Dear Fellow Shareholders,
Inside you will find the 2006 Annual Report for Smith Micro Software,
Inc. (Nasdaq:SMSI). The fiscal year 2006 was truly a milestone year for Smith
Micro, one in which we not only achieved record revenues and earnings, but
also successfully positioned the Company to maximize its leadership position as
the premier wireless software company in the marketplace today. We began the
year with several key strategic objectives, and I am extremely pleased to
announce that we exceeded expectations across the board.
During 2006 we saw record results for the third year in a row, with annual revenue
increasing 169% to $54.5 million, which compared to the $20.3 million reported in 2005. Pro
forma net income increased 219% to a record $17.5 million, or $0.69 on 25.3 million shares.
This compared to $5.5 million or $0.24 per share on 22.8 million shares in 2005.
We also strengthened our balance sheet significantly by completing a successful
secondary offering to the marketplace in December. The net proceeds from the offering to the
Company were $60.5 million, which includes additional proceeds of $5.5 million from the
“Green Shoe” closing in January of this year. As a result, we ended 2006 with a substantial cash
balance of $93 million, which will enable us to continue execution on our aggressive growth
strategy and pursue both acquisitive and organic opportunities for expansion.
Our M&A strategy remained active throughout the year, and we are continuing that trend
in 2007. In March of 2006 we closed our acquisition of PhoTags, which enabled us to expand
our product offerings to include cutting-edge multimedia solutions for wireless carriers and
handset manufacturers. In February of 2007, we closed the acquisition of Ecutel Systems, Inc.,
broadening our product footprint into the connectivity and security sector. And, more recently,
we acquired the assets of Insignia Solutions plc which not only provides significant cross-selling
opportunities for us in the device management space, but delivers on our commitments to
broaden our capabilities for our customers and to provide strong returns for our shareholders.
Due to the acquisitions and overall growth of our core business model, we realigned our
business into four operating units within the Company, each being managed by a General
Manager and Vice President in charge with each reporting directly to me.
The four operating segments are Connectivity & Security, Multimedia, Mobile Device
Management and Compression & Consumer.
Connectivity & Security
Our Connectivity & Security operating segment showed very strong
results for the year. We see our flagship product, Quicklink Mobile, remaining on
the upswing of the sales curve, as this solution becomes more and more
adaptable. We expect this growth trend to continue throughout 2007 as the
CMDA carriers begin to roll out their new EVDO REV-A service and as GSM
carriers deploy HSDPA. Our acquisition of Ecutel was in line with our continued
strategy of expanding product offerings. The strength lies in the seamless network
roaming and session persistence with IP Roam providing the mobile user with
always connected secure wireless access. The Ecutel acquisition also brings to us several large
customers including Siemens, Baylor Medical, and several government agencies to name a few
that we can now begin to cross sell with our other connectivity solutions. We also acquired
additional R&D and sales teams to further penetrate this infant market.
Multimedia
Our Multimedia Operations was by far the fastest growing segment of
the Company in 2006. The launch of the QuickLink Music solution has been a
smashing success, and I believe we have only tapped the surface of the
multimedia market. This technology came to Smith Micro from the
acquisition of Photags. To date, we have announced four wireless carriers,
including Verizon Wireless, currently our largest customer. Just recently we
signed Sprint, IUSACELL in Mexico. We anticipate we will continue to see
strong sales during fiscal 2007, as well as the addition of other multimedia
capabilities, including still images, videos, ring tones, and basically everything else managed on
the handset. During fiscal 2007, we expect to see a significant increase in our international
presence. We now have a stronger sales force on the street in both the Europe and Asia Pacific
regions, which have already begun to open up new opportunities that we haven’t had in the past.
Mobile Device Management
Our Mobile Device Management Operations, which is a direct result of
the recent acquisition of the assets of Insignia Solutions plc, is a new operation
for Smith Micro. Insignia was a true pioneer in mobile device management and a
key provider of infrastructure software to mobile operators and device
manufacturers around the world. The synergies with Smith Micro are very
extensive, taking device management to the next level. The Insignia technology
brings the ability to manage the device directly over the wireless infrastructure
and providing handset technology updates over-the-air, provide significant cost
savings to the carrier and gives the end-user a better overall experience.
The added functionality opens up multiple new doors for Smith Micro. Insignia had
several flagship customers, into which we can begin to sell other Smith Micro solutions. Insignia
adds significant European and Asia Pacific regional sales teams that will tie in nicely with our
existing sales force to better cross sell all Smith Micro offerings. I believe that Smith Micro’s
strong backing and available resources will enable us to leverage the Insignia technology and
successfully target and secure large carriers and handset manufacturers.
Compression & Consumer
Looking at our Compression & Consumer operations, we reached
significant milestones during 2006. Our Research and Development teams have
integrated our technologies to offer a strong compression solution to the handset
manufacturers and the wireless carriers. Our Compression & Consumer unit
continued a strong, profitable cash flow business during 2006. We announced
several new product launches during 2006. Looking to 2007, I believe that as
more and more smart devices enter the marketplace, there will be increased
demand for future consumer applications, expanding this market opportunity for
us.
Throughout 2006 we continued our discussions with several large handset manufactures
that would design our StuffIt Wireless compression solution into capable mobile handsets. We
recently announced our first joint development project with Kyocera Wireless for resource file
compression on their mobile devices. The work will continue throughout 2007 with the
anticipation of the first units being shipped in 2008. I was also pleased that we were recently
awarded an important patent for our technology within the compression space, creating a strong
barrier to entry for potential competitors.
Summation
Overall, 2006 was a banner year for Smith Micro: we added several new technologies
through key strategic acquisitions as well as our own successful efforts in R&D; we enhanced
and broadened our customer base with significant new additions; and, most importantly, we
continued to show record revenue and earnings growth. As we look ahead to 2007, we are well
positioned to capitalize on the many opportunities for continued growth in each of our core
business segments, and are very optimistic about our prospects for 2007 and beyond. I invite you
to examine the enclosed Form 10-K for a detailed analysis of our performance in 2006, and visit
our website at http://www.smithmicro.com for a complete description of all of products. Our
highest priority remains to increase profitability and enhance shareholder value, and I look
forward to updating you on our progress in our quarterly reports throughout the year.
I wish to thank our shareholders, our customers and our employees for another successful
year and continued support.
William W. Smith, Jr.
Chairman of the Board
President and Chief Executive Officer
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, 2006
[ ]
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
(State or other jurisdiction of incorporation or organization)
33-0029027
(I.R.S. Employer Identification Number)
51 Columbia, Suite 200, Aliso Viejo, CA
(Address of principal executive offices)
92656
(Zip Code)
Registrant's telephone number, including area code: (949) 362-5800
Common Stock, $.001 par value
(Title of each class)
The NASDAQ Stock Market LLC
(NASDAQ Global Market)
(Name of each exchange on which registered)
_____________________
Securities registered pursuant to Section 12(b) of the Act: Common Stock, $.001 par value
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as define d in Rule 405 of the Securities Act.
YES[ ] NO [ X ]
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13
or 15(d) of the Securities Exchange Act of 1934 YES [ ] NO [X ]
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 [ ].
Indicate by check mark if whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [X ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES[ ] NO [ X ]
As of June 30, 2006, the last business day of the registrant’s most recently completed second quarter, the aggregate market value of
the common stock of the registrant held by non-affiliates was $338,847,447 based upon the closing sale price of such stock as reported on the
Nasdaq Global Market on that date. For purposes of such calculation, only executive officers, board members, and beneficial owners of more
than 10% of the registrant’s outstanding common stock are deemed to be affiliates.
As of March 6, 2007, there were 29,366,277 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2007 Annual Meeting of Stockholders to be filed under the Securities Exchange
Act of 1934 are incorporated by reference in Part III of this report.
SMITH MICRO SOFTWARE, INC.
2006 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Item 1.
PART I
BUSINESS ...............................................................................................................................
Item 1A
RISK FACTORS ......................................................................................................................
Item 1B
UNRESOLVED STAFF COMMENTS ...................................................................................
Item 2.
PROPERTIES...........................................................................................................................
Item 3.
LEGAL PROCEEDINGS.........................................................................................................
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS ..............................
PART II
Item 5.
MARKET FOR REGISTRANT'S COMMON EQUITY RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASERS OF EQUITY SECURITIES................................
Item 6.
SELECTED CONSOLIDATED FINANCIAL DATA ............................................................
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS .................................................................................................
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK…….
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .........................................
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE ..............................................................
Item 9A. CONTROLS AND PROCEDURES.........................................................................................
Item 9B. OTHER INFORMATION ........................................................................................................
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE .........
Item 11.
EXECUTIVE COMPENSATION............................................................................................
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS………………………………………………
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Page
4
11
20
20
20
20
21
24
25
34
34
36
36
37
38
39
40
40
Item 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES…………………………………………..
40
Item 15.
PART IV
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES................................................
SIGNATURES………………………………………………………………………………….
41
44
_________________________
5
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
In this document, the terms “Smith Micro,” “Company,” “we,” “us,” and “our” refer to Smith Micro
Software, Inc. and its subsidiaries.
This report contains forward-looking statements regarding Smith Micro which include, but are not limited to,
statements concerning projected revenues, expenses, gross profit and income, the competitive factors affecting our
business, market acceptance of products, customer concentration, the success and timing of new product introductions
and the protection of our intellectual property. These forward-looking statements are based on our current
expectations, estimates and projections about our industry, management's beliefs, and certain assumptions made by us.
Words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “potential,” “believes,” “seeks,”
“estimates,” “should,” “may,” “will” and variations of these words or similar expressions are intended to identify
forward-looking statements. Forward-looking statements also include the assumptions underlying or relating to any of
the foregoing statements. These statements are not guarantees of future performance and are subject to risks,
uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and
adversely from those expressed in any forward-looking statements as a result of various factors. Such factors include,
but are not limited to the following:
•
•
•
•
•
•
•
our ability to predict consumer needs, introduce new products, gain broad market acceptance for
such products and ramp up manufacturing in a timely manner;
the intensity of the competition and our ability to successfully compete;
the pace at which the market for new products develop;
the response of competitors, many of whom are bigger and better financed than us;
our ability to successfully execute our business plan and control costs and expenses;
our ability to protect our intellectual property and our ability to not infringe on the rights of others;
and
those additional factors which are listed under the section “1A. Risk Factors” beginning on page 13
of this report.
All forward looking statements included in this document are based on information available to us on the date
hereof. We do not undertake any obligation to revise or update publicly any forward-looking statements for any
reason.
6
PART I
Item 1.
BUSINESS
General
Smith Micro Software, Inc. is a diversified developer and marketer of wireless communications software
products and services. Our primary focus and strategy for our products and services is directed to wireless
communications, including wireless wide area network (WWAN) & Wi-Fi software, personal handset information
management, managing mobile content to a handset, and mobile image management, wireless compression and
device management solutions. We sell our products and services to many of the world's leading companies as well
as to consumers. Specific Smith Micro wireless products include QuickLink Mobile, QuickLink Mobile Enterprise
and QuickLink PhoneManager, QuickLink Music, QuickLink Media and StuffIt Wireless. The proliferation of
wireless technologies is providing new opportunities globally. The wireless infrastructures being implemented, such
as the newer 3G technologies including EVDO, UMTS and HSDPA, offer wider bandwidth wireless data services.
This infrastructure combined with mobile platforms such as the basic mobile phone, notebook computing devices
(“PCs”), smart phone devices (“PDAs”), and new ultralight PCs provide opportunities for new communications
software products. Our core communications technology is designed to address this emerging wireless data market.
We manufacture, market and sell value-added wireless connectivity products targeted to the original
equipment manufacturers (“OEM”) market, particularly wireless service providers, mobile device manufacturers,
hardware manufacturers and corporations. We offer software products for Windows, Mac, Unix, Linux and
Windows Mobility operating systems. The underlying design concept is the long-standing Smith Micro purpose to
"enhance the out-of-box experience" for the customer. Our custom engineering services bring more than 20 years of
hardware and software experience, having shipped over 60 million copies of our QuickLink products to OEM's
worldwide.
QuickLink Mobile provides mobile users with a laptop the ability to easily connect between wireless wide
area networks (“WWAN”) and Wi-Fi hot spots. We currently maintain OEM relationships with many wireless
carrier companies, including Verizon Wireless, Vodafone, Telus Mobility, Alltel and CellularOne. In addition, we
have strong relationships with leading device manufactures include UTStarcom, LG Electronics, Novatell and
Kyocera and hardware manufacturers such as HP and Siemens.
Sales to Verizon Wireless amounted to approximately 74.4%, 57.1% and 68.4% of the Company’s net
revenues for 2006, 2005 and 2004, respectively.
Our operations are organized among three business units, Wireless and OEM, Consumer and Enterprise.
In the fourth quarter of 2005, we launched a new music product, the Music Essentials Kit for Verizon
Wireless V CAST music service. Following the success of this product, in 2006 Smith Micro developed the Music
Essentials Manager product that allows users to “dual” download music from the Verizon Wireless Music Store
direct to both the mobile handset and the PC. In addition, the application provides new capabilities, such as music
file management and music transfer capability between the PC and the mobile handset. This product first shipped in
our fourth quarter of 2006 and is expected to be a significant contributor to 2007 revenues. Verizon Wireless’ V
CAST Music Essentials Manager is powered by the core QuickLink Music product.
A continuing initiative for our Wireless and OEM Group is StuffIt Wireless. StuffIt Wireless incorporates
our patented JPEG compression technology that provides superior compression of multi-media data. This
technology focuses on delivering image and resource compression for device manufacturers in order to increase
storage space on the handset. By compressing phone resources we free up handset memory that can be allocated to
store, more images, music or video files on the device in an economic manner. We are currently in the prototype
stage of product development with potential customers and plan to fully market this product in 2007.
7
Our Enterprise Solutions Group delivers wireless mobility solutions to medium and large enterprise
businesses. QuickLink Mobile Enterprise has been developed for the enterprise marketplace that rely on multi-
wireless carrier networks and require enhanced security when connecting wirelessly to their corporate resources or
the Internet.. This product was introduced in the second quarter of 2005. In addition to addressing the need for
robust security, QuickLink Mobile Enterprise is a combination wireless wide area network (WWAN) and secure
Wi-Fi client application that provides the same easy to use interface and functionality regardless of carrier or device
specified. The application supports over 180 carriers worldwide, hundreds of wireless devices and PDA’s, many
different PC Cards, and several integrated WWAN devices in notebooks.
Supporting our wireless mobility business direction is our Professional Services Group. This area of
business development leverages our many years of providing custom-tooled web-based applications to support
growing businesses. From basic web design to complex solutions involving complete customer management, online
commerce and fulfillment services, the Professional Services Group helps businesses refine their processes and
implement cost-effective, empowering web systems.
The Consumer Products Group offers products in the PC Utility, and eBusiness markets. Smith Micro's
complete line of consumer products is available through direct sales on its websites, partner websites, direct through
customer service order desk and through traditional retail outlets. The Consumer Group is focused on the following
market segments: Compression, Access and Transmission (CAT), and Utilities, including Diagnosis, Performance,
Security and Internet and Compilation and Lifestyle.
The Consumer Products Group lead product line is StuffIt, which is driven by a patented, revolutionary
JPEG compression technology. StuffIt provides superior compression, encryption and archive capability. This
breakthrough technology can compress JPEG photos and images up to 30% without loss of image quality.
New for 2006 is Smith Micro’s pioneering product suite known as Active Images. Active Images turns any
JPEG file into a self-contained multimedia messaging system. Users can send text messages, music, sound files,
documents and more - all in a single JPEG file. Watermarks, forms, text messages, music, links to Internet sites,
voice recordings, portable digital wallet information, and even videos can all be stored in a JPEG image, and
accessed on any device that has the Active Image thin client application installed. This technology plays directly
into Smith Micro's strategy of broadening its wireless product offerings and provides carriers and handset
manufacturers enhanced music and photo management technology products. Our Active Images patented
technology is used in several of our new product offerings including our photo management products which are
bundled with camera manufactures, and sold through leading retail distribution. Another new Active Images
application is our Mobile Sweepstakes product, which creates a “digital scratch card” that can be sent to a mobile
phone via MMS or to a PC via email. This new product is currently prototyped and is being used in test markets in
Asia.
We currently operate in two business segments: Products and Professional Services. We do not separately
allocate operating expenses to these segments, nor do we allocate specific assets to these segments. Therefore,
segment information reported includes only revenues and cost of revenues. See Note 9 of Notes to Consolidated
Financial Statements for financial information related to our operating segments.
Smith Micro is actively involved and maintains industry affiliations with leading groups such as Wi-Fi
Alliance, OMA, GSM and CTIA to help develop industry standards and help drive the proliferation of various
wireless technologies.
Research and development expenses amounted to $7.9 million, $4.0 million and $2.6 million for the years
ended December 31, 2006, 2005 and 2004, respectively. Our research and development expenses consist primarily
of personnel and equipment costs required to conduct our software development efforts. We remain focused on the
development and expansion of our technology, particularly our wireless, diagnostic, utility and Internet software
technologies.
We were incorporated in California in November 1983, and we reincorporated in Delaware in June 1995.
Our principal executive offices are located at 51 Columbia, Suite 200, Aliso Viejo, California 92656. Our telephone
number is (949) 362-5800. Our website address is www.smithmicro.com. We make our filings with the SEC
available on the Investor Relations page of our website. Information contained on our website is not part of this
Annual Report on Form 10-K.
8
Industry Background
Smith Micro offers products in the following technology and communication-related markets:
Wireless - To help drive revenue growth and profitability, wireless carriers have introduced new value-
added products and services that coincide with a number of key enabling trends. Namely, traditional mobile devices
are being replaced with multimedia-enabled devices, carriers are deploying wireless broadband network
infrastructures and consumers are increasingly adopting mobile data and multimedia services. As carriers seek to
enhance their competitive position, they have increasingly focused on network expansion, customer acquisition and
customer service. This creates opportunities for software providers, such as Smith Micro, as carriers increase the use
of third-party applications, services and custom solutions. These industry trends are the key drivers for the mobile
data services market, which the Yankee Group has projected will grow from $10.5 billion in 2005 to $39.9 billion in
2010.
Mobile Music - Digital audio players and internet-based music download services have transformed music
consumption into a personal and mobile experience. As wireless carriers seek to offer premium services and mobile
devices support multimedia functionality, the market for digital music distribution over wireless networks and use
on wireless devices is expected to grow rapidly. The Yankee Group estimates that music-enabled mobile phone
shipments worldwide will grow from 130.2 million units in 2005 to 882.7 million units in 2010, and IDC estimates
that United States wireless subscribers who purchase full-track music delivered over cellular networks will grow
from 9.7 million subscribers in 2006 to 54.3 million subscribers in 2010.
Data Compression – Data compression is critical to both efficient data storage and multimedia transmission. As subscriber demand
increases for mobile access to larger image, audio and video files, we believe wireless carriers and mobile device manufacturers face a
pressing need to use better compression technologies to reduce the size of digital content sent over their networks and to maximize the
efficient use of limited device memory. According to the Mobile Imaging Report, of the approximately 600 million digital cameras shipped
in 2005, approximately 500 million were camera-enabled mobile phones. .
Diagnostic & Utility Software - Consumers and businesses have a need for diagnostic and utility software solutions for PCs. Consumers
demand products that can enhance PC performance, protect against spam, spyware and computer hacking and remove malicious code.
Businesses need cross-platform solutions that can quickly identify and repair a broad range of computer-related problems.
Products and Services
Products
Our primary product lines and products consist of the following:
Product Line
Products
Description
OEM — Wireless
QuickLink Mobile
V CAST Music Essentials Kit
QuickLink Mobile Manager
QuickLink Music
QuickLink Media
QuickLink Wi-Fi
QuickLink PhoneManager
Wireless — Enterprise
QuickLink Mobile Enterprise
Wireless — Compression
StuffIt Wireless
StuffIt Image
Enable or enhance broadband wireless,
multimedia services and management tools
offered by wireless operators and mobile
device manufacturers
Enhanced QuickLink Mobile that provides
security and support for enterprise
customers
Enable compression of data files to
facilitate storage in mobile devices and
transmission over wireless networks
Consumer Products
StuffIt Deluxe
Suite of products that includes Internet
9
cleanup and privacy software, fax and data
file transmission via modems and image
CheckIt Diagnosis
CheckIt System Performance Suite
Spring Cleaning
Internet Cleanup
FAXstf X Pro
HotFax MessageCenter
Personal Image Manager
Personal Photo Manager
Aquazone
Wireless carriers and mobile device manufacturers incorporate our products into their branded offerings,
selling directly to their market segments. Our technologies are utilized in many major wireless networks to facilitate
data communications via mobile devices. Our primary products include QuickLink Mobile, QuickLink Mobile
Enterprise, QuickLink Music and StuffIt Wireless, as well as a variety of consumer products, which are described
below.
