents net revenues, less cost of revenues, which includes cost of materials, costs related to the operations of our duplication facilities, freight charges and royalties to licensors. Our gross profit decreased 15.1% to $6.6 million in 1998 from $7.8 million in 1997. Gross profit as a percentage of net revenues increased to 27 28 69.6% in 1998 compared to 67.0% in 1997. The increase in our gross profit percentage was due to a shift in our product mix, our flexible manufacturing process and our improvement of controls over our manufacturing expenses. These improvements were partially offset by the translation costs of certain software products. Operating Expenses Our selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. Selling and marketing expenses increased 7.2% to $3.8 million in 1998 from $3.5 million in 1997. As a percent of net revenues, sales and marketing expenses increased to 39.5% in 1998 from 30.2% in 1997. The increase in our sales and marketing expenses in 1998 was primarily due to increased expenditures for our major retail products, including expenditures related to the introduction of Internet CommSuite, a multi-function Internet communications software product. Expenditures for our corporate and VAR product group, primarily our LAN fax products, also increased in 1998. Our research and development expenses consist primarily of personnel and equipment costs required to conduct our software development efforts. In 1998, research and development expenses remained constant at $3.3 million as compared to 1997. As a percentage of net revenues, research and development expenditures increased to 34.2% in 1998 from 27.9% in 1997. An increase in the amortization of purchased technologies, primarily for the network fax technology that we acquired in 1998, was offset by a reduction in salaries and benefits. To date, we have not capitalized any of our software development expenses because our development efforts have been completed concurrently with the establishment of technological feasibility. However, significant new products that we develop in the future may require the capitalization of certain software development expenses. Our general and administrative expenses include expenses related to our general operations. General and administrative expenses decreased 17.8% to $3.4 million in 1998 from $4.2 million in 1997. As a percentage of net revenues, general and administrative expenditures increased to 36.1% in 1998 from 35.9% in 1997, primarily due to the decrease in our net revenues. The overall decrease was primarily due to the lower allowance for bad debt in 1998 and cost control measures that reduced most expense categories during 1998. Income Taxes During 1998, our income tax benefit was 35.8% of the loss before income taxes. Income tax benefit was $1.1 million in 1998 and $839,000 in 1997. 1997 COMPARED TO 1996 Net Revenues Our net revenues decreased 47.1% to $11.7 million for 1997 from $22.1 million for 1996. This decrease consisted of a 40.7% decrease in OEM sales and an 82.2% decrease in retail sales in 1997 compared with 1996. The OEM decrease was the result of a combination of decreased unit volume, which we believe was primarily driven by the lack of a 56K modem standard during 1997, and an increased percentage of net revenues resulting from royalty agreements. These factors contributed to decreased revenues from sales to 3Com of 50.5% in 1997 and to decreased revenues from sales to Motorola of 77.0% in 1997. The decrease in retail sales was primarily driven by slower than anticipated sales of our video communication software product lines. We believe that these product lines continue to be impacted by consumers' lack of acceptance of current video technology and pricing. Gross Profit Gross profit represents net revenues, less cost of revenues, which includes cost of materials, costs related to the operations of our duplication facilities, freight charges and royalties to licensors. Gross profit decreased 48.8% to $7.8 million in 1997 from $15.3 million in 1996. Gross profit as a percentage of net revenues 28 29 decreased to 67.0% in 1997 compared to 69.2% in 1996. An increased percentage of revenue from royalty agreements, cost control measures and increased manufacturing efficiencies helped us to achieve only a slight decrease in gross profit percentage despite the 47.1% decrease in our sales. Gross profit as a percentage of net revenues decreased primarily due to the decrease in our net revenues, an increase in our inventory write-offs, which resulted from releases of new version retail product releases during 1997, and an increase in our royalty expenses, which were primarily related to our video products. Operating Expenses Our selling and marketing expenses consist primarily of personnel costs, advertising costs, sales commissions and trade show expenses. These expenses vary significantly from quarter to quarter based on the timing of trade shows and product introductions. Selling and marketing expenses increased 19.9% to $3.5 million in 1997 from $2.9 million in 1996. As a percentage of net revenues, sales and marketing expenses increased to 30.2% in 1997 from 13.3% in 1996. Our sales and marketing expenditures increased primarily due to our promotional campaigns in the retail channel during the first half of the year combined with an increase in personnel. Our research and development expenses consist primarily of personnel and equipment costs required to conduct our software development efforts. Our research and development expenses remained constant at $3.3 million in 1997 compared to 1996. As a percentage of net revenues, research and development expenditures increased to 27.9% in 1997 from 15.0% in 1996. An increase in the amortization of purchased technologies related to our video communication software was offset by a decrease in all other research and development expense categories. To date, we have not capitalized any of our software development expenses because our development efforts have been completed concurrently with the establishment of technological feasibility. However, significant new products that we develop in the future may require the capitalization of certain software development expenses. Our general and administrative expenses include expenses related to our general operations. General and administrative expenses increased 10.4% to $4.2 million in 1997 from $3.8 million in 1996. As a percentage of net revenues, our general and administrative expenditures increased to 35.9% in 1997 from 17.2% in 1996. Our cost control efforts reduced general and administrative expenses in most categories, particularly salaries and benefits, however, this reduction was offset by an increase in bad debt reserves. We increased bad debt reserves due to slower payment patterns from our customers that were largely influenced by slower than anticipated sales of our retail video communication software products. Income Taxes During 1997, our income tax benefit was 34.6% of the loss before income taxes. Income tax benefit was $839,000 in 1997 and the income tax expense was $2.4 million in 1996. The effective tax rate during 1996 differed from the statutory federal rate of 35.0%, principally because of nondeductible acquired in-process research and development costs of $1.8 million and state taxes. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have financed our operations primarily through cash generated from operations. Net cash used in operations was $858,000 for 1998 and $288,000 for 1996. Net cash provided by operating activities was $102,000 in 1997. In 1998, the cash used in our operations was primarily the result of our net loss for the year and an increase in accounts receivable that was partially offset by an increase in accounts payable and accrued liabilities. The increases in accounts receivable and accounts payable and accrued liabilities were primarily due to an increase in our retail activities during the later portion of the year. The cash provided by operations in 1997 was primarily due to a decrease in accounts receivable that was offset by a net loss for the year. The decrease in cash provided from operations in 1996 was primarily the result of increased accounts receivable and income taxes receivable, and increased operating costs, primarily in research and development expenditures. 29 30 We used $810,000 in cash in 1998, $222,000 in 1997 and $2.5 million in 1996, for investing activities. Our primary use of cash for investing activities related to our acquisition of technology from Mitek in 1998 and the purchase of Performance Computing Incorporated in 1996. We also invested in property and equipment, including computers and production equipment, during each of 1998, 1997 and 1996. During 1998 and 1997, we did not use or generate cash from financing activities. Net cash used in financing activities during 1996 of $1.8 million was primarily for the repayment of notes to our founders. At December 31, 1998, we had $12.7 million in cash and cash equivalents and $16.7 million of working capital. We had $4.1 million in accounts receivable, net of allowance for doubtful accounts and other adjustments. We currently anticipate that capital expenditures will not vary significantly from recent years. YEAR 2000 COMPLIANCE Smith Micro is aware of issues associated with computer systems as the year 2000 approaches. Many currently installed computer systems and software applications are coded to accept only two digit entries to identify the year in the date code field, without considering the impact of the change in the century. As a result, in less than one year, computer systems and/or software used in many companies may need to be upgraded to comply with such "Year 2000" requirements. We believe that Year 2000 issues could affect the internal systems used to operate and monitor our business, our third party vendors and customers and our software products. Significant uncertainty exists in the computer industry concerning the potential effects associated with such Year 2000 issues. We believe that we have identified substantially all of the major internal systems and software applications that are important to the operation and monitoring of our business. We have obtained confirmation from vendors of certain purchased systems and software applications used for our internal operations that current releases or upgrades, if installed, are designed to be Year 2000 compliant. We have recently completed the installation of such upgrades to our current systems. We believe that with the upgrades, modifications and conversions we have made to date, the Year 2000 issue will not have a material impact on our internal systems. However, it is possible that the systems and software applications used for our internal operations contain undetected errors or defects associated with Year 2000 date functions. We currently estimate that the total