OEM — Wireless. QuickLink Mobile provides Windows and Macintosh users with a centralized application
to control, customize and automate wireless connections, including WWAN and Wi-Fi. In the first quarter of 2006,
Verizon Wireless announced the V CAST Music Essentials Kit for Verizon Wireless, which incorporates our
QuickLink Music technology to allow users to purchase music from the Verizon Wireless music store, or any other
compatible store, and transfer it to or from any music-capable mobile device. We also launched QuickLink Music in
September 2006, a new product that expands upon the functionality in the V CAST Music Essentials Kit by adding
the ability to manage a consumer’s music on both a PC and a mobile device.
Wireless — Enterprise. QuickLink Mobile Enterprise is an enhanced version of QuickLink Mobile that has
expanded security functionality and web-base configuration tools tailored to an enterprise environment.
Additionally, QuickLink Mobile Enterprise supports approximately 185 carriers worldwide and interoperates with
many mobile devices connected via USB cable or Bluetooth.
Wireless — Compression. StuffIt Wireless offers carriers and mobile device manufactures a suite of image
and file compression solutions. StuffIt Wireless enables image compression without loss of quality, thereby
lowering demand on device resources. In addition, we have added resource compression to the product allowing
device manufacture to compress phone management resources thus freeing up memory on the device to allow more
multimedia files to be stored. StuffIt Wireless allows wireless carriers to use available network bandwidth more
efficiently and device manufacturers to reduce hardware memory costs through efficient use of limited memory
resources while improving battery life through faster file transfer.
Consumer Products. We also offer consumer products that provide compression, utility, diagnostic, fax and
eBusiness solutions. These products are designed to enhance PC performance, protect against spam, spyware and
computer hacking and remove malicious code. Our line of consumer products is available through direct sales on
our website, indirect sales on partner websites and through traditional retail outlets.
10
Strategy
Provide Service-Enhancing Products for Wireless Carriers and Mobile Device Manufacturers. We intend
to continue to develop innovative, enabling technology and infrastructure products that facilitate the usage of
wireless data and other premium services, thereby providing our customers with additional revenue opportunities
and differentiated services that encourage customer loyalty. We launched QuickLink Mobile in 2002, which has
been a key driver of our growth. In 2005, we announced StuffIt Wireless, a product that compresses data and image
files. In the first quarter of 2006, Verizon Wireless announced the V CAST Music Essentials Kit for Verizon
Wireless which incorporates our QuickLink Music technology.
Leverage OEM Relationships. We intend to continue to capitalize on our strong relationships with some of
the world’s leading wireless carriers and mobile device manufacturers. For example, our carrier customers serve as a
valuable distribution channel, providing access to millions of end-users and also providing market feedback for
future product offerings.
Focus on Multiple High-Growth Markets. We plan to continue to focus on the wireless communications
market and believe we are well-positioned to capitalize on the favorable trends in both wireless broadband
connectivity and consumer wireless data services. Among these trends are the ongoing introduction of new data
services by wireless carriers, the increasing availability of multimedia-enabled mobile devices and the need for
consumers and enterprises to manage their wireless access to the Internet.
Expand our Customer Base. We intend to grow our business domestically by offering our products to new
wireless carriers and mobile device manufacturers and internationally by leveraging our products and our market
expertise to build our presence with international carriers and mobile device manufacturers.
Selectively Pursue Acquisitions of Complementary Products and Services. We plan to continue to pursue
selected acquisition opportunities in an effort to expand our product and technological abilities, enter
complementary markets and extend our geographic reach. In the past, we have used acquisitions to enhance our
technology features and customer base, and to extend our offerings into new markets. For example, in July 2005 we
acquired Allume Systems, Inc. and launched our StuffIt Wireless compression technology product, and in April
2006 we acquired PhoTags, Inc. and integrated its multi-media management software into our product suite.
Sales and Marketing
Smith Micro Software develops productivity and entertainment software solutions for an expanding list of
customers. Our leading QuickLink® brands have long been products of choice for wireless carriers and device
manufacturers around the world.
These wireless carriers and device manufacturers (OEMs) generally incorporate our products into their
brands selling direct to individual consumers and in multiples to their enterprise customers. Our products are utilized
in many major wireless network installations throughout the world to facilitate data communications via PC Cards,
embedded network devices and mobile phones or manage user’s content on the PC and send to and from a mobile
device. We also sell our products and services utilizing direct sales and indirect distribution models to reach our
enterprise customers. Our retail products and product upgrades are sold over the Internet through our own web
store(s) at www.smithmicro.com.
Smith Micro is expanding its ability to serve OEM and enterprise customers in Europe and
Asia through an international sales and support office based in Jerusalem, Israel that is now
renamed Smith Micro Software, Israel.
11
Our OEM market continues to evolve as we continue to offer new communications, content and image
management products and OEM’s adopt new technologies and software bundling techniques. These manufacturers
bundle our software products with their own products. We have translated selected products into as many as eighteen
languages to allow our OEM customers the flexibility of offering multi-language products that meet the needs of their
worldwide markets.
Our three largest OEM customers (Verizon Wireless, Kyocera Wireless and Alltel in 2006 and
2005), and their respective affiliates, in each year, have accounted for 77.4% of our net revenue
in 2006, 63.5 % of our net revenue in 2005, and 77.8% of our net revenue in 2004. 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 or decisions by a significant
OEM customer to substantially reduce purchases could have a material adverse effect on our
business.
Customer Service and Technical Support
We provide technical support and customer service through our knowledge base on our web
site, email, voice and fax. OEM customers generally provide their own primary customer
support functions and rely on us for back-up support for their own technical support
personnel.
Product Development
The software industry, particularly the wireless market, is characterized by rapid and frequent changes in
technology and user needs. We work closely with industry groups and customers, both current and potential, to help us
anticipate changes in technology and determine future customer needs. Software functionality depends upon the
capabilities of the hardware. Accordingly, we maintain engineering relationships with various hardware manufacturers
and we develop our software in tandem with their development. Our engineering relationships with manufacturers, as
well as with our major customers, are central to our product development efforts. We remain focused on the
development and expansion of our technology, particularly in the wireless space. Research and development
expenditures amounted to $7.9 million, $4.0 million and $2.6 million for the years ended December 2006, 2005 and
2004, respectively.
Manufacturing
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Our software is sold in several forms. We offer a package or kit that may include: CD-ROM(s) for product
and hardware-specific drivers; a cable; a manual; and certain other documentation or marketing material. We offer
software on CD-ROMs. We also permit selected OEM customers to duplicate our products on their own CD-ROM’s
and pay a royalty based on usage. The majority of our OEM business requires that we provide a CD, which includes a
soft copy of a user guide. In other cases, we provide a complete data connectivity kit that includes a CD, manual and
cable. Finally, we grant licenses to certain OEM customers that enable those customers to preload a copy of our
software onto a personal computer. With the enterprise sales program, we offer site licenses under which a corporate
user is allowed to distribute copies of the software to users within the corporate sites.
Our product development group produces a product master for each product that is then duplicated and packaged into products by the
manufacturing organization. All product components are purchased by our personnel in our Aliso Viejo, California facility. The
manufacturing is subcontracted to outside vendors include the replication of CD-ROM’s and the printing of documentation materials.
Assembly of the final package is completed by an outside vendor or in our Aliso Viejo, California facility.
Competition
The markets in which we operate are highly competitive and subject to rapid changes in technology. Rapidly
changing technology combined with relatively low barriers to entry in the communication software market is constantly
creating new opportunities, and we expect new competitors to enter the market. We also believe that competition from
established and emerging software companies will continue to intensify as the emerging mobile, wireless and Internet
markets evolve. We compete with other software vendors for the attention of customers as well as in our efforts to
acquire technology and qualified personnel.
We believe that the principal competitive factors affecting the communication software market include:
product features, ease of use, customization to customer-specific needs, product quality, price, customer service and
effective 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. 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.
We face competition from Microsoft due to its market dominance and the fact that it is the publisher of the most
prevalent personal computer operating system, Windows. Microsoft represents a significant competitive threat to all
personal computer software vendors, including us.
Many existing and potential OEM customers have technological capabilities to 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 than design and develop their own software. Because 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
a source for communication software in the future.
Proprietary Rights and Licenses
Our success and ability to compete 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 secrets, nondisclosure and patent, copyright and trademark law that may afford only limited protection. As of
December 31, 2005, six currently effective U.S. patents have been issued since December 1997 and six patent
applications are currently pending. These patents provide generalized protection to our intellectual property base, and
we will continue to apply for various patents and trademarks in the future.
We seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to
our proprietary information to execute confidentiality agreements with us and by restricting access to our source code.
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
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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 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. Accordingly, the means we use currently to protect our proprietary rights may
not be adequate. Moreover, our competitors may independently develop technology similar 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 could be materially and adversely affected.
Employees
As of December 31, 2006, we had a total of 128 employees: 64 engaged in engineering; 33 in sales and
marketing; 17 in management and administration; seven in manufacturing and seven in customer support. We utilize
temporary labor to assist during peak periods of manufacturing volume. We believe that our future success will
depend in large part upon our continuing ability to attract and retain highly skilled managerial, sales, marketing,
customer support, research and development personnel and consulting staff. Like other software companies, we
face intense competition for such personnel, and we have at times experienced and continue to experience difficulty
in recruiting qualified personnel. There can be no assurance that we will be successful in attracting, assimilating and
retaining other qualified personnel in the future. We are not subject to any collective bargaining agreement and we
believe that our relationships with our employees are good.
Item 1A. RISK FACTORS
Our future operating results are highly uncertain. Before deciding to invest in our common
stock or to maintain or increase your investment, you should carefully consider the risks described
below, in addition to the other information contained in this report and in our other filings with the
SEC, including our reports on Forms 10-K, 10-Q and 8-K. The risks and uncertainties described
below are not the only ones we face. Additional risks and uncertainties not presently known to us or
that we currently deem immaterial may also affect our business operations. If any of these risks
actually occur, that could seriously harm our business, financial condition or results of operations. In
that event, the market price for our common stock could decline and you may lose all or part of your
investment.
We depend upon a single customer for a significant portion of our total net revenues.
Our largest customer, Verizon Wireless, accounted for 74.4% and 57.1% of our net
revenues in the years ended December 31, 2006 and December 31, 2005, respectively. In the past,
we have derived a substantial portion of our revenues from sales to a small number of customers,
including Verizon Wireless, and expect to continue to do so in the future. This concentration may
increase in future quarters, particularly if our relationship with one major customer makes it more
difficult to sell to its competitors. In that event, our revenue growth opportunities may be limited.
The agreements we have with these customers are no-exclusive and do not require them to
purchase any minimum quantity of our products and may be terminated by the customer or us at
any time for any reason upon minimal prior written notice. These customers may not continue to
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place large orders for our products in the future, or purchase our products at all. If these
customers fail to purchase our products at current levels, terminate or decide not to renew their
agreements with us, or if the terms of our future agreements with them are less favorable to us, our
revenues could decline.
Our customers may acquire products from our competitors or develop their own products
that compete directly with ours. In addition, our customers may adopt new and emerging
technologies that we are unable to serve effectively or that are served by more established
competitors. Any substantial decrease or delay in our sales to one or more of these customers,
particularly Verizon Wireless, in any quarter would have a material adverse effect on our results of
operations. In addition, certain of our customers have in the past and may in the future acquire
competitors in their industry or be acquired by competitors in their industry, causing further
industry consolidation. In the past, such acquisitions have caused the purchasing departments of
the combined companies to reevaluate their purchasing decisions. If one of our major customers
engages in an acquisition transaction in the future, the resulting entity could change its current
purchasing habits. As a result, we could lose the customer, or experience a decrease in orders from
or profit margins related to that customer or a delay in orders previously made by that customer.
Further, although we maintain allowances for doubtful accounts, the insolvency of one or more of
our major customers could result in a substantial decrease in our revenues.
Our quarterly revenues and operating results are difficult to predict and could fall below analyst or
investor expectations, which could cause the price of our common stock to fall.
Our quarterly revenue and operating results have fluctuated significantly in the past and
may continue to vary from quarter to quarter due to a number of factors, many of which are not
within our control. If our operating results do not meet the expectations of securities analysts or
investors, our stock price may decline. Fluctuations in our operating results may be due to a
number of factors, including the following:
•
•
•
•
•
•
•
•
•
•
the gain or loss of a key customer;
the size and timing of orders from and shipments to our major customers;
the size and timing of any return product requests for our products;
our ability to maintain or increase gross margins;
variations in our sales channels or the mix of our product sales;
our ability to anticipate market needs and to identify, develop, complete, introduce, market and
produce new products and technologies in a timely manner to address those needs;
the availability and pricing of competing products and technologies and the resulting effect on sales
and pricing of our products;
acquisitions;
the effect of new and emerging technologies;
the timing of acceptance of new mobile services by users of our customers’ services;
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•
deferrals of orders by our customers in anticipation of new products, applications, product
enhancements or operating systems; and
•
general economic and market conditions.
We have difficulty predicting the volume and timing of orders. In any given quarter, our sales have
involved, and we expect will continue to involve, large financial commitments from a relatively small number of
customers. As a result, the cancellation or deferral of even a small number of orders would reduce our revenues,
which would adversely affect our quarterly financial performance. Also, we have often booked a large amount of
our sales in the last month of the quarter and often in the last week of that month. Accordingly, delays in the closing
of sales near the end of a quarter could cause quarterly revenues to fall substantially short of anticipated levels.
Significant sales may also occur earlier than expected, which could cause operating results for later quarters to
compare unfavorably with operating results from earlier quarters.
A large portion of our operating expenses, including rent, depreciation and amortization is
fixed and difficult to reduce or change. Accordingly, if our total revenue does not meet our
expectations, we may not be able to adjust our expenses quickly enough to compensate for the
shortfall in revenue. In that event, our business, financial condition and results of operations would
be materially and adversely affected.
Due to all of the foregoing factors, and the other risks discussed in this report, you should
not rely on quarter-to-quarter comparisons of our operating results as an indication of future
performance.
Our total net revenues currently depend on a small number of products, so our operating results are vulnerable
to unexpected shifts in demand.
Substantially all of our total net revenue in recent years was derived from sales of our
wireless connectivity software products until the third quarter of 2005, when we began including
sales of products acquired in the Allume Systems, Inc. acquisition. In addition, during 2006, a
substantial portion of our total revenue has been derived from sales of our music management
software, particularly sales of V CAST Music Essentials Kit for Verizon Wireless. Although we
have introduced new products in recent quarters and our strategy is to continue to introduce new
products, these efforts may not reduce the extent to which our total revenues are dependent on one
or more of our products in future periods.
We also derive a significant portion of our revenues from a few vertical markets. In
particular, our music management software products are primarily sold to wireless carriers. In
order to sustain and grow our business, we must continue to sell our software products into these
vertical markets. Shifts in the dynamics of these vertical markets, such as new product
introductions by our competitors, could seriously harm our results of operations, financial
condition and prospects.
To increase our sales outside our core vertical markets, for example to large enterprises,
requires us to devote time and resources to hire and train sales employees familiar with those
industries. Even if we are successful in hiring and training sales teams, customers in other vertical
markets may not need or sufficiently value our current products or new product introductions.
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Competition within our target markets is intense and includes numerous established competitors, which could
negatively affect our revenues and results of operations.
We operate in markets that are extremely competitive and subject to rapid changes in
technology. Specifically, Microsoft Corporation poses a significant competitive threat to us because
Microsoft operating systems may include some capabilities now provided by certain of our OEM
and retail software products. If users are satisfied relying on the capabilities of the Windows-based
systems or other operating systems, or other vendors products, sales of our products are likely to
decline. In addition, because there are low barriers to entry into the software markets in which we
participate and may participate in the future, we expect significant competition from both
established and emerging software companies in the future. In fact, our growth opportunities in
new product markets could be limited to the extent established and emerging software companies
enter or have entered those markets. Furthermore, our existing and potential OEM customers may
acquire or develop products that compete directly with our products.
Microsoft and many of our other current and prospective competitors have significantly
greater financial, marketing, service, support, technical and other resources than we do. As a
result, they may be able to adapt more quickly than us to new or emerging technologies and
changes in customer requirements or to devote greater resources to the promotion and sale of their
products. Announcements of competing products by large competitors such as Microsoft or other
vendors could result in the cancellation of orders by customers in anticipation of the introduction of
such new products. In addition, some of our competitors currently make complementary products
that are sold separately. Such competitors could decide to enhance their competitive position by
bundling their products to attract customers seeking integrated, cost-effective software
applications. Some competitors have a retail emphasis and offer OEM products with a reduced set
of features. The opportunity for retail upgrade sales may induce these and other competitors to
make OEM products available at their own cost or even at a loss. We also expect competition to
increase as a result of software industry consolidations, which may lead to the creation of additional
large and well-financed competitors. Increased competition is likely to result in price reductions,
fewer customer orders, reduced margins and loss of market share.
Acquisitions of companies or technologies may disrupt our business and divert management attention and cause
our current operations to suffer.
In the past eighteen months we acquired Allume Systems, Inc. and PhoTags, Inc., As part
of any such acquisition, including those of Allume and PhoTags, we will be required to assimilate
the operations, products and personnel of the acquired businesses and train, retain and motivate
key personnel from the acquired businesses. We may not be able to maintain uniform standards,
controls, procedures and policies if we fail in these efforts. Similarly, acquisitions may cause
disruptions in our operations and divert management’s attention from our company’s day-to-day
operations, which could impair our relationships with our current employees, customers and
strategic partners. Acquisitions may also subject us to liabilities and risks that are not known or
identifiable at the time of the acquisition.
We may also have to incur debt or issue equity securities in order to finance future
acquisitions. Our financial condition could be harmed to the extent we incur substantial debt or
use significant amounts of our cash resources in acquisitions. The issuance of equity securities for
any acquisition could be substantially dilutive to our existing stockholders. In addition, we expect
our profitability could be adversely affected because of acquisition-related accounting costs, write
offs amortization expenses and charges related to acquired intangible assets. In consummating
acquisitions, we are also subject to risks of entering geographic and business markets in which we
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have had limited or no prior experience. If we are unable to fully integrate acquired businesses,
products or technologies within existing operations, we may not receive the intended benefits of
acquisitions.
We have recently entered new, emerging markets in which we have limited experience; if these markets do not
develop or we are unable to otherwise succeed in them, our revenues will suffer and the price of our common
stock will likely decline.
Our recent product introductions, such as StuffIt Wireless, a technology for file
compression, Active Images, an image-enhancement platform designed for portable devices, and
the technology that underlies our QuickLink Music service, have allowed us to enter the digital
image and music management markets. We have a short operating history in these emerging
markets and limited experience with image and music management software and platforms. A
viable market for these products may not develop or be sustainable, and we may face intense
competition in these markets. In addition, our success in these markets depends on our carrier
customers’ ability to successfully introduce new mobile services enabled by our products and our
ability to broaden our carrier customer base, which we believe will be difficult and time-consuming.
If the expected benefits from entering new markets do not materialize, our revenues will suffer and
the price of our common stock would likely decline. In addition, to the extent we enter new
markets through acquisitions of companies or technologies, our financial condition could be
harmed or our stockholders could suffer dilution without a corresponding benefit to our company
if we do not realize expected benefits of entering such new markets.
If the adoption of and investments in new technologies and services grows more slowly than anticipated in our
product planning and development, our operating results, financial condition and prospects may be negatively
affected.
If the adoption of and investments in new technologies and services does not grow or grows more slowly
than anticipated, we will not obtain the anticipated returns from our planning and development investments. For
example, our new QuickLink Mobile and QuickLink Enterprise products provide notebook users with the ability to
roam between wireless wide area networks and Wi-Fi hot spots. In addition, our new QuickLink Music product
enables users to download music files from a carrier’s music store, organize their music library and upload songs to
mobile devices. Future sales and any future profits from these and related products are substantially dependent upon
the acceptance and use of Wi-Fi, and on the continued adoption of music-capable mobile devices.
Many of our customers and other communications service providers have made and continue to make major
investments in next generation networks that are intended to support more complex applications. If communications
service providers delay their deployment of networks or fail to deploy such networks successfully, demand for our
products could decline, which would adversely affect our revenues. Also, to the extent we devote substantial
resources and incur significant expenses to enable our products to be interoperable with new networks that have
failed or have been delayed or not deployed, our operating results, financial condition and prospects may be
negatively affected.
Our growth depends in part on our carrier customers’ ability and willingness to promote services and attract and
retain new customers or achieve other goals outside of our control.
We sell our products for use on handheld devices primarily through our carrier customers. Losing the support
of these customers may limit our ability to compete in existing and potential markets and could negatively affect our
revenues. In addition, the success of these customers and their ability and willingness to market services supported
by our products are critical to our future success. Our ability to generate revenues from sales of our software,
including from Verizon Wireless’s use of our software in its V CAST Music Essentials Kit for Verizon Wireless, is
also constrained by our carrier customers’ ability to attract and retain customers. We have no input into or influence
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upon their marketing efforts and sales and customer retention activities. If our carrier customers, particularly our
largest customer, Verizon Wireless, fail to maintain or grow demand for their services, revenues or revenue growth
from of our products designed for use on mobile devices will decline and our results of operations will suffer.
Our gross margins may continue to decline due to shifts in our sales mix.
Gross margins associated with revenues from our data and music kits are significantly lower than gross
margins associated with revenues from sales of our software. This is primarily due to the fact that such kits contain
hardware that must be purchased from third parties. As we have expanded our sales of these kits, our overall gross
margins have declined from a high of 83% in the third quarter of 2005 to 68% in the fourth quarter of 2006. Our
future gross margin could fluctuate based on the mix of products sold in a quarter.
Our products may contain undetected software defects, which could negatively affect our revenues.
Our software products are complex and may contain undetected defects. In the past, we
have discovered software defects in certain of our products and have experienced delayed or lost
revenues during the period it took to correct these problems. Although we and our OEM customers
test our products, it is possible that errors may be found or occur in our new or existing products
after we have commenced commercial shipment of those products. Defects, whether actual or
perceived, could result in adverse publicity, loss of revenues, product returns, delay in market
acceptance of our products, loss of competitive position or claims against us by customers. Any such
problems could be costly to remedy and could cause interruptions, delays, or cessation of our
product sales, which could cause us to lose existing or prospective customers and could negatively
affect our results of operations.
Technology and customer needs change rapidly in our market, which could render our products obsolete and
negatively affect our business, financial condition and results of operations.
Our success depends on our ability to anticipate and adapt to changes in technology and industry standards.
We will also need to continue to develop and introduce new and enhanced products to meet our target markets’
changing demands, keep up with evolving industry standards, including changes in the Microsoft operating systems
with which our products are designed to be compatible, and to promote those products successfully. The
communications and utilities software markets in which we operate are characterized by rapid technological change,
changing customer needs, frequent new product introductions, evolving industry standards and short product life
cycles. Any of these factors could render our existing products obsolete and unmarketable. In addition, new products
and product enhancements can require long development and testing periods as a result of the complexities inherent
in today’s computing environments and the performance demanded by customers and called for by evolving
wireless networking technologies. If our target markets do not develop as we anticipate, our products do not gain
widespread acceptance in these markets, or we are unable to develop new versions of our software products that can
operate on future wireless networks and PC and mobile device operating systems and interoperate with other
popular applications, our business, financial condition and results of operations could be materially and adversely
affected.
Delays or failure in deliveries from our third-party suppliers could cause our net revenue to decline and harm
our results of operations.
We rely on third party suppliers to provide us with services and components for our
product kits. These components include: compact discs; cables; printed manuals; and boxes. We
do not have long-term supply arrangements with any vendor to obtain these necessary services and
components for our products. If we are unable to purchase components from these suppliers or if
the compact disc replication services that we use do not deliver our requirements on schedule, we
may not be able to deliver products to our customers on a timely basis or enter into new orders
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because of a shortage in components. Any delays that we experience in delivering our products to
customers could impair our customer relationships and adversely impact our reputation and our
business. In addition, if our third party suppliers raise their prices for components or services, our
gross margins would be reduced.
A shortage in the supply of wireless communication devices such as PC cards could adversely affect our
revenues.
Our products are utilized with major wireless networks throughout the world that support
data communications through the use of wireless communication devices such as PC cards.
Because wireless network providers generally incorporate our products into the wireless
communication devices that they sell directly to individual consumers, our future success depends
upon the availability of such devices to consumers at reasonable prices. A shortage in the supply of
wireless communication devices could put upward pressure on prices or limit the quantities
available to individual consumers which could materially affect the revenues that we generate from
our products.
If our products are not designed into customer products, our products may not be adopted by our target markets
and customers, either of which could negatively impact our results of operations.
Some of our products must be incorporated into our customers’ products at the design
stage. As a result, we rely on OEM customers to select our products to be designed into their
products. We may devote significant resources and incur significant expense on the development of
a new product without any assurance that an OEM customer will select our product for design into
its own product. Once an OEM customer designs a competitor’s product into its product offering, it
becomes significantly more difficult for us to sell our products to that customer because changing
vendors involves significant cost, time, effort and risk for the customer. In addition, such design
decisions are typically only made when a new system configuration is introduced, which may occur
infrequently. Our development expenses may never be recovered and our results of operations and
financial condition will be seriously harmed if our products are not selected at the design stage.
Even if our products are selected at the design stage, sales of such products are outside of our
control and we may never earn material revenues from such product sales.
Regulations affecting our customers and us and future regulations to which they or we may become subject may
harm our business.
Certain of our customers in the communications industry are subject to regulation by the
Federal Communications Commission, which could have an indirect effect on our business. In
addition, the United States telecommunications industry has been subject to continuing
deregulation since 1984. We cannot predict when, or upon what terms and conditions, further
regulation or deregulation might occur or the effect regulation or deregulation may have on
demand for our products from customers in the communications industry. Demand for our
products may be indirectly affected by regulations imposed upon potential users of those products,
which may increase our costs and expenses.
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We may be unable to adequately protect our intellectual property and other proprietary rights, which could
negatively impact our revenues.
Our success is dependent upon our software code base, our programming methodologies
and other intellectual properties and proprietary rights. In order to protect our proprietary
technology, we rely on a combination of trade secret, nondisclosure and copyright and trademark
law. We currently own United States trademark registrations for certain of our trademarks and
United States patents for certain of our technologies. However, these measures afford us only
limited protection. Furthermore, we rely primarily on “shrink wrap” licenses that are not signed
by the end user and, therefore, may be unenforceable under the laws of certain jurisdictions.
Accordingly, it is possible that third parties may copy or otherwise obtain our rights without our
authorization. It is also possible that third parties may independently develop technologies similar
to ours. It may be difficult for us to detect unauthorized use of our intellectual property and
proprietary rights.
We may be subject to claims of intellectual property infringement as the number of
trademarks, patents, copyrights and other intellectual property rights asserted by companies in our
industry grows and the coverage of these patents and other rights and the functionality of software
products increasingly overlap. From time to time, we have received communications from third
parties asserting that our trade name or features, content, or trademarks of certain of our products
infringe upon intellectual property rights held by such third parties. We have also received
correspondence from third parties separately asserting that our fax products may infringe on
certain patents held by each of the parties. Although we are not aware that any of our products
infringe on the proprietary rights of others, third parties may claim infringement by us with
respect to our current or future products. Additionally, our customer agreements require that we
indemnify our customers for infringement claims made by third parties involving our intellectual
property embedded in their products. Infringement claims, whether with or without merit, could
result in time-consuming and costly litigation, divert the attention of our management, cause
product shipment delays or require us to enter into royalty or licensing agreements with third
parties. If we are required to enter into royalty or licensing agreements, they may not be on terms
that are acceptable to us. Unfavorable royalty or licensing agreements could seriously impair our
ability to market our products.
Our ability to predict our revenues and operating results is extremely limited.
We have historically operated with little backlog because we have generally shipped our
software products and recognized revenue shortly after we received orders because our production
cycle has traditionally been very short. As a result, our sales in any quarter were generally
dependent on orders that were booked and shipped in that quarter. As our wireless business has
evolved, production cycle time for items such as data kits has increased to the point that orders
received toward the end of a quarter may not ship until the subsequent quarter. From time to time,
customers may issue purchase orders that have extended delivery dates that may cause the
shipment to be deferred to a subsequent quarter. These situations make it difficult for us to predict
what our revenues and operating results will be in any quarter. Therefore, our level of backlog is
not necessarily indicative of trends in our business.
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If we are unable to retain key personnel, the loss of their services could materially and adversely affect our
business, financial condition and results of operations.
Our future performance depends in significant part upon the continued service of our
senior management and other key technical and consulting personnel. We do not have employment
agreements with our key employees that govern the length of their service. The loss of the services
of our key employees would materially and adversely affect our business, financial condition and
results of operations. Our future success also depends on our ability to continue to attract, retain
and motivate qualified personnel, particularly highly skilled engineers involved in the ongoing
research and development required to develop and enhance our products. Competition for these
employees remains high and employee retention is a common problem in our industry. Our
inability to attract and retain the highly trained technical personnel that are essential to our
product development, marketing, service and support teams may limit the rate at which we can
generate revenue, develop new products or product enhancements and generally would have an
adverse effect on our business, financial condition and results of operations.
If we fail to continue to establish and maintain strategic relationships with mobile device manufacturers, market
acceptance of our products, and our profitability, may suffer.
Most of our strategic relationships with mobile device manufacturers are not subject to written contract, but
rather are in the form of informal working relationships. We believe these relationships are valuable to our success.
In particular, these relationships provide us with insights into product development and emerging technologies,
which allows us to keep abreast of, or anticipate, market trends and helps us serve our current and prospective
customers. Because these relationships are not typically governed by written agreements, there is no obligation for
many of our partners to continue working with us. If we are unable to maintain our existing strategic relationships
with mobile device manufacturers or if we fail to enter into additional strategic relationships or the parties with
whom we have strategic relationships favor one of our competitors, our ability to provide products that meet our
current and prospective customers’ needs could be compromised and our reputation and future revenue prospects
could suffer. For example, if our software does not function well with a popular mobile device because we have not
maintained a relationship with its manufacturer, carriers seeking to provide that device to their respective customers
could choose a competitor’s software over ours or develop their own. Even if we succeed in establishing these
relationships, they may not result in additional customers or revenues.
Certain individuals to whom we have granted stock options may have a right of rescission as to the options.
Approximately 4,539,500 stock options having a weighted average exercise price of $3.74 that were granted
under our 1995 Stock Option / Stock Issuance Plan and 2005 Stock Option / Stock Issuance Plan between August 5,
2002 and August 31, 2006 were not exempt from registration or qualification under the securities laws of certain
states, nor were they registered or qualified in such states. As a result, holders of these stock options, subject to the
securities laws of the state in which they live, have a right of rescission with respect to the options. This means that
if a holder elects to exercise his or her right of rescission, he or she will have a right to require us to repurchase the
option for cash. Rescission rights or similar remedies may be available to persons who were granted options and no
longer hold them. No liability has been recorded for these rescission rights or remedies. In addition, we may be
subject to fines, penalties or enforcement actions by applicable state regulatory agencies regarding these issuances.
We may raise additional capital through the issuance of additional equity or convertible debt securities or by
borrowing money, in order to meet our capital needs. Additional funds may not be available on terms acceptable
to us to allow us to meet our capital needs.
We believe that the cash, cash equivalents and investments on hand and the cash we expect
to generate from operations will be sufficient to meet our capital needs for at least the next twelve
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months. However, it is possible that we may need or choose to obtain additional financing to fund
our activities in the future. We could raise these funds by selling more stock to the public or to
selected investors, or by borrowing money. We may not be able to obtain additional funds on
favorable terms, or at all. If adequate funds are not available, we may be required to curtail our
operations or other business activities significantly or to obtain funds through arrangements with
strategic partners or others that may require us to relinquish rights to certain technologies or
potential markets. If we raise additional funds by issuing additional equity or convertible debt
securities, the ownership percentages of existing stockholders would be reduced. In addition, the
equity or debt securities that we issue may have rights, preferences or privileges senior to those of
the holders of our common stock. We currently have no established line of credit or other business
borrowing facility in place.
It is possible that our future capital requirements may vary materially from those now planned.
The amount of capital that we will need in the future will depend on many factors, including:
•
•
•
•
•
•
•
•
the market acceptance of our products;
the levels of promotion and advertising that will be required to launch our products and achieve
and maintain a competitive position in the marketplace;
our business, product, capital expenditure and research and development plans and product and
technology roadmaps;
the levels of inventory and accounts receivable that we maintain;
capital improvements to new and existing facilities;
technological advances;
our competitors’ response to our products; and
our relationships with suppliers and customers.
In addition, we may raise additional capital to accommodate planned growth, hiring, infrastructure
and facility needs or to consummate acquisitions of other businesses, products or technologies.
Our business, financial condition and operating results could be adversely affected as a result of legal, business
and economic risks specific to international operations.
In recent years, our revenues derived from sales to customers outside the United States have
not been material. Our revenues derived from such sales can vary from quarter to quarter and
from year to year. We also frequently ship products to our domestic customers’ international
manufacturing divisions and subcontractors. In the future, we may expand these international
business activities. International operations are subject to many inherent risks, including:
•
•
•
•
•
general political, social and economic instability;
trade restrictions;
the imposition of governmental controls;
exposure to different legal standards, particularly with respect to intellectual property;
burdens of complying with a variety of foreign laws;
23
•
•
•
•
•
•
•
•
•
import and export license requirements and restrictions of the United States and any other country
in which we operate;
unexpected changes in regulatory requirements;
foreign technical standards;
changes in tariffs;
difficulties in staffing and managing international operations;
difficulties in securing and servicing international customers;
difficulties in collecting receivables from foreign entities;
fluctuations in currency exchange rates and any imposition of currency exchange controls; and
potentially adverse tax consequences.
These conditions may increase our cost of doing business. Moreover, as our customers are
adversely affected by these conditions, our business with them may be disrupted and our results of
operations could be adversely affected.
We may be subject to regulatory scrutiny and may sustain a loss of public confidence if we are unable to satisfy
regulatory requirements relating to internal controls over financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to perform an evaluation of our
internal controls over financial reporting and have our independent registered public accounting
firm attest to such evaluation on an annual basis. Compliance with these requirements can be
expensive and time-consuming. While we believe that we will be able to meet the required
deadlines, no assurance can be given that we will meet the required deadlines in future years. If we
fail to timely complete this evaluation, or if our auditors cannot timely attest to our evaluation, we
may be subject to regulatory scrutiny and a loss of public confidence in our internal controls.
Existing efforts to improve our disclosure controls and internal control over financial reporting, combined with
new challenges of integrating the internal control environment of newly acquired companies with ours,
underscores the risk that our internal controls may not be adequate.
In the past several years, substantial downsizing and restructuring followed by rapid
expansion have placed significant strains on our existing personnel, resources and infrastructure,
which may be difficult to address. Our organization has grown from 52 employees as of December
31, 2004 based in Southern California to 128 as of December 31, 2006 based primarily in Southern
and Northern California and in Israel. Until our recent acquisition of PhoTags, we had not had
significant operations outside of the United States. Our acquisitions and our internal growth have
placed substantial demands on our management, resources and systems. To manage these
acquisitions and our internal growth, we will have to implement new operational and financial
systems, procedures and controls. We have already identified areas requiring improvement and
are in the process of designing enhanced processes and controls to address these issues. Our efforts
may not be effective or sufficient for us, or our independent registered accounting firm, to issue
unqualified reports in the future.
It may be difficult to design and implement effective financial controls for combined
operations and differences in existing controls of any acquired businesses may result in weaknesses
that require remediation when the financial controls and reporting are combined. Our ability to
24
manage our operations and growth will require us to improve our operational, financial and
management controls, as well as our internal reporting systems and controls. We may not be able to
implement improvements to our internal reporting systems and controls in an efficient and timely
manner and may discover deficiencies in existing systems and controls.
We may be subject to additional risks.
Additional risks and uncertainties not presently known to us or that we currently deem
immaterial may also adversely affect our business operations.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
Our corporate headquarters, including our principal administrative, sales and marketing, customer support and
research and development facility, is located in Aliso Viejo, California, where we currently lease and occupy
approximately 26,000 square feet of space pursuant to leases that expires May 31, 2009. We operate both our products
and services reporting segments within this facility.
We also lease approximately 13,600 square feet in Watsonville, California under leases that expires
September 30, 2010. We occupy office space in Lee’s Summit, Missouri on a month to month basis.
We believe that suitable additional or alternative space will be available in the future on commercially
reasonable terms as needed.
Item 3. LEGAL PROCEEDINGS
The Company is not involved in any pending material legal proceedings at this time
although we may become subject to legal proceedings or claims that arise in the ordinary course
of business or otherwise.
25
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, 2006.
26
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASERS OF EQUITY SECURITIES
Market Information
Our common stock is traded on the Nasdaq Global Market under the symbol "SMSI." The high and low sale
prices for our common stock as reported by Nasdaq are set forth below for the periods indicated.
YEAR ENDED DECEMBER 31, 2006:
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
YEAR ENDED DECEMBER 31, 2005:
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
High
Low
$
12.65
16.50
16.70
19.01
9.63
5.00
7.39
8.00
5.87
10.85
9.01
13.35
4.65
3.44
4.02
5.41
On March 6, 2007, the closing sale price for our common stock as reported by Nasdaq was $15.88.
Stock Performance Graph
The following graph and information compares the cumulative total stockholder return on our Common
Stock against the cumulative total return of the S&P Midcap 400 Index and the S&P Midcap Applications Software
Index (Peer Group) for the same period.
The graph covers the period from January 1, 2001, through December 31, 2006. The graph assumes that
$100 was invested in our Common Stock on January 1, 2001, and in each index, and that all dividends were
reinvested. No cash dividends have been declared on our Common Stock. Stockholder returns over the indicated
period should not be considered indicative of future stockholder returns.
27
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Smith Micro Software, Inc., The S & P Midcap 400 Index
And The S & P Midcap Software Application
$1,600
$1,400
$1,200
$1,000
$800
$600
$400
$200
$0
12/01
12/02
12/03
12/04
12/05
12/06
Smith Micro Software, Inc.
S & P Midcap 400
S & P Midcap Software Application
* $100 invested on 12/31/01 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.
Copyright © 2007, Standard & Poor's, a division of The McGraw-Hill Companies, Inc. All rights reserved.
www.researchdatagroup.com/S&P.htm
12/01
12/02
12/03
12/04
12/05
12/06
Smith Micro Software, Inc.
S & P Midcap 400
S & P Midcap Software Application
100.00
100.00
100.00
43.81
85.49
59.04
189.52
115.94
88.57
852.38
135.05
72.37
557.14
152.00
81.71
1351.43
167.69
95.11
Holders
As of March 6, 2007, there were approximately 123 holders of record of our common stock based on
information provided by our transfer agent.
Dividends
We have never paid any cash dividends on our common stock and we have no current plans to do so.
28
Recent Sales of Unregistered Securities
None
Purchasers of Equity Securities by the Company
None.
29
Item 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial
statements and the related notes thereto appearing elsewhere in this Annual Report. The following selected
consolidated statement of operations data for the years ended December 31, 2006, 2005 and 2004, and the
consolidated balance sheet data at December 31, 2006 and 2005, have been derived from audited consolidated
financial statements included elsewhere in this Annual Report. The consolidated statement of operations data
presented below for the years ended December 31, 2003 and 2002, and the consolidated balance sheet data at
December 31, 2004, 2003 and 2002 are derived from audited consolidated financial statements that are not included
in this Annual Report.
Year Ended December 31,
2006
2005
2004
2003
2002
Consolidated Statement of Operations Data:
Net Revenues:
Products
Services
Total Net Revenues
Cost of Revenues:
Products
Services
Total Cost of Revenues
Gross profit
Operating expenses:
Selling and marketing
Research and development
General and administrative
Total operating expenses
Operating income (loss)
Interest Income
Income (Loss) before income taxes
Income tax expense (benefit)
Net Income (Loss)
$
53,773
696
54,469
19,989
270
20,259
34,210
9,057
7,899
8,467
25,423
8,787
1,403
10,190
1,234
8,956
$
$
19,637
621
20,258
$
12,394
922
13,316
$
6,291
925
7,216
$
3,818
285
4,103
16,155
3,410
3,963
4,621
11,994
4,161
667
4,828
104
4,724
$
2,530
380
2,910
10,406
1,519
2,556
2,868
6,943
3,463
53
3,516
71
3,445
$
1,350
321
1,671
5,545
1,666
2,506
2,330
6,502
(957)
37
(920)
3
(923)
$
6,029
1,102
7,131
1,420
782
2,202
4,929
2,175
2,162
2,387
6,724
(1,795)
45
(1,750)
(1,062)
(688)
$
Net income (loss) per share, basic
$
0.38
$
0.22
$
0.20
$
(0.06)
$
(0.04)
Weighted average shares, basic
23,753
21,351
17,267
16,511
16,235
Net income (loss) per share, diluted
$
0.35
$
0.21
$
0.19
$
(0.06)
$
(0.04)
Weighted average shares, diluted
25,330
22,806
18,412
16,511
16,235
2006
2005
2004
2003
2002
As of December 31,
$
42,716
3,759
(11,945)
38,957
$
Consolidated Balance Sheet Data:
Total assets
Total liabilities
Accumulated deficit
Total stockholders' equity
$
$
131,026
4,969
(2,989)
126,057
30
$
12,828
1,729
(16,669)
11,099
$
$
6,587
997
(20,114)
5,590
$
$
6,766
1,154
(19,191)
5,612
$
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read in conjunction
with our consolidated financial statements and the related notes and other financial information appearing
elsewhere in this Annual Report. Readers are also urged to carefully review and consider the various disclosures
made by us which attempt to advise interested parties of the factors which affect our business, including without
limitation the disclosures made in Item 1A of Part I of this Annual Report under the caption “Risk Factors.”