cost remaining, after December 31, 1998, to address our Year 2000 issues is insignificant. This estimate is based on assumptions that include our assumption that the we have already identified the most significant Year 2000 issues and that the plans of our third party suppliers and customers will be fulfilled in a timely manner at no cost to us. All remaining Year 2000 issue costs will be funded through operating cash flows. We are currently in the process of evaluating our critical external relationships, including relationships with both third party vendors and customers, to determine the extent to which we may be vulnerable to the failure of such third parties to resolve their own Year 2000 issues. We are gathering information through direct communication with third parties, SEC filings, information provided by the third parties' corporate web sites and product marketing documentation. Third parties being evaluated include, among others, software duplication vendors, freight companies, payroll service providers and our largest customers. Where practicable, we will assess and attempt to mitigate our risks with respect to failure of these entities to be Year 2000 ready. The effect, if any, on our results of operations from the failure of such parties to be Year 2000 ready is not reasonably estimable. We currently offer software products that are designed to be Year 2000 compliant. Our software products do not utilize dates in their primary functions. We have evaluated our software products and their interaction with hardware, such as fax machines, and possible software applications, such as word processors, and believe that Year 2000 problems will not affect the functionality of its software products. However, it is possible that our products, or the hardware or software applications used by one of our customers, may contain undetected errors or defects associated with Year 2000 date functions. Although we are not aware of any material operational issues or costs associated with preparing our products or internal information systems for the Year 2000, it is possible that we may experience serious 30 31 unanticipated negative consequences and/or material costs caused by undetected errors or defects in the technology used in our internal systems, which are composed predominantly of third party software and hardware. If we are not completely successful in mitigating our internal and external Year 2000 risks, we could experience a system failure or disruptions in our operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. We are currently developing contingency plans to address the Year 2000 issues that may pose a significant risk to our ongoing operations. We believe, that under a worst case scenario, we could continue the majority of our normal business activities with the use of manual processing, alternate suppliers and an accelerated program of replacement for equipment or software applications. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Smith Micro's financial instruments include cash and cash equivalents. At December 31, 1998, the carrying values of our financial instruments approximated fair values based on current market prices and rates. It is our policy not to enter into derivative financial instruments. We do not currently have any significant foreign currency exposure as we do not transact business in foreign currencies. As such, we do not have significant currency exposure at December 31, 1998. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Smith Micro's consolidated financial statements and schedule, as listed under Item 14, appear in a separate section of this Annual Report on Form 10-K beginning on page F-1 and S-1, respectively. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE During the three years prior to the date of the most recent financial statements and the subsequent interim period, we have not had a change in our independent auditors nor have there been any disagreements between us and our independent auditors. 31 32 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS The sections titled "Executive Officers of the Company," "Directors and Nominees" and "Compliance with Section 16(a) of the Exchange Act" appearing in Smith Micro's Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated herein by reference ITEM 11. EXECUTIVE COMPENSATION The section titled "Executive Compensation and Related Information" appearing in Smith Micro's Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The section titled "Principal Stockholders" appearing in Smith Micro's Proxy Statement for the 1999 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. 32 33 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS Smith Micro's financial statements appear in a separate section of this Annual Report on Form 10-K beginning on the pages referenced below:
PAGE ---- Independent Auditors' Report.......................................................F-1 Consolidated Balance Sheets as of December 31, 1998 and 1997.......................F-2 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1998..............................................F-3 Consolidated Statements of Stockholders Equity for each of the three years in the period ended December 31, 1998.....................................F-4 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1998..................................................F-5 Notes to Consolidated Financial Statements for each of the three years in the period ended December 31, 1998...........................................F-7
(2) FINANCIAL STATEMENT SCHEDULE Smith Micro's financial statement schedule appears in a separate section of this Annual Report on Form 10-K on the pages referenced below. All other schedules have been omitted as they are not applicable, not required or the information is included in the consolidated financial statements or the notes thereto.
PAGE ---- Independent Auditors' Report.......................................................S-1 Schedule II - Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 1998...............................................S-2
(3) EXHIBITS
Exhibit No. Title Method of Filing ------- ----- ---------------- 3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1 to the Incorporation of the Company Registrant's Registration Statement No. 33-95096 3.2 Amended and Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement No. 33-95096 4.1 Specimen certificate representing shares of Incorporated by reference to Exhibit 4.1 to the Common Stock of the Company. 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
33 34
Exhibit No. Title Method of Filing ------- ----- ---------------- 10.3 Form of Notice of Grant of Stock Option Incorporated by reference to Exhibit 10.3 to the under 1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096 10.4 Form of 1995 Stock Option Agreement under Incorporated by reference to Exhibit 10.4 to the 1995 Stock Option /Stock Issuance Plan. Registrant's Registration Statement No. 33-95096 10.5 Form of 1995 Stock Purchase Agreement under Incorporated by reference to Exhibit 10.5 to the 1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096 10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6 to the September 30, 1991, by and between the Registrant's Registration Statement No. 33-95096 Company and Crandell Development Corporation. 10.7 Application Program Interface Retail License Incorporated by reference to Exhibit 10.7 to the Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096 Company and Rockwell International Corporation. 10.8 Application Program Interface License Incorporated by reference to Exhibit 10.8 to the Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096 Company and Rockwell International Corporation. 10.9 Rockwell High Speed Interface License Incorporated by reference to Exhibit 10.9 to the Agreement dated June 2, 1994, by and between Registrant's Registration Statement No. 33-95096 the Company and Rockwell International Corporation. 10.10 Letter Agreement dated February 22, 1994, by Incorporated by reference to Exhibit 10.10 to the and between the Company and Rockwell Registrant's Registration Statement No. 33-95096 International Corporation. 10.11 Letter Agreement dated April 22, 1993, by Incorporated by reference to Exhibit 10.11 to the and between the Company and Rockwell Registrant's Registration Statement No. 33-95096 International Corporation. 10.12 Software Distribution Agreement dated May 8, Incorporated by reference to Exhibit 10.12 to the 1995, by and between the Company and Registrant's Registration Statement No. 33-95096 International Business Machines Corporation. 10.13 Office Building Lease, dated June 10, 1992, Incorporated by reference to Exhibit 10.13 to the by and between the Company and Developers Registrant's Registration Statement No. 33-95096 Venture Capital Corporation. 10.14 Amendment No. 1 To Office Building Lease, Incorporated by reference to Exhibit 10.14 to the dated July 9, 1993, by and between the Registrant's Registration Statement No. 33-95096 Company and Pioneer Bank.
34 35
Exhibit No. Title Method of Filing ------- ----- ---------------- 10.15 Amendment No. 2 To Office Building Lease, Incorporated by reference to Exhibit 10.15 to the dated August 15, 1994, by and between the Registrant's Registration Statement No. 33-95096 Company and T&C Development. 10.16 Fourth Addendum to Office Building Lease, Incorporated by reference to Exhibit 10.16 to the dated April 21, 1995, by and between Registrant's Registration Statement No. 33-95096 the Company and T&C Development. 10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17 to the Corporation Distribution. Registrant's Registration Statement No. 33-95096 10.18 Smith Micro Software, Inc. Amended and Incorporated by reference to Exhibit 10.21 to the Restated Software Licensing and Distribution Registrant's Quarterly Report on Form 10-Q for the Agreement, dated April 18, 1996, by and quarter ended September 30, 1996 between the Company and U.S. Robotics Access Corp. 10.19 Office Building Lease, dated March 1, 1994, Incorporated by reference to Exhibit 10.19 to the by and between Performance Computing Registrant's Annual Report on Form 10-K for the Incorporated and Petula Associates, Ltd./KC fiscal year ended December 3l, 1995 Woodside. 10.20 Agreement and Plan of Merger by and between Incorporated by reference to Exhibit 2 to the Smith Micro Software, Inc., Performance Registrant's Current Report on Form 8-K filed with Computing Incorporated and PCI Video the Commission on March 28, 1996 Products, Inc. dated as of March 14, 1996. 10.21 Amendment No. 1, dated as of March 10, 1997, Incorporated by reference to Exhibit 10.21 to the to Agreement and Plan of Merger by and Registrant's Annual Report on Form 10-K for the between Smith Micro Software, Inc., fiscal year ended December 31, 1996 Performance Computing Incorporated and PCI Video Products, Inc. dated as of March 14, 1996. 10.22 Amendment No. 6 to Office Building Lease, Incorporated by reference to Exhibit 10.21 to the dated February 19, 1998, by and between the Registrant's Annual Report on Form 10-K for the Company and World Outreach Center. fiscal year ended December 31, 1997 10.23 Software Licensing and Distribution Filed Herewith. Confidential treatment being sought Agreement dated December 1, 1998, by and with respect to certain portions of this agreement. between the Company and 3Com Corporation Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission. 23.1 Independent Auditors' Consent. Filed Herewith 27 Financial Data Schedule. Filed Herewith