Risk factors that could cause actual results to differ from those contained in the forward-looking statements
including but are not limited to: our dependence upon a single customer for a significant portion of our revenues;
potential fluctuations in quarterly results; deriving revenues from a small number of products; failure to
successfully compete; failure to successfully integrate acquisitions; entry into new markets; failure of our customers
to adopt new technologies; dependence upon relationships with carrier customers; declines in gross margins;
undetected software defects; changes in technology; delays or failure in deliveries from component suppliers;
failure of our products to achieve broad acceptance; failure to protect intellectual property; exposure to intellectual
property claims; and loss of key personnel.
Introduction and Overview
Our business model is based primarily upon the design, production and sale of software that
supports the wireless data industry. Our products are utilized in major wireless networks
throughout the world that support data communications through the use of cell phones or
other wireless communication devices such as PC cards. Wireless network providers
generally incorporate our products into their accessory products sold directly to individual
consumers.
Our business is primarily dependent upon the demand for wireless communications and the corresponding
requirements for wireless connectivity software to support this demand. During the last three years, demand for
these types of products has fluctuated dramatically, and there continues to be new services launched that utilize the
improving wireless broadband networks.
We continue to invest in research and development of wireless software products, and we
believe that we have one the industry’s leading wireless product lines in terms of
performance and features. We believe that our “out-of-the-box” design technology further
differentiates our products.
31
We also sell eBusiness and utility software and professional consulting services related to
eBusiness applications.
During 2006, we have maintained a sharp focus on our operating cost structure while ensuring that we
maintain our operating flexibility to support future growth in the industry. We measure success by monitoring our
net sales and gross margins and operating cash flow. We believe that there continues to be excellent growth
opportunities within the wireless communications software marketplace and we continue to focus on positioning
Smith Micro to benefit from these opportunities.
32
Results of Operations
The following table sets forth certain consolidated statement of operating data as a percentage of total
revenues for the periods indicated:
Years Ended December 31,
2005
2006
2004
Net Revenues:
Products
Services
Total net revenues
Cost of revenues:
Products
Services
Total cost of revenues
Gross profit
Operating expenses:
Selling and marketing
Research and development
General and administrative
Total operating expenses
Operating Income
Interest Income
Income before income taxes
Income tax expense
Net Income
98.7%
1.3%
100.0%
96.9%
3.1%
100.0%
93.1%
6.9%
100.0%
36.7%
0.5%
37.2%
62.8%
16.6%
14.5%
15.6%
46.7%
16.1%
2.6%
18.7%
2.3%
16.4%
18.9%
1.4%
20.3%
79.7%
16.8%
19.6%
22.8%
59.2%
20.5%
3.3%
23.8%
0.5%
23.3%
19.0%
2.9%
21.9%
78.1%
11.4%
19.2%
21.5%
52.1%
26.0%
0.4%
26.4%
0.5%
25.9%
Revenues
Total net revenues were $54.5 million, $20.3 million and $13.3 million in 2006, 2005 and 2004, respectively,
with an increase of $34.2 million, or 168.9% from 2005 to 2006 and an increase of $6.9 million, or 52.1% from 2004 to
2005. The increase in our revenues from 2004 through 2006 is attributed to the growth in sales of our wireless
products. We acquired Allume Systems in 2005, which also contributed to the year on year sales growth from 2004 to
2005. In late 2005 we entered the wireless music software space which was the largest selling product group for 2006
and largely responsible for the increase in revenues from 2005 to 2006. Sales to individual customers and their
affiliates, which amounted to more than 10% of the Company’s net revenues, included one OEM customer at 74.4%
in 2006, 57.1% in 2005 and 68.4% of revenues in 2004.
We currently operate in two business segments: products and services. In addition, product revenues are
broken down into three business units, Wireless and OEM, Consumer and Enterprise. Our Consumer sales represent
the sales of Allume products to distributors, retail customers and individuals as well as legacy Smith Micro utility and
fax software products. Allume was acquired on July 1, 2005 (See Note 3 of Notes to Consolidated Financial
Statements). The Enterprise sales unit includes legacy Smith Micro consulting, fulfillment and hosting revenue.
33
The following table shows the net revenues and cost of revenues generated by each segment:
2006
Year Ended December 31,
2005
2004
Products
Services
Products
Services
Products
Services
Wireless & OEM
$
43,419
$
-
$
13,982
$
-
$
11,424
$
-
Consumer
Enterprise
Total Revenues
Cost of revenues
Gross Profit
10,019
335
-
696
5,460
195
-
621
746
224
-
922
53,773
19,989
33,784
$
696
270
426
$
19,637
3,818
15,819
$
621
285
336
$
12,394
2,530
9,864
$
922
380
542
$
Products. Net revenues from sales of products were $53.8 million, $19.6 million and $12.4 million for 2006,
2005 and 2004, respectively, representing an increase of $34.1 million, or 173.8% from 2005 to 2006 and an increase
of $7.2 million, or 58.4% from 2004 to 2005. Product revenues accounted for 98.7% of total revenues in 2006,
96.9% of total revenues in 2005 and 93.1% of total revenues in 2004. There are two key drivers to the increase in
our product revenues from 2004 through 2006. Our core wireless business increased from $11.4 million to $43.4
million. The increase can be attributed to the continued success of the wireless broadband data rollouts by our
carrier customers and the rollout of QuickLink Music in 2006. The second key contributor was the increase in the
Consumer business unit in 2005 attributed to the Allume acquisition on July 1, 2005. Allume posted revenues of
$4.9 million for 2005 and $9.7 million for 2006.
Services. Consulting services revenues were $696,000, $621,000 and $922,000 in 2006, 2005 and 2004,
respectively, representing an increase of $75,000, or 12.1% from 2005 to 2006 and a decrease of $301,000, or 32.7%
from 2004 to 2005. Services revenue accounted for 1.3% of total revenues in 2006, 3.1% of total revenues in 2005
and 6.9% of total revenues in 2004. We have reduced our focus on consulting services, which was announced in the
first quarter of 2002, due to the decrease in demand for such services.
Cost of Revenues and Gross Margin
Cost of Product Revenues. Cost of product revenues was $20.0 million, $3.8 million and $2.5 million in
2006, 2005 and 2004, respectively, representing an increase of $16.2 million, or 423.6% from 2005 to 2006 and an
increase of $1.3 million, or 50.9%, from 2004 to 2005. Product gross margin as a percentage of product net
revenue was 62.8% for 2006 as compared to 80.6% for 2005 and 79.6% for 2004. Cost of Revenues for the 2006
includes $1.1 million of amortization of intangibles associated with acquisitions as compared to $534,000 in 2005
and $0 in 2004. In addition, there is $33,000 of stock compensation expense included in 2006 which is not present
in the earlier years. Factoring out these costs product gross margin was 64.9% in 2006 and 83.3% in 2005. The
18.4% decrease in pro-forma product gross margin percentage from 2005 to 2006 is attributed to the increased sales
of lower margin Music Kits. The 4.3% pro-forma increase from 2004 to 2005 is attributed to increased sales of
higher margin PC card software product versus lower margin Mobile Office Kit products.
Direct costs of revenues consist primarily of CD replication costs, and the cost of music kit components
which include ear phones and a cable that connects the handheld device to the PC. We use a variety of providers
located in China, Korea and the United States. We consider CD replication, ear phones and cables to be
commodities with little or no risk to supplier fluctuations. We also purchase proprietary cables from Motorola and
generic OEM cables from a variety of suppliers.
Cost of Service Revenues. Cost of service revenues was $270,000, $285,000 and $380,000 in 2006, 2005
and 2004, respectively, representing a decrease of $15,000, or 5.3% from 2005 to 2006 and a decrease of $95,000,
or 25.0% from 2004 to 2005. Cost of Service revenue as a percentage of Service revenues was 61.2% in 2006,
54.1% in 2005 and 41.2% in 2004. Cost of service revenues includes the cost of our consulting personnel and the
cost of any outside consultants contracted to support our staff and vary by contract.
34
Operating Expenses
The following table presents a breakdown of our operating expenses by functional category and as a percentage of total net revenues:
2006
Years Ended December 31,
2005
2004
Operating expenses:
Selling and marketing
Research and development
General and administrative
Total operating expenses
$
9,057
7,899
8,467
25,423
$
16.6%
14.5%
15.6%
46.7%
$
3,410
3,963
4,621
11,994
$
16.8%
19.6%
22.8%
59.2%
$
$
1,519
2,556
2,868
6,943
11.4%
19.2%
21.5%
52.1%
Selling and Marketing. Selling and marketing expenses were $9.1 million, $3.4 million and $1.5 million in 2006, 2005 and 2004,
respectively, representing an increase of $5.6 million, or 165.6%, from 2005 to 2006 and an increase of $1.9 million, or 124.5%, from 2004
to 2005. 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. While most
of the increases in selling and marketing expenses in both years were due to the Allume acquisition, we also had a slight increase in
headcount and increases in costs related to product collateral concept and design. Advertising expenses were $379,000, $223,000 and
$47,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Selling and marketing expenses were 16.6%, 16.8% and
11.4% of revenues in the years ended December 31, 2006, 2005 and 2004, respectively. Increases in selling and marketing expenses as a
percentage of revenues in 2005 and 2006 were caused by the increase in costs as described above. Selling and marketing expenses include
$483,000 of amortization expense related to acquisitions in 2006 and $236,000 in 2005 which was not present in 2004. In addition, 2006
selling and marketing expenses include $2.1 million of stock based compensation expense, not included in the prior years. Factoring out
amortization and stock based compensation costs, selling and marketing expenses were 11.9% of revenues in 2006 and 15.7% in 2005 due
to the increases in revenues over the periods.
Research and Development. Research and development expenses were $7.9 million, $4.0 million and $2.6
million in 2006, 2005 and 2004, respectively, representing increases of $3.9 million, or 99.3% from 2005 to 2006
and $1.4 million, or 55.0%, from 2004 to 2005. Our research and development expenses consist primarily of
personnel and equipment costs required to conduct our software development efforts. We remain focused on the
development and expansion of our technology, particularly our wireless, multi-media, and compression software
technologies. The increase in our research and development expenses in each year was primarily due to the
development of new wireless products that were released during the periods, with an accompanying increase in
headcount and a refocus of engineering resources from consulting projects to development. Beginning in 2005, the key
driver to increased R&D expense was the acquisition of Allume Systems on July 1, 2005 and PhoTags, Inc. on April 3,
2006 along with the associated engineering staffs. Research and development expenses were 14.5%, 19.6% and 19.2%
of revenues in the years ended December 31, 2006, 2005 and 2004, respectively. In 2006, research and development
expenses include $1.1 million of stock based compensation expenses not present in previous years. Factoring out this
expense, research and development expenses were 12.5% of net revenues in 2006. The decrease in research and
development expenses as a percentage of revenues from 2005 to 2006 is due to the significant increase in revenues
during the period.
General and Administrative. General and administrative expenses were $8.5 million, $4.6 million and $2.9
million in 2006, 2005 and 2004, respectively, representing increases of $3.8 million, or 83.2% from 2005 to 2006
and $1.8 million, or 61.1%, from 2004 to 2005. The increases in general and administrative expenses are primarily
due to the acquisition of Allume Systems on July 1, 2005 and the assumption of Allume G&A staff and certain
integration costs. General and administrative expenses were 15.5%, 22.8% and 21.5% of net revenues in the years
ended December 31, 2006, 2005 and 2004, respectively. The decrease in general and administrative expenses as a
percentage of revenues from 2005 to 2006 is due to the increase in revenues, partially offset by the absolute dollar
increase in expenses. In 2006, general and administrative expenses include $2.3 million of stock based compensation
expense and $335,000 write off of goodwill related to our Services segment which were not present in previous years.
Factoring out these expenses, general and administrative expenses were 10.8% of net revenues in 2006. The decrease
35
in general and administrative expenses as a percentage of revenues from 2005 to 2006 is due to the significant increase
in revenues during the period.
Interest Income. Interest income was $1.4 million, $667,000 and $53,000 in 2006, 2005 and 2004,
respectively, representing increases of $736,000, or 110.3% from 2005 to 2006 and $614,000, or 1,158.5% from 2004
to 2005. The differences in our interest income are directly related to the fluctuations in our cash balances during
the periods and changing interest rates. We have not changed our investment strategy during the periods being
reported, with our excess cash consistently being invested in short term marketable securities. (See “Liquidity and
Capital Resources” for further discussion elsewhere in this report.)
Provision for Income Taxes. The provision for income taxes was $1.2 million, $104,000 and $71,000 in
2006, 2005 and 2004, respectively. The provision in 2006 relates to the release of the valuation allowance
previously recorded against our deferred tax assets. The provision in 2005 and 2004 relates to alternative minimum
tax liability.
Liquidity and Capital Resources
Since inception, we have financed our operations primarily through cash generated from operations and
from net proceeds of $18.1 million generated by our initial public offering in 1995. On February 18, 2005, we
entered into a Common Stock Purchase Agreement for the private placement of 3,500,000 shares of our common
stock, $0.001 par value, at a price of $6.40 per share, resulting in aggregate gross cash proceeds to the Company of
$22,400,000 before deducting commissions and other expenses. Offering costs related to the transaction totaled
$1,613,000, comprised of $1,344,000 in commissions and $269,000 cash payments for legal and investment
services, resulting in net proceeds to the Company of $20,786,000. The transaction closed simultaneously with the
execution of the Purchase Agreement on February 18, 2005. C.E. Unterberg, Towbin LLC, the placement agent for
the transaction, received a cash fee equal to 6% of the aggregate gross proceeds of the Private Placement.
On December 14, 2006, we completed a fully marketed secondary, issuing 4,000,000 shares of our
common stock, $0.001 par value, at a price of $14.75 per share, resulting in aggregate gross cash proceeds to the
Company of $59,000,000 before deducting commissions and other expenses. Offering costs related to the
transaction totaled $4,002,000, comprised of $3,304,000 in underwriting discounts and commissions and $698,000
cash payments for legal and investment services, resulting in net proceeds to the Company of $54,998,000.
Net cash provided by operations was $14.8 million in 2006 and $2.5 million in 2005. The primary source
of operating cash in both periods was the net income and the increase in accounts payable and accrued liabilities, offset
by the collection of accounts receivable.
Cash flows used in investing activities were $2.6 million in 2006 and $11.0 million in 2005. In 2006, $2.2
million was used for the acquisition of PhoTags, Inc. and $362,000 for capital expenditures. In 2005, $10.9 million
was used for the purchase of Allume in July, 2005 as well as $142,000 for other capital expenditures. Our capital
expenditures in both periods consisted of the purchase of computers and other office equipment.
We received $4.2 million in cash from the exercise of employee stock options in 2006 compared to
$369,000 in 2005.
At December 31, 2006, we had $92.6 million in cash and cash equivalents and $98.8 million
of working capital. We have no significant capital commitments, and currently anticipate that
capital expenditures will not vary significantly from recent periods. We believe that our existing
cash, cash equivalent investment balances and cash flow from operations will be sufficient to
finance our working capital and capital expenditure requirements through at least the next twelve
months. We may require additional funds to support our working capital requirements or for
other purposes and may seek to raise additional funds through public or private equity or debt
36
financing or from other sources. If additional financing is needed, we cannot assure that such
financing will be available to us at commercially reasonable terms or at all.
Our corporate headquarters, which includes our principal administrative, sales and
marketing, customer support and research and development facilities, is located in Aliso Viejo,
California. We have leased this space through May 2009. We also lease approximately 7,700
square feet in Watsonville, California under a new lease that expires September 30, 2010. We are
currently working on a new operating lease for our facility in Lee’s Summit, Missouri to replace the
lease that expired in June 2005.
As of December 31, 2006, we had no debt and no long term liabilities. The following table summarizes our
contractual obligations as of December 31, 2006 (in thousands):
Payments due by period
Contractual obligations:
Operating Lease Obligations
Purchase Obligations
Total
Total
2,006
332
2,338
$
$
Less than
1 year
$
679
332
1,011
$
1-3 years
$
1,141
3-5 years
$
186
More than
5 years
$
-
$
1,141
$
186
$
-
During our normal course of business, we have made certain indemnities, commitments and guarantees
under which we may be required to make payments in relation to certain transactions. These include: intellectual
property indemnities to our customers and licensees in connection with the use, sale and/or license of our products;
indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease;
indemnities to vendors and service providers pertaining to claims based on the negligence or willful misconduct;
indemnities involving the accuracy of representations and warranties in certain contracts; and indemnities to
directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware. In
addition, we have made contractual commitments to employees providing for severance payments upon the
occurrence of certain prescribed events. We may also issue a guarantee in the form of a standby letter of credit as
security for contingent liabilities under certain customer contracts. The duration of these indemnities, commitments
and guarantees varies, and in certain cases, may be indefinite. The majority of these indemnities, commitments and
guarantees may not provide for any limitation of the maximum potential for future payments we could be obligated
to make. We have not recorded any liability for these indemnities, commitments and guarantees in the
accompanying consolidated balance sheets.
Critical Accounting Policies
Our discussion and analysis of results of operations, financial condition and liquidity are based upon our
consolidated financial statements, which have been prepared in accordance with accounting principles generally
accepted in the United States of America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the
reporting period. We base our estimates on historical experience and on various other assumptions that are believed
to be reasonable under the circumstances. Actual results may materially differ from these estimates under different
assumptions or conditions. On an on-going basis, we review our estimates to ensure that the estimates appropriately
reflect changes in our business or new information as it becomes available.
We believe the following critical accounting policies affect our more significant estimates and assumptions
used in the preparation of our consolidated financial statements:
Revenue Recognition - Software revenue is recognized in accordance with the Statement of Position (“SOP”)
97-2, Software Revenue Recognition, as amended, when persuasive evidence of an arrangement exists, delivery has
37
occurred, the price is fixed and determinable, and collectibility is probable. We recognize revenues from sales of
our software to OEM customers or end users as completed products are shipped and title passes; or from royalties
generated as authorized customers duplicate our software, if the other requirements of SOP 97-2 are met. If the
requirements of SOP 97-2 are not met at the date of shipment, revenue is not recognized until these elements are
known or resolved. Returns from OEM customers are limited to defective goods or goods shipped in error.
Historically, OEM customer returns have not exceeded the very nominal estimates and reserves. Management
reviews available retail channel information and makes a determination of a return provision for sales made to
distributors and retailers based on current channel inventory levels and historical return patterns. Certain sales to
distributors or retailers are made on a consignment basis. Revenue for consignment sales are not recognized until
sell through to the final customer is established. We have few multiple elements agreement for which we
have contracted to provide a perpetual license for use of proprietary software, to provide non-recurring
engineering, and in some cases to provide software maintenance (post contract support). For multiple
element agreements, vendor specific objective evidence for all contract elements is reviewed and the
timing of the individual element revenue streams is determined and recognized consistent with SOP 97-2.
Product sales directly to end-users are recognized upon delivery. End users have a thirty day right of
return, but such returns are reasonably estimable and have historically been immaterial. We also provide technical
support to our customers. Such costs have historically been insignificant.
Service revenues include sales of consulting services, website hosting and fulfillment. We recognize
service revenues as services are provided or as milestones are delivered and accepted by our customers.
Accounts Receivable – We sell our products worldwide. We perform ongoing credit evaluations of our
customers and adjust credit limits based upon payment history, the customer’s current credit worthiness and various
other factors, as determined by our review of their current credit information. We continuously monitor collections
and payments from our customers. We estimate credit losses and maintain a bad debt reserve based upon these
estimates. While such credit losses have historically been within our estimated reserves, we cannot guarantee that
we will continue to experience the same credit loss rates that we have in the past. If not, this could have an adverse
effect on our consolidated financial statements.
Goodwill – We have adopted SFAS No. 142, Goodwill and Other Intangible Assets, effective January 1,
2002 and no impairment was identified. As a result of the adoption, we are no longer required to amortize goodwill.
Prior to the adoption of SFAS 142, goodwill was amortized over 7 years. In accordance with SFAS No. 142, we
review the recoverability of the carrying value of goodwill at least annually or whenever events or circumstances
indicate a potential impairment. Our annual impairment testing date is December 31. Recoverability of goodwill is
determined by comparing the estimated fair value of our reporting units to the carrying value of the underlying net
assets in the reporting units. If the estimated fair value of a reporting unit is determined to be less than the fair value
of its net assets, goodwill is deemed impaired and an impairment loss is recognized to the extent that the carrying
value of goodwill exceeds the difference between the estimated fair value of the reporting unit and the fair value of
its other assets and liabilities. At December 31, 2006, we elected to write off all goodwill associated with our
services sector, or $335,000. The consulting portion of our services sector has been de-emphasized and is no longer
considered a strategic element of our go forward plan. The amount of the write off is included in general and
administrative expenses. We determined that we did not have any impairment of goodwill as related to the products
sector at December 31, 2006. Estimates of reporting unit fair value are based upon market capitalization and
therefore are volatile being sensitive to market fluctuations. To the extent that our market capitalization decreases
significantly or the allocation of value to our reporting units change, we could be required to write off some or all of
our goodwill.
Deferred Income Taxes - We account for income taxes under SFAS No. 109, Accounting for Income Taxes. This
statement requires the recognition of deferred tax assets and liabilities for the future consequences of events that
have been recognized in our financial statements or tax returns. The measurement of the deferred items is based on
enacted tax laws. In the event the future consequences of differences between financial reporting bases and the tax
bases of our assets and liabilities result in a deferred tax asset, SFAS No. 109 requires an evaluation of the
38
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. At the end of 2005, we had a full valuation allowance on our deferred tax assets. Based on our
assessment of all available evidence, we concluded that it is more likely than not that our deferred tax assets will be
fully realized in the future. This conclusion is based primarily on our improving financial performance and
projected income in the future years. As a result, we released all of our valuation allowance in 2006. The release of
the valuation allowance decreased our tax expense in 2006.
Stock-Based Compensation – We currently account for the issuance of stock options to employees using the fair
market value method according to SFAS No. 123R, Share-Based Payment.
Recent Accounting Pronouncements
In February 2006, the FASB issued Statement SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments, which amends SFAS No. 133, Accounting for Derivatives Instruments and Hedging Activities and
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.
SFAS No. 155 amends SFAS No. 133 to narrow the scope exception for interest-only and principal-only strips on
debt instruments to include only such strips representing rights to receive a specified portion of the contractual
interest or principle cash flows. SFAS No. 155 also amends SFAS No. 140 to allow qualifying special-purpose
entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative
instrument. We are currently evaluating the impact this new Standard but believe that it will not have a material
impact on our financial position, results of operations, or cash flows.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets (SFAS NO.
156), which provides an approach to simplify efforts to obtain hedge-like (offset) accounting. This Statement
amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. The
Statement (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an
obligation to service a financial asset by entering into a servicing contract in certain situations; (2) requires that a
separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable; (3)
permits an entity to choose either the amortization method or the fair value method for subsequent measurement for
each class of separately recognized servicing assets or servicing liabilities; (4) permits at initial adoption a one-time
reclassification of available-for-sale securities to trading securities by an entity with recognized servicing rights,
provided the securities reclassified offset the entity’s exposure to changes in the fair value of the servicing assets or
liabilities; and (5) requires separate presentation of servicing assets and servicing liabilities subsequently measured
at fair value in the balance sheet and additional disclosures for all separately recognized servicing assets and
servicing liabilities. SFAS No. 156 is effective for all separately recognized servicing assets and liabilities as of the
beginning of an entity’s fiscal year that begins after September 15, 2006, with earlier adoption permitted in certain
circumstances. The Statement also describes the manner in which it should be initially applied. We do not believe
that SFAS No. 156 will have a material impact on our financial position, results of operations or cash flows.
In July 2006, the FASB released FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes,
an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting and reporting for
uncertainties in income tax law. This interpretation prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in
income tax returns. On January 17, 2007, the FASB affirmed its previous decision to make FIN 48 effective for
fiscal years beginning after December 15, 2006. Accordingly, we will adopt FIN 48 effective January 1, 2007.
Based on a preliminary analysis, we believe that the adoption of FIN 48 will not have a material impact
on our results of operation and financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which defines
the fair value, establishes a framework for measuring fair value and expands disclosures about fair value
measurements. This statement is effective for financial statements issued for fiscal years beginning after November
15, 2007, and interim periods within those fiscal years. Early adoption is encouraged, provided that we have not yet
39
issued financial statements for that fiscal year, including any financial statements for an interim period within that
fiscal year. We are currently in the process of evaluating the impact SFAS 157 may have on our results of operations
and financial position.
In September 2006, the FASB issued SFAS No. 158, Employer’s Accounting for Defined Benefit Pension and
Other Post Retirement Plans. SFAS No. 158 requires employers to recognize in its statement of financial position
an asset or liability based on the retirement plan’s over or under funded status. SFAS No. 158 is effective for fiscal
years ending after December 15, 2006. We are currently in the process of evaluating the effect that the application of
SFAS No. 158 will have on our results of operations and financial position.
In September 2006, the United States Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements (SAB 108). This SAB provides guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108
establishes an approach that requires quantification of financial statement errors based on the effects of each of the
company’s balance sheets and statement of operations and the related financial statement disclosures. The SAB
permits existing public companies to record the cumulative effect of initially applying this approach in the first year
ending after November 15, 2006 by recording the necessary correcting adjustments to the carrying values of assets
and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of
retained earnings. Additionally, the use of the cumulative effect transition method requires detailed disclosure of the
nature and amount of each individual error being corrected through the cumulative adjustment and how and when it
arose. We are currently in the process of evaluating the impact SAB 108 may have on our results of operations or
financial position.
In October 2006, the Emerging Issues Task Force (EITF) issued EITF 06-3, How Taxes Collected from
Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross
versus Net Presentation) to clarify diversity in practice on the presentation of different types of taxes in the financial
statements. The Task Force concluded that, for taxes within the scope of the issue, a company may adopt a policy of
presenting taxes either gross within revenue or net. That is, it may include charges to customers for taxes within
revenues and the charge for the taxes from the taxing authority within cost of sales, or, alternatively, it may net the
charge to the customer and the charge from the taxing authority. If taxes subject to EITF 06-3 are significant, a
company is required to disclose its accounting policy for presenting taxes and the amounts of such taxes that are
recognized on a gross basis. The guidance in this consensus is effective for the first interim reporting period
beginning after December 15, 2006 (the first quarter of our fiscal year 2007). We do not expect the adoption of EITF
06-3 will have a material impact on our results of operations, financial position or cash flow.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure at fair value
many financial instruments and certain other items that are not currently required to be measured
at fair value. Subsequent changes in fair value for designated items will be required to be reported
in earnings in the current period. SFAS No. 159 also establishes presentation and disclosure
requirements for similar types of assets and liabilities measured at fair value. SFAS No. 159 is
effective for fiscal years beginning after November 15, 2007. We are currently assessing the effect of
implementing this guidance, which directly depends on the nature and extent of eligible items
elected to be measured at fair value, upon initial application of the standard on January 1, 2008.
40
Item 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
Our financial instruments include cash and cash equivalents. At December 31, 2006, the carrying values of
our financial instruments approximated fair values based on current market prices and rates. Because of their short
duration, changes in market interest rates would not have a material effect on fair value.
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, 2006.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and schedule appear in a separate section of this Annual
Report on Form 10-K beginning on page F-1 and S-1, respectively.
41
SUPPLEMENTARY FINANCIAL DATA
SELECTED QUARTERLY FINANCIAL DATA
STATEMENT OF OPERATIONS DATA
(UNAUDITED)
Three Months Ended:
2006
March 31,
June 30,
September 30,
December 31,
(in thousands, except per share amounts)
Net Revenues
Gross Profit
Operating Income
Net Income
$
$
$
$
9,885
6,586
1,627
1,812
12,555
7,250
851
1,083
14,801
8,711
2,137
2,450
17,228
11,663
4,172
3,611
$
$
$
$
Net Income Per Share, Basic
$
0.08
$
0.05
$
0.10
$
0.14
Weighted Average Shares
Outstanding, Basic
22,303
23,635
24,123
24,930
Net Income Per Share, Diluted
$
0.07
$
0.04
$
0.09
$
0.14
Weighted Average Shares
Outstanding, Diluted
24,284
25,598
25,794
26,687
2005
March 31,
June 30,
September 30,
December 31,
(in thousands, except per share amounts)
Three Months Ended:
Net Revenues
Gross Profit
Operating (Loss) Income
Net (Loss) Income
$
$
$
$
2,030
1,685
(228)
(128)
3,330
2,785
558
764
6,896
5,731
1,763
1,877
8,002
5,954
2,068
2,211
$
$
$
$
Net (Loss) Income Per Share, Basic
$
(0.01)
$
0.04
$
0.09
$
0.10
Weighted Average Shares Outstanding,
Basic
19,665
21,584
22,016
22,106
Net (Loss) Income Per Share, Diluted
$
(0.01)
$
0.03
$
0.08
$
0.09
Weighted Average Shares
Outstanding, Diluted
19,665
22,713
23,222
23,900
42
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
Item 9A. CONTROLS AND PROCEDURES
(a)
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and
procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and
that such information is accumulated and communicated to our management including our Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. Under the
supervision and with the participation of our management, including our Chief Executive Officer and our Chief
Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures
(as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered in this report.
Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of
the period covered by this report, our disclosure controls and procedures were effective in timely alerting them to the
material information related to us (or our consolidated subsidiaries) required to be included in the reports we file or
submit under the Exchange Act.
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting. The
Company's internal control framework and processes were designed to provide reasonable assurance to management
and the Board of Directors regarding the reliability of financial reporting and the preparation of the Company's
consolidated financial statements for external purposes in accordance with accounting principles generally accepted
in the United States of America.
Management recognizes its responsibility for fostering a strong ethical climate so that the Company's affairs are
conducted according to the highest standards of personal and corporate conduct. The Company's internal control
over financial reporting includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the Company;
• provide reasonable assurance that transactions are recorded properly to allow for the preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the Company are being made only in accordance with authorizations of management
and Directors of the Company; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the Company's assets that could have a material effect on the consolidated
financial statements.
Because of its inherent limitations, a system of internal control over financial reporting can provide only
reasonable assurance and may not prevent or detect misstatements. Further, because of changing conditions,
effectiveness of internal control over financial reporting may vary over time. The Company's processes contain self-
monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.
43
To comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, the Company
designed and implemented a structured and comprehensive compliance process to evaluate its internal control over
financial reporting across the enterprise.
Management's Process to Assess the Effectiveness of Internal Control Over Financial Reporting
Management's conclusion on the effectiveness of internal control over financial reporting is based on a thorough
and comprehensive evaluation and analysis of the five elements of the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control - Integrated Framework.
(shown in italics below), and is based on, but not limited to, the following:
• Documentation of entity-wide controls establishing the culture and "tone-at-the-top" of the organization, in
support of the Company’s Control Environment, Risk Assessment Process, Information and Communication
policies and the ongoing Monitoring of these control processes and systems.
• An evaluation of Control Activities by work process. Key controls and compensating controls were
documented and tested by each work process within the Company, including controls over all relevant
financial statement assertions related to all significant accounts and disclosures. Internal control
deficiencies were identified and prioritized, and appropriate remediation action plans were defined,
implemented and retested.
• A centralized review and analysis of all internal control deficiencies across the enterprise to determine
whether such deficiencies, either separately or in the aggregate, represented a significant deficiency or
material weakness.
• An evaluation of any changes in work processes, systems, organization or policy that could materially
impact internal control over financial reporting.
Management assessed the effectiveness of the Company's internal control over financial reporting and
concluded that, as of December 31, 2006, such internal control is effective. In making this assessment, management
used the criteria set forth by COSO. Management’s assessment of the effectiveness of our internal control over
financial reporting has been audited by Singer Lewak Greenbaum & Goldstein LLP, an independent registered
public accounting firm, as stated in their report which is included herein.
(b)
Changes in Internal Controls. During the most recent fiscal quarter covered by this report, there has
been no change in our internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the
Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
Item 9B. OTHER INFORMATION
None.
44
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth certain information regarding our executive officers as of March 1, 2007.
Name
William W. Smith, Jr.
Andrew C. Schmidt
David P. Sperling
Jonathan Kahn
William R. Wyand
Christopher G. Lippincott
Age
59
45
38
49
59
36
Position
Chairman of the Board, President
and Chief Executive Officer
Chief Financial Officer
Vice President and Chief Technical
Officer
Senior Vice President
Vice President, Wireless and OEM
Sales
Vice President, Operations
Mr. Smith co-founded Smith Micro and has served as our Chairman of the Board, President and Chief
Executive Officer since inception in 1982. Mr. Smith was employed by Rockwell International Corporation in a
variety of technical and management positions from 1975 to 1984. Mr. Smith served with Xerox Data Systems from
1972 to 1975 and RCA Computer Systems Division from 1969 to 1972 in mainframe sales and pre-sale technical roles.
Mr. Smith received a B.A. in Business Administration from Grove City College.
Mr. Schmidt joined the Company in June 2005 and serves as the Company’s Chief Financial Officer. Prior to
joining Smith Micro, Mr. Schmidt was the Chief Financial Officer of Genius Products, Inc., a publicly traded
entertainment company from August 2004 to June 2005. From April 2003 to June 2004, he was Vice President
(Finance) and acting Chief Accounting Officer of Peregrine Systems, Inc., a publicly held provider of enterprise level
software then in Chapter 11 reorganization. From July 2000 to January 2003, he was Executive Vice President and
Chief Financial Officer of Mad Catz Interactive, Inc., a publicly traded provider of console video game accessories. He
holds a B.B.A. in Finance from the University of Texas and an M.S. in Accountancy from San Diego State University.
Mr. Sperling joined us in April 1989 and has been our Director of Software Engineering since April 1992.
He assumed the Chief Technology Officer position in September 1999. Mr. Sperling began his professional career
as a software engineer with us and he currently has three patents pending for various telephony and Internet
technologies. Mr. Sperling holds a B.S. degree in Computer Science and an MBA from the University of California,
Irvine.
Mr. Kahn joined the company with the acquisition of Allume Systems, Inc. in July 2005. Prior to the
acquisition, Mr. Kahn was President of the company. Mr. Kahn was one of the co-founders of Aladdin Systems, Inc.
which later became Allume Systems. Mr. Kahn was Chairman, President and Chief Executive Officer of Monterey Bay
Tech, Inc (OTC BB:MBYI), a public company from 1999 to May 2005 until its merger with SecureLogic Inc. Mr.
Kahn is a member of the Digital River Advisory Board and is a graduate of the University of Rhode Island with a B.A.
in Economics.
Mr. Wyand joined us in 1999 when Smith Micro acquired STF Technologies where Mr. Wyand was
President and Chief Executive Officer. As General Manager he ran the Macintosh division sales, marketing,
engineering and customer support efforts. Later that year, Mr. Wyand moved into the newly created Wireless and
Broadband division as General Manager and in 2004 became Vice President, Wireless and OEM Sales. From 1995
45
to 1999, Mr. Wyand was President and Chief Executive Officer of STF Technologies. From 1984 to 1995, Mr.
Wyand held various interim management and consulting positions. From 1977 to 1984, he held various positions
with United Telecom Computer Group. From 1973 to 1977, he was a Consultant with Arthur Young & Co. He
graduated with a B.S. from Pennsylvania State University and an MBA from Rockhurst College.
Mr. Lippincott joined us in 1993 as a senior sales representative. In 1998 he was appointed Director of
North American Sales and in 2000 named General Manager of the Internet Solutions Division, as Vice President,
Internet and Direct Sales in 2004 and then Vice President, Operations in 2007. Prior to joining Smith Micro, Mr.
Lippincott held several retail sales positions. He attended the University of California at Berkeley majoring in
business administration.
Officers are elected by, and serve at the discretion of, the Board of Directors.
For information about our Directors, please see the section titled “Directors and Executive Officers”
appearing in our Proxy Statement for our 2007 Annual Meeting of Stockholders, which is hereby incorporated by
reference.
The section titled “Corporate Governance” appearing in our Proxy Statement for our 2007 Annual Meeting
of Stockholders is hereby incorporated by reference.
Audit Committee; Audit Committee Financial Expert
Our Board of Directors has a standing Audit Committee. The members of the Audit Committee are
Messrs. Campbell, Gulko and Szabo. Our Board has determined that Mr. Gulko, Chairman of the Audit Committee,
is an audit committee financial expert as defined by Item 401(h) of Regulation S-K and that each member of the
Audit Committee is independent within the meaning of Nasdaq Marketplace Rule 4200(a)(15).
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires certain of the company’s executive officers, as well as its
directors and persons who own more than then percent (10%) of a registered class of the Company’s equity
securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission.
Based solely on its review of the copies of such forms received by the Company, or written representations
from certain reporting person, the Company believes that during the last fiscal year all executive officers and
directors complied with their filing requirements under Section 16(a) for all reportable transactions during the year.
Code of Ethics
We have adopted a Code of Ethics that applies to all of our employees, including our principal executive
officer, our principal financial officer, and all members of our finance department performing similar functions. Our
Code of Ethics was filed as Exhibit 14 to the Annual Report on Form 10-K for the year ended December 31, 2003
which was filed on March 25, 2004. In the event of an amendment to, or a waiver from, certain provisions of our Code
of Ethics, we intend, to the extent possible, to satisfy Form 8-K disclosure requirements by disclosing this information
on our website at www.smithmicro.com.
Item 11. EXECUTIVE COMPENSATION
The section titled “Executive Compensation and Related Information” appearing in our Proxy Statement
for our 2007 Annual Meeting of Stockholders is hereby incorporated by reference.
46
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The section titled “Ownership of Securities and Related Stockholder Matters” appearing in our Proxy
Statement for our 2007 Annual Meeting of Stockholders is hereby incorporated by reference.
Securities Authorized for Issuance Under An Equity Compensation Plan
The following table provides information as of December 31, 2006 with respect to the shares of common
stock that may be issued under our existing equity compensation plans.
(In thousands, except per share amounts)
Equity Compensation Plan Approved
by Shareholders (1)
Equity Compensation Plan Not Approved
by Shareholders
Total
Number of Shares to be
Issued Upon Exercise
of Outstanding Options
Weighted Average
Exercise Price of
Outstanding
Options
Number of Shares
Remaining Available
for Future Issuance
2,518
0
2,518
$4.80
0
$4.80
2,151
0
2,151
(1) The number of shares to be issued upson exercise includes options granted under both the
1995 Stock Option/Stock Issuance Plan and the 2005 Stock Option/Stock Issuance Plan.
The number of shares remaining available for future issuance consists only of the 2005 Plan.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The section titled “Related Party Transactions” and “Director Independence” appearing in our Proxy
Statement for our 2007 Annual Meeting of Stockholders is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The section titled “Ratification of Appointment of Independent Registered Public Accounting Firm –
Principal Accountant Fees and Services” appearing in our Proxy Statement for our 2007 Annual Meeting of
Stockholders is incorporated herein by reference.
47
PART IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(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
Report of Independent Registered Public Accounting Firm ................................................................................... F-1
Consolidated Balance Sheets as of December 31, 2006 and 2005.......................................................................... F-4
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 2006.................................................................................................................... F-5
Consolidated Statements of Stockholders’ Equity for each of the three
years in the period ended December 31, 2006...................................................................................................... F-6
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2006 ......................................................................................................................... F-7
Notes to Consolidated Financial Statements for each of the three years
in the period ended December 31, 2006 ............................................................................................................... F-8
(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
Schedule II - Valuation and Qualifying Accounts for each of the three years in
the period ended December 31, 2006..................................................................................................................... S-1
(3) Exhibits
Exhibit
No.
Title
2.1
2.2
2.3
Stock Purchase Agreement, dated July 1,
2005, between Smith Micro Software, Inc.
and International Microcomputer Software,
Inc. (sole shareholder of Allume Systems,
Inc.)
Agreement and Plan of Merger, dated April
3, 2006, by and among Smith Micro
Software, Inc., Tag Acquisition Corporation,
Tag Acquisition Corporation II, Photags,
Inc., Harry Fox, and certain stockholders of
Photags, Inc.
Agreement and Plan of Merger, dated
January 31, 2007, by and among Smith
Micro Software, Inc., TEL Acquisition
Corp., Ecutel Systems, Inc., John J.
McDonnell, Jr. and certain stockholders of
Ecutel Systems, Inc.
48
Method of Filing
Incorporated by reference to Exhibit 2.1 to the
Registrant’s Current Report on Form 8-K filed on
July 5, 2005.
Incorporated by reference to Exhibit 2.1 to the
Registrant’s Current Report on Form 8-K filed on
April 7, 2006
Incorporated by reference to Exhibit 2.1 to the
Registrant’s Current Report on Form 8-K filed on
February 6, 2007.
2.4
3.1
3.1.1
3.1.2
3.2
4.1
10.4 †
10.4.1†
10.4.2†
10.5*
10.6*
Exhibit
No.
Title
Asset Purchase Agreement, dated
February 11, 2007, by and among Smith
Micro Software, Inc., IS Acquisition Sub,
Inc., Insignia Solutions plc, Insignia
Solutions Inc. and Insignia Solutions AB.