(b) EXHIBITS ON FORM 8-K No Current Reports on Form 8-K were filed during the quarter ended December 31, 1998. 35 36 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SMITH MICRO SOFTWARE, INC. Date: March 26, 1999 By:/s/ William W. Smith, Jr. ------------------------------------- William W. Smith, Jr. Chairman of the Board, President and Chief Executive Officer Date: March 26, 1999 By /s/ Mark W. Nelson ------------------------------------- Mark W. Nelson Chief Financial Officer (Principal Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ William W. Smith, Jr. Chairman of the Board, March 26, 1999 - ------------------------------------ President and Chief Executive Officer William W. Smith, Jr. (principal executive officer) /s/ Rhonda L. Smith Vice-Chairman of the Board, Secretary, March 26, 1999 - ------------------------------------ Treasurer and Director Rhonda L. Smith /s/ Robert W. Scheussler Senior Vice President, Chief Technical March 26, 1999 - ------------------------------------ Officer, and Director Robert W. Scheussler /s/ Mark W. Nelson Vice President of Finance and Chief March 26, 1999 - ------------------------------------ Financial Officer (principal financial Mark W. Nelson and accounting officer) /s/ Thomas G. Campbell Director March 26, 1999 - ------------------------------------ Thomas G. Campbell /s/ F. Terry Eger Director March 26, 1999 - ------------------------------------ F. Terry Eger
36 37 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Smith Micro Software, Inc.: We have audited the accompanying consolidated balance sheets of Smith Micro Software, Inc. and subsidiary (the Company) as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Smith Micro Software, Inc. and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. DELOITTE & TOUCHE, LLP Costa Mesa, California February 12, 1999 F-1 38 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997 - -------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1998 1997 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 12,699 $ 14,367 Accounts receivable, net of allowances for doubtful accounts and other adjustments of $1,255 (1998) and $1,413 (1997) 4,093 3,808 Income taxes receivable 931 1,127 Deferred tax asset (Note 4) 470 467 Inventories 629 553 Prepaid expenses and other current assets 423 503 -------- -------- Total current assets 19,245 20,825 EQUIPMENT AND IMPROVEMENTS, net (Note 2) 350 444 DEFERRED TAX ASSET (Note 4) 336 139 OTHER ASSETS 304 58 INTANGIBLE ASSETS, net (Note 9) 568 289 -------- -------- $ 20,803 $ 21,755 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,373 $ 877 Accrued liabilities (Note 3) 1,185 635 -------- -------- Total current liabilities 2,558 1,512 COMMITMENTS AND CONTINGENCIES (Note 5) STOCKHOLDERS' EQUITY (Note 8): 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 (3,019) (1,021) -------- -------- Total stockholders' equity 18,245 20,243 -------- -------- $ 20,803 $ 21,755 ======== ========
See notes to consolidated financial statements. F-2 39 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 - -------------------------------------------------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA)
Year ended December 31, ---------------------------------- 1998 1997 1996 -------- -------- -------- NET REVENUES (Note 6) $ 9,547 $ 11,684 $ 22,091 COST OF REVENUES 2,898 3,853 6,795 -------- -------- -------- GROSS PROFIT 6,649 7,831 15,296 OPERATING EXPENSES: Selling and marketing 3,779 3,525 2,939 Research and development 3,262 3,266 3,324 General and administrative (Note 7) 3,443 4,191 3,796 Acquired in-process research and development (Note 9) 5,169 -------- -------- -------- Total operating expenses 10,484 10,982 15,228 -------- -------- -------- OPERATING INCOME (LOSS) (3,835) (3,151) 68 INTEREST INCOME 725 725 849 -------- -------- -------- INCOME (LOSS) BEFORE INCOME TAXES (3,110) (2,426) 917 INCOME TAX EXPENSE (BENEFIT) (Note 4) (1,112) (839) 2,436 -------- -------- -------- NET LOSS $ (1,998) $ (1,587) $ (1,519) ======== ======== ======== NET LOSS PER SHARE, basic and diluted $ (0.14) $ (0.11) $ (0.11) ======== ======== ======== WEIGHTED AVERAGE NUMBER OF SHARES OUTSTANDING 14,075 14,075 13,992 ======== ======== ========
See notes to consolidated financial statements. F-3 40 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 - -------------------------------------------------------------------------------- (IN THOUSANDS)
Retained Common stock Additional earnings ------------------ paid-in (accumulated Shares Amount capital deficit) Total ------ ------- ---------- ------------ ------- BALANCE, January 1, 1996 13,700 $ 14 $18,146 $ 2,085 $20,245 Issuance of common stock in acquisition 350 2,944 2,944 Exercise of common stock options 25 160 160 Net loss (1,519) (1,519) ------ ------- ------- ------- ------- BALANCE, December 31, 1996 14,075 14 21,250 566 21,830 Net loss (1,587) (1,587) ------ ------- ------- ------- ------- BALANCE, December 31, 1997 14,075 14 21,250 (1,021) 20,243 Net loss (1,998) (1,998) ------ ------- ------- ------- ------- BALANCE, December 31, 1998 14,075 $ 14 $21,250 $(3,019) $18,245 ====== ======= ======= ======= =======
See notes to consolidated financial statements. F-4 41 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 - -------------------------------------------------------------------------------- (IN THOUSANDS)
Year ended December 31, ---------------------------------- 1998 1997 1996 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (1,998) $ (1,587) $ (1,519) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization 683 688 452 Write-off of in-process research and development 5,169 Provision for doubtful accounts and other adjustments to accounts receivable (158) (409) 1,304 Deferred income taxes (200) 82 (648) Change in operating accounts, net of amounts acquired: Accounts receivable (127) 2,618 (3,723) Income taxes receivable 196 (607) (599) Inventories (76) 8 (118) Prepaid expenses and other assets (224) (88) (197) Accounts payable and accrued liabilities 1,046 (603) (409) -------- -------- -------- Net cash provided by (used in) operating activities (858) 102 (288) CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (163) (222) (259) Acquisition of technologies (647) Acquisition of Performance Computing, Inc. (2,211) -------- -------- -------- Net cash used in investing activities (810) (222) (2,470) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 160 Repayment of notes payable to founders (1,935) -------- -------- -------- Net cash used in financing activities (1,775) -------- -------- -------- NET DECREASE IN CASH AND CASH EQUIVALENTS (1,668) (120) (4,533) CASH AND CASH EQUIVALENTS, beginning of year 14,367 14,487 19,020 -------- -------- -------- CASH AND CASH EQUIVALENTS, end of year $ 12,699 $ 14,367 $ 14,487 ======== ======== ========
See notes to consolidated financial statements. F-5 42 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (CONTINUED) - -------------------------------------------------------------------------------- (IN THOUSANDS)
DECEMBER 31, -------------------------- 1998 1997 1996 ------ ------ ------ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION - Cash paid during the year for income taxes $ -- $ 206 $1,142 ====== ====== ======
During 1996, the Company acquired a business in a transaction summarized as follows: Acquired in-process research and development $ 5,169 Fair value of assets acquired 1,107 Value of common stock issued in transaction (2,944) Liabilities assumed or created (1,121) ------- Cash paid, net of cash acquired $ 2,211 =======
See notes to consolidated financial statements. F-6 43 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of Business - Smith Micro Software, Inc. and subsidiary (the Company) develops, manufactures and sells personal computer communication software for personal and business use. The Company's products allow its customers to communicate through fax, telephony, video conferencing, multimedia email, video security, paging and data transmission. The Company's software products allow communication over a variety of data transmission devices that include regular telephone lines via analog modems and over the Internet and other IP protocol services (including the Local Area Networks and Wide Area Networks) via connectivity hardware including cable modems, xDSL modems, network interface devices and analog modems. A substantial portion of the Company's sales are direct to hardware connectivity device and personal computer manufacturers under OEM agreements. The Company also sells its products through independent distributors and retail channels. Basis of Presentation - The accompanying 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. Cash Equivalents - Cash equivalents are considered to be highly-liquid investments with initial maturities of three months or less. Accounts Receivable - The Company sells its products worldwide. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for 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. Long Lived Assets - The Company accounts for the impairment and disposition of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. In accordance with SFAS No. 121, long-lived assets to be held are reviewed for events or changes in circumstances which indicate that their carrying value may not be recoverable. The Company periodically reviews the carrying value of long-lived assets to determine whether or not an impairment to such value has occurred and has determined that there was no impairment at December 31, 1998. F-7 44 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- Goodwill and Other Intangibles - Goodwill represents the excess purchase cost over the net assets acquired and is amortized over five years using the straight-line method. Other intangible assets include acquired workforce value, acquired technology and translation costs which are being amortized using the straight-line methods over three to five years. Accumulated amortization on goodwill and other intangible assets amounted to $841,000 and $415,000 as of December 31, 1998 and 1997, respectively. The Company periodically evaluates the recoverability of goodwill based on a profitability analysis related to its product sales and evaluates the recoverability of other intangible assets based on the requirements of SFAS No. 121. 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 services 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 December 31, 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 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. F-8 45 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- 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, 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 Loss per Share - Pursuant to SFAS No. 128, Earnings per Share, the Company provides dual presentation of "basic" and "diluted" earnings per share (EPS). Basic EPS amounts are based upon the weighted average number of common shares outstanding. Diluted EPS amounts are based upon the weighted average number of common and 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 years, as the impact is antidilutive. There was no difference between basic and diluted EPS for each period presented. 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 non-owner sources. For each of the years ended December 31, 1998, 1997 and 1996, there was no difference between net loss and comprehensive loss. Reclassification - Certain reclassifications have been made to the prior years financial statements to conform to the current year presentation. F-9 46 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- 2. EQUIPMENT AND IMPROVEMENTS Equipment and improvements consist of the following (in thousands):
December 31, ----------------------- 1998 1997 ------- ------- Machinery and equipment $ 1,032 $ 880 Leasehold improvements 143 137 Office furniture and fixtures 244 239 ------- ------- 1,419 1,256 Less accumulated depreciation and amortization (1,069) (812) ------- ------- $ 350 $ 444 ======= =======
3. ACCRUED LIABILITIES Accrued liabilities consists of the following (in thousands):
December 31, ----------------------- 1998 1997 ------ ------ Salaries and benefits $ 505 $ 463 Cooperative advertising and rebates 357 131 Manufacturers' representative commissions 114 Other 209 41 ------ ------ $1,185 $ 635 ====== ======
F-10 47 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- 4. INCOME TAXES A summary of income tax expense (benefit) is as follows (in thousands):
Year ended December 31, ---------------------------------- 1998 1997 1996 ------- ------- ------- Current: Federal $(1,071) $ (981) $ 2,471 State 74 6 613 Foreign 85 54 ------- ------- ------- (912) (921) 3,084 Deferred: Federal 26 202 (552) State (226) (120) (96) ------- ------- ------- (200) 82 (648) ------- ------- ------- $(1,112) $ (839) $ 2,436 ======= ======= =======
A reconciliation of the provision (benefit) for income taxes to the amount of income tax expense that would result from applying the federal statutory rate (35%) to income before provision for taxes is as follows:
December 31, ----------------------------------- 1998 1997 1996 ------- ------- ------- Federal statutory rate (35)% (35)% 35% State tax, net of federal benefit (3) (3) 37 Nondeductible expense related to acquired intangibles 3 4 197 Other (1) (1) (3) --- --- --- (36)% (35)% 266% === === ===
F-11 48 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- The major components of the Company's deferred tax assets and liabilities are as follows (in thousands):
December 31, --------------------- 1998 1997 ----- ----- Various reserves $ 564 $ 632 Nondeductible accruals 74 97 Accrual to cash adjustment (44) (163) State taxes (153) (76) Prepaid expenses (90) (65) Credit carryforwards 216 81 Net operating loss carryforwards 234 94 Other 5 6 ----- ----- $ 806 $ 606 ===== =====
The company has state net operating loss carryforwards of approximately $2,675,000 at December 31, 1998. These losses will begin to expire in 2002. In addition, the Company has federal foreign tax credit carryforwards and state research and development credit carryforwards of approximately $103,000 and $113,000, respectively, at December 31, 1998. 5. COMMITMENTS AND CONTINGENCIES Leases - The Company has noncancelable operating leases for its building facilities. Future minimum rental commitments under leases with terms of one year or more consist of the following (in thousands): Year ending December 31: 1999 $ 639 2000 562 2001 566 2002 583 2003 147 ------ $2,497 ======
Total rent expense was $621,000, $539,000 and $492,000 for the years ended December 31, 1998, 1997 and 1996, respectively. F-12 49 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- Litigation - The Company is subject to litigation in the normal course of business, none of which management believes will have a material adverse effect on the Company's financial condition or results of operations. 6. SEGMENT INFORMATION The Company engages in business activity in only one operating segment, the development, marketing and sale of communication software for personal computers. The Company's software products are developed, sold and marketed by common departments within the Company. Sales to individual customers or customers under common control which amounted to more than 10% of the Company's net revenues in the year indicated were as follows:
e DECEMBER 31, -------------------- 1998 1997 1996 ---- ---- ---- Customer: 1 - (OEM) 24.7% 43.4% 46.4% 2 - (OEM) - - 12.6 3 - (Retail) - - 11.8 4 - (Retail) 19.1 - - ---- ---- ---- 43.8% 43.4% 70.8% ==== ==== ====
The Company has historically derived a significant portion of its revenues from a relatively small number of customers. A decision by a significant customer to substantially decrease or delay purchases from the Company or the Company's inability to collect receivables from these customers could have a material adverse effect on the Company's financial condition and results of operations. The Company also has international sales representing 22.8%, 24.3% and 14.4% of its net revenues for the years ended December 31, 1998, 1997 and 1996, respectively. Sales to customers in the Asia Pacific region were 16.1%, 11.6% and 6.7% of its net revenues for the years ended December 31, 1998, 1997 and 1996, respectively. All export sales have been denominated in U.S. dollars. 7. PROFIT SHARING The Company offers its employees a 401(k) plan, in which the Company matches the employee contribution at a rate of 20%, subject to a vesting schedule. Total employer contributions amounted to $42,000 and $49,000 for the years ended December 31, 1998 and 1997, respectively. Prior to the establishment of the 401(k) plan, the Company sponsored a profit sharing plan for the benefit of all F-13 50 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- employees meeting certain age and service requirements. The Company made approximately $68,000 in discretionary contributions to the profit sharing plan for the year ended December 31, 1996. 8. STOCK-BASED COMPENSATION In 1995, the Company adopted the 1995 Stock Option/Stock Issuance Plan (the Plan). The Plan, as amended, provides for issuance of, or options to be granted for the purchase of, an aggregate of 1,750,000 shares of common stock. Under the terms of the Plan, incentive and nonqualified options may be granted at an exercise price not less than 100% and 85%, respectively, of the fair market value on the grant date, with terms of up to 10 years, and with vesting to be determined by the Board of Directors. During 1997, the Company canceled 381,000 options held by certain employees and simultaneously issued 381,000 options to the same employees with a vesting period of two or three years depending upon the grant date of the options canceled. Stock option activity under the Plan is as follows:
Weighted average Number exercise of shares price ---------- -------- OUTSTANDING, January 1, 1996 (0 exercisable) 451,000 $ 8.08 Granted (weighted average fair value of $4.28) 335,000 7.70 Exercised (25,000) 6.40 Canceled (134,000) 8.64 --------- OUTSTANDING, December 31, 1996 (138,000 exercisable) 627,000 7.85 Granted (weighted average fair value of $2.12) 746,000 2.89 Canceled (565,000) 7.21 --------- OUTSTANDING, December 31, 1997 (164,000 exercisable) 808,000 3.72 Granted (weighted average fair value of $1.34) 507,000 1.61 Canceled (152,000) 3.38 --------- OUTSTANDING, December 31, 1998 1,163,000 2.85 =========
F-14 51 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- Additional information regarding options outstanding as of December 31, 1998 is as follows:
Options outstanding Options exercisable --------------------------- ---------------------- Weighted average Weighted Weighted Range of remaining average average exercise Number contractual exercise Number exercise prices outstanding life (years) price exercisable price --------- ----------- ---------------- -------- ----------- -------- $1.44 - $ 2.25 450,000 9.7 $ 1.56 - - $2.88 - $ 3.13 618,000 8.6 $ 2.89 295,000 $ 2.89 $6.40 - $ 7.25 53,000 6.8 $ 6.85 48,000 $ 6.85 $9.07 - $14.00 42,000 6.8 $11.00 39,000 $11.09 --------- ------- 1,163,000 8.7 $ 2.85 382,000 $ 4.23 ========= =======
At December 31, 1998, 562,000 shares were available for future grants under the Stock Option Plan. Additional Stock Plan Information - As discussed in Note 1, the Company continues to account for its stock-based awards using the intrinsic value method in accordance with APB Opinion No. 25 and its related interpretations. No compensation expense has been recognized in the financial statements for employee stock arrangements as all grants have been made with an exercise price equal to the fair market value of the underlying shares at the date of grant. SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure of pro forma net loss and loss per share had the Company adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The Company's calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions: expected life, 48 months following vesting; stock volatility, 89%, 86% and 50% for grants issued in 1998, 1997 and 1996, respectively; risk-free interest rates, 5.2%, 5.9% and 6.0% in 1998, 1997 and 1996, respectively; and no dividends during the expected term. The Company's calculations are based on a single-option valuation approach, and forfeitures or cancellations are recognized as they occur. If the computed fair values of the 1998, 1997 and 1996 awards had been amortized to expense over the vesting period of the awards, pro forma net loss would have been $(2,381,000), or $(.17) per share, in 1998, $(1,818,000), or $(.13) per share, in 1997 and $(1,846,000), or $(.13) per share, in 1996. F-15 52 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 (Continued) - -------------------------------------------------------------------------------- 9. ACQUISITIONS In January 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, the Internet and intranets. In March 1996, the Company completed its acquisition of Performance Computing Incorporated (PCI), an audio/video software solutions provider. In connection with the acquisition, all