Method of Filing
Incorporated by reference to Exhibit 2.2 to the
Registrant’s Current Report on Form 8-K filed on
February 13, 2007.
Amended and Restated Certificate of
Incorporation of the Registrant.
Incorporated by reference to Exhibit 3.1 to the
Registrant's Registration Statement No. 33-95096.
Amendment to the Amended and Restated
Certificate of Incorporation of the
Registrant.
Incorporated by reference to Exhibit 3.1.1 to the
Registrant’s Quarterly Report on Form 10-Q for the
period ended June 30, 2000.
Certificate of Amendment to Amended and
Restated Certificate of Incorporation of
Registrant as filed August 18, 2005 with
Delaware Secretary of State
Incorporated by reference to Exhibit 3.1.2 to the
Registrant’s Annual Report on Form 10-K for the
period ended December 31, 2005.
Amended and Restated Bylaws of the
Registrant.
Incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement No. 33-95096.
Specimen certificate representing shares of
Common Stock of the Registrant.
Incorporated by reference to Exhibit 4.1 to the
Registrant's Registration Statement No. 33-95096.
10.1
Form of Indemnification Agreement.
10.2*
1995 Stock Option/Stock Issuance Plan as
Amended and Restated through February 7,
2001.
10.3*
2005 Stock Option / Stock Issuance Plan
Master Software License and Distribution
Agreement (Contract No. 220-00-0134)
effective as of December 1, 2000, between
Cellco Partnership (d/b/a Verizon Wireless)
and the Registrant
Incorporated by reference to Exhibit 10.1 to the
Registrant's Registration Statement No. 33-95096.
Incorporated by reference to the Appendix attached
to the Definitive Proxy Statement for the 2001
Annual Meeting of Stockholders filed on April 27,
2001.
Incorporated by reference to Appendix A attached to
the Definitive Proxy Statement for the 2005 Annual
Meeting as filed June 10, 2005.
Incorporated by reference to Exhibit 10.1 to the
Registrant’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003.
Amendment of Master Software License and
Distribution Agreement (Contract No. 220-
00-0134)
Incorporated by reference to Exhibit 10.1.1 to the
Registrant’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003.
Amendment No. 2 to the Master Software
License and Distribution Agreement
(Contract No. 220-00-0134)
Incorporated by reference to Exhibit 10.1.2 to the
Registrant’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003.
Letter Agreement, dated June 13, 2005, by
and between Smith Micro Software, Inc. and
Andrew Schmidt
Incorporated by reference to Exhibit 10.5 to the
Registrant’s Current Report on Form 8-K filed on
November 30, 2006.
Employment Agreement dated April 9, 1999
by and between Smith Micro Software, Inc.
and William Wyand.
Incorporated by reference to Exhibit 10.6 to the
Registrant’s Current Report on Form 8-K filed on
November 30, 2006.
49
Exhibit
No.
Title
14.1
Code of Ethics
14.1.1
Attachment 1 to Code of Ethics
21.1
Subsidiaries
Method of Filing
Incorporated by reference to Exhibit 14.1 to the
Registrant’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2003.
Incorporated by reference to Exhibit 14.1 to the
Registrant’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2003.
Incorporated by reference to Exhibit 21.1 to the
Registrant’s Annual Report on Form 10-K for the
fiscal year ended December 31, 2000.
23.1
31.1
31.2
32.1
Consent of Independent Registered Public
Accounting Firm.
Filed herewith
Certification of the Chief Executive Officer
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
Certification of the Chief Financial Officer
pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002
Certifications of the Chief Executive Officer
and the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
Filed herewith
Filed herewith
Furnished herewith
___________________
*
Indicates management contract or compensatory plan or arrangement.
†
Confidential treatment has been granted with respect to certain confidential portions of this exhibit pursuant to
Rule 24b-2 under the Securities Exchange Act of 1934, which confidential portions have been omitted from
the exhibit and filed separately with the Securities and Exchange Commission.
(b)
Exhibits
The exhibits filed as part of this report are listed above in Item 15(a) (3) of this Form 10-K.
(c)
Financial Statement Schedule
The Financial Statement Schedule required by Regulation S-X and Item 8 of this Form are listed above in
Item 15(a)(2) of this Form 10-K.
50
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.
SIGNATURES
SMITH MICRO SOFTWARE, INC.
Date: March 29, 2007
Date: March 29, 2007
By:/s/ William W. Smith, Jr.
William W. Smith, Jr.
Chairman of the Board,
President and Chief Executive Officer
(Principal Executive Officer)
By:/s/ Andrew C. Schmidt
Andrew C. Schmidt,
Chief Financial Officer
(Principal Financial and Accounting 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
/s/ William W. Smith, Jr.
William W. Smith, Jr.
Chairman of the Board,
President and Chief Executive Officer
(Principal Executive Officer)
Date
March 29, 2007
/s/ Andrew C. Schmidt
Andrew C. Schmidt
Chief Financial Officer (Principal Financial
and Accounting Officer)
March 29, 2007
/s/ Thomas G. Campbell
Thomas G. Campbell
Director
/s/ Samuel Gulko
Samuel Gulko
/s/ Ted L. Hoffman
Ted L. Hoffman
Director
Director
/s/ William C. Keiper
William C. Keiper
Director
/s/Gregory J. Szabo
Gregory J. Szabo
Director
51
March 29, 2007
March 29, 2007
March 29, 2007
March 29, 2007
March 29, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of
Smith Micro Software, Inc.:
We have audited the consolidated balance sheets of Smith Micro Software, Inc. and subsidiaries (the
“Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations,
stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2006. Our
audits also included the financial statement schedule of the Company listed in Item 15(a). These financial
statements and financial statement schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). 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 also 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 subsidiaries as of December 31, 2006 and 2005, and the results of
their operations and their cash flows for each of the three years in the period ended December 31, 2006, in
conformity with U. S. generally accepted accounting principles. Also, in our opinion, the related 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.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the effectiveness of Smith Micro Software, Inc. and subsidiaries’ internal control over
financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and
our report dated March 16, 2007 expressed an unqualified opinion on management’s assessment of the
effectiveness of Smith Micro Software, Inc.’s internal control over financial reporting and an unqualified
opinion on the effectiveness of Smith Micro Software, Inc.’s internal control over financial reporting.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 16, 2007
F-1
To the Audit Committee
Smith Micro Software, Inc.
Aliso Viejo, CA 92656
We have audited management's assessment, included in the accompanying “Management’s Report on Internal
Control over Financial Reporting,” that Smith Micro Software, Inc. (the “Company”) maintained effective
internal control over financial reporting as of December 31, 2006, based on criteria established in Internal
Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO). The Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal control over financial reporting.
Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness
of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating effectiveness of internal control,
and performing such other procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principles. A company's internal control over financial
reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over
financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria
established in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion, the Company maintained, in all
material respects, effective internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the consolidated balance sheets of the Company as of December 31, 2006 and 2005, and the
F-2
related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years
in the period ended December 31, 2006 of the Company and our report dated March 16, 2007 expressed an
unqualified opinion.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 16, 2007
F-3
SMITH MICRO SOFTWARE INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2006 AND 2005
(In thousands, except share and per share data)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents
Accounts receivable, net of allowances for doubtful accounts
and other adjustments of $500 (2006) and $439 (2005)
Income tax receivable
Deferred tax asset - current
Inventories, net
Prepaid expenses and other current assets
Total current assets
EQUIPMENT AND IMPROVEMENTS, net
INTANGIBLE ASSETS, net
DEFERRED TAX ASSET - LONG TERM
GOODWILL
OTHER ASSETS, net
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable
Accrued liabilities
Total current liabilities
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS’ EQUITY:
Preferred stock, par value $0.001 per share; 5,000,000 shares
authorized; none issued and outstanding
Common stock, par value $0.001 per share; 50,000,000 shares
authorized; 28,444,000 and 22,147,000 shares issued and outstanding
Additional paid-in capital
Accumulated deficit
Total stockholders’ equity
See accompanying notes to consolidated financial statements
F-4
2006
2005
$
92,564
$
21,215
9,828
122
90
857
308
6,786
--
--
530
556
103,769
29,087
417
3,788
7,786
15,266
--
241
4,093
--
9,288
7
$
131,026
$
42,716
$
2,941
2,028
$
2,383
1,376
4,969
3,759
28
129,018
(2,989)
22
50,880
(11,945)
126,057
38,957
$
131,026
$
42,716
SMITH MICRO SOFTWARE INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
(In thousands, except per share data)
NET REVENUES:
Products
Services
Total Net Revenues
COST OF REVENUES:
Products
Services
Total Cost of Revenues
GROSS PROFIT
OPERATING EXPENSES:
Selling and marketing
Research and development
General and administrative
Years ended December 31,
2006
2005
2004
$
53,773
696
$
19,637
621
$
12,394
922
54,469
20,258
13,316
19,989
270
20,259
34,210
9,057
7,899
8,467
3,818
285
4,103
2,530
380
2,910
16,155
10,406
3,410
3,963
4,621
1,519
2,556
2,868
6,943
3,463
53
3,516
71
Total operating expenses
25,423
11,994
OPERATING INCOME
INTEREST INCOME
INCOME BEFORE INCOM E TAXES
INCOME TAX EXPENSE
NET INCOM E
8,787
1,403
10,190
1,234
4,161
667
4,828
104
$
8,956
$
4,724
$
3,445
NET INCOME PER SHARE, basic
$
0.38
$
0.22
$
0.20
WEIGHTED AVG SHARES OUTSTANDING,
basic
23,753
21,351
17,267
NET INCOME PER SHARE, diluted
$
0.35
$
0.21
$
0.19
WEIGHTED AVG SHARES OUTSTANDING,
diluted
See accompanying notes to consolidated financial statements
25,330
22,806
18,412
F-5
SMITH MICRO SOFTWARE INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
(In thousands
BALANCE, December 31, 2003
Exercise of common stock options
Tax benefit related to the exercise
of stock options
Net income
BALANCE, December 31, 2004
Issuance of common stock in
private placement
Issuance of common stock in
Allume acquisition
Exercise of common stock options
Tax benefit related to the exercise
of stock options
Non cash compensation recognized
on stock options
Net income
BALANCE, December 31, 2005
Issuance of common stock in secondary
offering, net of offering costs
Issuance of common stock in
PhoTags acquisition
Exercise of common stock options
Restricted Stock Grants
Tax benefit related to the exercise
of stock options and release of
valuation allowance
Non cash compensation recognized
on stock options
Net income
Common stock
Shares
Amount
17,011
1,000
$
17
1
Additional
paid-in
capital
$
25,687
1,995
Accumulated
deficit
$
(20,114)
Total
$
5,590
1,996
3,445
68
3,445
(16,669)
11,099
18
4
18,011
3,500
398
238
68
27,750
20,782
1,858
369
20
101
22,147
22
50,880
4,724
(11,945)
4,000
385
1,462
450
4
2
54,994
4,730
4,185
2,020
9,567
2,642
8,956
20,786
1,858
369
20
101
4,724
38,957
54,998
4,730
4,187
2,020
9,567
2,642
8,956
BALANCE, December 31, 2006
28,444
$
28
$
129,018
$
(2,989)
$
126,057
See accompanying notes to consolidated financial statements
F-6
SMITH MICRO SOFTWARE INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
(In thousands)
Years ended December 31,
2005
2004
2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization
Provision for doubtful accounts
and other adjustments to accounts receivable
Tax benefit related to the exercise of stock options
Non cash stock compensation expense
Release of tax valuation allowance
Change in operating accounts:
Accounts receivable
Deferred Income Taxes
Income tax receivable
Inventories
Prepaid expenses and other assets
Accounts payable and accrued liabilities
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of PhoTags, Inc., net of cash acquired
Acquisition of Allume Systems, Inc., net of cash acquired
Capital expenditures
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of offering costs
Proceeds from exercise of stock options
Net cash provided by financing activities
NET CHANGE IN CASH & CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS, beginning of year
$
8,956
$
4,724
$
3,445
2,098
468
1,781
4,662
7,786
(3,510)
(8,376)
(122)
(327)
174
1,160
901
573
20
101
--
146
112
68
--
--
(4,513)
(1,395)
--
35
(246)
(109)
978
--
(35)
(25)
(30)
732
14,750
2,464
3,018
(2,224)
--
--
(362)
(10,896)
(142)
(2,586)
(11,038)
54,998
4,187
59,185
71,349
21,215
20,786
369
21,155
12,581
8,634
--
--
(102)
(102)
1,996
--
1,996
4,912
3,722
CASH AND CASH EQUIVALENTS, end of year
$
92,564
$
21,215
$
8,634
See accompanying notes to consolidated financial statements
F-7
SMITH MICRO SOFTWARE INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006 (Continued)
(In thousands)
Year ended December 31,
2005
2006
2004
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION -
Cash paid during the year for income taxes
$ 203
$ 42
$ 38
See accompanying notes to consolidated financial statements
F-8
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business - Smith Micro Software, Inc. and subsidiaries (the “Company”) is a
developer and marketer of communications and utilities software products and services. Our
business model is based primarily upon developing and marketing innovative software
solutions for the wireless industry. We sell our products and services to some of the world’s
leading wireless companies as well as to consumers. Our products are primarily directed to
wireless data connectivity, including wireless wide area network (WWAN) for CDMA/GPRS
networks, and wireless local area network (WLAN) for Wi-Fi. We also provide software to
manage music and other multimedia content, including photo and full motion video, on
mobile devices. We are also heavily involved in data compression, primarily focused on a
unique way of compression to enable enhanced wireless communications. Our software
products target the original equipment manufacturers (“OEM”) market, particularly wireless
service providers and mobile device manufacturers, as well as direct to the consumer. Smith
Micro’s fundamental product design philosophy is to enhance, simplify, and streamline
applications to ensure the best possible consumer experience. Since our inception in 1983, we
have shipped over 60 million copies of our various software products.
On April 5, 2006, the Company acquired PhoTags, Inc. (“PhoTags”), a Delaware Corporation
with offices in Jerusalem, Israel (see Note 2). PhoTags is a leading developer and marketer of
revolutionary photo and music management technology. The company's pioneering product
suite known as Active Images turns any JPEG file into a self-contained multimedia messaging
system, allowing users to send text messages, music, sound files, documents and more - all in
a single JPEG file. Among PhoTags' product suite was Music Express, now known as
QuickLink Music, an innovative music management solution which assists users to enhance
the media-rich capabilities of listening to music on their PCs. QuickLink Music allows users
to simplify managing their music files, buy music from an online store and manage music
files on a PC. PhoTags Inc.'s patented Active Images technology is designed to easily add any
type of metadata or media file to a JPEG Image. Watermarks, forms, text messages, music,
links to Internet sites, voice recordings, portable digital wallet information, and even videos
can all be stored in a JPEG image, and accessed on any device that has the Active Image thin
client application installed. This technology plays directly into Smith Micro's strategy of
broadening its wireless product offerings and provides for the first time that carriers and
handset manufacturers can provide enhanced music and photo management technology that
can reside directly in the handset and on a consumer’s PC. In addition to broadening Smith
Micro's family of mobility products, the PhoTags acquisition will help expand Smith Micro's
ability to serve OEM customers in Europe and Asia through an international sales and support
office based in Jerusalem, Israel that is now renamed Smith Micro Software, Israel.
On July 1, 2005, the Company acquired Allume Systems (“Allume”), which was a wholly
owned subsidiary of International Microcomputer Software, Inc. (see Note 3). Allume
develops and publishes award-winning software solutions that empower users in the area of
F-9
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
information access, removal, recovery, security, productivity and online distribution.
Allume’s flagship product is StuffIt® Deluxe. StuffIt Wireless, a new and advanced
technology that is patent pending by Allume Systems, will compress an already compressed
JPEG file by up to 30% more without loosing any of the picture quality. This technology is
particularly important to mobile phone manufactures who now can store up to 30% more
images and carriers who are interested in the reduction of utilized bandwidth. Other award
winning products include icSpyware Suite® and Internet Cleanup® which targets spyware
and phishing intrusions, and Spring Cleaning® which cleans and optimizes computer
operating systems.
Basis of Presentation - The accompanying consolidated financial statements reflect the
operating results and financial position of Smith Micro Software, Inc. and its wholly owned
subsidiaries in accordance with accounting principles generally accepted in the United States
of America. All intercompany amounts have been eliminated in consolidation.
Cash and Cash Equivalents - Cash and cash equivalents generally consist of cash,
government securities and money market funds. These securities are primarily held in one
financial institution and are uninsured except for minimum FDIC coverage. As of December
31, 2006 and December 31, 2005, balances totaling approximately $93.1 million and $21.4
million, respectively, were uninsured. All have original maturity dates of three months or
less.
Accounts Receivable - The Company performs ongoing credit evaluations of its customers
and generally does not require collateral. The Company maintains allowances for estimated
credit losses, and those losses have been within management’s estimates. Allowances for
product returns are included in other adjustments to accounts receivable on the accompanying
consolidated balance sheets. Product returns are estimated based on historical experience and
have also been within management’s estimates.
Inventories - Inventories consist principally of cables, CDs, boxes and manuals and are stated
at the lower of cost (determined by the first-in, first-out method) or market. The Company
regularly reviews its inventory quantities on hand and records a provision for excess and
obsolete inventory based primarily on management’s estimated forecast of product demand
and production requirements. At December 31, 2006 our inventory balance consisted of
approximately $95,000 in assembled products and $762,000 of components.
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.
F-10
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Long Lived Assets - The Company accounts for the impairment and disposition of long-lived
assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for Impairment or Disposal of Long-Lived Assets. This statement addresses
financial accounting and reporting for the impairment of long-lived assets and for the disposal
of long-lived assets. In accordance with SFAS No. 144, long-lived assets to be held are
reviewed for events or changes in circumstances which indicate that their carrying value may
not be recoverable. The Company periodically reviews the carrying value of long-lived
assets to determine whether or not an impairment to such value has occurred. The Company
has determined that there was no impairment at December 31, 2006.
Goodwill - The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets,
effective January 1, 2002 and no impairment was identified. As a result of the adoption, the
Company is no longer required to amortize goodwill. In accordance with SFAS No. 142, the
Company reviews the recoverability of the carrying value of goodwill at least annually or
whenever events or circumstances indicate a potential impairment. The Company’s annual
impairment testing date is December 31. Recoverability of goodwill is determined by
comparing the fair value of the Company’s reporting units to the carrying value of the
underlying net assets in the reporting units. If the fair value of a reporting unit is determined
to be less than the carrying value of its net assets, goodwill is deemed impaired and an
impairment loss is recognized to the extent that the carrying value of goodwill exceeds the
difference between the fair value of the reporting unit and the fair value of its other assets and
liabilities. At December 31, 2006, we elected to write off all goodwill allocated to the
services sector, or $335,000. The consulting portion of our services sector has been de-
emphasized and is no longer considered a strategic element of our go forward plan. The
amount of the write off is included in general and administrative expenses. We determined
that we did not have any impairment of goodwill associated with the products sector at
December 31, 2006.
Revenue Recognition - Software revenue is recognized in accordance with the Statement of
Position (“SOP”) 97-2, Software Revenue Recognition, as amended, when persuasive
evidence of an arrangement exists, delivery has occurred, the price is fixed and determinable,
and collection is probable. The Company recognizes revenues from sales of its software to
Retail and OEM customers or end users as completed products are shipped and title passes, or
from royalties generated as authorized customers duplicate its software, if the other
requirements of SOP 97-2 are met. If the requirements of SOP 97-2 are not met at the date of
shipment, revenue is not recognized until these elements are known or resolved. Returns from
Retail and OEM customers are limited to defective goods or goods shipped in error.
Historically, OEM customer returns have not been significant. The Company reviews
available retail channel information and makes a determination of a return provision for sales
made to distributors and retailers based on current channel inventory levels and historical
return patterns. Certain sales to distributors are made on a consignment basis. Revenue for
consignment sales is not recognized until sell through to the final customer has occurred. The
F-11
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Company has few multiple elements agreement for which the Company has contracted to
provide a perpetual license for use of proprietary software, to provide non-recurring
engineering, and in some cases to provide software maintenance (post contract support). For
multiple element agreements, vendor specific objective evidence for all contract elements is
reviewed and the timing of the individual element revenue streams is determined and
recognized consistent with SOP 97-2.
Product sales directly to end users are recognized upon delivery. End users have a thirty day
right of return, but such returns are reasonably estimable and have historically been
immaterial. The Company also provides technical support to its customers. Such costs have
historically been insignificant.
Service revenues include sales of consulting services, web site hosting and fulfillment.
Service revenues are recognized as services are provided or as milestones are delivered and
accepted by our customers.
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, 2006, software has
been substantially completed concurrently with the establishment of technological feasibility;
and, accordingly, no costs have been capitalized to date.