of 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 contingent on the achievement of certain milestones. Such amount was accrued as part of the purchase price; all of the milestones were subsequently met and the entire amount was paid during 1997. The Company also incurred direct costs of approximately $111,000 related to the acquisition. The Company obtained an independent valuation of the net assets acquired in the purchase transaction which resulted in the allocation of the purchase price to $1,107,000 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. The acquisition was accounted for using the purchase method of accounting, and PCI's operating results have been included in the accompanying consolidated statements of operations from the date of acquisition. Pro forma unaudited consolidated results of operations for the year ended December 31, 1996 did not differ significantly from reported amounts and therefore are not reflected herein. F-16 53 INDEPENDENT AUDITORS' REPORT To the Stockholders of Smith Micro Software, Inc.: We have audited the consolidated financial statements of Smith Micro Software, Inc. as of December 31, 1998 and 1997 and for each of the three years in the period ended December 31, 1998, and have issued our report thereon dated February 12, 1999, included elsewhere in this Annual Report on Form 10-K. Our audits also included the financial statement schedule listed in Item 14a(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole presents fairly, in all material respects, the information set forth therein. DELOITTE & TOUCHE, LLP Costa Mesa, California February 12, 1999 S-1 54 SMITH MICRO SOFTWARE, INC. AND SUBSIDIARY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1998 - -------------------------------------------------------------------------------- (IN THOUSANDS)
Additions Balance at charged to Balance at beginning of costs and end of period expenses Deductions period ------------ ---------- ---------- ---------- Allowance for doubtful accounts and other adjustments(1): 1998 $1,413 $2,227 $(2,385) $1,255 1997 1,822 2,335 (2,744) 1,413 1996 518 2,756 (1,452) 1,822
- ------------- (1) Other adjustments relate principally to sales returns. S-2 55 EXHIBIT INDEX
Exhibit No. Title Method of Filing - ------- ----- ---------------- 3.1 Amended and Restated Certificate of Incorporated by reference to Exhibit 3.1 to the Incorporation of the Company Registrant's Registration Statement No. 33-95096 3.2 Amended and Restated Bylaws of the Company. Incorporated by reference to Exhibit 3.2 to the Registrant's Registration Statement No. 33-95096 4.1 Specimen certificate representing shares of Incorporated by reference to Exhibit 4.1 to the Common Stock of the Company. 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 to the under 1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096 10.4 Form of 1995 Stock Option Agreement under Incorporated by reference to Exhibit 10.4 to the 1995 Stock Option /Stock Issuance Plan. Registrant's Registration Statement No. 33-95096 10.5 Form of 1995 Stock Purchase Agreement under Incorporated by reference to Exhibit 10.5 to the 1995 Stock Option/Stock Issuance Plan. Registrant's Registration Statement No. 33-95096 10.6 Distribution License Agreement dated Incorporated by reference to Exhibit 10.6 to the September 30, 1991, by and between the Registrant's Registration Statement No. 33-95096 Company and Crandell Development Corporation. 10.7 Application Program Interface Retail License Incorporated by reference to Exhibit 10.7 to the Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096 Company and Rockwell International Corporation. 10.8 Application Program Interface License Incorporated by reference to Exhibit 10.8 to the Agreement July 28, 1992 by and between the Registrant's Registration Statement No. 33-95096 Company and Rockwell International Corporation. 10.9 Rockwell High Speed Interface License Incorporated by reference to Exhibit 10.9 to the Agreement dated June 2, 1994, by and between Registrant's Registration Statement No. 33-95096 the Company and Rockwell International Corporation. 10.10 Letter Agreement dated February 22, 1994, by Incorporated by reference to Exhibit 10.10 to the and between the Company and Rockwell Registrant's Registration Statement No. 33-95096 International Corporation. 10.11 Letter Agreement dated April 22, 1993, by Incorporated by reference to Exhibit 10.11 to the and between the Company and Rockwell Registrant's Registration Statement No. 33-95096 International Corporation. 10.12 Software Distribution Agreement dated May 8, Incorporated by reference to Exhibit 10.12 to the 1995, by and between the Company and Registrant's Registration Statement No. 33-95096 International Business Machines Corporation. 10.13 Office Building Lease, dated June 10, 1992, Incorporated by reference to Exhibit 10.13 to the by and between the Company and Developers Registrant's Registration Statement No. 33-95096 Venture Capital Corporation. 10.14 Amendment No. 1 To Office Building Lease, Incorporated by reference to Exhibit 10.14 to the dated July 9, 1993, by and between the Registrant's Registration Statement No. 33-95096 Company and Pioneer Bank.
56
Exhibit No. Title Method of Filing - ------- ----- ---------------- 10.15 Amendment No. 2 To Office Building Lease, Incorporated by reference to Exhibit 10.15 to the dated August 15, 1994, by and between the Registrant's Registration Statement No. 33-95096 Company and T&C Development. 10.16 Fourth Addendum to Office Building Lease, Incorporated by reference to Exhibit 10.16 to the dated April 21, 1995, by and between Registrant's Registration Statement No. 33-95096 the Company and T&C Development. 10.17 Form of Promissory Note related to S Incorporated by reference to Exhibit 10.17 to the Corporation Distribution. Registrant's Registration Statement No. 33-95096 10.18 Smith Micro Software, Inc. Amended and Incorporated by reference to Exhibit 10.21 to the Restated Software Licensing and Distribution Registrant's Quarterly Report on Form 10-Q for the Agreement, dated April 18, 1996, by and quarter ended September 30, 1996 between the Company and U.S. Robotics Access Corp. 10.19 Office Building Lease, dated March 1, 1994, Incorporated by reference to Exhibit 10.19 to the by and between Performance Computing Registrant's Annual Report on Form 10-K for the Incorporated and Petula Associates, Ltd./KC fiscal year ended December 3l, 1995 Woodside. 10.20 Agreement and Plan of Merger by and between Incorporated by reference to Exhibit 2 to the Smith Micro Software, Inc., Performance Registrant's Current Report on Form 8-K filed with Computing Incorporated and PCI Video the Commission on March 28, 1996 Products, Inc. dated as of March 14, 1996. 10.21 Amendment No. 1, dated as of March 10, 1997, Incorporated by reference to Exhibit 10.21 to the to Agreement and Plan of Merger by and Registrant's Annual Report on Form 10-K for the between Smith Micro Software, Inc., fiscal year ended December 31, 1996 Performance Computing Incorporated and PCI Video Products, Inc. dated as of March 14, 1996. 10.22 Amendment No. 6 to Office Building Lease, Incorporated by reference to Exhibit 10.21 to the dated February 19, 1998, by and between the Registrant's Annual Report on Form 10-K for the Company and World Outreach Center. fiscal year ended December 31, 1997 10.23 Software Licensing and Distribution Filed Herewith. Confidential treatment being sought Agreement dated December 1, 1998, by and with respect to certain portions of this agreement. between the Company and 3Com Corporation Such portions have been omitted from this filing and have been filed separately with the Securities and Exchange Commission. 23.1 Independent Auditors' Consent. Filed Herewith 27 Financial Data Schedule. Filed Herewith
EX-10.23 2 SOFTWARE LICENSING AND DISTRIBUTION AGMT 1 EXHIBIT 10.23 "CONFIDENTIAL TREATMENT HAS BEEN REQUESTED FOR CERTAIN REDACTED PROVISIONS OF THIS AGREEMENT. THE REDACTED PROVISIONS ARE IDENTIFIED BY THREE ASTERISKS AND ENCLOSED BY BRACKETS. THE CONFIDENTIAL PORTION HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION." [SMITHMICRO SOFTWARE LOGO] SOFTWARE LICENSING AND DISTRIBUTION AGREEMENT THIS AGREEMENT, including Appendixes A and B attached hereto (hereinafter, the "Agreement"), is entered into and effective as of December 1, 1998 by and between SMITH MICRO SOFTWARE, INC., a corporation organized and existing under the laws of the State of Delaware, (hereinafter referred to as "SMSI"), and 3Com Corporation, the party specified as "OEM" on Appendix A, hereto (hereinafter referred to as "OEM"). 1. Rights and Licenses Granted to OEM, Services, Term. 1.1 SMSI publishes the software programs listed in Appendix A and documentation and instruction manuals related to the software programs (collectively referred to as the "Licensed Products"). Subject to the terms and conditions of this agreement, SMSI hereby grants OEM a limited, non-exclusive, non-transferable right to copy, have copied,, market, and distribute the Licensed Products to distributors, re-sellers, OEM customers of OEM and end-users, solely when distributed concurrently with the sale of the products listed in Appendix A (hereinafter referred to as the "Hardware") of OEM, its parents, subsidiaries and affiliates, and not as separate, unbundled products except as needed to replace a customer's defective media, or to remedy an error in the Licensed Products that can be resolved by providing customer with an upgrade. 1.2 The term of this Agreement shall be as specified in Appendix A, hereto and shall extend automatically for additional terms of the same length unless either party gives the other party written notice of cancellation at least sixty (60) days prior to the end of the then current term. After the first three months of the initial term of this Agreement, either party may terminate this agreement at any time for convenience by providing 90 days written notice. 2. OEM's Obligations. 2.1 OEM, including its parents, subsidiaries and affiliates, shall include from time to time, the promotional literature furnished by SMSI with respect to other products of SMSI including products which provide enhancement upgrades to the Licensed Products. Such promotional material shall be subject to approval by OEM, which approval shall not be unreasonably withheld. 2.2 OEM may, in its discretion, promote the fact that the Licensed Products are included with Hardware shipped by OEM including references to SMSI and the Licensed Products on product packaging, advertising and promotional literature where reasonable. 1 2 2.3 OEM shall supply SMSI, at no charge to SMSI, within 15 days of execution of this Agreement, a sample of each type of Hardware products which it proposes to ship with the Licensed Products for SMSI's testing and quality control purposes. In the event OEM releases new products or significantly changes the design of any Hardware product with which it ships the Licensed Products, OEM shall supply a sample of such Hardware product, as changed, to SMSI at no charge. Should such design changes require significant software modifications to provide the previously existing functionality, SMSI reserves the right to charge for the reasonable costs of such changes. 2.4 OEM shall establish a registration procedure by which end users of its products may register ownership. OEM shall provide this registration information to SMSI quarterly in ASCII machine readable format. Users will have the option to not be included in this list. 3. SMSI's Obligations. 3.1 SMSI shall use commercially reasonable efforts to assure that the Licensed Products are compatible with the Hardware. 3.2. Improvements. Reasonable improvements in the Licensed Products (which shall mean any minor additions or modifications made by SMSI to or in the Licensed Products at any time) which improve the efficiency and effectiveness of the Licensed Products and which do not change its function(s) shall be furnished from time to time to OEM at no charge. 3.3 Program Changes. If at any time SMSI shall develop any changes in the Licensed Products which change the basic program function(s) of the Licensed Products or add one or more new ones, the sublicensees of OEM shall have the right to obtain such program changes at the standard rate SMSI charges other licensees of the Licensed Products. The determination of whether a change is an improvement or program change shall be in the sole discretion of SMSI. 4. Technical Support. The party specified in Appendix A, hereto shall provide end users who receive copies of the Licensed Products from OEM telephonic advice by knowledgeable personnel on installation, operation and trouble-shooting questions with respect to the Licensed Products ("Technical Support"). Such party shall not refer such callers to the other party. If OEM is designated to provide customer support in Appendix A, OEM shall provide to SMSI the telephone numbers for OEM's Technical Support personnel for the Licensed Products which SMSI may provide to callers who have acquired the Licensed Products through OEM. SMSI shall provide tier 2 support in the operation of the Licensed Products to the customer service staffs of OEM, its subsidiaries and affiliates to assist the customer service staffs in providing Technical Support for the Licensed Products but unless otherwise provided in Appendix A, hereto, SMSI shall not otherwise be obligated to provide Technical Support. 5. Delivery. Except as explained in Appendix A, SMSI has delivered Copy Masters of the Licensed Products and the appropriate End User License Agreement to OEM. 2 3 6. Payment Schedule, Fees and Charges. 6.1 Price. OEM shall pay the prices specified in Appendix A hereto. Within forty-five (45) days after the end of each calender month OEM shall pay SMSI for each copy shipped during the month. OEM shall accompany each monthly payment with a report containing all information reasonably necessary to verify accuracy of the payment for that month. OEM shall pay a late charge of 1.0% for each month or partial month that payment is late, or, if lower, the maximum rate permitted by law. 6.2 Taxes and Duties. The prices stated are exclusive of sales or use taxes, ad valorem taxes, duties, licenses, or levies imposed on the production, storage, sale, transportation or use of the Licensed Products. OEM shall pay all such charges, excepting taxes based on the income of SMSI, either as levied by taxing authorities, or in lieu thereof, OEM shall provide an exemption certificate acceptable to the relevant taxing authorities. 7. Copies of Licensed Products. 7.1 Right to Copy.OEM shall have the right to copy, duplicate or otherwise reproduce, or have copied, duplicated or otherwise reproduced, the Licensed Products for inclusion with OEM's Hardware. 7.2 Right to Audit. OEM shall keep records concerning the shipment of, and all transactions relating to, the sale of the Licensed Products. Such records shall set forth the number of copies of the Licensed Products sold or transferred by OEM. OEM shall allow an independent certified public accountant appointed by SMSI, subject to reasonable approval of OEM, upon ten (10) days written notice, to inspect, audit and analyze all of OEM's records as described in this section, and all of OEM's other books, accounts and shipping records relating to the items licensed hereunder, during normal business hours at OEM's regular place of business. SMSI shall bear the costs of such inspection and audit, unless the audit discloses that additional amounts equal to or greater than 5% during the period being examined are due SMSI, in which case OEM shall pay such additional amounts and reasonable costs of such inspection and audit. SMSI agrees to sign, and have the auditor sign, any reasonable and appropriate confidentiality agreement with respect to such inspection and audit which is submitted by OEM during the term of this Agreement. 8. Limited Warranties. 8.1 SMSI's Warranties. SMSI warrants that during the Warranty Period (as defined below), the Licensed Products furnished hereunder shall be free from material programming errors and from material defects in workmanship and materials. OEM acknowledges that inevitably some errors may exist in the Licensed Software, and the presence of such errors, if not material errors, shall not be a breach of this provision This warranty shall be of no effect should OEM cause the Licensed Products to be modified or used other than as licensed hereunder or as provided in the documentation without the written consent of SMSI. 8.2 SMSI's Fulfillment of Warranty Obligations. If at any time during the 90-day period immediately following the date of delivery of the Licensed Products (the "Warranty Period") SMSI or OEM shall discover one or more material defects or errors in the Licensed Products or any other respect in which the Licensed Products fails to conform to the provisions of any warranty contained in this Agreement, SMSI shall, entirely at its own expense, promptly correct such defect, error or nonconformity by, among other things supplying OEM with corrected versions of the Licensed Products. 8.3 No Warranty Pass-Through. OEM shall not pass through to its customers, end users or any other third party the warranties made by SMSI under this Agreement. OEM shall make no representations to its 3 4 customers, end users or any other third party on behalf of SMSI. No warranty, representation or agreement herein shall be deemed to be made for the benefit of any customer, end user, or licensee of OEM or any other third party. 8.5 LIMITATION OF LIABILITY. THE FOREGOING WARRANTIES ARE IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. SMSI MAKES NO AND SPECIFICALLY DISCLAIMS ALL REPRESENTATIONS GUARANTEES AND WARRANTIES TO ANY PERSON OR ENTITY REGARDING THE USE OR THE RESULTS OF THE USE OF THE LICENSED PRODUCTS. 9. Indemnification 9.1 SMSI agrees to indemnify, defend, and hold OEM harmless from and against any and all actions, suits, claims, liabilities, damages, losses and expenses (including the reasonable fees of attorneys and other professionals and related costs and expenses) arising directly or indirectly out of or in connection with any claim that the Licensed Products violates any patent, trademark, copyright and any other intellectual or industrial property right of third parties, finally awarded in any such claim, suit or proceeding. SMSI shall have no liability for infringement based on (a) use of other than the current release of the Licensed Products, (b) modification of the Licensed Products without SMSI's written consent, (c) the combination or use of the Licensed Products with any other software, equipment, product, device, item or process not furnished by SMSI or not contemplated under this Agreement, if such infringement would have been avoided by the use of the Licensed Products as contemplated herein or alone and in their current unmodified form. (d) OEM's continued infringing activities after being notified thereof or after being informed of modifications that would have avoided the infringement or (e) OEM's use of the licensed product which is incidental to an infringement not resulting primarily from the licensed product. OEM will indemnify SMSI from all damages and liabilities related to a claim excluded from SMSI's indemnity obligation by the previous sentence. 9.2 OEM agrees to indemnify, defend, and hold SMSI harmless from and against any and all actions, suits, claims, liabilities, damages, losses and expenses (including the reasonable fees of attorneys and other professionals and related costs and expenses) arising directly or indirectly out of or in connection with any claim related to the Hardware, the breach by OEM of any warranty or obligation under this Agreement, or any claim that (1) the distribution of the Hardware violates any local, state, or federal law, rule or regulation or violates any patent, trademark, copyright and any other intellectual or industrial property right of third parties, or (2) of property damage or personal injury or death arising from use of the Hardware, and to pay any liabilities, damages, costs and expenses finally awarded in any such claim, suit or proceeding. 9.3 The indemnifying party shall be relieved of the foregoing obligation unless (i) the other party promptly notifies the indemnifying party of any such claim, (ii) the indemnifying party shall have sole control of the defense and all related settlement negotiations, and (iii) the other party provides the indemnifying party with the assistance, information and authority necessary to perform the above. However, if the other party desires to have separate legal representation in any such action, it shall be responsible for the costs and fees related to its separate counsel. In the event a product provided by the indemnifying party is finally held or believed by the indemnifying party to infringe a third party's rights, the indemnifying party, at its option, shall use reasonable efforts to obtain a license under the rights that have been infringed, or to modify the infringing product so it is non-infringing or to provide to the other party substitute products that are non-infringing; provided that if in the indemnifying party's judgment such options are not commercially reasonable, the indemnifying party may terminate the licenses granted to the other party hereunder upon written notice to the other party. 4 5 10. Proprietary Rights, Confidentiality. 10.1 RapidComm Trademark. OEM has marketed the Licensed Products - or their predecessor products - under the trademark RapidComm. SMSI acknowledges that all right, title and interest in and to the RapidComm mark resides in OEM, and hereby agrees that OEM may continue to market the Licensed Products under the RapidComm mark during the term of this Agreement. 