Sales Incentives - Pursuant to the consensus of EITF 01-09, Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Product), effective
January 1, 2002, the cost of sales incentives the Company offers without charge to customers
that can be used in, or that are exercisable by a customer as a result of, a single exchange
transaction is accounted for as a reduction of revenue. Total rebates were $307,000,
$193,000 and $0 for the years ended December 31, 2006, 2005 and 2004, respectively.
Advertising Expense - Advertising costs are expensed as incurred. Advertising expenses were
$379,000, $223,000 and $47,000 for the years ended December 31, 2006, 2005 and 2004,
respectively.
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
F-12
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
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. The Company reversed all of its valuation allowance on its deferred tax assets
during the year ended 2006 as a result of the Company’s improving financial performance
and projected income in future years.
Stock-Based Compensation - Effective January 1, 2006, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 123(R), Share-Based Payment (SFAS 123(R)),
which requires the measurement and recognition of compensation expense for all share-based
payment awards made to employees and directors, including stock options based on their fair
values. SFAS 123(R) supersedes Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees (APB 25), which the Company previously followed in
accounting for stock-based awards. In March 2005, the SEC issued Staff Accounting Bulletin
No. 107 (SAB 107) to provide guidance on SFAS 123(R). The Company has applied SAB 107
in its adoption of SFAS 123(R).
The Company adopted SFAS 123(R) using the modified prospective transition method as of
and for the year ended December 31, 2006. In accordance with the modified prospective
transition method, the Company’s financial statements for prior periods have not been restated
to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense
recognized is based on the value of the portion of share-based payment awards that is
ultimately expected to vest. Share-based compensation expense recognized in the Company’s
Consolidated Statement of Operations during the year ended December 31, 2006 includes
compensation expense for share-based payment awards granted prior to, but not yet vested as
of, December 31, 2005 based on the grant date fair value estimated in accordance with the pro
forma provisions of SFAS 123.
In conjunction with the adoption of SFAS 123(R), the Company elected to attribute the value
of share-based compensation to expense using the straight-line method, which was previously
used for its pro forma information required under SFAS 123. Share-based compensation
expense related to stock options and restricted stock grants was $5.5 million for the year
ended December 31, 2006, and was recorded in the financial statements as follows (in
thousands):
F-13
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO
FOR EACH
OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Cost of Goods Sold
Selling and Marketing
Research and Development
General and Administrative
Total Stock Compensation Expense
2006
$
33
2,077
1,088
2,269
5,467
$
The Company’s calculations were made using the Black-Scholes option pricing model with
the following assumptions: expected life, 12 to 48 months following the grant date; average
stock volatility, 84.1% for grants issued in 2006; weighted average risk-free interest rate of
4.86% in the year ended December 31, 2006; and no dividends during the expected term.
In the year ended December 31, 2006 a total of 50,000 shares of Restricted Stock, with a total
value of $440,000, were granted to the Board of Directors. This cost will be amortized over
12 months. In addition, 400,000 shares of Restricted Stock, with a total value $4.3 million,
were granted to key officers and employees of the Company. This cost will be amortized over
24 months.
During the years ended December 31, 2005 and December 31, 2004, there was no share-based
compensation expense related to stock options recognized under the intrinsic value method in
accordance with APB 25. In addition, there was no compensation expense for restricted stock
grants as the Company had not issued any restricted stock prior to 2006. Had compensation
cost for the Company’s stock options been recognized based upon the estimated fair value on
the grant date under the fair value methodology prescribed by SFAS No. 123, as amended by
SFAS No. 148, the Company’s net income and income per share would have been as follows:
Year Ended December 31,
2005
2004
(in thousands, except per share data)
Net income, as reported
Less total stock based compensation
Pro forma net income
Income per Common Share
As reported, Basic
As reported, Diluted
Pro forma, Basic
Pro forma, Diluted
$
$
$
$
4,724
(1,582)
3,142
3,445
(308)
3,137
$
$
$
$
0.22
0.21
0.15
0.14
$
$
$
$
0.20
0.19
0.18
0.17
F-14
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
The Company’s calculations were made using the Black-Scholes option pricing model with
the following weighted average assumptions: expected life, 12 to 48 months following grant
date; stock volatility, 85% and 127% for grants issued in 2005 and 2004, respectively; risk-
free interest rates of 3.98% and 3.47% for 2005 and 2004, respectively; and no dividends
during the expected term. As stock-based compensation expense recognized in the
consolidated statement of operations pursuant to SFAS No. 123(R) is based on awards
ultimately expected to vest, expense for grants beginning upon adoption of SFAS No. 123(R)
on January 1, 2006 will be reduced for estimated forfeitures. SFAS No. 123(R) requires
forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical
experience.
Net Income per Share - Pursuant to SFAS No. 128, Earnings per Share, the Company is
required to provide 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 potential common shares outstanding. Potential common shares include stock options
using the treasury stock method.
Fulfillment Services - The Company currently holds consigned inventory from a customer,
which is used to fulfill orders. As the Company does not hold title to the inventory, it is not
recorded in the accompanying consolidated balance sheets. In addition, the Company
receives cash for fulfillment orders, which is paid out to the fulfillment customer on a
monthly basis. Such cash and the related payable are recorded on a net basis as the amounts
are held for the benefit of this fulfillment customer. Revenue is recognized for fulfillment
services as services are performed.
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 - 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, 2006, 2005 and 2004, there was no difference between net income and comprehensive
income.
Fair Value of Financial Instruments - The Company’s financial instruments consist of cash,
cash equivalents and trade receivables and payables. The carrying amounts of these
instruments approximate fair value because of their short-term maturities.
F-15
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
New Accounting Pronouncements - In February 2006, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting Issues (SFAS) No. 155, Accounting
for Certain Hybrid Financial Instruments, which amends SFAS No. 133, Accounting for
Derivatives Instruments and Hedging Activities and SFAS No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of Liabilities. SFAS 155 amends SFAS
No. 133 to narrow the scope exception for interest-only and principal-only strips on debt
instruments to include only such strips representing rights to receive a specified portion of the
contractual interest or principle cash flows. SFAS 155 also amends SFAS No. 140 to allow
qualifying special-purpose entities to hold a passive derivative financial instrument pertaining
to beneficial interests that itself is a derivative instrument. The Company is currently
evaluating the impact this new Standard but believes that it will not have a material impact on
the Company’s financial position, results of operations, or cash flows.
In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets
(SFAS 156), which provides an approach to simplify efforts to obtain hedge-like (offset)
accounting. This Statement amends FASB Statement 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the
accounting for separately recognized servicing assets and servicing liabilities. The Statement
(1) requires an entity to recognize a servicing asset or servicing liability each time it
undertakes an obligation to service a financial asset by entering into a servicing contract in
certain situations; (2) requires that a separately recognized servicing asset or servicing liability
be initially measured at fair value, if practicable; (3) permits an entity to choose either the
amortization method or the fair value method for subsequent measurement for each class of
separately recognized servicing assets or servicing liabilities; (4) permits at initial adoption a
one-time reclassification of available-for-sale securities to trading securities by an entity with
recognized servicing rights, provided the securities reclassified offset the entity’s exposure to
changes in the fair value of the servicing assets or liabilities; and (5) requires separate
presentation of servicing assets and servicing liabilities subsequently measured at fair value in
the balance sheet and additional disclosures for all separately recognized servicing assets and
servicing liabilities. SFAS 156 is effective for all separately recognized servicing assets and
liabilities as of the beginning of an entity’s fiscal year that begins after September 15, 2006,
with earlier adoption permitted in certain circumstances. The Statement also describes the
manner in which it should be initially applied. The Company does not believe that SFAS 156
will have a material impact on its financial position, results of operations or cash flows.
In July 2006, the FASB released FASB Interpretation No. 48, Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the
accounting and reporting for uncertainties in income tax law. This interpretation prescribes a
comprehensive model for the financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions taken or expected to be taken in income tax returns. On
January 17, 2007, the FASB affirmed its previous decision to make FIN 48 effective for fiscal
years beginning after December 15, 2006. Accordingly, FIN 48 is effective for the Company
F-16
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
on January 1, 2007. The Company is still assessing the impacts of the adoption of FIN 48.
Based on a preliminary analysis, management believes that the adoption of FIN 48 will not
have a material impact on its results of operations and financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157),
which defines the fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. This statement is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years. Early adoption is encouraged, provided that we have not yet issued financial
statements for that fiscal year, including any financial statements for an interim period within
that fiscal year. The Company is currently in the process of evaluating the impact SFAS 157
may have on its results of operations and financial position.
In September 2006, the FASB issued SFAS No. 158, Employer’s accounting for Defined
Benefit Pension and Other Post Retirement Plans. SFAS No. 158 requires employers to
recognize in its statement of financial position an asset or liability based on the retirement
plan’s over or under funded status. SFAS No. 158 is effective for fiscal years ending after
December 15, 2006. The Company is currently in the process of evaluating the effect that the
application of SFAS No. 158 will have on its results of operations and financial position.
In September 2006, the United States Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements (SAB 108). This SAB
provides guidance on the consideration of the effects of prior year misstatements in
quantifying current year misstatements for the purpose of a materiality assessment. SAB 108
establishes an approach that requires quantification of financial statement errors based on the
effects of each of the company’s balance sheets and statement of operations and the related
financial statement disclosures. The SAB permits existing public companies to record the
cumulative effect of initially applying this approach in the first year ending after November
15, 2006 by recording the necessary correcting adjustments to the carrying values of assets
and liabilities as of the beginning of that year with the offsetting adjustment recorded to the
opening balance of retained earnings. Additionally, the use of the cumulative effect transition
method requires detailed disclosure of the nature and amount of each individual error being
corrected through the cumulative adjustment and how and when it arose. The Company is
currently in the process of evaluating the impact SAB 108 may have on its results of
operations or financial position.
In October 2006, the Emerging Issues Task Force (EITF) issued EITF 06-3, How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be Presented in
the Income Statement (That is, Gross versus Net Presentation) to clarify diversity in practice
on the presentation of different types of taxes in the financial statements. The Task Force
concluded that, for taxes within the scope of the issue, a company may adopt a policy of
presenting taxes either gross within revenue or net. That is, it may include charges to
F-17
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
customers for taxes within revenues and the charge for the taxes from the taxing authority
within cost of sales, or, alternatively, it may net the charge to the customer and the charge
from the taxing authority. If taxes subject to EITF 06-3 are significant, a company is required
to disclose its accounting policy for presenting taxes and the amounts of such taxes that are
recognized on a gross basis. The guidance in this consensus is effective for the first interim
reporting period beginning after December 15, 2006 (the first quarter of our fiscal year 2007).
The Company does not expect the adoption of EITF 06-3 will have a material impact on its
results of operations, financial position or cash flow.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure at fair
value many financial instruments and certain other items that are not currently required to be
measured at fair value. Subsequent changes in fair value for designated items will be required
to be reported in earnings in the current period. SFAS No. 159 also establishes presentation
and disclosure requirements for similar types of assets and liabilities measured at fair value.
SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company
is currently assessing the effect of implementing this guidance, which directly depends on the
nature and extent of eligible items elected to be measured at fair value, upon initial application
of the standard on January 1, 2008.
F-18
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
2. ACQUISITION OF PHOTAGS INC.
On April 3, 2006, the Company entered into an Agreement and Plan of Merger (the “Merger
Agreement”) by and among the Company, Tag Acquisition Corporation, a Delaware
corporation and a wholly owned subsidiary of the Company (“Merger Sub”), Tag Acquisition
Corporation II, a Delaware corporation and wholly owned subsidiary of the Company
(“Merger Sub II”), PhoTags, Inc., a Delaware corporation (“PhoTags”), Harry Fox, as
Stockholders’ Agent, and certain stockholders of PhoTags, that provides for, among other
things, the merger of Merger Sub with and into PhoTags and, immediately upon the
completion thereof, the merger of PhoTags with and into Merger Sub II pursuant to which
PhoTags became a wholly owned subsidiary of the Company (the “Merger”). The transaction
closed on April 5, 2006.
In connection with the Merger, the Company acquired the underlying technology of PhoTags,
Inc. which includes patented JPEG enhancements. As a result, the Company paid
approximately $2,000,000 to PhoTags, Inc. who paid their existing liabilities at closing, and
issued 384,897 shares of the Company’s common stock with an aggregate fair market value of
$4,730,384 (based on a closing share price on the closing date, April 5, 2006, of $12.29) as
consideration for the purchase of all of the outstanding shares of PhoTags. In addition, the
Company agreed to pay an earn-out payment of up to an additional $3,500,000 in the
Company’s common stock, if the PhoTags business line achieves certain milestones at the end
of the 15-month earn-out period beginning April 1, 2006. As of December 31, 2006,
approximately $1.7 million in Wireless & OEM revenues have been attributed to the
acquisition toward the earn-out goal of $4.2 million. The Company estimates that $226,000 in
direct cash costs (legal and professional services) and $77,000 of non-cash direct costs were
incurred to close the transaction.
As part of the transaction, CDI, a company organized under the laws of the State of Israel and
a related party of PhoTags (“CDI”), agreed to grant the Company an option to acquire CDI for
a period of ten (10) years following the effective time of the Merger at a purchase price of
$3,000.
The Merger is intended to constitute a reorganization under Section 368 of the Internal
Revenue Code of 1986, as amended.
As part of the transaction, the Company filed a registration statement with the Securities and
Exchange Commission covering the resale of the shares of the Company’s common stock
F-19
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
issued to the stockholders of PhoTags at closing. The registration statement was filed on July
28, 2006 and became effective August 3, 2006.
A copy of the Merger Agreement has been filed under Form 8-K with the Securities and
Exchange Commission.
The results of operations of the business acquired have been included in the Company’s
consolidated financial statements from the date of acquisition. Amortization related to the
acquisition was calculated based on an independent valuation for certain identifiable
intangibles acquired.
The total purchase price is summarized as follows (in thousands):
Cash consideration
Common stock
Deferred taxes
Acquisition related costs - cash
Acquisition related costs - non cash
Total purchase price
$2,000
4,730
500
226
76
$7,532
The Company’s allocation of the purchase price is summarized as follows (in thousands):
Assets:
Cash
Accounts Receivable, net
Intangible Assets
Goodwill
Total Assets
Liabilities:
Accrued Liabilities
Total Liabilities
2
$
3
1,265
6,312
7,582
50
50
Total purchase price
$
7,532
The pro-forma effect of the acquisition on historical results of operations is not material and
therefore is not included.
F-20
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
3. ACQUISITION OF ALLUME INC.
On July 1, 2005, the Company acquired 100% of the issued and outstanding capital stock of
Allume, Inc. from International Microcomputer Software, Inc. (IMSI) for $10.6 million in
cash and 397,547 restricted shares of its common stock. Allume, Inc. is a leading developer of
compression software solutions for JPEG, MPEG and MP3 platforms. A portion of the
purchase price, including $1,250,000 cash and shares of common stock having a market value
of $750,000 were deposited in an indemnity escrow to secure certain representations and
warranties included in the Stock Purchase Agreement. The aggregate purchase price was
approximately $12.8 million, which includes $10.6 million cash paid, the 397,547 shares
issued, which have been valued using the average closing market price of the Company's
common stock over the two-day period before and after the sale was announced, and
$316,000 of direct acquisition costs. The direct acquisition costs incurred to date include
$116,000 for legal and professional services, as well as a transaction fee of $200,000.
The results of operations of the business acquired have been included in the Company’s
consolidated financial statements from the date of acquisition. Depreciation and amortization
related to the acquisition were calculated based on the estimated fair market values and
estimated lives for property and equipment and an independent valuation for certain
identifiable intangibles acquired.
The total purchase price is summarized as follows (in thousands):
Cash consideration
Common stock
Acquisition related costs
Total purchase price
$10,626
1,858
316
$12,800
The Company’s allocation of the purchase price is summarized as follows (in thousands):
F-21
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOL
FOR EACH
OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
IDATED FINANCIAL STATEMENTS
Assets:
Cash
Accounts Receivable, net
Inventories, net
Property & Equipment
Other Assets
Intangible Assets
Goodwill
Total Assets
Liabilities:
Accounts Payable
Accrued Liabilities
Total Liabilities
$
46
822
237
67
244
4,863
7,573
13,852
659
393
1,052
Total purchase price
$
12,800
Unaudited pro forma consolidated results of operations for the years ended December 31,
2005 and 2004 as if the acquisition had occurred as of January 1, 2004 are as follows (in
thousands, except per share data):
F-22
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Year Ended
December 31, 2005
Year Ended
December 31, 2004
Historical
Proforma Historical
Proforma
Net Revenues
Net Income
$
20,258
$
24,647
$
13,316
$
22,902
$
4,724
$
4,288
$
3,445
$
2,810
Net Income per share, basic
$
0.22
$
0.20
$
0.20
$
0.16
Net Income per share, diluted
$
0.21
$
0.19
$
0.19
$
0.15
Weighted average shares
outstanding, basic
Weighted average shares
outstanding, diluted
21,351
21,549
17,267
17,665
22,806
23,004
18,412
18,810
Pro forma adjustments have been applied to reflect the addition of amortization related to the
intangible assets and the fixed assets acquired and reduction in interest income as if the
acquisition had occurred at the beginning of such period presented. The pro forma adjustment
for amortization related to intangible assets acquired was $1.5 million and $608,000 for the
proforma periods ending December 31, 2004 and 2005, respectively.
F-23
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
4. EQUIPMENT AND IMPROVEMENTS
Equipment and improvements consist of the following (in thousands):
Machinery and equipmen
t
Leasehold improvements
Office furniture and fixtures
December 31,
2006
2005
$
1,187
443
72
$
906
362
72
1,702
1,340
Less accumulated depreciation and amortization
(1,285)
(1,099)
$
417
$
241
5. GOODWILL AND INTANGIBLE ASSETS
The following table sets forth the acquired intangible assets by major asset class:
F-24
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Useful
Life
(Years)
December 31, 2006
Accumulated
Amortization
Gross
Net Book
Value
December 31, 2005
Accumulated
Amortization
Net Book
Value
Gross
(in thousands)
Amortizing:
Purchased and
Licensed Technology
3
$
2,260
$
(2,260)
$
-
$
2,260
$
(2,260)
$
-
Capitalized Software
4 - 5
3,849
(1,621)
2,228
2,649
(534)
2,115
Distribution Rights
Customer Lists
Trademarks
Customer Agreements
5
5
10
1.5
482
923
809
65
(208)
(276)
(196)
(39)
274
647
613
26
482
923
809
(76)
(92)
(68)
406
831
741
-
-
-
Totals
$
8,388
$
(4,600)
$
3,788
$
7,123
$
(3,030)
$
4,093
Aggregate amortization expense on intangible assets was approximately $1,570,000,
$770,000 and $40,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Expected future amortization expense is as follows: $1,696,000 for the year 2007, $1,121,000
for the year 2008, $522,000 for the year 2009 and $449,000 thereafter. Amortization expense
related to intangibles acquired in the Allume acquisition is calculated on a discounted cash
flow basis over five years for Capitalized Software, Distribution Rights and Customer Lists
and ten years for Trademarks. Amortization is calculated on a straight line basis over five
years for Customer Lists. Amortization expense related to intangibles acquired in the
PhoTags acquisition is calculated on a discounted cash flow basis over four years for
Capitalized Software and 18 months for Customer Agreements.
At December 31, 2006, upon review of the goodwill the Company elected to write off all
goodwill allocated to the consulting portion of its services sector, or $335,000. The
consulting portion of its services sector has been de-emphasized and is no longer considered a
strategic element of our go forward plan. The amount of the write off is included in general
and administrative expenses. The Company determined that it did not have any impairment
of goodwill associated with the products sector at December 31, 2006.
F-25
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
The carrying amount of the Company’s goodwill was $15,266,000 as of December 31, 2006
and $9,288,000 as of December 31, 2005. The Company’s reporting units are equivalent to
its operating segments. At December 31, 2006 and 2005, the amount of goodwill allocated to
the products segment is $15,266,000 and $8,953,000, respectively and the amount of
goodwill allocated to the services segment is $0 and $335,000, respectively.