10.2 Ownership. Except as set forth in Section 10.1 above, OEM agrees that the Licensed Products provided hereunder, and any copies thereof, in whole or in part, and all intellectual property rights, including without limitation, patent, copyright, trademark, trade secret, and any other intellectual or industrial property rights, are and shall remain the sole property of SMSI, and that all rights thereto are reserved by SMSI. OEM agrees that it will not create derivatives of such Licensed Products, nor use, copy, disclose, sell, assign, sublicense, or otherwise transfer the Licensed Products except as expressly provided in this License Agreement. OEM is prohibited from the disassembly or decompilation of the object code or the disclosure of any other aspect of the workings of the Licensed Products without the written consent of SMSI. 10.3 Trademarks. Unless otherwise agreed by the parties in writing, OEM shall use SMSI's trademarks only for purposes of advertisement, promotion, and licensing of the corresponding Licensed Products and for no other purposes. OEM shall use such trademarks in accordance with the guidelines established by SMSI from time to time. OEM shall not use any of SMSI's trademarks, service marks, logos, or slogans in any manner likely to confuse, mislead, or deceive the public, or to in any way that is injurious to the SMSI's reputation. In the event OEM is permitted under this agreement to make copies of the Licensed Products, OEM shall include copyright notices on any and all copies of Licensed Products. Licensed Products shall always be known by the names set forth in Appendix A attached hereto, or as otherwise agreed by the parties. OEM shall restrict its sub-licensees of the Licensed Products similarly. SMSI may audit OEM's use of SMSI's trademarks upon request. Should SMSI decide to register any or all of its trademarks, OEM shall cooperate in all registration applications, renewals and other procedures with the applicable trademark authorities. Likewise, SMSI shall provide similar cooperation in OEM's efforts to register and protect the RapidComm mark. 10.4 Confidentiality. 10.4.1 "Confidential Information" shall mean all information that is not generally known to the public and in which a party has rights of any kind, including, but not limited to, proprietary technology, trade secrets, know-how, inventions (whether or not patentable), ideas, improvements, works of authorship, derivative works, modifications, product development plans, forecasts, strategies, names and expertise of employees and consultants, techniques, processes, algorithms, schematics, software programs, designs, together with all other business and technical information that a party discloses to the other party, and such other information as is deemed confidential by the disclosing party and identified as such at the time of disclosure, or which, under the circumstances surrounding the disclosure to the other party, ought reasonably to be treated as confidential. Information shall not be deemed "Confidential Information" for the purposes of this Agreement that (i) is already known to the non-disclosing party at the time of disclosure; (ii) is or becomes publicly known through no wrongful act of the non-disclosing party, including by public announcement by the disclosing party; (iii) is received from a third party without similar restrictions and without breach of this Agreement; (iv) is independently developed by the non-disclosing party; or (v) is lawfully required to be disclosed by any governmental agency or otherwise required to be disclosed by law. 10.4.2 Each party shall hold in trust and confidence and shall not disclose any Confidential Information of the other party during the term of this Agreement, and for a period of three (3) years following termination of this Agreement other than its own employees who have a need to know and are bound in writing 5 6 under an appropriate confidentiality agreement. In so doing, such party shall use the same degree of care, but no less than a reasonable degree of care, as such party uses to protect its own confidential information of a like nature. 11. Termination. 11.1 Default. Each party has the right to terminate this Agreement for the following reasons or causes: 11.1.1 In the case of a breach of Section 10 (Proprietary Information, Confidentiality) termination shall be effective, upon ten (10) days written notice; 11.1.2 For defaults in payment of money, if such other party materially breaches or is in material default of any obligation hereunder, which breach or default which has not been cured within thirty (30) days after service of written notice of default of the non-breaching party; 11.1.3 In the event that OEM fails to maintain a satisfactory credit rating or financial condition or if SMSI reasonably concludes that, for any reason, OEM is or will become unable to discharge its obligations hereunder, SMSI may immediately suspend shipment of the Licensed Software and may terminate this Agreement upon thirty (30) days written notice. Alternatively, and without waiving its termination rights hereunder, if SMSI deems that OEM has failed to maintain a satisfactory credit rating or financial condition, SMSI may require that shipments be paid for in advance or that payment be secured by letter of credit or other form of security acceptable to SMSI in its absolute discretion. 11.1.4 If a party becomes insolvent, is adjudicated bankrupt or if a receiver or trustee is appointed for a party for a substantial portion of its assets, or if a party institutes or becomes a party to any proceeding for the settlement of debts or an assignment for the benefit of creditors of such party, and the situation is not corrected within thirty (30) days after it received written notice from the non-defaulting party. 11.2 Conditions Upon Termination. The following conditions shall apply upon termination: 11.2.1 OEM shall discontinue all use of the Licensed Products and any copies thereof and, upon the written instruction of SMSI, shall deliver to SMSI, or destroy, at SMSI's option, all previously delivered copies of the Licensed Products and related materials furnished by SMSI and any copies thereof in the possession of or under control of OEM. Notwithstanding the above, OEM shall have the right to ship any Licensed Product previously copied and bundled with the OEM's hardware for a period of ninety (90) days. 11.2.2 OEM shall also erase or destroy all Licensed Products or copies or portions thereof contained or stored in any form or media, including the memory of a computer or computer system in its possession or under its control except as used to provide tier 1 customer support. 11.2.3 OEM shall certify to SMSI that the requirements of Sections 11.2.1 and 11.2.2 have been completed within fifteen (15) days of termination. 11.3 Addition to Other Rights. The termination rights set forth above shall be in addition to, and not in substitution for, any other remedies that may be available to the party serving notice upon the other party, and any termination and any exercise of any such right shall not relieve the party receiving notice from any obligations accrued to the date of such termination or relieve such party from liability and damage to the other for breach of this Agreement. No termination hereunder shall terminate any end user license. 6 7 11.4 The termination of this Agreement shall not in any way affect OEM's rights under any end user licenses for the Licensed Products heretofore or hereafter acquired by OEM other than the pursuant to this Agreement. 12. Miscellaneous. 12.1 U.S. Government contracts. Any Licensed Products which OEM distributes or licenses to or on behalf of the United States of America, its agencies and/or instrumentalities (the "U.S. Government") are provided to OEM with RESTRICTED RIGHTS. Use, duplication, or disclosure by the U.S. Government is subject to restrictions as set forth in subparagraph (cX1)(ii) of the Rights in Technical Data and Computer Software clause at 48 C.F.R. 252.227-7013 or in subparagraphs (c)(1) and (2) of the Commercial Computer Software-Restricted Rights clause at 48 C.F.R. 52.227-19, as applicable. The Contractor/Manufacturer is: Smith Micro Software, Inc. 51 Columbia, Aliso Viejo, California 92656. OEM shall comply with any requirements of the U.S. Government to obtain such RESTRICTED RIGHTS protection, including without limitation, the placement of any restrictive legends on the Licensed Products and any license agreement used in connection with the distribution of the Licensed Products. Under no circumstances shall SMSI be obligated to comply with any U.S. Governmental requirements regarding the submission of or the request for exemption for submission of cost or pricing data or cost accounting requirements. For any distribution or license of the Licensed Products that would require compliance by SMSI with U.S. Governmental requirements relating to cost or pricing data or cost accounting requirements, OEM must obtain an appropriate waiver or exemption from such requirements for the benefit of SMSI from the appropriate U.S. Governmental authority before the distribution and/or license of the Licensed Products to the U.S. Government. Use, duplication, or disclosure by the U.S. Government is subject to restrictions as set forth in this Agreement. OEM shall procure U.S. Government waiver of any intellectual property rights in or relating to Licensed Products. 12.2 Export. OEM will not, directly or indirectly, export or transmit the Licensed Products, to any country to which such export or transmission is restricted by regulation or statute, without the prior written consent, if required, of the Office of Export Administration of the U.S. Department of Commerce, or such other governmental entity as may have jurisdiction over such export or transmission. 12.3 Independent Contractors. The parties are not employees or legal representatives of the other party for any purpose. Neither party shall have the authority to enter into any contracts in the name of or on behalf of the other party. 12.4 Intentionally omitted. 12.5 Injunction. With respect to any breach of any agreement or covenant contained in this Agreement, including without limitation, any agreement not to use, disclose, copy, or distribute the Licensed Products or regarding SMSI's confidential information and trade secrets, OEM agrees that SMSI will be entitled to seek injunctive relief. OEM agrees and recognizes that SMSI may suffer immediate and irreparable harm and money damages may not be adequate to compensate SMSI or protect and preserve the status quo. 12.6 Survival. The obligations of Section 6 (Payment Schedule, Fees and Charges), Section 8.5 (Limitation of Liability), Section 8.6 (Consequential Damages), Section 9 (Indemnification), Section 10 (Proprietary Rights, Confidentiality), Section 11 (Termination), and Section 12.4 (Injunction) shall survive termination of any license hereunder. 12.7 Force Majeure. Neither party hereto shall be liable for the failure to perform of any of its obligations under this Agreement, except an obligation to pay, if such failure is caused by the occurrence of any force Majeure beyond the reasonable control of such party, including without limitation fire, flood, strikes and other industrial disturbances, failure of transport, accidents, wars, riots, insurrections or acts of God. If the period of 7 8 nonperformance exceeds thirty (30) days from the Force Majeure Event, the party whose ability to perform has not been so affected may by giving written notice terminate this Agreement. 12.8 CONSEQUENTIAL DAMAGES. IN NO EVENT SHALL EITHER OF THE PARTIES HERETO BE LIABLE TO THE OTHER FOR THE PAYMENT OF ANY INDIRECT, SPECIAL OR CONSEQUENTIAL DAMAGES, INCLUDING LOSS OF PROFITS, REVENUE, DATA, OR USE, COST OF PROCUREMENT OF SUBSTITUTE GOODS, SERVICES OR TECHNOLOGY INCURRED BY EITHER PARTY OR ANY THIRD PARTY, WHETHER IN AN ACTION IN CONTRACT OR TORT OR BASED ON A WARRANTY, EVEN IF THE OTHER PARTY OR ANY OTHER PERSON HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. THE REMEDIES PROVIDED FOR HEREIN EMBODY THE ESSENTIAL PURPOSE OF THE PARTIES HERETO WITH RESPECT TO REMEDIAL ACTION IN THE EVENT OF BREACH OF THIS AGREEMENT. 12.9 Applicable Law. This Agreement shall be governed by the laws of the State of California including its Uniform Commercial Code, without reference to conflict of laws principles. The sole jurisdiction and Venue for any action with respect to this Agreement shall be in Santa Clara County, California. 12.10 Notices. Any notice or other communication hereunder shall be in writing and deemed given if personally delivered or sent to a party by commercial overnight delivery or registered or certified mail, return receipt requested or, first class mail (air mail if served from outside the United States) to SMSI at: Smith Micro Software, Inc. 51 Columbia Aliso Viejo, CA 92656 Attn.: Mr. Mark W. Nelson Telephone (949) 362-5800 Fax (949) 362-2300 and to OEM at the address specified in Appendix A, hereto with a copy to: General Counsel 3Com Corporation 5400 Bayfront Plaza Santa Clara, CA 95092 Fax (408) 326-6434 Notices delivered personally, by overnight delivery or by registered or certified mail shall be deemed communicated as of actual receipt; notices sent by first class mail shall be deemed communicated as of three (3) days after mailing. Each party may change such party's address by written notice in accordance with this section. 12.11 Waiver. No term or provision hereof shall be deemed waived and no breach excused unless such waiver or consent shall be in writing and signed by the party claimed to have waived or consented. 12.12 Assignment. OEM shall not assign or subcontract all or any part of this Agreement, or any interest therein, without SMSI's prior written consent, except that OEM may assign to any corporate affiliate without SMSI's consent provided that OEM remains the guarantor of all of its obligations under this Agreement. 12.13 Binding Effects; Benefits. This Agreement shall inure to the benefit of, and shall be binding upon, the parties hereto and their respective successors and assigns. Nothing herein is intended to confer on any 8 9 person other than the parties hereto or their respective successors and assigns any rights, remedies, obligations or liabilities under, or by reason of, this Agreement. 12.14 Attorney's Fees. In the event of any controversy, claim or dispute between the parties hereto arising out of or relating to this Agreement, the prevailing party shall be entitled to recovery from the non-prevailing party its reasonable expenses including, but not by way of limitation, attorneys' fees. 12.15 Severability; Partial Invalidity. If any provision of this Agreement shall be declared invalid, void or unenforceable by a court of competent jurisdiction, such provision shall be ineffective only to the extent of such prohibition or invalidity without invalidating the remainder of such provision or any remaining provisions of this Agreement. 12.16 Captions; Headings. The headings of articles, sections and other subdivisions hereof are inserted only for the purpose of convenient reference and it is recognized that they may not adequately or accurately describe the contents of the sections which they head. Such headings shall not be deemed to govern, limit, modify, or in any other manner affect the scope, meaning or intent of the provisions of this Agreement or any part or portion thereof, nor shall they otherwise be given any legal effect. 12.17 Entire Agreement. This Agreement, together with all appendices or other attachments referenced herein, constitutes the entire agreement between SMSI and OEM and supersedes all proposals, oral and written, between the parties on this subject. No changes or modifications to this agreement or waivers of any provisions of this agreement shall be effective unless made in writing and signed by both parties. 12.18 Counterparts. This Agreement may be executed in counterparts, which together shall constitute the contract of the parties. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed at Aliso Viejo, California and each hereby warrants and represents that its representative whose signature appears below has been and is on the date of this Agreement duly authorized by all necessary and appropriate corporate action to execute this Agreement. SMITH MICRO SOFTWARE, INC. By: /s/William W. Smith Jr.__________________________ Title: President/CEO_________________________________ Date: 12/15/98_______________________________________ 3COM CORPORATION By: /s/Jerry Devlin__________________________________ Title: V.P. and G.M._________________________________ Date: 12/15/98_______________________________________ 9 10 [***] Confidential treatment has been requested for the bracketed portions. The confidential redacted portion has been omitted and filed separately with the Securities and Exchange Commission. SOFTWARE LICENSING AND DISTRIBUTION AGREEMENT APPENDIX A Name of OEM: 3Com Corporation, Client Access Business Unit (CABU). Address of OEM: 3Com Corporation Phone: 847-262-5000 3800 Golf Rd. Rolling Meadows, IL. 60008 Fax: 847-262-0142 1. OEM is a [corporation] organized and existing under the laws of the State of Delaware. 2. Term of Agreement 1 year(s) commencing December 1, 1998. 3. Licensed Products:
Product Name(s): Version: ------------------------------------------------------------------------------- a. RapidComm for Win.95/98/NT 2.0 b. RapidComm Voice for Win.95/98/NT 2.0 c. Combined RapidComm/RapidComm Voice for Win.95/98/NT 2.0 d. RapidComm for Win.3.x/95/98/NT 1.3.2 L, P e. RapidComm Voice for Win.3.x/95/98/NT 1.3.2 L, P f. RapidComm Mac 2.0 g. RapidComm Voice Mac 2.0 Any other current versions shipped by 3Com
4. OEM's Hardware: a. Any OEM hardware 5. The Price per license shall be $[***] per copy. No royalties or other charges shall be due or payable by OEM hereunder. 6. Technical Support: Technical Support shall be provided by 3Com Corporation. 10 11 [***] Confidential treatment has been requested for the bracketed portions. The confidential redacted portion has been omitted and filed separately with the Securities and Exchange Commission. 7. SMSI deliver to 3Com a gold master of RapidComm/RapidComm Voice 2.0 no later than November 30, 1998. 7.1 In the event that SMSI fails to deliver such gold master to 3Com on or before January 31, 1999, the royalty to be paid by 3Com for all copies of RapidComm 1.3.2L/P and/or RapidComm 2.0 shipped during the month of January, 1999 shall be $[***] per copy until such time as gold master is delivered. Approval will not be unreasonably withheld. 8. RapidComm 2.0 shall contain the following features: [***] 9. RapidComm 2.x additional feature requests. [***] 11 12 9. Future development work. SMSI may perform additional development work ("Future Projects") for additional features for RapidComm 2.0. The parties shall mutually agree as to the timetable and costs associated for the Future Projects from time to time. 10. Translations and Localizations. SMSI shall translate and localize at no cost to OEM, RapidComm 2.0 and its Quick Start Guide for Windows 95/98, Windows NT and Mac for the following languages: Windows: a. Spanish b. Portuguese c. French d. Japanese e. Korean f. Simplified Chinese g. Italian h. German i. Swedish j. Dutch k. Cyrillic/Russian l. U.K /International English Mac: a. French b. Spanish c. U.K./International English 11. 3Com shall commit to volumes and regions for translations requested in addition to the languages specified above or will pay a reasonable translation fee per language for those not listed in section 10. above. 12 13 APPENDIX B [SMITHMICRO SOFTWARE LOGO] MASTER RELEASE AUTHORIZATION Smith Micro Software, Inc. has supplied the below referenced product master to you so that you can test it and let us know if it is acceptable. Please test this master carefully since we will consider your approval as an acceptance of all products duplicated from this master. Once signed, please fax this form back to Smith Micro Software at (714) 362-2300 so we may insure that our latest version of software is available for your customers. No fax cover page is necessary. Thank you. DUPLICATION AND SHIPMENT OF THE PRODUCT MASTER(S) MAY BE DELAYED IF NO AUTHORIZATION IS RECEIVED. Master is satisfactory: [ ] YES [ ] NO Comments: Master has been approved by:__________________________ _______________ Signature Date Company: _____________________________________________ SMSI Engineering Manager: __________________________ _______________ Signature Date SMSI Account Representative:__________________________ _______________ Signature Date ________________________________________________________________________________ Tested with all hardware and software that is to be shipped with the following build? Identification: __________________________________ ________________ Model Version SMSI Quality Control: __________________________ ________________ Signature Date ________________________________________________________________________________ BUILD INFORMATION Product Date: Product No.: Version: Volume Label: Directory: 13 EX-23.1 3 INDEPENDENT AUDITORS' CONSENT 1 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-02418 of Smith Micro Software, Inc. on Form S-8 of our reports dated February 12, 1999, appearing in this Annual Report on Form 10-K of Smith Micro Software, Inc. for the year ended December 31, 1998. DELOITTE & TOUCHE LLP Costa Mesa, California March 29, 1999 EX-27 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 12,699 0 4,093 1,255 629 19,245 350 1,069 20,803 2,558 0 0 0 14 21,250 20,803 9,547 9,547 2,898 2,898 10,484 0 0 (3,110) (1,112) (1,998) 0 0 0 (1,998) (0.14) (0.14)
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