6. ACCRUED LIABILITIES
Accrued liabilities consist of the following (in thousands):
Salaries and benefits
Royalties
Marketing expenses and rebates
Deferred revenue
Other
December 31,
2006
2005
$
1,478
270
189
78
13
$
1,055
180
103
-
38
$
2,028
$
1,376
F-26
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
7. INCOME TAXES
A summary of the income tax expense (benefit) is as follows (in thousands):
Year ended December 31,
2005
2006
2004
Current:
Federal
State
Deferred:
Federal
State
Tax benefit related to exercise of stock
options and release of valuation allowance
Purchase price adjustment - PhoTags
Other adjustments
Change in valuation allowance
23
$
--
$
100
4
$
68
3
23
104
71
(58)
(33)
9,567
(500)
21
(7,786)
1,211
1,286
(197)
--
--
--
(1,089)
0
1,025
427
--
--
--
(1,452)
0
$
1,234
$
104
$
71
F-27
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
A reconciliation of the provision (benefit) for income taxes to the amount of income tax
expense (benefit) that would result from applying the federal statutory rate (35%) to the
income (loss) before income taxes is as follows:
Federal statutory rate
State tax, net of federal benefit
Nondeductible expense related to acquired intangibles
Other
Change in valuation allowance
December 31,
2006
2005
2004
34 %
6
--
3
(31)
35 %
3
--
(1)
(35)
35 %
--
--
(1)
(32)
12 %
2 %
2 %
F-28
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
The major components of the Company’s deferred tax assets and liabilities are as follows (in
thousands):
Various reserves
Nondeductible accruals
State taxes
Prepaid expenses
Credit carryforwards
Net operating loss carryforwards
Fixed assets
Amortization
Identifiable intangibles acquired
Equity based compensation
Other
Subtotal
Valuation allowance
December 31,
2006
2005
$
91
128
(592)
(156)
1,697
6,091
57
831
(537)
216
50
7,876
0
$
107
204
(587)
(99)
1,687
6,118
48
265
--
--
43
7,786
(7,786)
$
7,876
$
0
The Company has federal and state net operating loss carryforwards of approximately
$14,900,000 and $11,900,000, respectively, at December 31, 2006. These federal and state
net operating loss carryforwards will expire in 2007 through 2026.
In addition, the Company has federal and state tax credit carryforwards of approximately
$1,115,000 and $581,000, respectively, at December 31, 2006. These tax credits will begin
to expire in 2010.
As of December 31, 2005 the Company had recorded a valuation allowance to fully reserve
its net deferred tax assets based on the Company’s assessment that the realization of the
deferred tax assets did not meet the “More likely than not” criterion under SFAS No. 109,
Accounting for Income Taxes. The Company reversed all of its valuation allowance on its
deferred tax assets during the year ended December 31, 2006 as a result of the Company’s
improving financial performance and projected income in the future years.
F-29
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
8. COMMITMENTS AND CONTINGENCIES
Leases - The Company has non-cancelable operating leases for its building facilities in Aliso
Viejo, California and Watsonville, California, which expire in May 2009 and September
2010, respectively. The Company also leases space for its facility in Lee’s Summit, Missouri
on a month to month basis. Future minimum rental commitments consist of the following (in
thousands):
Year ending December 31:
2007
2008
2009
2010
Total
$
679
703
438
186
2,006
$
Total rent expense was $573,000, $492,000 and $480,000 for the years ended December 31,
2006, 2005 and 2004, respectively.
Litigation – From time to time the Company is subject to litigation in the normal course of
business, none of which management believes will likely have a material adverse effect on
the Company’s consolidated financial condition or results of operations.
Other Contingent Contractual Obligations - During its normal course of business, the
Company has made certain indemnities, commitments and guarantees under which it may be
required to make payments in relation to certain transactions. These include: intellectual
property indemnities to the Company’s customers and licensees in connection with the use,
sale and/or license of Company products; indemnities to various lessors in connection with
facility leases for certain claims arising from such facility or lease; indemnities to vendors
and service providers pertaining to claims based on the negligence or willful misconduct of
the Company; indemnities involving the accuracy of representations and warranties in certain
contracts; and indemnities to directors and officers of the Company to the maximum extent
permitted under the laws of the State of Delaware. In addition, the Company has made
contractual commitments to employees providing for severance payments upon the
occurrence of certain prescribed events. The Company may also issue a guarantee in the
form of a standby letter of credit as security for contingent liabilities under certain customer
contracts. The duration of these indemnities, commitments and guarantees varies, and in
certain cases, may be indefinite. The majority of these indemnities, commitments and
guarantees may not provide for any limitation of the maximum potential for future payments
F-30
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
the Company could be obligated to make. The Company has not recorded any liability for
these indemnities, commitments and guarantees in the accompanying consolidated balance
sheets.
9. SEGMENT INFORMATION
The Company currently operates in two business segments: products and services. In
addition, revenues are classified into three markets, Wireless and OEM sales, Consumer
sales, and Enterprise sales. Our Enterprise market includes software product sales as well as
consulting, fulfillment and hosting revenue.
The Company does not separately allocate operating expenses to these segments, nor does it
allocate specific assets to these segments. Therefore, segment information reported includes
only revenues and cost of revenues.
The following table shows the net revenues and cost of revenues generated by each segment:
2006
Year Ended December 31,
2005
2004
Products
Services
Products
Services
Products
Services
Wireless & OEM
$
43,419
$
-
$
13,982
$
-
$
11,424
$
-
Consumer
Enterprise
Total Revenues
Cost of revenues
Gross Profit
10,019
335
-
696
5,460
195
-
621
746
224
-
922
53,773
19,989
33,784
$
696
270
426
$
19,637
3,818
15,819
$
621
285
336
$
12,394
2,530
9,864
$
922
380
542
$
Sales to individual customers and their affiliates, which amounted to more than 10% of the
Company’s net revenues, included one OEM customer at 74.4% in 2006, 57.1% in 2005, and
68.4% in 2004. Accounts receivable from this customer was $6.6 million at December 31,
2006, $4.6 million at December 31, 2005 and $1.7 million at December 31, 2004. A decision
by this customer to substantially decrease or delay purchases from the Company or the
Company’s inability to collect receivables from this customer could have a material adverse
effect on the Company’s consolidated financial condition and results of operations.
10. PROFIT SHARING
F-31
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
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 $125,000, $65,000, and $54,000 for the years ended December 31,
2006, 2005 and 2004, respectively.
11. STOCK-BASED COMPENSATION
On July 28, 2005, the Shareholders approved the 2005 Stock Option / Stock Issuance Plan.
The Plan, which became effective the same date, replaced the 1995 Stock Option / Stock
Issuance Plan which expired on May 24, 2005. All outstanding options under the 1995 Plan
will remain outstanding, but no further grants will be made under that Plan. The 2005 Plan
provides for the issuance of non-qualified or incentive stock options to employees, non-
employee members of the board and consultants. The exercise price per share is not to be less
than the fair market value per share of the Company’s common stock on the date of grant.
The Board of Directors has the discretion to determine the vesting schedule. Options may be
either immediately exercisable or in installments, but generally vest over a four-year period
from the date of grant. In the event the holder ceases to be employed by the Company, all
unvested options terminate and all vested installment options may be exercised within an
installment period following termination. In general, options expire ten years from the date of
grant. The maximum number of shares of the Company’s Common Stock available for
issuance over the term of the 2005 Plan may not exceed 5,000,000 shares, plus that number of
additional shares equal to 2.5% of the number of shares of Common Stock outstanding on the
last trading day of the calendar year commencing with calendar year 2006 (but not in excess
of 750,000 shares).
Stock option activity under the Plan is as follows:
F-32
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Weighted
average
exercise
price
Aggregate
Intrinsic
Value
Number
of options
OUTSTANDING, December 31, 2003
(1,140 options, exercisable at a weighted
average exercise price of $2.43)
Granted (weighted average fair value of $1.70)
Exercised
Canceled
OUTSTANDING, December 31, 2004
(479,000 options, exercisable at a weighted
average exercise price of $2.12)
Granted (weighted average fair value of $2.75)
Exercised
Canceled
OUTSTANDING, December 31, 2005
(898,000 options, exercisable at a weighted
average exercise price of $1.85)
Granted (weighted average fair value of $2.75)
Exercised
Canceled
1,911,000
922,000
(1,000,000)
(34,000)
$
$
$
$
1.62
1.95
2.00
1.74
1,799,000
$
1.58
2,371,000
(238,000)
(76,000)
$
$
$
4.94
1.55
5.22
3,856,000
$
3.57
266,000
(1,462,000)
(142,000)
$
$
$
11.69
2.86
4.39
OUTSTANDING, December 31, 2006
2,518,000
$
4.80
$
23,654,000
Exercisable at December 31, 2006
914,000
$
3.91
$
9,389,000
F-33
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Additional information regarding options outstanding as of December 31, 2006 is as follows:
Range of
exercise
prices
Number
outstanding
$0.24 - $ 0.50
$0.51 - $ 1.00
$1.01 - $ 2.00
$2.01 - $ 4.00
$4.01 - $ 5.00
$5.01 - $16.00
124,000
6,000
518,000
35,000
1,517,000
318,000
2,518,000
Options outstanding
Weighted average Weighted
average
exercise
price
remaining
contractual
life (years)
Options exercisable
Weighted
average
exercise
price
Number
exercisable
5.8
4.2
7.4
7.7
8.6
9.2
8.3
$
$
$
$
$
$
0.25
0.88
1.90
3.49
4.95
10.79
123,000
6,000
186,000
33,000
512,000
54,000
$
$
$
$
$
$
0.25
0.88
1.89
3.55
4.95
9.93
$
4.80
914,000
$
3.91
During the year ended December 31, 2006 approximately 1,462,000 options have been
exercised with an intrinsic value of $16.6 million, resulting in cash proceeds to the Company
of $4.2 million. The weighted-average grant-date fair value of options granted during the year
ended December 31, 2006 was $7.13. At December 31, 2006 there was $4.5 million of total
unrecognized compensation costs related to non-vested stock options granted under the Plan,
which will be recognized over a period not to exceed four years. At December 31, 2006,
2,151,000 shares were available for future grants under the Stock Option Plan.
12. RELATED PARTY TRANSACTIONS
In October 2004, the Company entered into a Master Software Services Agreement with
Arrange Technology LLC, providing for the development of certain software applications and
integration services. A member of the Company’s Board of Directors was a principal
beneficial owner of Arrange Technology LLC, however, that relationship terminated in 2005.
$118,000 and $19,000 was expensed under the terms of the agreement in the years ended
December 31, 2005 and 2004, respectively.
In conjunction with the severance agreement, entered into in June 2005, with Robert
Scheussler,
in
severance related costs which is included in general and administrative expenses in the
the former CFO, the Company recognized approximately $230,000
F-34
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
consolidated statement of operations for the year ended December 31, 2005. As per the
agreement, Mr. Scheussler will continue to provide services to the Company as a consultant
and, under the terms of the Company's Stock Option Plan, will continue to vest in his
existing, unvested option grants (which were not modified) totaling 108,333 options. The
unvested portion of these option grants were valued by the Company at approximately
$424,000 on July 1, 2005, utilizing the Black Scholes option pricing model. With respect
to Mr. Scheussler's employee stock option agreements, the Company expensed approximately
$41,000 and $101,000 in the years ended December 31, 2006 and December 31, 2005,
respectively.
In September 2004, the Company entered into a severance agreement with a principal
stockholder and former officer and director of the Company. The Company has discharged
its obligation under the agreement by purchasing a single premium annuity in the amount of
$192,000 which is included in general and administrative expenses in the consolidated
statement of operations for the year ended December 31, 2004.
13. EQUITY TRANSACTIONS
On February 18, 2005, the Company entered into a Securities Purchase Agreement with
certain institutional investors related to the private placement of 3,500,000 shares of our
common stock, par value $0.001 per share. The transaction closed on February 18, 2005 and
the Company realized gross proceeds of $22.4 million from the financing before deducting
commissions and other expenses. Offering costs related to the transaction totaled $1,613,000,
comprised of $1,344,000 in commissions and $269,000 cash payments for legal and
investment services, resulting in net proceeds of $20,786,000. The Company agreed to
register for resale the shares of Common Stock issued in the private placement. Such
registration statement became effective on June 17, 2005. The agreement provides for
penalties of one percent (1%) of the purchase price per month should effectiveness of the
registration not be maintained. C.E. Unterberg, Towbin LLC, the placement agent for the
transaction, received a cash fee equal to 6% of the aggregate gross proceeds of the Private
Placement.
On July 28, 2005, the Shareholders approved a proposal to amend the Amended and restated
Certificate of Incorporation to increase the number of authorized Common Shares from
30,000,000 to 50,000,000. Increasing the number of authorized shares of Common Stock is
expected to provide the Company with additional capital resources to finance the long-term
growth of the Company and with sufficient shares of Common Stock for stock splits. The
additional shares of Common Stock could be issued for acquisitions and in public or private
offerings, the proceeds of which could be used to finance the Company’s growth through
increased working capital, expansion of existing businesses and other corporate purposes.
F-35
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
On December 14, 2006, the Company completed a fully marketed secondary, issuing
4,000,000 shares of our common stock, $0.001 par value, at a price of $14.75 per share,
resulting in aggregate gross cash proceeds to the Company of $59,000,000 before deducting
commissions and other expenses. Offering costs related to the transaction totaled $4,002,000,
comprised of $3,304,000 in underwriting discounts and commissions and $698,000 cash
payments for legal and investment services, resulting in net proceeds to the Company of
$54,998,000 as of December 31, 2006. On January 18, 2007 an additional 387,000 shares
were sold under the same agreement, resulting in estimated net proceeds of $5,388,000 to the
Company.
14. SHARES SUBJECT TO RESCISSION (UNAUDITED)
Under our 1995 Stock Option / Stock Issuance Plan and 2005 Stock Option / Stock Issuance
Plan (the “Plans”), the Company granted options to purchase shares of common stock to
certain of our employees, directors and consultants. The issuances of common stock upon
exercise of options that were granted under these Plans between March 2005 and August 2006
may not have been exempt from qualification under certain state securities laws and, as a
result, the Company may have potential liability to the individuals who exercised these
options.
The Company accounts for shares which have been issued that may be subject to rescission
claims as a put liability based on the price to be paid for equity to be repurchased. Since
equity instruments subject to rescission are redeemable at the holder’s option or upon the
occurrence of an uncertain event not solely within the Company’s control, such equity
instruments are outside the scope of SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, and its related interpretations.
Under the SEC’s interpretation of generally accepted accounting principles, reporting such
claims outside of stockholders’ equity is required, regardless of how remote the redemption
event may be. However, during the relevant period for which the Plans were not in
compliance with certain state securities laws, all of the individuals who exercised options sold
all of the shares underlying the options exercised. As such, the Company does not feel that
there is a material exposure for rescission of issued shares to those who exercised stock
options as they had subsequently sold their shares and at a value greater than the option strike
price and no longer hold the shares.
In addition to shares of common stock which were issued upon option exercises, certain
option grants made under the Plans between March 2005 and August 2006 which have not yet
been exercised may not have been exempt from qualification under certain state securities
laws. As a result, we may have potential liability to the individuals who received those option
grants but who have not yet exercised those options. We may in the future choose to make a
rescission offer to the holders of these outstanding options to give them the opportunity to
rescind the grant of their options in exchange for a cash payment.
F-36
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Prior to the implementation of SFAS 123(R) in January 2006, the Company accounted for
share options under APB 25. Since all of the options under the Plans were granted at fair
market value at the time of grant, no expense is recorded in our financial statements related to
options that were vested prior to January 1, 2006. Under SFAS 123 (R), the first quarter
results of 2006 included expense related to options that were granted prior to January 1, 2006
but had not vested at that date. Accordingly, no provision is made in our financial statements
for options that were vested as of January 1, 2006, that were granted under the Plans which
are not yet exercised, but may be subject to a rescission offer, if and when made. Should any
optionees accept the rescission offer and put their options back to the Company, the Company
will reflect such offer in our financial statements at that time.
As of March 16, 2007, assuming every eligible holder of unexercised options granted under
the Plans during the period in question were to accept a rescission offer, we estimate the total
cost to us to complete the rescission for the unexercised options would not be material to our
financial condition. Management feels that acceptance of a rescission offer, if made, would
be remote, since the weighted average exercise price of these options which were outstanding
at March 16, 2007 was $6.40 per share and the market price of the Company’s stock was
trading at a significantly higher price.
15. SUBSEQUENT EVENTS
Acquisition of Ecutel Systems, Inc.
On February 9, 2007, the Company, TEL Acquisition Corp., a wholly-owned subsidiary of the
Company, Ecutel Systems, Inc., John J. McDonnell, Jr. and the Principal Stockholders of
Ecutel consummated the merger of Ecutel with and into Acquisition Co. pursuant to the terms
of that certain Agreement and Plan of Merger dated as of January 31, 2007.
In connection with the Merger, all outstanding shares of capital stock of Ecutel were
converted into the right to receive a portion of the merger consideration. The aggregate
merger consideration paid by the Company in connection with the Merger was $8,000,000 in
cash, of which $1,000,000 is being withheld as security for satisfaction of certain
indemnification obligations pursuant to the terms of the Merger Agreement. The
consideration for and the other terms and conditions of the Merger were determined by arms-
length negotiations between the Company, Ecutel and the Principal Stockholders of Ectuel.
Intent to Acquire Insignia Solutions, plc.
On February 11, 2007 the Company announced that it had entered into a definitive agreement
to acquire substantially all of the assets of Insignia Solutions, including its mobile device
management business. The agreement is anticipated to close early in the second quarter.
F-37
SMITH MICRO SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
Restricted Stock Grant.
On February 19, 2007 a total of 50,000 shares of Restricted Stock, with a total value of
$627,500, were granted to directors of the Company. This cost will be amortized over
12 months. In addition, 420,000 shares of Restricted Stock, with a total value of $5.3 million,
were granted to officers and key employees of the Company. This cost will be amortized over
24 months.
Stock Option Grants.
As of March 14, 2007, a total of 2,153,500 options have been granted with a weighted
average exercise price of $13.55. All options will vest over a four year period.
F-38
SMITH MICRO SOFTWARE INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2006
(In thousands)
Balance at
beginning of
period
Additions
charged to
costs and
expenses
Balance at
end of
period
Deductions
Allowance for doubtful accounts and
other adjustments (1):
2006
2005
2004
$
439
137
33
$
468
573
112
$
(407)
(271)
(8)
$
500
439
137
(1) Other adjustments relate principally to sales returns.
S-1
EXHIBIT 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in Registration Statement (Nos. 333-02418, 333-40106, 333-
62134, 333-121330 and 333-123042 and 333-129132) on Form S-8 and Registration Statement (Nos. 333-
123821, 333-128695 and 333-134611) on Form S-3 of Smith Micro Software, Inc. and subsidiaries
(collectively, the “Company”) of our reports dated March 16, 2007 relating to our audits of the consolidated
financial statements and the financial statement schedule, and internal control over financial reporting, which
appear in this Annual Report on Form 10-K of Smith Micro Software, Inc. for the year ended December 31,
2006.
SINGER, LEWAK, GREENBAUM & GOLDSTEIN, LLP
Los Angeles, California
March 29, 2007
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SMITH MICRO SOFTWARE INC. AND SUBSIDIARIES
OFFICERS & DIRECTORS
OFFICERS AND SENIOR MANAGEMENT
William W. Smith, Jr.
Chairman of the Board, President and CEO
Andrew Schmidt
Vice President & CFO
Thomas G. Campbell
Director
William C. Keiper
Director
Gregory Szabo
Director
Samuel Gulko
Director
Ted Hoffman
Director
CORPORATE HEADQUARTERS
51 Columbia
Aliso Viejo, CA 92656
(949) 362-5800
TRANSFER AGENT AND REGISTRAR
Mellon Investor Services LLC
480 Washington Blvd
Jersey City, NJ 07310
(800) 356-2017
www.melloninvestor.com
LEGAL COUNSEL
Morrison & Foerster
Los Angles, California 90013-1024
AUDITORS
Singer Lewak Greenbaum & Goldstein LLP
Los Angeles, California 90024
Robert Elliot
Vice President of Corporate Marketing & CMO
David P. Sperling
Vice President & CTO
Bruce T. Quigley
Vice President of Corporate Development and Investor Relations
Chris Lippincott
Vice President of Operations
Tom Mathews
General Manager & Vice President Connectivity & Security
Harry Fox
General Manager & Vice President of Multimedia
Mark McMillan
General Manager & Vice President of Mobile Device
Management
Jonathan Kahn
Senior Vice President, General Manager Consumer Products
William W. Smith, Jr.
Acting Vice President of Enterprise Sales
W. Rick Wyand
Vice President of OEM Sales
Jeff Costello
Vice President of Channel Sales
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SMITH MICRO SOFTWARE INC. AND SUBSIDIARIES
ADDITONAL INFORMATION
Smith Micro maintains an active investor relations
program. If you have any questions, or would like
additional information concerning the operations or
financial statements, please contact either:
Bruce T. Quigley
Vice President of Business Development and
Investor Relations
Smith Micro Software, Inc.
51 Columbia
Aliso Viejo, CA 92656
(949) 362-5800
bquigley@smithmicro.com
or
Charles Messman / Todd Kehrli
MKR Group LLC
323 N. San Fernando
Burbank, CA 92502
(818) 556-3700
ir@mkr-group.com
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SMITH MICRO SOFTWARE INC. AND SUBSIDIARIES
51 Columbia • Aliso Viejo • California 92656 • Voice: 949-362-5800 • Fax: 949-362-2300
Nasdaq: SMSI
www.smithmicro.com
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